As early as the 1950s the Nobel Laureate economist Arthur Lewis (1955, quoted in Lin and Chang 2009) exclaimed, “No country has made economic progress without positive stimulus from intelligent government.” The appropriate role for government in the economy has been a source of heated debate among academics and policymakers ever since. While the private sector is widely viewed as a driver of growth, there appears to have been little consensus on the role and ability of government to push the private sector toward promoting growth and development, let alone on whether such interventions are necessary for industrial takeoff. Proponents of free market policies claim government interventions in the economy distort relative prices and therefore diminish the allocative efficiency of the economy overall. Consequently, they argue for a minimalist state that confines itself to setting the legal boundaries necessary for market interaction.
Yet historical evidence suggests that, with the right policies, governments in poor countries can systematically improve the material welfare of their societies through technological catch up and industrial upgrading. In fact, given the ubiquity of market failures in these economies, ranging from information externalities to high levels of transaction costs and coordination problems, many argue that government intervention in the allocation of productive resources is unavoidable (for example, Lin and Chang 2009). Without decisive government intervention, it is likely that such market failures would hinder industries from being established in the first place, or else prevent them from taking off even when established.
A close reading of the well-known East Asian experience demonstrates the exceptional roles the states played in bringing about the transformation of these economies (Wade 1990). The Ethiopian government has been very keen to discover how such industrial upgrading and structural transformation was possible in the span of only a few years. One insight that is gleaned from the East Asian experience is the importance of industrial policies to stimulate the formation and growth of profitable industries that, in the absence of appropriate intervention, might not have happened.
Since the inception of the first industry strategy paper in 2002, the Ethiopian government has been actively promoting strategic sectors under the theme of an agricultural-led industrialization development policy (better known as Agricultural Development-Led Industrialization, or ADLI). The overarching focus of the strategy paper is to promote export-oriented and labor-intensive industries in line with the country’s perceived comparative advantage. Textiles and garments, food processing, floriculture, and leather products all rely on relatively simple technology and require large amounts of labor, including low-skilled labor, making them well-suited to the labor abundant/capital scarce nature of the Ethiopian economy. The two recent fiveyear national plans, Plan for Accelerated and Sustained Development to End Poverty (PASDEP) and Growth and Transformation Plan (GTP), both included ambitious goals for cut flower and leather sectors as well as other sectors, and policies have been put in place to attract and nurture investments in these areas. Industrial policy was given focus in Ethiopia with the launching of the industry strategy paper in 2002. The strategy paper outlined policy measures in support of labor-intensive industries with particular emphasis on attracting investment toward the manufacturing sector and enhancing the competiveness of the export sector.
Within a few years of launching explicit industrial policymaking, striking success was recorded in the floriculture and leather goods industries in Ethiopia. For example, while leather goods exports were a paltry USD 59 million in 1997, they increased significantly to USD 120 million in 2012 and are poised for a dramatic takeoff with a large investment by a major international shoe producer. A remarkable growth pattern is also observed in the floriculture industry, in which exports were a little more than USD 150,000 in 1997, a figure that grew to more than USD 210 million in 2012. This chapter seeks to highlight Ethiopia’s experience in experimenting with industrial policies, and more specifically to trace and evaluate the role industrial policy played in the growth of these two industries. We trace the evolution of industrial policies in both sectors and give a detailed account of the institutions created to deliver these policies. We place particular emphasis on the various setbacks and problems that both government institutions and private firms had to overcome, and we extract lessons for future policymaking.
The experiments with industrial policy in both the leather and floriculture sectors are especially useful for drawing practical lessons because Ethiopia enjoyed a clear and a priori comparative advantage only in one of them. The leather sector has vast potential resources for the commercialization of the leather products to draw on from Ethiopia’s huge livestock sector. The large gap between the livestock resource base of the country and leather goods production is evidence of the potential for future growth, and the natural quality of Ethiopian leather is sought after in international markets for the production of high-quality footwear, bags, cases, gloves, and other leather articles. Of course favorable climatic conditions, proximity to the market, and low labor costs have by now made the floriculture industry viable in Ethiopia, but this was far from obvious at the outset. Floriculture is a knowledge-driven industry, and Ethiopian firms started at an immense disadvantage compared to their direct competitors in Kenya. Consequently, the Ethiopian government adopted quite different approaches in designing industrial policies to promote these two industries.
In the leather and leather products industry, mutually reinforcing problems at several stages of the leather value chain have kept production volume and quality low (Altenburg 2010). The government has thus devised policies to improve the supply and quality of raw materials and has sought to stabilize their prices. Efforts have also been made to upgrade the production facilities and technology of leather processing units while attempting to improve the international marketability of leather products. In short, government interventions in the industry range from the point of skin and hides collection to the leather production and marketing stages. These were problems that the market, left to its own devices, could not overcome. The government proactively identified bottlenecks along the value chain and compelled private sector companies to engage in a continuous program of upgrading and quality improvement.
In the floriculture industry, on the other hand, the government policies have generally been in response to specific problems raised by private actors. The industry is relatively new to the country and requires tacit and firm-specific knowledge at input procurement, production, and marketing stages. While the entry of large specialized private firms demonstrated the potential viability of the sector in Ethiopia, it was the rapid response of the government to eliminate constraints such as access to credit, land, and air freight services at affordable rates that led to the remarkable flourishing of the sector. The takeoff period of the floriculture industry overlapped with the launch of sector-specific support by the government in the early and mid-2000s. Although industrial policy measures in the cut flower sector have been more reactive compared to policies in the leather industries, they are much more interventionist than industrial policies in other flower-producing countries in Africa, including Kenya and Uganda.
We find that industrial policies in both sectors have been successful in driving their growth. The differentiated challenges in each sector were met with flexible policy regimes, tailored to the unique challenges in each sector. However, policy must continuously evolve as sectors mature and face new problems and opportunities. Impressive results to date notwithstanding, important improvements still need to be made in terms of policy responsiveness and in ensuring growth is broad based across relevant value chains.
The rest of the chapter is structured as follows: the section titled “The Leather Sector” provides an overview of the leather sector and reviews policy implementation. The next section in turn looks at the cut flower sector. The section titled “Conclusion and Recommendations” concludes by drawing out the main lessons to be learned for policymaking in the future.
THE LEATHER SECTOR
Ethiopia is generously endowed with livestock resources. Its cattle population of more than 53 million, along with sheep and goat populations of 25.5 and 24.1 million, respectively, put the country first in Africa (CSA 2013). With an annual off-take rate of nearly 10 percent for cattle, 33 percent for sheep, and 38 percent for goats, the country has enormous potential for cheap supplies of skins and hides. Policymakers in Ethiopia have long recognized the potential of the sector, as indicated by the Growth and Transformation Plan (GTP)
1 and several other national plans that preceded it. In the GTP the leather and leather products industry is one of six priority industries expected to contribute to export diversification and foreign exchange earnings. Unlocking this potential requires sustained productivity improvements to make the industry internationally competitive and allow for greater value addition prior to export (FDRE 2010).
Crucially, for a country that is still largely agrarian in its employment structure, the leather and leather products industry has multiple linkages to the rural economy. It is also highly labor intensive in the raw material sourcing, transportation, processing, and marketing phases, which are distributed across rural and urban areas. The industry thus possesses enormous potential to create much-needed nonagricultural employment, and looks set to play an important role in poverty reduction. Yet this potential has remained underexploited. Given the far-reaching structural problems unique to the leather sector, ranging from ad hoc hide and skin collection systems to poor marketing infrastructure, it is not immediately clear whether the sector could take off without coordinated policy support.
OVERVIEW OF THE LEATHER INDUSTRY
The leather sector is composed of leather tanneries, which source their supply mostly from the local market, and footwear producers, who use both local and international markets for raw material supply. The most important source of raw material for leather tanneries is hides and skins procured from skin collectors and traders. Larger tanneries that are fitted with machines and equipment to produce leather products higher up the leather value chain buy semi-processed leather products from tanneries with more simple production technology. More often than not, the footwear sector relies on imports for accessories, such as soles and laces. Owing to the problems with both quality and consistency of leather supplies by tanneries, footwear producers have had to supplement local purchases with imported leather to maintain output levels and meet contractual obligations. The largest component of raw material by both value and volume is, however, processed leather that is obtained from local tanneries.
Figure 5.1 describes products and participants at various stages of the leather value chain.
Figure 5.1 Products and participants in the leather value chain
Ethiopia has a long history of handcrafting and blacksmithing. As far back as the late 1920s and the 1930s, there were several leather processing and shoe manufacturing enterprises in the country. Despite the huge resource potential, commercialization was extremely slow and uneven, and consequently both production and export of leather products have remained disappointingly low for several decades.
In the 1950s and 1960s, for example, leather and leather goods production were small in volume and largely targeted the local market (Van der Loop 2003). In the 1980s, the socialist Derg regime banned the export of raw hides and skin in an attempt to encourage the domestic production of semi-processed leather articles. This ban radically altered the marketing structure of hides and skins by restricting exports to at least the wet-blue level. While the ban forced hide and skin traders to sell directly to tanneries for processing, it also encouraged illegal cross-border trade in both live animals and hides and skins. The ban had a limited impact in terms of improving the local leather tanning and leather goods manufacturing capacity. For example, there were only about six thousand jobs in large-scale tanning and manufacturing of leather products such as footwear, luggage, and handbags when the Derg regime was overthrown in 1991 (CSA 1994).
After the 1991 revolution, the new government began moving toward a market economy, although the state retained a prominent role in the economy. By 2008, there were twenty-one tanneries in Ethiopia with a combined tanning capacity of four thousand pieces of hide and thirty thousand pieces of skin per day. There are now twenty-six tanneries and more than fifteen large export-oriented footwear producers, as well as an untold number of micro- and small-scale shoemakers in Ethiopia. The tanneries have a combined tanning capacity of more than 170,000 pieces of skin and hide per day, and footwear producers can produce more than 20,000 pairs of shoes per day. However, industry representatives estimate the current annual capacity utilization of these tanneries at only about seventeen million pieces of skin and hide, that is, less than 50 percent of full capacity.
This lack of capacity utilization explains not just the inability of local leather goods producers to penetrate the export market, but also their failure to withstand competition from imports once the economy was liberalized after 1991. Not surprisingly, following the liberalization policy of the current regime in the late 1990s, the leather footwear sector was inundated with cheap imports. This drove many footwear producers out of business, “plunging the sector into slump” in the early 2000s (Sonobe, Akoten, and Otsuka 2009). Helped by improved local capability and effective industrial policies, the sector has since then registered impressive growth that has enabled it to reclaim some of the domestic market and even successfully venture into the export market. In the process, several enterprises improved the quality, design, and durability of their products by learning from their foreign-based trading partners. While credit must of course be given to the perseverance and resourcefulness of private entrepreneurs, the role government policies played in restructuring leather and leather goods production and marketing cannot be overestimated. The next subsection presents the features of industrial policies that were initiated to promote the sector.
INDUSTRIAL POLICY IN THE LEATHER AND LEATHER PRODUCTS INDUSTRY
As part of a wide-ranging program of economic liberalization, the Ethiopian government has introduced several business-friendly policies since the early 1990s. The policy packages aim to mobilize domestic resources for investment and to attract investment funds from abroad, both from foreign nationals and from the Ethiopian diaspora. For example, investors are granted customs duty exemption, making imported capital goods and construction materials completely exempted from import duty. Customs duty drawbacks are also available for those who import raw materials and packaging supplies for processing exportable goods. To promote exports in the manufacturing sectors, a voucher scheme and bonded manufacturing warehouse facilities were introduced in 2001.
2 There is also a provision for income tax exemptions for between two and eight years, depending on the area of investment, export volume, and investment location. Investors are also allowed to forward losses incurred during the tax break period for half of the income exemption period.
All these are nondiscriminatory general incentives that are available to all investors irrespective of the investment sector and the nationality of the investor, although the exact levels of incentives on offer are tailored to the needs of different sectors. In addition to these general incentives, there have been several other policy measures and direct government interventions aimed specifically at promoting industrial upgrading and value addition in the leather and leather products industry.
These can be traced back to the Industrial Development Strategy (IDS) paper drafted in 2002. While specific policy menus were not articulated in the strategy paper, it broadly emphasized the need to work on problems associated with hide and skin production, collection, and processing.
The disappointing performance of the sector is mostly due to an inefficient supply chain, which is not capable of reliably delivering sufficient amounts of high-quality skins and hides at acceptable prices. There are several interrelated problems that plague the supply system. First, parasitic skin diseases in live animals affect the quality of skins and hides used in leather manufacturing. Second, commonly used traditional livestock husbandry practices, including flaying, branding, and curing, greatly deteriorate the quality of skin and hides. Lastly, rudimentary post-mortem management of skins and hides, including backyard slaughtering, poor and unorganized skin and hide collection, and substandard storage and transportation systems, results in both lower quality and an overall shortage of the raw materials required for leather processing. For example, 90 percent of sheep and goats and 70 percent of cattle slaughtering are carried out in the backyards of residential and farming units using traditional methods (UNIDO 2012). As a result, nearly 30 percent of hides and skins delivered to tanneries are rejected owing to poor quality (Bekele and Ayele 2008). These problems are further compounded by the unorganized supply of skin and hides. Downstream in the processing stage, challenges include rudimentary technology, insufficient capital, lack of skilled manpower, and marketing, among others.
Given that the production technology is standardized and markets are well established (if inefficient), the leather industry could expand by solving these problems at various stages of the leather value chain. This in turn requires the coordination of several activities to upgrade skin and hide collection systems upstream and processing downstream. As quality problems “travel” down the supply chain, and there are complex issues around price incentives for quality assurance and consistency, all stages of the supply chain must be tackled at the same time. In other words, this is a textbook coordination failure. No private entity, however, has the capacity (or size) to simultaneously overcome these problems that appear at multiple stages of the leather value chain, at least not in the context of Ethiopia (Altenburg 2010). Without the active involvement of the state, it is also not clear that there are adequate private incentives to improve the leather supply chain, which would involve properly reorganizing the livestock sector and the leather manufacturing sector, as well as several intermediary stages between the two. Recognizing the need for better coordination of the skins-to-leather value chain to exploit the potential provided by the leather resource base, the government of Ethiopia has initiated several interventions. It has been trying to remove barriers to expansion of the leather industry in particular.
To help overcome the problems associated with supply issues, the industry strategy paper stressed the importance of collective slaughtering and skin gathering. In the processing stage, the government was to be actively involved in establishing modern slaughterhouses, improving the capacity utilization of tanneries and the skills of workers involved at various stages of leather processing.
In fact, in 1994, eight years before the strategy paper was made public, the government helped organize six state-owned companies to form the Ethiopian Tanners’ Association, which was later renamed Ethiopian Leather Industries Association (ELIA) in 2007. The establishment of this association was a first step to properly organize the market for raw hides and skins. Members of the association produce wet-blue, crust, and finished leather products from sheep and goat skins. Today ELIA brings together privately owned tanneries, footwear, and leather garment and goods producers with the objective of initiating and coordinating capacity-building activities through training programs, industry discussion forums, and pilot project developments. ELIA, in partnership with the Ministry of Industry (MoI), also coordinates the presence of Ethiopian firms at international trade fairs and organizes the All African Leather Fair (AALF), which has been hosted in Ethiopia every year since 2008. ELIA also provides marketing information to its customers and lobbies the government on behalf of its members. The association now encompasses the largest forty-seven leather goods producers as members.
Another milestone in the government’s effort to promote the leather sector was setting up the Leather and Leather Products Technology Institute (LLPTI) in 1998. After a slow start owing to limited funds and a lack of skilled staff, it was languishing in near obscurity until the mandate of LLPTI was significantly expanded in 2010. It was renamed the Leather Industry Development Institute (LIDI) and was given direct responsibility for the development of the leather industry by the MoI. The rationale for setting up LIDI was threefold. First, the institute is to act as a conduit for the absorption, improvement, and diffusion of technologies in the leather and leather products industry, that is, it is to facilitate sector-wide learning, including learning from abroad. By working closely with tanneries and footwear manufacturers, the institute is tasked with conducting practical technology training that will help spread improved practices across the sector. Second, LIDI is expected to enhance the competitiveness of the leather industry by undertaking benchmarking studies and by introducing global excellence standards to domestic producers. LIDI’s Quality Testing and Approval Laboratory is used not only to assess the quality and comfort of shoes produced but also to detect any chemical contamination in the shoes. Third, LIDI is tasked with providing high-quality consultancy and training services in various technical and managerial skills relevant to the industry, “such as branding and marketing, effluent management and laboratory testing of quality parameters” (Altenburg 2010).
Perhaps the second most influential policy paper from the leather industry’s point of view was a sector master plan prepared by UNIDO in collaboration with the then Ministry of Trade and Industry (MoTI, now MoI). The collaboration between UNIDO and the MoI from 2005 onward resulted in two documents, a master plan and a business plan for the leather and leather products sector (UNIDO 2012). The master plan emphasized the need for the tanning industry to continuously improve both value addition and the quality of inputs supplied to the leather goods industry, including the footwear sector. The master plan also introduced the technical benchmarking of the Ethiopian leather and leather product industry against four countries with more technically advanced leather industries, namely Italy, China, Vietnam, and India.
Drawing on the master plan, the MoI prepared a concrete action plan that mainly consisted of upgrading programs for tanneries and footwear producers. The MoI has, in partnership with UNIDO and international donors, carried out several projects to put into practice the capacity-building and competitiveness programs articulated in the action plan. Of these, the “Made in Ethiopia” project, which introduced “Taytu,” the first luxury designer label to originate from Ethiopia, to the high-end European and American markets, has been a notable success.
Since the early 2000s, the government, in collaboration with donors, also invested heavily into education and training initiatives for staff at LIDI itself. For example, from 2005 to 2008, foreign experts were invited to improve the basic training programs offered by LIDI by adapting the training manuals to international standards and best practices. LIDI’s leather quality testing laboratory has also received assistance from donors including UNIDO.
The government’s intervention in the leather sector was, however, not confined to large tanneries and footwear producers. There are more than two thousand micro- and small-scale shoemakers clustered in Ethiopia’s largest market in Addis Ababa, called Mercato, where a plethora of shoe producers, parts suppliers, accessories retailers, machining and equipment service providers, and product outlets are concentrated. Most of these enterprises lack proper business premises and are forced to operate out of small rented cribs in the back alleys of businesses and residential houses in the area. The government responded to this lack of both retail and production space by offering fully constructed production sites at highly subsidized rental rates. A prominent example is an integrated shoe cluster development in six blocks of four-story buildings close to the market. These premises now house the Ethio-International Footwear Cluster Cooperative Society (EIFCCOS), the most important association of micro-, small-, and medium-scale shoemakers in Ethiopia, which has over one thousand members. This was a joint initiative by the government and an entrepreneur, who now is the chairman of the society, to unify the intermediate stages of the shoemaking process in a modern cluster to better exploit agglomeration economies.
In 2009 the MoI, in collaboration with UNIDO, designed a project titled “Technical Assistance Project for the Upgrading of the Ethiopian Leather and Leather Products Industry” to be implemented by UNIDO experts by 2012. This involved “a wide range of technical assistance from production layout to management and marketing” (UNIDO 2012). The government also adopted a benchmarking exercise to upgrade the leather and leather products industry. To this effect, LIDI entered into a twinning arrangement with the Central Leather Research Institute (CLRI) and the Footwear Design and Development Institute (FDDI) of India to execute the benchmarking exercises at factory level. The government selected seven tanneries and seven footwear producers to implement UNIDO’s initial benchmarking study recommendations. At the time of drafting this chapter, this has been an ongoing program, which is yet to be evaluated.
INTERVENTIONS AND OUTCOMES IN THE LEATHER AND LEATHER PRODUCTS INDUSTRY
The government’s objective in all interventions in the leather sector is achieving the highest possible value addition at each stage of leather processing, that is, transforming leather production from unprocessed hide and skin to wet-blue and then to crust in the short run, and finally to finished leather products for the export market in the medium to long run. To begin with, the government had long banned the export of raw hides and skins to force firms to add value domestically and enhance supply to the local industry. More recently, the government considered banning the export of crusted leather in December 2011. Instead, the government decided to levy a 150 percent tax on the export of such leather in April 2012. A year before that, to protect input prices for tanneries, the Ministry of Industry had put a cap on market prices of hides and skins (at 47 Ethiopian Birr and 80 Ethiopian Birr, respectively) after prices rose steeply following the traditional mass slaughter of animals in celebration of the Ethiopian Easter festival. An important feature contributing to the success of such direct forms of intervention is that they were fully anticipated. These interventions did not take the private sector by surprise, as the government had announced its intentions long before such policies came into effect, allowing the private sector actors time to adapt their business practices and models. For example, the government’s desire to tax the export of crusted leather “to discourage those who do not upgrade” was apparent as early as 2005 (Zenawi 2006). The taxes therefore led only to a relatively small and temporary drop in export revenues, as firms scrambled to upgrade their production capabilities.
Figure 5.2 Timeline of important events in the leather industry
Source: Ethiopian Customs and Revenue Authority (ERCA), various years.
Growth of leather and leather product exports in Ethiopia has been rapid, albeit from a very low level to begin with. Regular exports of leather footwear, for instance, began with a small volume of sales to Italian buyers in 2004/2005. That year, total revenue from the export of leather footwear was worth less than USD 0.5 million. Three years later, export earnings had increased nearly twentyfold to USD 8.1 million. By 2012 export earnings from footwear had reached more than USD 11 million.
Export earnings from the wider leather and leather products industry have increased steadily from USD 67 million in 2004/2005 to USD 104 million in 2010/2011 (see
figure 5.3). Correspondingly, formal employment has grown from 7,900 jobs in 2004 and 2005 to more than 14,100 jobs in 2010/2011 (CSA 2007 and 2012). Recent data also show that in 2012/2013, export earnings from processed leather and footwear were USD 123.4 million.
Figure 5.3 Trend in export earnings in the leather and leather products industry
Source: Ethiopian Customs and Revenue Authority (ERCA), various years.
Figure 5.4 shows that real value added in the tanning and footwear industries has recently shown a significant upward trend. A remarkable shift in value addition is observed in both industries since the 2008/2009 fiscal year. The most likely cause is the heavy taxes levied on exports of the wet-blue and pickle stages of unfinished leather in order to promote production and export of finished leather. Indeed the export value of wetblue and pickle leather has dropped drastically from a high point of more than USD 50 million in 2007/2008. As mentioned earlier, these taxes also partly explain the decline in export revenue from 2008 through 2010 seen in
figure 5.3. In 2009/2010 there was a significant spike in formal employment in large- and medium-scale enterprises engaged in the leather processing business. Informal employment and employment in micro and small enterprises engaged in the leather industry is estimated to be much higher than these numbers suggest. EDRI’s micro and small shoemakers’ surveys conducted in 2008 and 2009 suggest that there could be more than twelve thousand individuals working in the shoemaking business in the Mercato area alone.
Figure 5.4 Value addition and employment in the leather and leather products industry
Source: Authors’ compilation using CSA’s various large and medium enterprise reports.
Fiscal policies, combined with other interventions, have had the effect of pushing producers up the leather value chain. For example, McMillan (2012) reports that these interventions induced four large foreign-owned companies, who previously had exported only unfinished leather from Ethiopia, to procure machinery and equipment for the production and export of finished leather products. Local tanneries were initially forced to cut their exports due to limited capacity to produce finished leather products. Recently, however, there is evidence suggesting that they have upgraded their machinery and, as a result, are increasingly moving from selling semi-processed leather to other tanneries to involvement in the more lucrative export market. Indeed in both 2009 and 2011 the number of new leather product exporters far exceeded the number of incumbent exporters (World Bank 2014). What this episode clearly demonstrates is that information alone does not readily translate into capabilities. The tanneries knew of the coming export taxes on unfinished leather products in advance. However, they lacked the credit lines and technical expertise to upgrade in time. While information is vital, successful learning also requires making additional resources available at firm level.
In earlier periods, the local tanning industry was protected from competition, as foreign-based companies were not permitted to buy hides and skins, nor were they allowed to tan leather. Due to a lack of local capability, however, the ban on new foreign investment in these areas was removed for many years, before being restored in 2011. During this time, there were a number of new foreign investments in the leather sector. McMillan (2012) interviewed six new foreign investors who established tanneries in Ethiopia. The most striking feature to emerge from the interviews was that all of these companies were longtime buyers of Ethiopian leather, and that they decided to invest in production in Ethiopia because they wanted to “secure their leather supply.”
Tanneries have received a wide-ranging support package to improve the quality of their products. LIDI offers training on production and managerial skills for workers and managers of tanneries free of charge. The government has also co-financed the employment of foreign experts and consultants who helped improve the production facilities of tanneries. Regarding land and finance, the government has offered land at reasonably low lease rates and provided export credit guarantees and loan facilities at highly subsidized rates.
The story is similar in the leather manufacturing sector. In the footwear sector, for example, while the importance of improving conditions for existing investors and attracting new investors has been high on the agenda, the government has largely shunned direct protectionist policies.
3 Instead, the government decided that the long-term sustainability of the industry hinged on upgrading the capability of local producers through skills formation and technology adoption. Enterprises that survived the intense competition from imports were those most able to improve their supply chain management, product quality, and delivery times of their product, and more generally upgrade their machinery and equipment, as well as labor and inventory management. In many cases, international buyers played a key role in these upgrading processes. In particular, equipment and input manufacturers have every incentive to help Ethiopian producers employ increasingly sophisticated technology, as this of course necessitates purchasing the products of those very same providers. Equipment providers dispatch engineers who not only help their clients set up machines but also train local production engineers. Likewise, companies that provide the various chemicals needed at various parts of the production process are interested in broadening the product palette producers can offer, as this means buying more and different chemicals, and so they provide Ethiopian producers with seminars on market trends and fashions.
That said, the Ethiopian government has not simply let the industry fend for itself. A range of incentives instituted, was including, but not limited to, the provision of land in export processing zones, the provision of cheap credit, subsidized and free training for workers and managers at LIDI, and co-financing the employment of foreign experts to temporarily work in the local shoe factories. The government freely provided semi-constructed factories located in an industrial zone to firms that sought the production and export of footwear and other leather products in 2004 (Redi 2009), accompanied by tax breaks for importing machines for use in these plants. More recently, the government has granted three shoe producers, one Ethiopian, one Turkish, and the other Indian, tracts of land (approximately 2,800m2 each) on which to build factories.
The government has also recognized the importance of attracting large-scale investment from global leaders in the footwear industry. A high-profile case is the Huajian group from China. The Huajian group is a global footwear manufacturer that uses its massive production site in Dongguan, Gaungdong Province, to churn out more than twenty million pairs of shoes annually, mostly for the Western markets. The former prime minister “head-hunted” the group, as he had taken a personal interest in seeing the formation of large-scale industrial clusters. After the group’s representative met the former prime minister in August 2011, Huajian decided to invest in Ethiopia. This company now employs around 1,600 workers and produces nearly 2,000 pairs of shoes per day for well-known brands. The company intends to expand its production to generate export earnings equivalent to USD 4 billion per year within a decade. As part of the expansion scheme, it has recently acquired 300 hectares of land on the outskirts of Addis Ababa, and it plans to erect a complex of factories for the production of footwear, handbags, and accessories.
What sets this company apart from other foreign direct investment (FDI) in the footwear sector is its commitment to training local staff. It has selected and sent more than 130 young Ethiopian university graduates to China for training, with another batch of nearly 300 trainees soon to follow.
4 Such forms of training are vital in building local technological and managerial capabilities. For example, many studies attribute the rapid growth of the export-oriented garment industry in Bangladesh to young trainees who received intense training in production techniques, factory management, international procurement, and marketing in South Korea (for example, Mottaleb and Sonobe 2011). It remains to be seen whether such positive externalities will arise in the leather goods industry in Ethiopia.
INTERIM SUMMARY
Ethiopia is endowed with the resource base required for the commercial production of leather and leather products. The resources, however, still remained largely untapped due to a host of reasons ranging from poor hide and skin collection to limited technological sophistication at the leather-processing phase. The problems in the leather sector are multifaceted, and without a critical market size it is not clear that large private enterprises would emerge to improve the skin-to-leather value chain (Altenburg 2010). This would require coordinated action in which only states with long-term visions are willing (and able) to engage. The Ethiopian government has reacted by employing several forms of industrial policies. In addition to nondiscriminatory general incentives available to all investors, there have been several interventions aimed more explicitly at upgrading the leather and leather products industry. These interventions can be usefully subdivided into four forms of industrial policies.
First, the government is aggressively engaged in building the local production and marketing capacity through technology imports and learning from abroad. LIDI is used as an instrument to facilitate technology diffusion and upgrade the skills of workers and managers in the industry. To this end LIDI has organized training programs in collaboration with development partners, often involving foreign consultants. The government has also encouraged enterprises to use foreign experts by subsidizing the costs of their employment. Benchmarking exercises have been carried out in the hope of emulating more successful countries in the industry. Capacity building also means improving the institutional capacity of LIDI itself. As a result, LIDI has received direct support from both the government and international donors.
Second, due to its priority sector status, the leather and leather goods industry has had better access to finance from the Development Bank of Ethiopia (DBE). The familiar 70/30 credit modality accorded to industries in the priority sectors implies that the DBE would avail loans amounting to 70 percent of the total project cost once the investor raises equity equivalent to 30 percent of the investment cost.
Third, the government has provided land and semi-constructed factories to large- and medium-sized tanneries and footwear producers at highly discounted lease rates. The government has also erected several buildings that are given out to micro and small shoemakers at nominal rental fees. Both local and international investors are also offered huge tracts of land along with basic infrastructural facilities in the industrial zones strategically located in different parts of Ethiopia.
Fourth, the government has extensively used its tax and regulatory policies to encourage upgrading along the leather value chain. The export of raw hides and skins, for example, is banned to push local processing of leather. Similarly, the export of semi-finished leather products was subjected to a 150 percent export tax in 2008. In 2009, the same level of tax was imposed on the export of crust leather products. While limited local capacity might have attenuated the benefits of these interventions, studies suggest that they have encouraged the production of high-value leather goods. Such types of preannounced interventions are enormous disincentives to producers who are reluctant to move up the leather value chain, and they help push more innovative and efficient producers up the value chain.
All of these interventions have had the combined effects of improving value addition, export, and employment in the leather and leather products industry. Further, the provision of land at highly discounted lease rates, duty-free import of raw material and capital goods, as well as access to subsidized credit have attracted both foreign and domestic investors by reducing entry costs. These achievements are not, however, very large, particularly seen against the sector’s potential, though as noted earlier the government’s proactive attraction of investment by a large foreign producer of shoes is likely to make a dramatic impact. There remains much room for policy to improve several facets of livestock management and hide and skin collection. This would greatly improve raw material supply and quality for the leather processing enterprises.
THE CUT FLOWER SECTOR
The cut flower sector has the potential to make inroads into the twin problems of unemployment and the gap in technology between developed and developing countries. Unlike the traditional agricultural sector, the cut flower industry requires modern technologies during the production phase and more intense labor use per unit of land at the processing and post-harvest phases. It also provides a broader base for export through diversification, which improves export earnings while reducing their volatility. This is essential for low-income countries like Ethiopia that are dependent on traditional agriculture, which is highly sensitive to the vagaries of weather and provides only limited opportunity for additional technology and labor absorption.
Ethiopia is endowed with favorable climatic conditions for the production of different varieties of flowers, which presents it with a strategic advantage over other flower-growing countries. The possibility of high-altitude growing locations and suitable soil types constitute ideal conditions for producing higher-quality flower varieties. In addition to favorable climatic conditions, a reputable airliner and airport facilities and the physical proximity to the European market help reduce the cost of freight and enable the delivery of fresh, high-quality blossoms on time. Ethiopia’s rural and urban poverty mean that wages are very low, which balances out the lower labor productivity and contributes to the low costs of production. The flower industry has thus developed mainly in the highlands, where climatic conditions are favorable, and is concentrated in areas that have relatively easy access to the airport.
OVERVIEW OF THE CUT FLOWER INDUSTRY
The earliest attempt to set up a flower farm for export to the European market dates back to the 1980s. In this period, it was state-owned farms that began exporting flowers to Europe. However, these projects failed. Following the economic liberalization in the early 1990s, two Ethiopian entrepreneurs established privately owned cut flower farms. Although these entrepreneurs have greatly contributed to the industry by way of information externalities regarding the feasibility of the industry, a major breakthrough came only in 1999 when an Indian owned (U.K.-based) company started rose production using steel structure greenhouses—a technology that hitherto had been adopted by neither the SOEs nor the two Ethiopian farms (Gebreeyesus and Iizuka 2010).
In the early 2000s, the industry started expanding with the entry of both domestic and foreign entrepreneurs. Yet the flower industry faced several challenges in the farm-to-market value chain (see
figure 5.5 for a simplified presentation of the cut flower value chain). First, there was a problem associated with access to suitable land for floriculture development, that is, land that is located close to the airport. Investors acquired land through a time-consuming process of leasing from individual smallholder farmers, a process that then required the “consolidation of small contiguous holdings” (Gebreeyesus and Iizuka 2010). The second problem growers faced in the 1990s and early 2000s was the absence of regular and dependable air freight at rates competitive to the European market. Because cut flowers are a delicate product, post-harvest life and foliage are highly dependent on the availability of reliable and efficient air transport logistics. Along the farm-to-market value chain, air freight costs to market destinations often make up a substantial fraction of the total cost (GDS 2011). This cost factor is even more important in Ethiopia where, as noted earlier, wages are very low. Thus without ensuring cost-efficient structures at shipping and marketing phases, efficient flower production cannot be translated into profitability. The third commonly observed problem in the industry was the limited ability of firms to raise capital, as investment in cut flower farms required substantial amounts of upfront expenditure for fixed capital acquisition, such as greenhouses, pack houses, and cold storage facilities.
Figure 5.5 Participants and products in the cut flower value chain
All of these problems came to the government’s attention in 2002, a period that also saw the establishment of the Ethiopian Horticulture Producers and Exporters Association (EHPEA). This business association was originally established by five investors and has since expanded considerably to incorporate more than eighty-five members. The EHPEA quickly proved itself a competent and effective lobbying agency, generously endowed with donor funds. Through consultation with the EHPEA, the government recognized the potential of the flower industry for export earnings and as a means to provide stable wage income to the landless and near-landless farming households.
Concerted measures were then taken to stimulate the sector. As a result, export earnings from the cut flower sector jumped from a paltry USD 150,000 in 2001 to USD 212.56 million in 2011/2012 (EHDA 2012). Similarly, land under flower cultivation drastically increased from less than 40 hectares in the early 2000s to 1,440 hectares in 2011/2012 (EHDA 2012). The question that then arises is: What role did policymakers play in boosting the sector? A recurrent finding in the studies of the industry is that takeoff only came about when the government started providing industry-specific supports in 2003 (Altenburg 2010; Taylor 2010; Gebreeyesus and Iizuka 2010).
Figure 5.6 illustrates the evolution of the cut flower industry since the early 1990s.
Figure 5.6 Timeline of important events in the cut flower industry
INDUSTRIAL POLICY IN THE CUT FLOWER INDUSTRY
The government’s early and continuous commitment to promoting the cut flower industry is one of the most important factors that enabled the industry to reach a critical mass for takeoff (Taylor 2010). In late 2002, the prime minister’s office requested that the Ministry of Trade and Industry (MoTI) prepare a five-year action plan for the industry detailing potentials, problems, and possible solutions (Gebreeyesus and Iizuka 2010). Based on this plan, a five-year target was prepared and three concrete areas of intervention were identified. The latter involved the provision of land, long-term credit, and facilitation of air cargo logistics.
The government’s initial support schemes primarily targeted the alleviation of the three major problems mentioned earlier. Suitable land located at reasonable distance from the airport was made available to investors at very low lease rates with extended lease periods. With regard to the air transport and logistics problem, the government “initiated discussion and cooperation between the flower exporters and the Ethiopian Airlines (EAL)” (Gebreeyesus and Iizuka 2010). The government then subsidized the air freight rates, and exporters were also granted the privilege to ship on EAL on a credit basis. The government also attempted to redress the financing problem by instituting a soft loan scheme at the Development Bank of Ethiopia (DBE) with generous terms (Gebreeyesus and Iizuka 2010). The bank extends long-term credit based on a 70/30 debt-equity ratio modality, asking for no additional collateral except the investment project and the fixed capital employed therein.
To overcome the credit constraints faced by prospective investors, the government deployed the DBE as a prime lender in the sector. The DBE, as a result, has played a crucial role in the development of the cut flower industry. This role has evolved as the nature of the problems facing the industry changed and the sector matured. The next subsection presents a detailed account of the DBE’s engagements in the cut flower industry.
FINANCE AND THE ROLE OF THE DEVELOPMENT BANK OF ETHIOPIA
Capital markets are either completely nonexistent or highly deficient in many developing countries. Particularly private sector financing of investments with long gestation periods and uncertain returns is challenging. Such forms of investments might be heavily discounted particularly when they result in substantial spillover effects in the form of knowledge that can spur complementary investments as the investors and the financier cannot appropriate the full benefits of their investments. Investors are also likely to be myopic and lack the knowledge to correctly appraise the risk involved in financing new projects. New industries are inherently more risky than established ones. As a result, investments with high social returns may not be able to attract sufficient capital if capital allocation is left purely to the market. In other words, markets by themselves will tend to maximize short-term returns, and will tend to underinvest in areas that carry high social returns, especially if these are only realized in the long run. Governments, especially in low-income countries, need to find alternative ways of financing medium- and long-term projects. Development banks are often established to finance projects in strategic sectors, as well as to provide technical support for investors with limited project management capacity (DBE 2010).
The Development Bank of Ethiopia was established in 1970 to streamline the limited financial resources of the country toward priority areas. According to a key respondent at the DBE, the bank is there “to take risks that commercial banks would not.” To align the bank’s role with the government’s development plans, such as the PASDEP and GTP, the bank produces five-year strategic plans, which are then used to develop detailed annual plans. To increase its effectiveness, the government has limited the bank’s role to supporting priority sectors.
5 Consequently, the bank provides medium- to long-term credit to investment projects in priority sectors and is willing to take short-term risks and shoulder costs in order to enhance the economic development of the country in the medium and long term.
Not surprisingly, at the early stage of the cut flower industry, commercial banks in Ethiopia were averse to lending to entrepreneurs who wanted to invest in the industry (Taylor 2010).
6 The government has thus used the DBE to meet the financial needs of prospective investors in the industry since the early 2000s.
Although the financing modalities available at the DBE from the outset were attractive compared to neighboring countries, credit takeup was initially low. Once the profitability of the sector became apparent, however, both foreign and local investors started borrowing from the DBE using the 70/30 modality, whereby the investor is required to pay down 30 percent of the project costs and the bank then lends the other 70 percent. Initially, interest rates on the loans were as low as 7.5 percent. Rates have since increased by one percentage point, but they remain lower than rates available either in commercial banks in Ethiopia or in other flower-producing countries in the region, such as Kenya and Uganda.
The DBE’s initial lending experience in the flower industry was not all rosy. Because the cut flower industry was new to the country and had intricate production and marketing systems, local knowledge required for proper feasibility evaluation of investments in the industry was very limited. In the beginning, the bank lacked relevant knowledge and capacity to properly appraise business plans. For example, as the bank lacked experience in floriculture, it was not able to assess the veracity or accuracy of claims made by loan seekers about project costs (including, but not limited to, greenhouses, international staff, chemical inputs, and fertilizers). The bank had limited information on what the correct industry standard rates were, which led to significant overinvoicing in some projects. In particular, this affected the collateral the bank took for its 70 percent portion of the project costs. As most investors were unable to provide any collateral other than the fixed investments made in the projects themselves, and because this constituted part of the incentive package, the bank was forced to accept these overvalued assets as collateral. Floriculture by its nature has lower fixed capital content than other industries; this combined with the faulty project valuation implies that the collaterals collected by the bank were insufficient to cover even the 30 percent pay down required for loans disbursed by the bank. In other words, a larger proportion of the project risk was shouldered by the DBE. These highly favorable terms were in some cases exploited by unscrupulous investors who greatly overstated their costs to criminally extract funds from the bank (Taylor 2010).
Recognizing its initial weakness and under pressure from the highest echelons of the political system, the bank embarked on a drive to both engage more directly with the sector and to build up its own expertise. This resulted in a number of initiatives. First, the bank tailored its credit policy to better serve the idiosyncratic needs of the cut flower industry. Second, the bank started working with overseas development banks and local stakeholders to build its capacity and strengthen its own research department. Bank employees assigned to work on the cut flower industry received regular training in collaboration with the Ethiopian Horticulture Producers and Exporters Association (EHPEA). Partnerships were established with development banks in other countries, notably the Netherlands, Turkey, Korea, and India, the latter being the destination of large numbers of DBE staff sent for training. Third, since the establishment of the EHDA, the agency and the bank have been working closely together, holding monthly meetings and sharing relevant information. This has helped the bank to expand its learning scope and keep track of the status of each project through active follow up.
After undergoing a steep and painful learning curve, the DBE has now managed to learn the ins and outs of the industry. The bank has developed a credit policy specifically tailored to the cut flower industry, and its customer assistance framework has evolved. For example, each farm is now assigned a contact officer who is uniquely responsible for that farm, backed up by a team ready to lend assistance to the farm. This includes many forms of technical assistance, not just in purely financial terms but also in export and marketing knowledge, among other things. Regular inspection trips are undertaken to each farm, and the DBE staff is supposed to be aware of all relevant developments, irrespective of whether or not they are directly related to repayment capacity. In this way, whenever problems arise, the bank is able to quickly recognize the problem and can propose an appropriate solution.
THE FINANCIAL CRISIS AND STATE INTERVENTION
A defining moment in the interaction between the bank and its cut flower clients came in 2008 and 2009, when the cut flower industry was on the verge of collapse following the global financial crisis. With key export markets in economic turmoil, demand for flowers plummeted.
In 2008, the National Export Promotion Committee directed the EHDA to evaluate the health of the industry. At the time, forty-three flower farms had collectively borrowed more than one billion Ethiopian Birr from the Development Bank of Ethiopia (EHDA 2009). When flower prices spiraled downward during the global financial crisis, many of these borrowers were suddenly unable to service their debt. Faced with the possibility of large parts of the sector imploding, the government and the DBE engaged in a desperate attempt to stem the coming wave of farm bankruptcies.
A team comprising staff from the DBE, the National Bank of Ethiopia (NBE), the Ministry of Agriculture and Rural Development (MoARD), and the EHDA, as well as owners of the farms and sector representatives, was formed and tasked with evaluating each farm individually, with the aim of preventing foreclosures. Based on these evaluations, the team made recommendations for each farm. After reviewing the recommendations, the bank then implemented measures including rescheduling of loan repayments, additional credit for troubled farms, and even direct management intervention in some of the worst cases. To handle this process, the bank set up a special section, which has since been tasked primarily with following up on the status of borrowers in the cut flower industry.
The combination of these measures meant that foreclosures were avoided in all but two or three cases. All other afflicted farms are apparently still operational. The DBE summarized the bank’s stance during the bailout process as follows: “If it is a genuine problem, we want to be part of the solution. We will reschedule the loans, we won’t foreclose, and we will transfer sick loans to others who can manage the farm.” The sentiment appears to be shared with investors in the cut flower industry. For example, an investor interviewed by Taylor (2010) reflects that “the government asked us what more mechanism should we put? Not many governments do this.”
While the DBE’s assistance in the form of loan rescheduling and cash injections was available for both foreign- and locally owned flower farms, Ethiopian-owned farms were more likely to be in financial distress and hence have benefited more from the intervention. This suggests that the financial crisis alone might not have precipitated the problems, but rather acted to exasperate and expose already existing structural weaknesses in the product portfolio, management capacity, and marketing knowhow of some Ethiopian-owned firms. Addressing these weaknesses required going beyond sector-specific interventions to targeted policy interventions aimed at improving the capacity of Ethiopian-owned farms. This motive partly lies behind the establishment of the EHDA.
A SECTORAL SERVICE AGENCY: THE ROLE OF THE ETHIOPIAN HORTICULTURAL DEVELOPMENT AGENCY
Since its establishment in July 2007, the EHDA has been the principal government institution designed to support flower growers in Ethiopia. The agency was set up to act as a one-stop shop for services required by investors. Prior to 2007, the sector was characterized by administrative dispersion, with investors having to deal with a number of different branches of government simultaneously to acquire the necessary licenses and other documents. The rationale behind the agency is to bundle these services in a single institution. It should be noted, however, that the agency is a service institution for investors and not a sector regulator. Regulatory functions for the sector remain in the hands of a variety of institutions, each of which is responsible for its field of authority.
The support the agency provides to investors can be subdivided into three broad pillars: capacity building, investment support, and market promotion. Capacity-building efforts are geared toward local investors who often (at least initially) have limited knowledge regarding production technologies, input procurement systems, and flower marketing chains. Some of these investors had no prior experience either in the cut flower industry or in sectors similar to flower farming. This is especially true for Ethiopian-owned farms, most of which had had no previous involvement in the sector. Foreign-owned farms, in contrast, are often run by specialized floriculture companies or are established by investors with many years of experience in the industry. To address these shortcomings, the agency launched the Integrated Capacity Building Program that, among other interventions, involved employing foreign consultants to assist Ethiopian-run farms with all aspects of the business, including production, product handling, farm management, and financial management. The Integrated Capacity Building Program also comprises short-term training programs for flower workers and managers on issues as diverse as benchmarking, farm management, harvesting, and marketing. These programs were implemented with assistance from Dutch training and research institutions (Boer and Pfisterer 2009).
The Ethiopian government quickly realized that strengthening the agricultural research and extension system would play a pivotal role in the long-term sustainability of the cut flower industry. Ethiopian farms, both foreign and domestic owned, for example, incur substantial costs in the form of royalty payments to international flower breeders, who tend to sit in the Netherlands and other advanced flower-producing countries. These breeders occupy a unique position in the floriculture value chain. They produce new varieties of flowers for which they then hold the intellectual property rights. Farms may plant these varieties in exchange for payment of royalty fees to breeders. Varieties rapidly go in and out of fashion, and the correct choice of varieties is often a life or death decision for flower farms. Farms owned by international companies, who often have their own breeding operations or have longstanding business relationships with renowned international breeders, are at a distinct advantage here vis-à-vis many Ethiopian-owned farms, who lack such connections and the intimate market knowledge they bring with them.
The country could retain some of the breeders’ royalties by encouraging flower variety research and development locally in both the public and private research institutions. The EHDA is involved in some attempts to upgrade the existing local knowledge stock. One of the public universities has, for example, recently launched a regular education program for students in the field of horticulture at BSc and MSc levels (Gebreeyesus and Iizuka 2010). Similarly, to address the knowledge issue, a Horticultural Practical Training Centre has been established for graduates, investors, government staff, and stakeholders in the industry.
Under the second pillar of investment support, land provision constitutes the most important support the EHDA provides to investors. The EHDA has been working closely with the federal and regional governments to facilitate the acquisition of land suitable for growing flowers by investors. Initially, land located close to Addis Ababa was given to investors at low lease rates. The sector has, however, moved into a period in which most of the growth is driven by the expansion of existing projects rather than the establishment of entirely new farms. Expansion of existing projects, however, is hampered by the availability of suitable land. Suitable land for cut flower farming needs to be conveniently located, have leases that are not too expensive, and have the necessary infrastructure in place. Ideally, plots for expansion should be adjacent to existing projects.
Recently, there has been some migration of growers to areas outside of Addis. But most of the existing flower farms are located in close proximity to Addis Ababa, and they have already taken up nearly all the available government land situated in areas surrounding Addis Ababa. The remaining land is owned
7 by local farmers who mainly produce cash crops for the Addis Ababa market. They would, therefore, require substantial compensation to cede the land to flower farms. Two solutions are offered by the EHDA to resolve the land problem. First, the incentive package with respect to land is tailored so that farms located in less suitable locations, or far away from Addis Ababa, get bigger financial incentives to compensate for the drawbacks of the location. Second, the agency has recently started earmarking land in five “development corridors” across five regional states for horticulture development. Land located in these areas is registered in a “land bank” and will be fitted with the necessary infrastructure, including power, cold storage facilities, and transport linkages to and from either regional airports or Bole International airport in Addis Ababa for export and Djibouti port for imports. The corridors have the advantage of being geographically concentrated, which makes service provision easier. Infrastructure such as water reservoirs and pack houses can also be shared among farms. Uptake appears to have been limited.
As part of the investment support scheme, the agency also plays an arbitration role between investors and workers employed in the industry. The agency seeks to maintain good labor and community relations by avoiding industrial action and smoothing out conflicts that may arise between management and labor. Far from being a neutral arbitration body, the agency sees its role as maintaining production by preventing work stoppages or other forms of disruptive collective action on part of workers.
The third support pillar involves market promotion. By working closely with Ethiopian diplomatic missions abroad, the agency tries to promote both the products and the overall image of Ethiopian floriculture abroad. It aims to grow the Ethiopian flower industry’s global market share and reach by distributing samples, finding new importers, and attending trade shows. To facilitate exports, the agency also works with public logistics providers such as EAL and Ethiopian Shipping Lines (ESL), as well as private logistics companies, to open up new routes and increase capacity on existing ones.
PERFORMANCE OF THE CUT FLOWER INDUSTRY
Figure 5.7 summarizes the growth of the cut flower industry in the past several years. Production and export of flowers were virtually zero during the 1990s. In the early and mid-2000s, two important developments helped unleash the growth of the industry. The Ethiopian Horticulture Producers and Exporters Association (EHPEA) was established by producers engaged in the cut flower industry in September 2002. The association started lobbying the government, stressing the potentials of the sector. As a result, the government initiated several incentive schemes that granted a number of privileges to the industry. Consequently, cut flower production and export increased substantially between 2002/2003 and 2005/2006. In three years’ time, the number of flower stems exported rose by more than 1,000 percent, from 16 million to 186 million. Correspondingly, export revenue and the share of the flower industry in total export revenues grew from $1.8 million to $37.5 million and from 0.01 percent to 1.4 percent, respectively.
More aggressive support for the industry came with the five-year national development plan, the Plan for Accelerated and Sustained Development to End Poverty (PASDEP), covering 2006 to 2010. The plan explicitly named the industry as one of the priority sectors that would receive direct state support, mostly in the form of investment incentives. The 1998 export promotion strategy had not even mentioned the cut flower industry (Gebreeyesus and Iizuka 2010). Once the industry’s potential became apparent, it prompted support at the highest levels of government. The former prime minister, for example, got personally involved in the development of the sector, holding regular meetings with investors in the cut flower industry to get up-to-date information and seek immediate solutions to the business constraints faced by the industry in consultation with investors. Investors consistently stress how important this direct line of communication and the “open ears” at the top of the political leadership had been to their initial success.
Figure 5.7 Volume and value of export in the cut flower industry
Source: ERCA and Ethiopian Horticulture Sector Statistical Bulletin (2012).
The combined effects of these measures made the cut flower industry one of the major export earning sectors in the country. In 2009/2010, the cut flower industry generated 10 percent of total export earnings, an impressive expansion by about eight percentage points within just three years (see
figure 5.8). The number of stems exported reached two billion in 2011/2012, generating revenue amounting to USD 212.6 million.
Labor intensity, and hence employment opportunity, is another beneficial feature of the cut flower industry. As shown in
figure 5.8, employment has substantially increased in the sector in the period considered. Land development for flower production appears to follow a strikingly similar trend with employment levels. Unlike other industries in which expansion is often associated with the adoption of labor-saving technologies,
figure 5.8 perhaps suggests that expansion in the flower industry remains highly labor intensive. This trend is good news given the severe unemployment problem in Ethiopia.
Figure 5.8 Levels of employment and land use in the cut flower industry (recent trends)
Source: EHDA (2012) statistical bulletin (for land coverage) and EDRI’s panel surveys (for employment)
The employment figures might actually understate the actual number of jobs created in the sector. These figures were gathered from seventy farms in 2012, while EHDA data show that there were more than eighty flower farms in the same period. As a result, the EHDA official forecast puts employment in the cut flower industry at much higher levels. Accordingly, in 2011/2012, the number of workers engaged in the industry was 50,500.
Questions remain regarding pay and working conditions. Ethiopia has a single, state-affiliated labor union that, unsurprisingly, is thoroughly corporatist in outlook and does not engage in collective bargaining on behalf of workers. While the cut flower sector as a whole has been very keen to comply with international production standards, wages remain low and the use of pesticides and herbicides can pose serious health hazards.
8 While voluntary standards and government oversight are better than no regulation at all, independent labor organizations and mandatory collective bargaining could better balance the interests of investors and those of their—mostly young and female—workers.
INTERIM SUMMARY
The development of the cut flower industry in Ethiopia spans three decades since the 1980s, when state-owned farms attempted to export summer flowers for the first time. In the late 1990s, a large foreign-owned farm introduced innovative production techniques, and its success was emulated by both local and foreign investors, in addition to attracting the government’s attention to the sector’s potential and what it might be able to do to realize it. As a result, the number and relative size of flower farms had noticeably increased by the early 2000s. These early entrants, however, faced several problems. Access to suitable land, cheap and dependable air freight services, and start-up capital were some of the earliest constraints on the growth of the sector.
With the introduction of sector-specific support in 2003, the government of Ethiopia demonstrated its intentions to promote the cut flower industry. The establishment of the EHPEA and its strong ties with the government helped identify and quickly tackle problems in the sector. Policy measures that provided prospective investors with land at low lease rates, subsidized and reliable air freight services, and low-interest credit were introduced. Regarding the latter, for example, the DBE started generously tailoring its credit policy to better serve the industry. There is little doubt that such measures led to a radical shift in the industry, with the export revenue topping more than USD 100 million in 2006/2007. Similarly, the active involvement of the DBE is credited for stabilizing the industry when flower demand plummeted following the global financial crisis in 2008 and 2009. This is a clear demonstration of the value of development banks, which are of sufficient size to not only provide much-needed seed funding and start-up finance but also to act as backstops to protect investments in the face of external shocks.
Because the nature of farms in the cut flower industry is heterogeneous, not every farm will be affected by policy measures or external shocks in the same way. There are sophisticated foreign conglomerates that possess state of the art production technologies and that established robust market structures. On the other hand, there are Ethiopian investors who migrated from trading businesses in the hopes of exploiting the favorable agro-climatic conditions for growing flowers, while having limited technological and marketing knowledge in the cut flower sector. In order to improve local capacity, provide investment support for all types of investors, and search for new marketing frontiers for Ethiopian flowers, the EHDA was established in 2007 on the behest of the government. The EHDA was created as a one-stop shop to facilitate the development of the industry in close consultation with private sector representatives, most notably the EHPEA. Such forms of public-private partnerships can be used as instruments for continuous information exchange on constraints on and opportunities for growth. From interviews with relevant sector actors, we know that there is greater scope to utilize such arrangements to better inform and coordinate interventions in the sector, particularly when new rules and directives are to be enacted and promulgated.
CONCLUSION AND RECOMMENDATIONS
The government of Ethiopia has used industrial policy to both exploit and create (dynamic) comparative advantages in the priority sectors defined in its industrial strategy. This chapter has focused in particular on the policies employed to foster and support the leather and floriculture sectors. It has found that the mixture of general incentives and targeted interventions used in both sectors has been highly effective in nurturing entrepreneurship and investment and has resulted in remarkable growth in both sectors. Moreover, it is clear that takeoff in either sector would not have been possible without direct government intervention and support.
It is tempting to argue ex post that Ethiopia followed its comparative advantage in setting up a successful and internationally competitive floriculture sector and in providing for strong growth and a pathway to competitiveness through further investment in leather. After all, Ethiopia has cheap labor, and these are labor-intensive activities. Both require the application of modern technology with limited complexity and skill requirements, thereby suiting Ethiopia’s “factor endowments.” But this argument disregards the slow and complex process of discovery, testing, failure, and adaption that led to growing sectors in both cases. Especially in floriculture, by far the more successful of the cases—at least until recently—examined here, Ethiopia’s supposed comparative advantage was hardly obvious at the outset. Instead, the competitiveness now achieved was consciously crafted by skilled entrepreneurs, hardworking laborers on low wages, and a government that did not shy away from repeated and direct involvement, right down to day-to-day management decisions in ailing farms. It is probably better to say that there was a potential for creating a competitive industry.
We agree with Altenburg (2010) that the challenges faced by both sectors were quite different and called for different policy responses. In the leather sector, the challenge was a classical coordination failure, whereby problems all along the value chain had to be tackled simultaneously to achieve the necessary quality of inputs and outputs for global competitiveness. In the absence of large, fully vertically integrated private companies, such coordination and concomitant investment could only be undertaken by government. By contrast, the floriculture sector did not lack private sector coordination capacity, but instead required interventions to create an enabling environment, in particular to overcome weaknesses in logistics and initial capital formation. By adopting a flexible and differentiated policy regime, the government is able to meet the requirements of both sectors.
Because both sectors are, in their modern forms, new to the Ethiopian economy, these successes were the result of sometimes painful learning processes and were not achieved without cost. It is therefore necessary to draw lessons from the experiences gained.
BUILDING IMPLEMENTING CAPACITY EARLY
Industrial policy necessarily implies a process of testing and experimentation with new industries. To be able to effectively support infant industries, the relevant government bodies must strive to equip themselves with appropriate technical knowledge before support to these sectors is commenced. As the experience of early support to floriculture demonstrates, a lack of sector-specific knowledge can result in costly misallocation of scarce capital resources and funds. Sector-specific knowledge also allows government bodies to build the kinds of close collaborative partnerships that are now in evidence in both the leather and floriculture sectors. International assistance can be sought to pull in relevant knowledge at relatively little budgetary cost.
RESPONSIVE REGULATION
Regulation is a vitally important aspect of industrial policy. Regulatory regimes must be transparent, predictable, and easy to comply with, while at the same time holding companies to the high standards expected of them. By its very nature the regulation of complex agricultural, agroindustrial, and industrial sectors is often spread across a variety of different government institutions, including line ministries and authorities. The role of government here is twofold. First, the government has to assure effective communication across responsible institutions, allowing them to build a coherent and consistent regulatory regime. Second, the government has to make sure that regulations are technically feasible and will not place unnecessary burdens on companies. To ensure this, draft regulations should be communicated to sector actors in advance, and opportunities for feedback should be provided. Regular sector roundtables involving all stakeholders could be used to achieve this. That being said, regulators must also be able to hold individual companies and their owners accountable. In sectors that require larger initial capital outlays, there may then well be a trade-off between minimum efficient scales and companies that are effectively too big to regulate.
DIFFERENTIATE COMPANIES
There can be huge differences between companies
within a single sector in terms of both initial endowments and the speeds with which they are able to move up respective learning curves. A salient difference in the context of the Ethiopian economy is that between foreign- and domesticowned companies. These will frequently face different challenges and require different types of support to succeed. Foreign companies often have greater access to capital resources and tend to have greater knowledge of relevant production systems and demand structures in final markets. Ethiopian-owned companies are often initially behind in these respects, but they tend to be much more familiar with the Ethiopian regulatory and legal framework within which they operate. To reach the greatest efficiency and effectiveness of support possible, some types of interventions should be tailored to these differentiated requirements. Difficult decisions also have to be made in considering how long to support ailing companies. Every company must be given a chance to move up the sector learning curve, and this will generally entail some false starts. But not every company will succeed, and some must be allowed to fail so that their capital can be put to more productive uses.
CONTINUOUS DIALOGUE
It is important to note that the lessons discussed here were drawn from the successes in fostering newly grown industries. As these industries achieve takeoff, mature, and face new and different challenges, industrial policy will have to change with them. In maturing industries, problems shift from capital formation and market making to upgrading and sustainability. For this to occur, industrial policy must move toward sustainable knowledge creation and training, as well as the implementation of labor and environmental standards to ensure the long-term viability of industries. Labor income acts as an important transmission mechanism for benefits to society, and government should consider policy levers such as minimum wage requirements to guarantee that expanding economic opportunities are translated into improving livelihoods. Labor standards are important to help ensure that success is not achieved on the backs of workers. To know when and how support must shift, it is important that regular channels of communication, but also of close monitoring and evaluation, are kept open between government and sector actors.
DEVELOPMENT FINANCE
Both sectors benefited from finance made available by the Development Bank of Ethiopia. DBE loans are slightly cheaper than commercial loans, but this is not why they are important. In many low-income countries, the private banking sector has neither the size nor the administrative capacity to lend to risky projects with long gestation periods, as characterized by the establishment of entirely new sectors or the comprehensive overhaul of existing ones. A state-owned development bank of sufficient size can shoulder such risks and, as we have seen, can even act as implicit insurance against external shocks. Crucially, though, such banks have to be able to work in close consultation with the sector to offer not just financial advice but also direct technical and commercial expertise. They will have to hire a broad selection of technical staff with sector-relevant knowledge, going far beyond financial specialists. Their staff should be embedded directly in larger clients and at the very least make regular visits to smaller borrowers. Working closely with private sector firms also gives development banks an important oversight role. They must be willing and able to enforce disciplinary measures against companies when necessary, and they should be sufficiently independent to terminate loans when companies are either unable or unwilling to perform.
NOTES
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