the road to private sector led economic...

The Road to Private Sector Led Economic Growth

A Strategy Document

Presented at and Endorsed

by

The Third Annual National PSD Conference

held on

30 June 2008

Researcher

Dr. Alemayehu Geda (Associate Professor), PhD in Development Economics, Institute of Social Studies, The Hague, Netherlands

Produced and distributed by the Addis Ababa Chamber of Commerce and

Sectoral Associations with financial support from the Swedish Agency for

International Development Cooperation, Sida Sida

© Private Sector Development Hub/Addis Ababa Chamber of Commerce and Sectoral Associations, 2009

P. O. Box 2458, Mexico Square, Addis Ababa, EthiopiaTel: +251(0) 115 504570/ 542405, Fax: +251 (0) 115 542404,

Email: [email protected]

All Rights Reserved.

No part of the publication may be produced or transmitted in any form or by any means without the prior permission of the copyright holder. The only exception is for a reviewer,

who may quote short excerpts in a review.

Disclaimer:- The views expressed in the study do not necessarily reflect the views of PSD-Hub or Addis Ababa Chamber of Commerce and Sectoral Associations or Sida. They are solely the responsibilities of the authors.

CONTENTS

Introduction..........................................................................................................9

PART IChapter One

The Three Phased Approach to Private Sector Development.......................13

Institution Building and Self-Discovery...........................................................14

Steady Growth and Economic Leadership. .....................................................29

PART II

Chapter Two

The Business Climate and Private Sector Development in Ethiopia............35

Government Policy and the Business Environment........................................37

Government Supporting Investment and the Business Environment...........40

Institutions, Structural Factors and the Business Environment.....................41

Other Related Issues..........................................................................................45

Chapter Three

The Judicial System and Private Sector Development...................................49

The Judicial System: Independence of the Judiciary......................................50

The Role of an Independent Judiciary for Private

Sector Growth.....................................................................................................58

Chapter Four

Property Rights and Private Sector Development. .........................................61

Land and Property Rights: Brief View of the Legal System,Problems..........63

Major Challenges of the Land Lease System and

How to Tackle Them..........................................................................................65

Other Major Issues of Property Rights............................................................77

Chapter Five

Competition Law and Private Sector Development. ....................................81

Institutions for Promoting Competition.........................................................81

Competition and Competition Law in Ethiopia. ..........................................87

The Way Forward for Competition Policy,

Private Sector Development in Ethiopia........................................................93

Chapter Six

Corporate Governance and Private Sector Development............................97

Governance Institutions for Firms and Corporate Governance..................97

Types of Governance Institution. ....................................................................99

Corporate Governance in Ethiopia...............................................................102

Dominance of Private Corporate Governance Institutions in Ethiopia. ...105

The Road Map for Corporate Governance in Ethiopia. .............................111

Chapter Seven

The Financial Sector and Private Sector Development...............................119

Regime Shift, the Financial Sector and Private

Sector Development........................................................................................120

Current Structure and Performance of the Financial Sector......................122

The Ethiopian Financial Sector and its Implication for

Private Sector Development. .........................................................................127

Chapter Eight

Challenge of the Macroeconomic Environment, the Global

Trading System for Private Sector Development.........................................137

The Macroeconomic Environment and Private

Sector Development.......................................................................................137

The Challenge of the Global Trading System to

Ethiopia’s Private Sector...............................................................................139

PART III

Chapter Nine

Lessons for Private Sector Development Strategy from the Newly

Industrialised Asian and Successful African Countries..................................147

Taiwan and South Korea....................................................................................148

Botswana and Mauritius.....................................................................................158

Policy Making Process and the Private Sector Development in

East Asia..............................................................................................................164

The Lessons for Private Sector Development in Ethiopia.............................164

References..............................................................................................169

LIST Of TAbLES

Table 1 The public and private sectors in institution building ...................................17

Table 2 Tax rates and administrative constraints..........................................................38

Table 3 Trade related problems.....................................................................................38

Table 4 Licensing related problems...............................................................................39

Table 5 Infrastructural development.............................................................................40

Table 6 Security. ..............................................................................................................41

Table 7 Corrupt practices...............................................................................................42

Table 8 Use of technology..............................................................................................43

Table 9 Access to finance. ..............................................................................................43

Table 10 Loans, advances break down for 4th quarter of 07/8 ....................................125

Table 11 Banks’ claim on central government..............................................................126

Table 12 Access to finance in Ethiopia. ........................................................................127

Table 13 Stated constraints for lack of full-capacity in percentage. ...........................141

Table 14 Percentage share of exports by destination (1989-2005/6) ..........................144

LIST Of fIguRES

Figure 1 The three phases of the Road Map for Private Sector Development ...........13

Figure 2 Self-Discovery of the private sector: Major Sectors........................................18

Figure 3 Summary of interventions..................................................................................30

Figure 4 Illustration of financing contributions..............................................................33

Figure 5 Sales per worker: Ethiopia, Kenya and Vietnam ............................................44

Figure 6 Sales per worker in garments- Ethiopia, Kenya and Vietnam........................44

Figure 7 Sales per worker in Ethiopia in 2002 and 2006................................................45

Figure 8 Three dimensional issues for private sector development in Ethiopia..........47

LIST Of TAbLES

Table 1 The public and private sectors in institution building ...................................17

Table 2 Tax rates and administrative constraints..........................................................38

Table 3 Trade related problems.....................................................................................38

Table 4 Licensing related problems...............................................................................39

Table 5 Infrastructural development.............................................................................40

Table 6 Security. ..............................................................................................................41

Table 7 Corrupt practices...............................................................................................42

Table 8 Use of technology..............................................................................................43

Table 9 Access to finance. ..............................................................................................43

Table 10 Loans, advances break down for 4th quarter of 07/8 ....................................125

Table 11 Banks’ claim on central government..............................................................126

Table 12 Access to finance in Ethiopia. ........................................................................127

Table 13 Stated constraints for lack of full-capacity in percentage. ...........................141

Table 14 Percentage share of exports by destination (1989-2005/6) ..........................144

LIST Of fIguRES

Figure 1 The three phases of the Road Map for Private Sector Development ...........13

Figure 2 Self-Discovery of the private sector: Major Sectors........................................18

Figure 3 Summary of interventions..................................................................................30

Figure 4 Illustration of financing contributions..............................................................33

Figure 5 Sales per worker: Ethiopia, Kenya and Vietnam ............................................44

Figure 6 Sales per worker in garments- Ethiopia, Kenya and Vietnam........................44

Figure 7 Sales per worker in Ethiopia in 2002 and 2006................................................45

Figure 8 Three dimensional issues for private sector development in Ethiopia..........47

ACRONymS

AACCSA Addis Ababa Chamber of Commerce and Sectoral Associations

ADR Alternative Dispute Resolution

BMS Business Management Skills

CBE Commercial Bank of Ethiopia

CBOs Civil-based Organizations

CCG Code of Corporate Governance

CEPD Council for Economic Planning Development

COMESA Common Market for Eastern and Southern Africa

CSOs Civil Society Organizations

DBE Development Bank of Ethiopia

ECCSA Ethiopian Chamber of Commerce and Sectoral Associations

EEA Ethiopian Economic Association

EEC European Economic Community

EIC Ethiopian Insurance Company

EPAAA Ethiopian Professional Association of Accountants and Auditors

EPZ Export Processing Zone

FDI Foreign Direct Investment

FIRA Federal Inland Revenue Authority

FTA Free Trade Area

GSP Generalized System of Preferences

HSB Housing and Saving Bank

ICOR Incremental Capital-output Ratio

ICT Information and Communication Technology

IT Information Technology

LMSM Large and Medium Scale Manufacturing firms

MFIs Micro Finance Institutions

MoTI Ministry of Trade and Industry

NBE National Bank of Ethiopia

NGOs Non-governmental Organizations

OECD Organization for Economic Cooperation and Development

OFAG Office of the Federal Auditor General

OTC Over the counter

PASDEP A Plan for Accelerated and Sustainable Development to

End Poverty

PSD-Hub Private Sector Development Hub

PPESA Privatization and Public Enterprises Supervising Agency

PPPD Private Public Partnership Dialogue

PPPF Public Private Partnership Forum

PPSA Pension and Social Security Authority

SACU South African Customs Union

SCAs Saving and Credit Associations

SDPRP Sustainable Development and Poverty Reduction

SMEs Small and Micro Enterprises

TOT Turn-over Tax

VAT Value Added Tax

WB World Bank

WTO World Trade Organization

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IntroductIon

The strategy document for the Private Sector Led Economic growth in Ethiopia has three parts. Part I deals with the strategic direction and consists of three distinct but interrelated phases. The phases are designated as Institution Building and Self-Discovery, Consolidation and Transformation, and Steady Growth and Economic Leadership. Major activities that need to be performed in each phase have been provided with more emphasis on Phase one. The starting point of the proposed strategy is an evaluation of the current state of the Ethiopian private sector. Recognizing the strengths and weaknesses of the existing private sector, operating environment is considered vital for the successful implementation of the strategy.

The transformation of the weak and uncompetitive private sector into a dynamic, vibrant and competitive private sector in Ethiopia requires a somewhat long lead time to address the challenges and prepare the ground for its takeoff.

Part II of the report addresses the major challenges confronting Ethiopia’s private sector. It provides an analysis of the challenges and the measures that need to be taken to address them.

The strategy document is also in harmony with government policy and programmes and hopes to be a major instrument in the implementation of the Plan for Accelerated and Sustainable Development to End Poverty (PASDEP).

The Ethiopian government policy is clear about the importance it attaches to the development of the private sector. In two recent important policy-cum-plan documents, the SDPRP (Sustainable Development and Poverty Reduction Program) for 2002-2005 and the newly approved PASDEP (Plan for Accelerated and Sustained Development to End Poverty) for 2006-2010, this is unequivocally stated. Thus, there can be no doubt about the Government’s commitment to private sector development.

With regard to private sector development, these two important documents focus on :

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Agriculture, which is the source of livelihood for 85 percent •of the population, as a potential source of surplus to fuel the growth of other sectors of the economy;Strengthening private sector growth, especially in industry •to promote non-agricultural employment and output, supported by public investments to provide the necessary infrastructure;Promoting rapid export growth, including high value •agricultural products and export-oriented manufactures (particularly intensified processing of high quality skins/leather and textile garments);Investing in education and enhanced efforts to build capacity •to overcome critical constraints for the implementation of development programmes;Deepening decentralization to shift decision-making closer •to the grass roots, to improve accountability, responsiveness and service delivery; andPromoting improvements in governance.•

Some bilateral agencies such as Sida are skeptical whether the above objectives are being implemented. Similarly, even multilateral agencies such as the World Bank (World Bank, 2007), have stated that the strategy for private sector development under PASDEP has to be supported by detailed actions which are lacking at the moment. Such actions include the establishment of market-oriented institutors, financial sector reform, and a sectoral growth strategy building on the experience of self-discovery such as that of the flower exporting sector and the strengthening of economic governance. The private sector is a key player in engendering sustainable economic growth. While the public sector’s supportive role is also important, it should not be a dominant one where it crowds out private sector initiative.

This study is motivated by several factors. First, the need to highlight the pivotal role of the private sector in enhancing Ethiopia’s economic growth and formulating a road map that the Ethiopian private sector needs to engage with the Government to promote private sector development.

The second motivation for the study is the need to establish a framework for carrying out an in-depth, sector specific problem identification study, which is technical, specific and rigorous, that the private sector can use in identifying the challenges facing a particular sector and how these challenges may be overcome. The need for such sector specific problem

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identification studies cannot be overemphasized. Such studies serve as a good basis for engaging and negotiating with the Government on the best way forward for removing obstacles and overcoming challenges facing the sector. An outline of a framework for carrying out such studies is provided in this report.

In Part III of the study are presented experiences of successful Asian and African countries in the hope that they could contribute toward seeking solutions to the major problems that the private sector is facing from various dimensions --- the business climate, the judicial system and property rights, corporate governance, and the challenges of both the macroeconomic environment and the global trading system by learning from those experiences.

The study articulates the problems at a general and institutional level with the objective of making the document an instrument to initiate a dialogue with the Government. For the latter purpose, the following major categories of institutional problems are addressed in the study: the business climate for the private sector, the judicial system, property rights, corporate governance, competition policy and private sector development, the financial sector and the private sector, the challenge of the macroeconomic environment and the global trading system, and lessons from successful developing Asian and African countries.

The methodology accepted is basically analytical that makes use of similar country experiences, creative use of current information using descriptive data and use of private sector-related analytical/theoretical models.

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PART Ichapter one

The Three Phased Approach to Private Sector Development

It is important that the Government and the private sector are like-minded in their way of thinking and both adopt a pragmatic approach to the problems. To assist in the realization of this,the following three-phase approach to private sector development in Ethiopia is proposed.

Phase I: Institution Building and Self-DiscoveryPhase II: Consolidation and Transformation Phase III: Steady Growth and Economic Leadership

A summary of the activities that need to be implemented in each phase are given in Figure 1 and the phases are discussed in detail below.

Figure 1 The Three Phases of the Road Map for Private Sector Development

Institution Building & Self Discovery Revision of the Commercial Code•Modernization of Company Register •Institutionalization of Corporate Governance•Standardization of Accounting and Auditing•Capital Market development•Introduction of Competition Policy•Develop a public – private sector policy dialogue and policy study •platformFocus on selected sectors for action (commercial agriculture, livestock, •tourism, and electronics)

Consolidation and Transformation The sectoral diversity and size of the private sector gets consolidated•The private sector transforms itself in terms of business conduct•Growth and expansion in domestic market and beyond•

Steady Growth and Economic leadership

A vibrant sector with full capacity that competes both in the• domestic and foreign market emergesBig companies that subcontract medium and small companies, and •closely work with multinational companies will emergeThe firms can conduct their own research and closely work with •academia in the area of basic research

Phase I

Phase II

Phase III

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Institution Building and Self-Discovery

Institution Building

The main tasks in this first phase of the strategy are institution building and self- discovery. It is the most demanding of all the three phases and may take five to seven years to implement.

Institution building is central in the Ethiopian context because the response of the private sector depends in part on the quality of institutions which will:

Help develop products that reflect international •standards; Support a long-term predictable market and economic •environment;Enable long-term predictable relationships within domestic •and external supply chains and help minimize the cost of doing business;Facilitate competitive access to inputs including access to •finance; andCreate a level playing field for all economic actors through •fair competition, security of property rights and a prudent judicial system.

The expansion of the private sector in Ethiopia is severely hampered by the lack of adequate capacity in important fields like accounting, auditing, business and project evaluation, and commercial law( Sida, 2004). The legal institutions for handling commercial relations and disputes are also found to be weak and lead to uncertainties for business people in their decision-making and business operations. The Sida study also pointed out problems of trust between the Ethiopian Government and the private sector as well as between domestic and foreign financial institutions. Based on such analysis, this study noted the following three important conditions that must be improved in the Ethiopian economic system to allow the private sector to increase its role in the development of the economy:

Modernisation of institutions that support and promote the development of the market economy; The financial system fully supports the new role of the private sector as declared by the Government ; and The business climate (including the government-business

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partnership) must be improved in terms of stability and good governance, and served by institutions that are capable of facilitating private sector development.

Similarly, the World Bank (WB), 2007 study defined constraints to Ethiopian private sector development and suggested that Ethiopian firms vary widely in performance. The Ethiopian markets are distorted to the extent that they may not be rewarding competitive firms and punishing uncompetitive ones. Hence, Ethiopian industry as a whole is not as competitive as it could and should be. In order to develop the private sector the study suggested addressing:

Major constraintsi) Land, finance, tax administration.•

Issues of fair competitionii) Entry barriers to domestic and foreign investors.•Level playing field for all as part of overall effort to make •markets competitive.Competition since it improves the performance of both •public and private firms.

Moving firms to a competitive frontier iii) Faster learning, specialisation, linkages.•Cluster development may play a role.•

Building Trustiv) Public-private consultation mechanisms to build trust and •social capital.

It should be noted here that the Ethiopian private sector itself has many weaknesses. Some of these include traditional organisation structures, weak financial positions, weak human capital (skills), limited exposure to international trade practices, lack of dynamic entrepreneurship, non-optimal size of enterprises, etc. Addressing these weaknesses requires a strategy incorporating a joint effort from both the public and private sectors. This will involve elaborating the major problems in more detail and suggesting approaches to address them during Phase I. In this phase the private sector is expected to begin transforming itself in terms of business conduct (governance) and organisation. The first step involves changing some of the negative perceptions about the private sector (which in Amharic is associated with “Negade”) from being perceived as a simple “money-chaser” to the modern understanding of the sector with social and corporate responsibilities. This change of perception is needed both in the government bureaucracy and among the population at large.

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The challenges that have been identified and which will need to be addressed during the institution building and self-discovery phase are:

Business Environment;•Judicial System and Property Rights; •Finance and Financial Sector; and •Global and Marco Environment.•

Proposals for tackling these challenges are summarised in Part II of this document. These fall primarily within the domain of Government while information about their impact on economic development can be provided by the private sector.

The analysis in this study points to the need to focus on the following institution building plan that facilitates the development of a market economy with a vibrant private sector. This has to be carried out by the Government with the active participation and provisioning of inputs by the private sector. The focus areas should include :

Revision of the Commercial Code; Modernisation of Company Register; Institutionalization of Corporate Governance; Standardization of Accounting and Auditing; Financial Sector re-engineering and Capital Market development; Implementation of Competition Policy; and Devlopment of a public-private sector dialogue and platform which studys, develops and implements policies.

While the bulk of the task of institution and capacity building is on the responsibility of the government, the contribution of the private sector remains vital. The private sector will in particular be the driving force in promoting the set of institutions provided in the preceeding paragraph as they are vital to the development of a market economy. The Ethiopian private sector is already in the process of developing project proposals and studies that would be submitted to the relevant government institutions for implementation. Table 1 below briefly shows the roles of the Government and the private sector with regard to institution building issues outlined above.

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In tandem with this institutional building, there is also a need for self-discovery by the private sector, with the help of the Government whenever appropriate.

Table 1 The Public and Private Sectors in Institution Building

Aspect of Institution Building

(Challenges)

Task for the Government/ Public

SectorTask for the Private Sector

Business Environment

Primarily needs to be done and led by the Government

1. Engage in building trust between the Government and the private sector.

2. Understanding and ownership of Government policy.

3. Developing entrepreneurship.4. Propose areas that need improvement.

Judicial System and Property Rights


1. Engage in transparent relationship with other firms.

2. Develop conflict resolution mechanisms.3. Propose areas that need improvement.

Competition Policy and Corporate Governance


1. Ensure legality and transparency in tax related issues.

2. Be part of a study team that develops these institutions.

3. Abide by the laws of the institutions.4. Be part of the governance structure.

Finance and Financial Sector


1. Be part of the study team for building new financial institution.

2. Upgrade skills in new financial innovation.

Global and Macro Environment


1. Be part of the study team working on the global trading system.

2. Design own strategy and align it with that of the Government.

Self-Discovery in the Private Sector1

The private sector is weak in identifying opportunities and acting upon them. This underscores the need for self-discovery by the private sector itself. The Ethiopian private sector is more often reactive than proactive.The recent developments in floricultue and the cement industry attest to this fact. Past trends indicate that the development of the private sector is

1 This section heavily draws from Weeks and Alemayehu (2004). Interested readers may consult the three major studies on source of growth, concretization of Agricultural Development Led Industrialization (ADLI) and Financing Development from which this synthesis report is prepared.

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not assured by using market mechanisms alone. In 2006 the Government launched a Plan for Accelerated and Sustainable Development to End Poverty (PASDEP) by planning massive investments and employing a balanced growth model. However, it did not clearly articulate the areas where the private sector could best contribute to the realisation of PASDEP. This calls for identifying sectors in which the private sector can contribute in the short to medium-term.

In order to make best use of the capacity and resources of the private sector to end poverty, selected sectors of the economy should be identified and respective action points for the public and private sectors identified. In this respect, pending further in-depth study, four major sectors shown in Figure 2 deserve the most attention in the immediate future.

Figure 2 Self-Discovery of the Private Sector Major Sectors

The selection of these priority sectors is based on the comparative advantage of Ethiopia in the short to medium-term in the first three sectors. The choice of the fourth sector is not only to create a knowledge-based society in the long-term but also to better integrate with the global economy. These sectors have also been identified as priority areas in the Government’s major policy documents such as the PASDEP, thus facilitating the dialogue between the public and the private sectors.The development and expansion of Small and Micro Enterprises (SMEs) is expected to result in the implementation of the envisaged public-private programmes in the four priority sectors.

i) Commercial Agriculture

One of the areas where the public and the private sectors can work jointly is the development of commercial crops.But this depends on the speed with which the Government can construct dams to generate hydropower

Electronics & ICT - Policy Direction- Provision of IT

infrastructure- Private sector

incentive for software & service export

- Marketing & country experience studies

Tourism

- Policy Direction - Infrastructure for

tourism- Incentive structure- Marketing & country experience studies

Livestock Sector - Policy Direction - Removing

constraints - Marketing studies - Research on

productivity - Building relevant

institutions

Commercial Agriculture

- Policy Direction- Irrigation zone - Water management- Provision of infrastructure- High value crops - Coping with market failure & risk

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and develop irrigated agriculture. Developing tertiary canals and producing crops as per market requirements would be the responsibility of the private sector.

Institutional reform must be followed by major public and private investment in infrastructure, especially in irrigation. In fact, the goal should be to accelerate public and private investment in land and water to facilitate the transition to intensive agriculture. In India, for instance, private farmers’ capital formation took the form of minor irrigation works, construction of bunds (embankments), and farm houses, machinery and equipment acquisition, increments to livestock, and development of orchards and plantations, while public investment was predominantly directed to large-scale irrigation projects and other physical infrastructure. The share of the private sector in the total investment in gross capital formation increased over time from 54.4 percent in 1960-61 to 75.6 percent in 1999-2000. Apart from its critical role in the “Green Revolution”, a recent study has also confirmed that irrigation had the strongest influence (followed by literacy) in explaining the reduction of poverty in India. This is an important lesson for Ethiopia. One simple rule of the thumb to delineate activities between the private and public sectors is to limit the Government to costly projects with large externalities while activities that need closer management and continuous operations, are allocated to the private sector.

Any agricultural development strategy in Ethiopia must tackle the high risk of crop failure. At least two irrigation sub-zones, similar to industrial zones, could be identified within the irrigated areas:

Irrigation zones of high value crops and livestock •products around major cities, and

Irrigation zones for industrial crops.•

Agricultural areas around Addis Ababa, for instance, have a huge potential for horticultural crops, including floriculture as well as dairy and poultry. The favourable climate, ranging from cool to hot weather, at a radius of only 200 to 250 km, allows the growth of various high value crops both for the local and export markets. Marginal areas have a disadvantage in producing many types of crops compared with high potential areas. But there are many food and other types of crops that could be profitably grown without damaging the environment. Starchy root and tuber crops (e.g. cassava), with high food calorie output per

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unit area compared to cereals, could be introduced through screening appropriate and adaptable varieties and cultivars.

Public investment in irrigation has not been very successful in many African countries because of poor and non-participatory management, unsustainable operation and maintenance, and lack of systematic development of market opportunities for high value crops that justify the high investment and production costs. A more effective performance can be achieved by transferring the management, operation and maintenance of irrigation schemes to users. Private water management initiatives are more viable and self-sustaining. Human resources trained in irrigation and smallholders well-trained in water management are critical for the success of irrigation agriculture. In this regard, strengthening the Arbaminch Water Institute in terms of teaching quality and research capacity tuned to the private sector demand would have a considerable positive impact. In general, the irrigation strategy needs to:

Have active participation of the private sector; •Reform the land tenure system and property rights •institutions;Research and introduce low-cost pumps; and •Promote local marketing and trade in the high value products •that are produced.

Public and private investment in irrigation and other forms of capital formation would not lead to sustainable high growth unless complemented by investment in land improvement and change in product mix in favour of a variety of high-value non-traditional alternative crops with the potential to spur investments in other sectors (industry, international trade, services, etc) through forward supply and backward demand linkages. This can be realized only if strategic decisions are made to take advantage of the country’s ecological conditions and global market opportunities.

The diversity of soil, climate, and elevation in Ethiopia allows production of a wide range of agricultural commodities. But these opportunities cannot be tapped without a substantial investment not just in irrigation but also in land improvement and watershed management. The very survival of the country depends on the change of the existing farming system, which has resulted in massive environmental degradation, to a new one based strictly on land improvement as well as conservation of soil, water, genetic and forest resources of the country. Moreover, sustainable intensification and diversification cannot be effective without a strong

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research and development system in which the private sector participates in research, problem identification and management.

To realize this goal, public institutions must undergo restructuring and reorganization to correct market failures without running into the problem of state failure. Most types of market failure do not necessarily call for public provision. Agricultural support services such as marketing, processing and finance can be supplied by the private sector provided an enabling policy environment is in place and an appropriate regulatory framework is operational. But public sector reform cannot be sustained without empowering the real stakeholders to ensure accountability. Related to the issue of agriculture is the need to begin to work on commercial agriculture that could create surplus production. This may requires institutional arrangements of some type. Thus, the self-discovery of the private sector is conditional on building institutions that are outlined in detail above.

ii) Livestock Sector

Most studies indicate that there is a huge potential for growth in this sector which is not adequately exploited due to a number of constraints. The public sector could invest in removing the constraints while the private sector works on marketing, processing and supplying the domestic and export markets. In particular, with Government initiative and the help of research, drought-prone areas with poor soils can be developed into sustainable pasture lands as well as for feed production.

It is possible to identify zones for high quality sheep, goat and cattle husbandry in drought-prone areas. A case in point is the opportunity of specialising in goat husbandry in Tanqua Abergele (lowland in Tigray), sheep production in Menz (North Shoa), and cattle husbandry in Borena. Farmers in these areas have already perfected their traditional herd management skills. With the provision of solutions to the feed problem and effective veterinary and marketing services, these areas could easily be transformed into major suppliers of goat, sheep and cattle not only for the national market but also for export to the Middle East (a market distant Latin American countries have been exploiting). Specialisation in small stock and beef production could offer a much better prospect in most of the marginal areas.

Low potential areas or arid and semi-arid parts of the country are also suitable for various activities, including livestock husbandry and tree crops. Comparative experiences show that the single biggest constraint on

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successful vertical diversification into processing primary commodities is the challenge of securing a reliable supply of high quality raw material inputs. Perhaps the clearest example of this challenge in Ethiopia is in the livestock sector. The prospect for rapid expansion will be very limited from a large livestock population which is disease-ridden. Slaughtering and storage practices are also inadequate and need to be significantly improved if Ethiopia is to suceed in export markets.

Ethiopia still has an “edge” in international markets for some goods, e.g. glove and soft shoe leather, but its reputation is fading rapidly because of poor quality control in production. Resources have been spent for years on efforts to control diseases in sheep and goats but have basically failed, suggesting institutional inefficiencies. The country cannot exploit its export potential without a dramatic increase in attention to these constraints, both by the Government and the private sector.

In sum, a recent study by the Private Setor Development Hub (PSD-Hub,2006) on the potential and the constraints of the livestock sector concluded that in spite of the substantial resource endowment and the various important cultural and economic fundamentals prevailing in the sector, the contribution of the sub-sector is not commensurate with the existing potential in the country as a whole. The major factors that account for the low productivity of the sub-sector are:

Subsistence production orientation of farmers; • Low production and productivity; • Underdeveloped processing opportunities; • Weak technological and extension support; • Poorly developed infrastructure;• Stifled livestock market; • Lack of effective policy support; and • Weak private sector participation. •

On the other hand, all of these represent potential areas for intervention by both the public and private sectors. Based on the conclusions drawn from the situation analysis of the past and present livestock sub-sector, the following are some of the recommended actions for the sub-sector’s development:

Strengthening extension services; Providing more quality services in feeding, housing, breeding and health;

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Increasing coverage of services to reach regions with potential; Forging closer public-private partnership thereby enhancing the efforts of the federal and regional governments to work better in promoting the sub-sector; Providing better service delivery to areas currently not attractive for private investors because of underdeveloped infrastructure; Withdrawing the public sector from activities that can be carried out by the private sector and instead focus on regulating the sub-sector effectively ; Encouraging the development of large commercial private farms;and Formulating a well-designed economic relationship between large commercial farms and smallholder farmers.

Among the potential areas the private sector can in particular engage include service delivery (vetinerary, artificial insemination, transportation and marketing), concentrate feed production, forage seed production, multiplication and dissemination of improved animal genotypes,collecting and processing of milk and honey, as well as operation of abattoirs and tanneries.

Finally, improvements in the quality and commitments of professionals serving the sub-sector by providing them with a good incentive system and career opportunities, and the provision of a supportive policy environment are preconditions for the existence of a viable livestock industry in the country.

iii) Tourism

Tourism, a sector whose potential is not tapped in Ethiopia, has immense potential that can be promoted with minimum investment. This sub-sector can generate large foreign exchange earnings as well as employment and other indirect benefits.

The major bottleneck to a more robust tourism sector is the underdeveloped infrastructure in the country. Besides focusing on infrastructure development, the Government should assume a proactive stance in promoting the sector in major tourist-originating markets. The private sector can develop the services needed by tourists and generate foreign exchange for the country.

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The sub-sector also has significant scope for promoting linkages, e.g. the packaging industries, and the scope for cyclically reinforcing synergies say, for instace, between the coffee and tourism industry. However, very little has been done to encourage the development of these linkages and synergies except for one or two highly publicized initiatives. There needs to be an organised process of collecting and disseminating the lessons from other successful country’ experiences, such as those of Kenya, Tanzania, Egypt and South Africa.

The Government needs to give priority to tourism development in a way it has never done before. Tourism is a foreign exchange generating activity and, hence, fits precisely into the group of activities that could be described as “export diversification” which is a key objective of the Government under the PASDEP.

Tourism, similar to other exporting sectors, has the role of generating demand and relieving the pressure on the balance of payments. Tourism has powerful potential synergies with other exports --- for instance the potential for mutually beneficial linkages between tourism and the specialty coffee market, the airlines industry and horticulture exports. Tourism can help to market Ethiopian coffee, and the marketing and consumption of high quality Ethiopian coffee (branded with the history of coffee in Ethiopia) can help promote and encourage tourism in the country.

Furthermore, a great number of visitor s would make it easier to reduce airfreight costs for floricultural and horticultural exports, thus enhancing their competitiveness. Therefore, both from the perspective of indirect and direct benefits, it is important that the Government gives policy and institutional priority to promoting tourism. In what has been the world’s fastest growing industry in recent years, Ethiopia’s tourism potential remains significantly untapped.

To tap that potential requires faster development of tourism infrastructure. However, tourism cannot be radically changed overnight. Therefore, it is worth concentrating on selective areas where the infrastructure and activities for tourism are relatively well developed or areas that have the greatest potential to attract tourists. One example is the aggressive promotion of tourism and tourism facilities in the major coffee-growing areas, the Rift Valley Lakes and historical sites.

There is a need to carry out public investment in infrastructure in selected tourist potential areas --- roads, power, and communication. Even the

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Rift Valley Lakes and hotsprings which are close to Addis Ababa lack basic infrastructural facilities. Some are completely run-down, signalling the need for transfering them to private or majority private share holding operators. The Government needs to invest in areas that have the greatest tourism potential and create the enabling environment for private sector operators. Such facilities built by the public sector need to be transferred on a long-term credit basis to private operators, or through joint ventures with the private sector.

An appropriate incentive system should also be put in place for those engaged in tourism, similar to the incentive system introduced for those engaged in the export sector. The country can also learn a lot from Kenya’s advancement in tourism policy, provision of facilities, research into potential tourist markets and foreign exchange and employment generation ideas that have worked well. A less costly and yet viable strategy is to first work on Rift Valley Lakes Zone (e.g., Zeway-Langano-Abayata-Shala areas ), followed by Historic Tourist Zones (e.g., Axum-Gonder, Lalibela, Sofomar, Harar) and Geologic Tourist Zone (e.g., Bale Mountains, Dallol Depression, National Parks).

More imaginative ways should also be found to market Ethiopian tourist destinations on passenger flights to and from Ethiopia.

iv) Electronics and the Information and Communication Technology (ICT)

Although the emphasis here is limited to a few sectors in the first phase of this strategy, it is imperative to note that the country needs to explore new non-traditional export sectors along what economist call the “Kaldorian line” where the country does not have apparent comparative advantage as of yet. One such area where Ethiopia seems to have potential, but failed to exploit thus far, is the electronics sector in general and the software and ICT industry in particular. Given the proliferation of domestic software firms, young skilled labour, and some excellent private sector software IT schools, sufficient attention and infusion of investment into this sector has not been made. There is the potential to turn it into a software exporting sector with global service delivery hubs that could exploit labour costs and time difference advantages compared to firms in developed countries. Given the stiff global competition to reduce costs and hence the outsourcing of labour intensive services to skilled and cheap labour countries, (the best example being from the UK and USA to India, and nowadays from India to Egypt), there is a great potential for development of this sub-sector.

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Notwithstanding the Government’s investment in infrastructure for the Information and Technology (IT) sector, it has to broaden its vision in at least two directions. First, the IT infrastructure planning should be visionary, ensuring the participation of private sector operators and timely implementation. It is important for instance that the Ethiopian Telecommunications Corporation, owing perhaps to its lack of foresight and skilled personnel, does not settle for a limited connection speed as low as 250Mb when the frontline technology in many countries in Europe for an ordinary connection is above 2,000Mb. Such planning shortcomings emanate from not being visionary, timely and lacking in market knowledge and global trends.

Secondly, the opening up of the telecom industry to the private sector and/or the joint running of the sector with international private sector operators, as Kenya has done, is central to address the major bottlenecks in the sector. It is also important that the Government introduces incentives encourage more investment into the development of “electronic processing zone” that produces software for export and services by creating a partnership both with public and private IT colleges and firms, as well as creating an enabling environment for potential entrepreneurs, including skilled Ethiopians in diaspora.

Making Ethiopia a hub in the region, which facilitates attractes regional and international organizations to locate their operation in the country, will realistically materialize only in Phase II. As the experience in India shows, investing in human skills and good infrastructure are the key to success. In India about 1,000 programmers are being produced in a day and IT product exports have become one of the most important exports of the country in the last decade. Ethiopia needs to learn a lot from this and the recent enhanced ties between India and several African countries, including Ethiopia, could be usefully exploited to develop the sector. The Government, in partnership with the private sector, also needs to invest in high speed connections to the Internet, provide internationally competitive salaries and prospects for career development to retain staff and attract the best (especially from the Ethiopian diaspora), and also improve working and living locations for technicians and their families.

Realising the objectives outlined above is daunting. It cannot be handled either by the Government or the private sector alone. There is a need to work together from inception to realisation. That requires the coordinated action of the private and the public sectors for which they have to develop a common plan with defined responsibilities for action.

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The major strategy of realising the above proposed programme of action is through the Private Public Partnership Dialogue (PPPD) that could be mandated to work on the planning aspect by taking each area as a project. It is imperative to draw from the experiences of successful countries in Asia and Africa so as to develop appropriate plans and policies for the development of the ICT sector.

The creation of a conducive environment through modernizing market supporting institutions will not only motivate local investors but also attract foreign direct investment. This, combined with self-discovery, will result in increasing the contribution of the private sector to the national economy. When the private sector grows in size and economic power, its voice in economic decision-making will also increase and it can play a significant role in employment creation and poverty reduction.

Consolidation and Transformation

The last stage of Phase I is the beginning of Phase II. When the development policies and programmes of the Government are increasingly designed in such a way as to attract and engage the participation of the private sector, complementarities between the sectors will gradually emerge. The sectoral diversity and relative size of the private sector will consolidate partnership within itself and with the Government.

The private sector also needs to rapidly transform itself in terms of business practices and organizations, building on what was achieved in Phase I. Big companies with multiple shareholders will emerge with the potential to grow and expand in the domestic market, and later to export markets as well. These types of businesses will dominate the economy in terms of value creation, while proprietorships and partnerships may still be large in number.

Phase II will also see the development of clusters that emerge through market forces and the Government’s focus on its priority sectors. The effort in this phase will be towards the advanced development of competitive clusters. This will require that firms in a sector begin to develop higher levels of sector collaboration, moving from dialogue and problem solving to more complex joint undertakings, including establishing technological institutes, industry-sponsored research, joint identification of markets and key suppliers, advocacy and strategic plans. In this phase, firms will thus move as commercial responses to complex incentives and problems far beyond those that can be solved simply through lower costs and tax privileges, which dominated Phase I. Each sector will require careful

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and continuous analysis, experimentation and problem-solving. It may be useful to consider investing in the implementation of industrial policies in a highly capable public-private institution that has the resources to support innovation in industry linking to global solutions, evaluating progress, ending support to failures and scaling-up support to the successful firms.

The roles of the state in entrepreneurial and technological development will also be highly developed in Phase II. Support by the Government needs to be made through education, research and development, imparting the latest technologies and know-how for the private sector and creating a cadre of managerial and entrepreneurial class that could aspire to go beyond domestic markets to regional and global ones. In short, the Government must at this stage accomplish the task of building capacities of the private and the public sector groups to organise themselves, to analyse key constraints by themselves, to continually participate in policy dialogue, monitoring of results, and to advocate and negotiate systemic changes to make Ethiopian firms regionally and globally competitive.

One of the suggested activities in Phase I, in parallel with addressing institutional problems, is the laying down of foundation for private sector development in non-traditional production and export sectors such as electronics and ICT, energy development and export, biomedical, etc. The investment in relevant infrastructure such as a Science Park, research institutions, as well as in physical and human capital required for the task need to “mature” in Phase II. This in turn implies the need to create a link between production activity and the research work carried out by research institutions.

In Phase II firms should be in a position to use the results of the investment in the non-traditional production and export sectors in Phase I for production and export in Phase II. With the consolidation of these activities, this phase can also unleash the potential of making Ethiopia a “centre of excellence” in education, thus attracting specialised and globally competitive research and education institutions to set up campuses in Ethiopia. This scheme can potentially generate foreign exchange from fee-paying foreign students (referred to as education export). Such institutions could be built on existing institutions like the Aviation Academy of Ethiopian Airline, private or public-private information technology institutes that will develop in the context of the focus on the electronics sub-sector, the Leather Technology Institute, Defence Engineering College, etc.

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Finally, Phase II also needs to lay the foundation for advanced industrial sectors in heavy industries, large chemical industries as well as knowledge-intensive production and an export sector that will flourish in Phase III. Works on a private-public sector collaborative effort to provide the infrastructure, research, as well as the human and physical capital required, need to be carried out in this phase.

Steady Growth and Economic Leadership

It is difficult to chart details of Phase III at this stage as it requires foreseeing what will happen in Ethiopia in the coming 10 to 15 years. Moreover, the success of Phase III is conditional on what happens in Phases I and II. With that caveat, a vibrant private sector with full capacity to compete both in the domestic and foreign markets need to emerge in Phase III. Big companies that subcontract to medium and small companies, and enterprises which work closely with multinational companies will emerge in this phase.

In addition to having their own research departments, large companies will work closely with academia in the area of basic research, and attempt to explore uncharted territories for production and exports. Thus, this phase will be characterized, among other things, by the production and export of knowledge-intensive goods. It is also hoped that non-traditional production and export sectors that are developed in Phases I and II (such as electronics and ICT, energy, biomedical and education export) will mature and assume a dominant position in the regional, and perhaps also in the Middle Eastern market.

Phase III will also see the consolidation and development of heavy industry, advanced chemical industry, knowledge-intensive production and export sectors, which are the seeds sown in Phase II. This phase should see the possibility of transforming these sectors to the production and export phase using public-private sector joint venture companies as well as big private companies,including those in joint ventures with multinational firms.

In sum, Phase III will see the culmination of all the plans and implementation schemes for the creation of globally competitive national firms. In this phase, the firms will maintain their global and regional competitive edge using country-based advantages such as skilled, but relatively low labour cost, geographic and ecological advantages, a big domestic market as well as proximity to the nearby high-income Middle Eastern market. Most of these firms will self-finance both their research

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and investment.Although the Government’s effort in advancing research and charting out policy direction will still be needed, a lot will be left to the private sector, with the Government focusing on regulatory functions, provision of security and stability as well as the charting of new policies that will develop the economy and reduce poverty.

Basic Requirements and Financing of the Strategy

The private sector in Ethiopia is besieged by a number of challenges which have been alluded to earlier. The Government of Ethiopia has an important role to play in creating an enabling environment, in building capacity, as well as in facilitating the implementation of the road map for private sector development based on joint dialogue and programmes that involve both the public and private sectors. The Government has the potential to unlock the huge potential in the private sector through selective investments as it is doing in the floriculture, leather and textile sectors. Apart from working on the major problems outlined above in relation to institutional building, there are also specific areas of government intervention that are required to implement the three phases of the strategy. These interventions are summarized in the figure below.

Figure 3 Basic Requirements for Each of the Phases

Phase I

Building institutions that support private sector development

Human resource development

Provision of business management skills

Conducting studies that address institutional problem and self- discovery possibilities (identification of priority sectors for

promotion /support)

Phase II

Advanced skill formation

Conducting studies in the subsequent downstream production and export growth

Phase III Private Sector Self Financing

of basic research with Academia Advances in its development

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Implementations of the Three-Phase Strategy

As shown in Figure 3, the intervention in Phase I requires working on institutional development, human resource development, provision of business management skills (BMS), and the provision of supporting services and institutions.

a) Institutional Development

Institutional development refers to a number of tasks that are outlined in detail in this study and described as fundamental and imperative for private sector development. These activities include company register modernization, financial reporting and auditing standardization, instituting competition policy, strengthening the judicial system and revising the commercial code, addressing issues of property rights, developing better corporate governance in all sectors. The bulk of these tasks, possibly all of them, need to be carried out in Phase I. However, some of them may extend into Phase II.

b) Human Resource Development

One of the basic concerns with respect to the competitiveness and growth of the private sector is the low productivity of labour. Some studies indicate that wages in Ethiopia are 37 percent of those in China while productivity is only 11 percent of China. This state of affairs should change with strong cooperation between the Government and the private sector. Thus, the development of human capital through training, technology transfer, joint venture and similar endeavours should be of a top priority.

In addition to institutional development the bulk of the activities related to human capital formation will be concentrated in Phase I. The task is however challenging since the country basically starts from an extremely low and weak human capital base. Moreover, redirecting the current educational system towards addressing the human capital needs of the country in the envisaged manner is another challenge. Once these challenges are met in Phase I, the country could proceed to Phases II and III.

The process of human capital formation is usually characterised by dynamism and hence the process will continue into Phase II and Phase III by advancing the level and complexity of human capital formation. This is central to further develop and maintain the competitive edge of the country over others in a continuous and sustainable manner.

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c) Provision of Business Management Skills

The entrepreneurial and business management skills of the Ethiopian private sector are at an extremely low level. Development of entrepreneurial competencies and the upgrading of business management skills require the special attention of both Government and non-government actors. This is particularly true in the first phase of this strategy. The task in Phase I will be daunting as the country starts from an extremely weak base, the relevant private sector enhancing institutions are not developed yet, and there are limited resources both in the hands of the Government and the private sector to invest in business and management development. It is hoped that these challenges will be eased in Phase II and will be completely overcome in Phase III.

d) Support Services and Institutions

The support programme of the three activities indicated above should be designed carefully. In the initial phase there are low levels of financial resources and social capital to support the development of the private sector. Preparations of project proposals for modernising institutions that promote the development of a market economy require huge resources and qualified experts. Engaging the private sector in an effective dialogue with the Government also requires studies that provide the private sector with hard facts and other information and analysis that make it a credible partner of the Government in the dialogue.

Trends in the general macroeconomic environment (including global and regional opportunities) and sectoral studies must be referenced to assist the private sector to identify business opportunities and act on them. These services cannot all be made available by the Chambers of Commerce and Sectoral Associations network. Support service providers such as the PSD-Hub at the Addis Ababa Chamber of Commerce and Sectoral Associations (AACCSA), the office for coordinating the Public Private Partnership Forum (PPPF), and others are invaluable for private sector development. Research and studies that would be useful for private sector development should be strengthened. The necessary financial resources in this first phase should mainly be from international donors, and possibly from the Government of Ethiopia.

It is hoped that during Phase II, the private sector will be significantly strengthened to be able to create and partially finance the formation and strengthening of support institutions.

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In Phase III, the economy is expected to be fully integrated across regions and within the global economy where large companies and medium and small enterprises work together in the form of subcontracting and linkages. The business sector, academia and the Government are expected to jointly work together in the area of basic research and advances in knowledge during this phase. At this stage, the services needed for the support of the private sector could mainly come from within and the public sector while the role of donors will be reduced to the minimum. This will be the path that the support to the private sector is anticipated to follow in the implementation of the strategy outlined in this study.

Last but not least, the plan should be supported with a framework to evaluate and monitor whether the actions are in conformity with the original plan in each phase and what the major challenges are being encountered. This monitoring and evaluation should be institutionalized as part of the proposed strategy of private sector development so as to ensure the continuity of actions in meeting the objectives.

Financing the Strategy

Planning the financing requirement of each of the phases is crucial for the successful implementation of the strategy. The financing strategy needs to be based on the current capacity of the Government and the private sector in terms of resources as well as the future development of these capacities. On this basis, it is important that the financing of activities in Phase I heavily rely on development partners, perhaps with small contributions from the Government,and in Phase II jointly by donors and the private sector. Phase III will largely be financed from the resources of the private sector.

Figure 4 Illustration of Financing Contributions

Phase Proportion of Funding

I Government Donors

II Donors Private Sector

III Donors Private Sector

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Dialogue between the Government and the Private Sector

The successful implementation of the strategy outlined in this study is conditional on the existence of a cordial relationship between the Government and the private sector. Such a relationship needs to be based on the common interest of developing and growing the national economy. This requires a continuous dialogue between the Government and the private sector. For effective dialogue between the two parties, there must be trust between the Government and the private sector. Without such dialogue and trust it is extremely difficult to realise the strategy. A starting point for this is to have a joint public-private sector dialogue forum. The importance of such a forum to realise the strategy cannot be overemphasised. Finally,once the above strategy is in place, its implementation will hopefully be fully supported by the private sector and the Government, with the help of development partners.

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PART IIchapter two

The Business Climate and Private Sector Development in Ethiopia

The Ethiopian Government is clear about the importance it attaches to the development of the private sector. This is articulated in the important policy-cum-plan documents, the “Sustainable Development and Poverty Reduction Program (SDPRP) for 2002-2005” and “A Plan for Accelerated and Sustained Development to End Poverty (PASDEP) for 2006-2010”.

Thus, there is no question about the Government’s commitment, at least in principle, to private sector development. The question is whether this is being implemented.

Evaluating the economic management of any government is a demanding task. Yet after examining the problems of private sector development in Ethiopia, Sida (2004) noted that the expansion of the private sector in Ethiopia is severely hampered by the lack of adequate competence in important fields like accounting, auditing, business- and project evaluation, and commercial law. The legal institutions for handling commercial relations and disputes are also found to be weak and lead to uncertainties for business people in their decision-making and business operations. The study also noted the problem of trust between the Ethiopian Government and the private sector, as well as between domestic and foreign financial institutions.

Based on such an analysis, Sida cited three important conditions that must be improved in Ethiopia to enable the private sector to play a more central role. First, it is important that the financial system becomes fully supportive of the new larger role of the private sector that the Government has declared. Second, reforms of institutions like the Competition Commission and the legislation related to loan collateral must be quickly introduced and implemented. Third, the business climate, including the government-business partnership, must be improved in terms of stability, good governance and supported by institutions that are able to facilitate private sector development.

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Similarly, the World Bank (2007) study on the Ethiopian private sector development noted that constraints most associated with growth are access to land and poor tax administration. However, low productivity persists, and productivity gains are modest relative to the recent improvements in the investment climate. The survey of the bank suggests that Ethiopian firms vary widely in performance. Markets may not be rewarding competitive firms and punishing uncompetitive firms so that the Ethiopian industry as a whole is not clustered around a competitive frontier. Expanding the frontier through investment climate reforms will have a limited impact according to the World Bank. In order to develop the private sector, the World Bank study suggested:

Removing major constraints, namely, land, finance, tax administration.Introducing fair competition.- Entry barriers to domestic and foreign investors.- Level playing field for all as part of overall effort to

make markets competitive.- Competition improves the performance of both public

and private firms.Moving firms to the competitive frontier.- Faster learning, specialization and linkages.- Cluster development. Building trust.- Public-private consultation mechanisms to build trust

and social-capital.

Notwithstanding the findings noted above, manufacturing (food and beverages, garments, furniture, wood and metal) with more than 5 employees covered 124 service enterprises and 126 informal sector enterprises with less than 5 employees. The survey is a follow-up of a similar survey conducted in 2002. The period 2002-2006 saw four years of growth, PASDEP, massive public investments, key reforms and it gave a good picture of the current business environment.

Issues relating to the business environment along three lines outlined by Amin (2005) are categorized below. The categories are policies, institutions and supporting public investment, each of which has a number of aspects.

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A. Government Policies and the Business Environment

Macroeconomic stabilityTax rates/administration and tariff levelsAccess to and cost of finance; and also access to landTime to clear customsAvailability of business support services - export facilities, etc.

B. Government Supporting Investment and the Business Environment

Power, Telecommunications services and Internet access Roads, Ports and Air freight

C. Institutions, Structural Factors and the Business Environment

Bureaucracy and regulatory structures Skill and education levels of labour force Strength of financial institutions

Rule of law, Control of corruption and crime.

A. Government Policy and the Business Environment

i) Macroeconomic Stability

The incentive environment within which the private sector is operating is found to be highly volatile. After investing resources in one sector, the return from this investment cannot be forecasted with any certainty. This is partly related to the signals of macroeconomic imbalance, political conflict and at times frequent policy changes and reversals. Private agents invest their assets assuming that they would get the maximum support from the Government. Such policy reversals and signals of instability create doubt in the mind of private agents as to whether any sort of conducive environment can be sustained in the long run.

ii) Taxes and Tax Administration

The World Bank study indicates that both tax rates and tax administration are reported to be major constraints for private business operations in Ethiopia.

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Table 2 Tax Rates and Administrative Constraints

Regulations and Tax Ethiopia RegionAll countries

Senior management time spent in dealing with requirements of government regulation (in percentage)

3.77 7.95 7.29

Average number of visits or required meetings with tax officials 1.78 4.35 3.61

Percentage of firms identifying tax rates as major constraint 39.96 45.16 36.49

Percentage of firms identifying tax administration as major constraint 29.05 32.55 27.28

Source: World Bank 2006 Enterprise Survey

As shown in Table 2 almost 40 percent of the respondents found tax rates to be a major constraint (comparable figure for all countries in the sample is 37 percent and 45 percent for the region). Despite this, only a small amount of time and resources is spent with senior government officials in dealing with these problems. Table 2 also shows that Ethiopian management must only spend a relatively small amount of time in dealing with the requirement of government regulations which have been deemed to be quite good both by regional and world standards.

Table 3 Trade Related Problems

Trade activities Ethiopia Region All

Average time to clear direct exports through customs (days) 4.3 5.14 5.21

Average time to clear imports from customs (days) 14.06 8.74 8.29

Percentage of exporter firms 10.12 22.71 25.81

Percentage of firms that use material inputs and/or supplies of foreign origin 67.97 65.57 57.8

Percentage of firms that trade identifying customs & trade regulations as a major constraint 16.95 22.83 17.87

Source: World Bank 2006 Enterprise Survey

Table 3 shows the trade related problems the private sector encounters. With regard to customs offices, business firms in Ethiopia require approximately twice as much time as that of the region or the world. A firm requires four days on average to clear exports from the customs office. Yet firms do not seem to recognize it as a serious problem.

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The Table also indicates that almost 70 percent of the respondents in Ethiopia use material inputs from foreign suppliers and the number of exporting firms is only half of the region’s average.

iii) Access to land and land policy

Among the problems that restrain the growth of the private sector include land and land related issues, according to Melese and Abera (2005). Their list of problems comprises lengthy bureaucratic procedures in acquiring land, lack of transparent procedures in dealing with officials about land, lack of coordination and information flow, and the introduction of a long term and very costly leasing system. Even when the investor is making the required payment, it takes a long time to acquire the land, handle disputes, and start the business.

iv) Permits and Licenses

As indicated in Table 4 below it is relatively easier for most firms to get a license or permit to start a business except for construction-related permits which are comparable to regional and world averages. It requires about 62 days on average to get construction-related permits. The table also shows that only one percent of the respondents consider getting licenses as an obstacle to pursue their business. This is one of the positive sides of the business environment in Ethiopia compared to the average figure of 17 percent and 15 percent in the region and the total sample, respectively.

Table 4 Licensing Related Problems

Permits and licenses Ethiopia Region All countries

Days to obtain operating license 11.35 15.4 29.66

Days to obtain construction-related permit 61.36 54.35 61.24

Days to obtain import license 13.85 14.3 19.03

Percentage of firms identifying business licensing and permits as major constraint 1.67 17 14.85

Source: World Bank (2006) Enterprise Survey

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B. Government Supporting Investment and the Business Environmenti) Infrastructure Development

Almost all empirical works as well as theoretical discussion on the issue underscore the importance of infrastructure in enhancing the development of the private sector. Thus, investment in infrastructure (road, telecommunication, electricity, internet service) is a fundamental requirement for a well-functioning private sector. A properly established infrastructure is a major factor that will also help attract foreign investment. Despite this fact, the provision of public utilities to private sector operators in Ethiopia has remained poor.

The survey result about infrastructure reported in Table 5 next indicates that serious problems exist in availing all types of public utilities except in obtaining water connection which is good in Ethiopia (the Ethiopian figure is comparable with the regional and the total sample average). There is a delay of about 59 days and 44 days for getting telephone and electric connections respectively. Both figures are found to be greater than the regional and the total world sample average. Despite their negative response about getting connection for electricity and telephone, the respondents reported that there was only one percent loss in sales owing to power outages.

Table 5 Infrastructural Development

Infrastructure Ethiopia RegionAll countries

Number of power outages in a typical month 5.08 14.93 11.86

Value lost due to power outages (% of sales) 0.91 5.94 4.28

Delay in obtaining an electrical connection (days) 44.22 38.21 30.47

Average number of water shortages in a typical month 8.3 8.39 7.47

Delay in obtaining a water connections (days) 19.44 42.24 36.4

Delay in obtaining a mainline telephone connection (days) 58.51 54.14 33.82

Source: World Bank 2006 Enterprise survey

ii) Expenditure on Research and Development

Only a few of the firms surveyed have research and development departments established within the structure of their businesses. Most of the firms assume that it is the duty of public institutions to take care of such activities. The majority of the privatised firms are fairly small and weak, hence, spending on research and development is not as such significant, if indeed there is any.

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C. Institutions, Structural Factors and the Business Environmenti) The Issue of Security

With regard to security of the environment for the operation of the private sector in the country, Ethiopia fares better compared to regional countries as well as the total sample average. Only a few firms (1.5 percent) report the existence of theft, robbery and the occurrence of vandalism. Despite that however, close to 92 percent of the firms do procure security services.

Table 6 Security

Crime Ethiopia Region All

Percentage of firms paying for security 91.93 63.83 62.71

Losses due to theft, robbery, vandalism, and arson against the firm (% of sales) 1.44 3.28 1.8

Security costs (% of sales) 1.1 1.95 1.62

Products shipped to supply domestic markets lost due to theft (in %) 0 0.48 0.42

Percentage of firms identifying crime, theft and disorder as major constraints 11.64 26.56 21.15

Source: World Bank 2006

ii) Corruption

The survey result reported in the following table indicates that a number of firms pay bribes either in kind or in cash to run their businesses. The degree of corruption is relatively lower in Ethiopia compared with both regional countries and the total sample average. But much more needs to be done to make the business environment free from corruption because a significant number of firms (23 percent) perceive corruption as a major constraint.

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Table 7 Corrupt Practices

Corruption Ethiopia Region All

Percentage of firms expected to pay informal payment (to get things done) 12.42 45.54 36.23

Percentage of firms expected to give gifts to get an operating license 2.7 17.93 16.69

Percentage of firms expected to give gifts in meetings with tax inspectors 4.35 19.89 26.37

Percentage of firms expected to give gifts to secure a government contract 11.8 42.87 26.9

Percentage of firms identifying corruption as a major constraint 23.08 34.39 32.7

Source World Bank 2006

iii) The Dominance of the Agricultural Sector in the Economy

The majority of the Ethiopian labour force is engaged in the agricultural sector. It is however, not realistic to designate the smallholder farmers as part of the private sector. Since the sector is not yet commercialized and neither is strong enough to get the attention of the Government, it cannot play a dynamic role that is expected from a vibrant private sector. Currently, few smallholders are being transformed into commercial farmers. In addition, investing in the agricultural sector in most cases is found to be risky and difficult, as one cannot use the investment in land and the land itself as collateral.

iv) The Market Structure

The market structure within which the organized private sector operates is characterized by imperfection and lack of a level playing field which negatively impacts on its development. The need to address this issue through revising the commercial code and related policies is of paramount importance for the development of the sector.

v) The Nature and Attitude of Private Sector Actors

The attitude of the private sector actors is also an important factor. This relates both to the firms innovation and technology as well as their financial position. About half of the firms have their financial statements audited by external auditors (the regional and total sample figure being about 50 percent. Ethiopian firms seem less inclined to use the World Wide Web, and are very limited in the use of licensed technology, both by regional and the total sample standards. The World Bank survey indicates

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that only about 4 percent of the firms have both ISO certification and employ licensed technology which is about threefold less than the sample and the region’s average. This shows how weak Ethiopian firms are when it comes to fundamental strengths.

Table 8 Use of Technology

Innovation and Technology Ethiopia RegionAll countries

Percentage of firms with ISO certification ownership 4.16 11.69 13.82

Percentage of firms with annual financial statement reviewed by external auditor 46.46 51.15 53.08

Percentage of firms using technology licensed from foreign companies 4.19 10.39 11.75

Percentage of firms using the Web to communicate with clients/suppliers 18.01 21.78 39.57


Access to finance is also very limited (needing about 178 percent of the loan amount for collateral, compared to the regional and the sample average of 145 percent and 140 percent, respectively). Only 11 percent of firms use bank loans for investment purposes while nearly half of the firms having a line of credit with banks (the regional and the sample average being 23 percent and 27 percent respectively). Nearly 44 percent of firms noted that they have been constrained by finance and this is a comparable figure with the regional average (see Table 9).

Table 9 Access to Finance

Finance Ethiopia RegionAll countries

Percentage of firms with bank loans/line of credit 46.03 24.71 33.54

Percentage of firms using banks to finance investments 10.95 13.88 16.09

Percentage of firms using banks to finance expenses 40.7 23.16 27.34

Value of collateral needed for a loan (% of the loan amount) 178.59 145.89 140.66

Percentage of firms identifying access/cost of finance as a Major Constraint 44.24 48.97 30.29


According to the World Bank survey, Ethiopian private firms are comparatively very weak in competitiveness compared to those of neighboring countries (see Figure 5 below).

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Figure 5 Sales per Worker: Ethiopia, Kenya and Vietnam

Source: World Bank (2007)

Figure 6 Sales per worker in garments – Ethiopia, Kenya and Vietnam


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According to the World Bank survey, Ethiopian private firms are comparatively very weak in competitiveness compared to those of neighboring countries (see Figure 5 below).

Figure 5 Sales per Worker: Ethiopia, Kenya and Vietnam


Ethiopian industry is characterized by a very broad distribution of performance levels – efficient and inefficient firms coexist and this low level of competitiveness is acute in some sectors. The Government is attempting to target some sectors, such as garments (Figure 6).

0

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kdensity Ethiopia kdensity Kenyakdensity Vietnam

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Figure 6 Sales per worker in garments – Ethiopia, Kenya and Vietnam


According to the World Bank analysis, the competitiveness of Ethiopian firms did not improve much over time. This is shown in Figure 7. From 2002 to 2006, the study indicated that Ethiopian industry has become marginally more “competitive” but its basic weak structure has persisted.

0

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kdensity Ethiopia kdensity Kenyakdensity Vietnam

Garments

Log sales per worker - Ethiopia, Kenya & Vietnam

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Ethiopian industry is characterized by a very broad distribution of performance levels – efficient and inefficient firms coexist and this low level of competitiveness is acute in some sectors. The Government is attempting to target some sectors, such as garments (Figure 6).

According to the World Bank analysis, the competitiveness of Ethiopian firms did not improve much over time. This is shown in Figure 7. From 2002 to 2006, the study indicated that Ethiopian industry has become marginally more “competitive” but its basic weak structure has persisted.

Figure 7 Sales Per Worker in Ethiopia in 2002 and 2006


D. Other Related Issues

In addition to the problems discussed in detail above, there are other related problems that hamper the business climate in Ethiopia. The major ones being:

i) The role of imported inputs

Most private firms are utilizing imported inputs whose prices are determined in the international markets. Whenever there is a price shock in the international markets it can negatively impact the private sector. In addition, the tax rate for imported inputs is usually very high.

ii) The degree of complementarities and substitutability

There are problems that may arise from the degree of complementarities and substitutability between private and public investment. The proportion of public to private investment and its growth rate is expected to affect private investment. Some public investments are complementary, like investment in infrastructure and public utilities where the incentive for the private sector to engage in the provision of such services is not attractive (such investments are referred to as crowding-in the private investment). There could be, however, a possibility of the Government doing what the private sector could have done, perhaps more efficiently, such as credit (this is what is referred to as crowding-out). Maintaining the appropriate balance between crowding-in and crowding-out by the Government is crucial for private sector development in Ethiopia.

iii) Donors and Non-governmental Organizations (NGOs)

Non-governmental institutions, donors and international organizations could also play a role in facilitating training for the business community, providing technical support for business owners, facilitating public-private partnership and dialogue to enhance the cooperation between the public and private sectors. In this regard, the role of NGOs is generally limited to provisions supporting the poor and vulnerable citizens. According to an Inter-American Development Bank study (2004), most NGOs are playing a role in the financial sector working as micro finance institutions in Latin America. These institutions could easily adopt policies and strategies that address the constraint of credit to the private sector.

iv) Issues of Management and Support System

Poor and inefficient management of natural resources, agriculture, fishing, tourism, industry, forestry and minerals make the desire to invest in the private sector unattractive for private agents. As Amin (2005) noted, a good business climate is central for productivity growth. A good business climate consists of elements shown in Figure 8 (good institutions, policies and infrastructure). Thus, the Government needs to work on these three dimensional issues outlined in the figure in order to effectively develop the Ethiopian private sector.

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Figure 8 Three Dimensional Issues for Private Sector Development in Ethiopia

Source: Amin(2005) chapter three

An efficient investment climate creates conditions for productivity growth

InvestmentsPowerTelecommunications servicesRoadsPortsWaste disposalAir freightInternet

PoliciesMacroeconomic stabilityTax rates / adninistration Access to and cost of financeTime to clear customs Availability of business support servicesTariff levelsAccess to landAvailability of export facilities

InstitutionsBureaucracy and regulatory structuresSkill and education of labour forceStrength of financial institutionsRule of lawControl of corruption and crime

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chapter threeThe Judicial System and Private Sector Development

An independent judiciary is now a requirement of all modern political systems; even the military government (Dergue) used to boast of setting up an independent judiciary. There were several provisions in its short-lived constitution that laid down rules and standards on judicial independence. What might have been lacking was the political will to turn this lofty ideal into practice in the hard reality of governance. An independent judiciary implies “… a judiciary which dispenses justice according to law without regard to the policies and inclinations of the government of the day….” (Sir Ninan M. 1985, p.529). Judicial independence is thus characterized as the single greatest institutional support for the rule of law (Maria D. et al. 2000, p.353). By separating the adjudicatory function and placing it in a body independent of the political branches, it seeks to promote impartiality, fairness, consistency and predictability in the interpretation and application of laws (Kramer, et al. 2002, p. 967).

Independence of the judiciary shelters the process of adjudication from interference by the political officials responsible for enacting or enforcing law. Interference from these actors undermines the substantive commitments embodied in law through partial applications ---partial both in the sense of being biased and in the sense of encompassing less than the whole (Ibid). It goes without saying that an independent judiciary is indispensable to the administration of justice that its absence would certainly arrest the economic, social and political development of a country.

Judicial independence has two dimensions. The first dimension pertains to institutional independence, which is the requirement that judgments delivered by the judicial branch be respected and enforced by the legislative and executive branches; that the judiciary will be treated on an equal footing with the other branches; that it will receive the material support necessary to carry out its functions appropriately; that all judicial powers remain within its province; and most important, that the other two branches will refrain from conduct that may undermine the legitimacy of the judiciary (Torruella, R. undated, p.48). The second dimension

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relates to decisional independence, also called personal independence of the judges. It bestows on judges unfettered freedom to perform their functions, particularly in deciding their cases, subject to no overriding authority save that of the law. Decisional independence requires that judges be granted protection in their tenures, in their compensations, and in their physical security, irrespective of the decisions they reach. Recognition of merely one aspect of judicial independence, whichever that may be, will make futile the whole objective of having an independent judiciary; one cannot exist without the other.2

With the adoption of a federal system of governance, Ethiopia’s 1995 Constitution brought about two parallel court systems, a new approach in the hitherto unitary body politique of the nation. It establishes a three-tiered federal court system and state court systems to be established, at least theoretically, by the nine members of the federation. It is therefore appropriate at this point to pose the queries: Does the legal system recognize and practically give effect to the principle of judicial independence? And what is the implication of that for private sector development? The discussion that follows will shed light on these.

The Judicial System: Independence of the Judiciary

Institutional Independence

The Constitution of the Federal Democratic Republic of Ethiopia (FDRE) has reserved a number of provisions set to establish and protect the institutional independence of the judiciary. Article 78(1) state that an independent judiciary is to be established. Judicial powers are thus vested, both at the Federal and State levels, in the courts that have been so declared to be independent.3 To ensure that these judicial powers would remain exclusively within the province of regular courts, the Constitution prohibits the establishment of special courts that encroach upon the jurisdictions of regular courts of law.4 The institutional independence of the judiciary is heightened further when the Constitution states categorically that “courts of any level shall be free from any interference or influence of any governmental body, government officials or from any other source”.5 The judiciary is also empowered to make decisions on its internal matters by its own. These internal matters include preparation

2 Ibid.3 Art.79 (1) of the FDRE Constitution4 Art.78 (4) of the FDRE Constitution 5 Art.79 (2) of the FDRE Constitution

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and, upon approval, administration of its budget6, administration of courts,7 selection of judges8 and recruitment of support staff.

Decisional Independence of the Judiciary

Institutional independence alone is by no means sufficient to realize the independence of the judiciary. It is therefore equally important to ensure the personal independence of the judges. Judges must be subordinate to no other authority than that of the law in the discharge of their judicial business. Framed in that light, Art.79 (3) of the FDRE Constitution provides, in no uncertain terms, that “judges shall exercise their functions in full independence and shall be directed solely by the law.” To avoid any form of intrusion into this autonomy, a number of other guarantees have also been provided to the judges. The tenure of judges, for instance, is put beyond the whim and caprice of the executive or of the legislature since the Constitution accords lifetime tenure of judgeship. It is only on exceptional grounds that this lifetime tenure may be terminated. Even then, it is the jurisdiction of the Judicial Administration Council to decide to remove a judge from his office on the grounds provided therein.9

Be that as it may, a mere constitutional declaration of independence of the judiciary is not in itself sufficient to bring about the desired objective, for even constitutions of the most autocratic systems are replete with these vows. In this context it is said that “declaration of independence does not equate to the creation of independence if institutions and systems are unable or unwilling to shoulder the burdens and share the power” (WB, 2004). It must be underscored that everyone will embrace the principle only when its practical reality leads to ensuring protection of fundamental interests.

Is judicial independence then a myth or a reality in the Ethiopian context? This is a question as valid in the country today as it had been in the past. Even if the Constitution promises not to give away judicial power of the regular courts to any special or ad hoc court, for instance, the reality

6 Art. 79(6) &(7) of the FDRE Constitution authorizes the Federal Supreme Court and State Court to draw up and submit for approval their budget to the House of Peoples’ Representatives and to the respective State Councils.

7 Art. 16 of Proclamation 25/96, Proclamation on the Establishment of Federal Courts 8 Art.81 (2) of the FDRE Constitution states that, except the President and the Vice-President of

the Supreme Court, selection of judges should be made by the Judicial Administration Council. The administration includes taking disciplinary measures against judges. See also Art. 79(4) of the FDRE Constitution.

9 Art.79(4) of the FDRE Constitution

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depicts otherwise. Current trends show that such courts do in fact exist. Certain conflict resolution mechanisms, such as the Foreclosure Law, are incidences that erode the power of the judiciary (Tilahun T. 2004, pp.23-27). This trend is a subject of heated controversy and will be dealt with in depth later. Powers given to the Federal Ethics and Anti-corruption Commission under its establishment legislation and those given to the tax authorities under the Income Tax Law are yet other examples.

Democratic systems recognize that interpretation of the law, including the Constitution, falls under the authority of the judiciary. This extends from ascertaining the meaning and giving effect to a provision in a particular legislation to examining the constitutionality of laws, regulations and executive actions, and to interpreting the meaning of a provision in the Constitution, the supreme law of the land. This should not imply that the judiciary is superior to the other two branches of the Government. It rather supposes the superiority of the will of the people.10 Unfortunately, the Ethiopian judiciary is effectively denied this power of reviewing the constitutionality of actions of the legislative and the executive. The Constitution grants this judicial power to another wing of the legislature, the House of Federation.11 Understandably, this approach, by and large, limits the power of the courts to put a check on both the legislature and the executive branch, whose improper actions or laws that are unconstitutional could be rendered void by an independent judiciary.

In practice the Ethiopian judiciary still suffers from a wide range of problems.

The World Bank study conducted on the judiciary also confirmed that judicial independence in Ethiopia does not look bright. It noted that “Internal (or vertical) independence is arguably a problem at the federal level, although it was not widely reported. In the past, telephone calls have allegedly been placed from higher-level judges or Commission members to First Instance judges questioning decisions and perhaps trying to influence case outcomes. In at least some instances, the First Instance judges were able to hold their ground without repercussions. In most cases, however, the government has no real substantive interest in the outcome and this has not presented a significant problem. In cases where one of the parties is a state enterprise engaging in commercial activities, obtaining and enforcing a judgment against the State has reportedly been problematic. It was reported that where government interests are

10 Ibid.11 Art. 83 (1) of the FDRE Constitution

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at stake, direct interference has been noted; influence of the executive is otherwise much less apparent (WB, 2004).”

Unchecked political pressure by the executive, even if applied infrequently, casts doubt on the free and fair disposition of judicial business, causing judges and others involved in law enforcement to beware of considerations extraneous to the case at hand. Only the strongest of judges and law enforcement officers would act otherwise (World Bank, 2004). To ensure the independence of the judiciary, the following reform measures are recommended as they may help build the confidence of the public on the judiciary:

Appointment of judges should be made strictly on the basis of merit;The judges must be free, as so declared in the Constitution, to be guided only by the law no matter how delicate the issue might be;The judiciary should be equipped with all the necessary manpower and other resources;Clear standards, procedures, and rules for decision-making with regard to judicial selection, promotion, discipline, termination, and other conditions of employment must be set;The Judicial Administration Commission is better put beyond the reach of the officials of the executive branch of the Government.

Accountability of Judges

“In the traditional telling, an independent judiciary is regarded as if it were the font of justice, the rule of law and individual rights, if not the font of all good things. Such worship of judicial independence is not sustainable, theoretically or empirically. Indeed, the concept of judicial independence potentially flies in the face of our fundamental constitutional concept of checks and balances. While there is no doubt that a measure of judicial independence is a good thing, such independence must be kept in balance with judicial accountability (Cross, & Frank, B. 2003)”.

An independent judiciary, which is corollary to the principle of separation of powers, provides the best hope for protecting fundamental freedoms and values as expressed in the Constitution. On the other hand, scholars warn that unregulated judiciary does also have tyrannical tendencies (Clifford W). This danger can only be averted if proper mechanisms that

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ensure accountability of the judiciary itself are in place. In the absence of such accountability, many fear that corruption and impropriety are threats that cannot be ruled out (Maria D. et al. 2000).

In a word, the concept of judicial accountability may be understood as “the responsibility of judges for their decisions and/or the liability of judges to give reasons or justifications for their conduct and to demonstrate that their conduct in the resolution of disputes is not the product of mere whim or caprice.” (Louis M. 2002) Judicial independence, which sometimes stands in tension with judicial accountability, does not therefore mean the right to decide cases according to standards alien to norms and values of society but to decide according to those norms and values, without outside pressure, or fear of reprisals (Cross, Frank, B. 2003). Undeniably, judges wield wide powers over the life, liberty and property of citizens. Indeed, they are the repositories of the third branch of state power – the judicial power and, as the saying goes, power corrupts and absolute power i.e. power without limits, corrupts absolutely.12

Seen in this light, the Ethiopian Constitution seeks to achieve this objective by the check and balance system that exists among the three branches of the government.13 In addition to such institutional check, it is of prime importance to put in place the individual liabilities of judges in the event of gross violations of the laws of the country, or ethical standards of the profession. Judges are not fully immune from civil or criminal liabilities. Every judge needs to subscribe to the accepted rules of the profession and the officially endorsed code of conduct.

Examined against these standards and norms, some measures have already been taken by the Ethiopian judiciary to ensure the accountability of its members. A survey conducted during this study witnessed that:

Improper conducts of judges are subjected to disciplinary •measures by the judicial administration commission (there are judges dismissed on this ground);There is a Judicial Code of Conduct that ensures accountability •of judges; and Any judgment rendered unlawfully entails accountability of the •concerned judge who would be brought before a disciplinary committee.

12 Ibid.13 For a clear understanding a reference may be made to Chapter One of the Constitution that

deals with separation of power and checks and balances.

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Access to Justice

Access to justice is one of the basic human rights that must be realized in a democratic society. In fact there is no point of having an independent judiciary if access to justice is not feasible or is impaired. As the term itself implies, access to justice can be taken to mean the ability of individuals or groups to avail themselves of the use of the justice system whenever and wherever they feel their rights and interests have been jeopardized in one form or another. Broadly taken, it may also include access to the laws and legal information, to affordable and effective remedies in a reasonable period of time, to legal representation, etc.

Access to justice, therefore, pertains to access to a coordinated and user-friendly justice system, including private, traditional and/or informal mechanisms, which are accessible in terms of cost, distance, language, and remedies. It thus includes:

Access to laws, case reports and other forms of legal materials; Access to appropriate, efficient, affordable and effective remedies; Access to legal services, legal aid and representation, where necessary; and Access to effective alternative dispute resolution systems (ADR).

In this regard, the right of access to justice is recognised under the FDRE Constitution. Art. 37(1) thus reads “everyone has the right to bring a justifiable matter to, and to obtain a decision or judgment by, a court of law or any other competent body with judicial power.” A number of other provisions have also been spelt out to this effect both in the Constitution and other subordinate legislations. This is apparent particularly in criminal matters. The right to legal counsel of one’s choice or of a state appointed one, the right to an interpreter where the court proceedings are conducted in a language one cannot understand, and the right to be tried within a reasonable period of time14, to mention but some, are instrumental in securing the right of access to justice. Likewise, other subsidiary laws have also laid down rules that enable people to vindicate their rights before a court of law. The Civil Procedure Code of 1965, for example, has provisions that enable a person with insufficient means to initiate a civil action.

14 Art. 20(1) (5) & (7) of the FDRE Constitution

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In a developing country like Ethiopia, however, access to justice can be impeded by different factors. As a result, converting this right into reality and providing mechanisms for meaningful enforcement will require confronting and overcoming a multitude of practical and legal challenges (WB, 2004). To start with, backlog in a court is one of the pressing challenges that cripple the realization of access to justice, although there have been some improvements in reducing delay and backlog in some courts by the court reform.15 The lack of legal information is also a pressing problem in the country. This problem is best described in the following quotation.

“The right [of access to justice] is seriously undermined by the lack of awareness of, or knowledge about, the law or the formal legal system. The publication and dissemination of laws and legal reference materials is very limited. Judges at lower judicial levels, particularly at the district level, usually complain that they do not have copies of laws or updates. Courts must sometimes adjourn proceedings in order to find copies of pertinent laws or revisions. Judges sometimes request the advocates to produce relevant proclamations when they cannot proceed with litigation due to the lack of pertinent laws”.16

Even though a two-tiered court structure is established following the adoption of the Constitution, physical distance and costs still constitute enormous barriers to accessing justice. The following quotation from the above mentioned report by the World Bank lends support to this chronic problem.

“Courts now exist in most districts (woredas), but these are still far from where much of the rural population lives, and a person may have to leave his or her fields and walk for several days to reach the closest court. Courts have little significance to the rural population. Very few courts have the resources or ability to operate on circuits, and therefore cannot effectively move closer to the populations they serve. When determined people make the long journey on foot to the court, they often simply show up at the courthouse steps on their own with no idea how to present or defend their claims. Attitudes in the courts towards assistance to the public can be poor. Language barriers can often be a problem, and interpreters may not be available. Accommodation of needs for handicapped access is minimal. Although relatively low, filing fees may be prohibitively high

15 WB, 200416 Ibid.

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for many people (even if petitions can be filed for fee waivers). (World Bank, 2004).”

Execution of Judgments

Save for cases of a declaratory nature, the whole point of instituting any civil action is, more often than not, to seek redress for wrongs done to one’s rights or interests. As noted above, an independent judiciary encompassing the element of accountability is indispensable to enhance effective remedy of this type. Access to such a judicial organ is a condition precedent for one to benefit from the system, one way or the other. But at the end of the tunnel, the issue will boil down to enforcing the decision.

It is obvious that judgments in a civil case may not necessarily hand in the remedy required unconditionally. Following the court decision thus remains a separate litigation to seek enforcement.17 In the light of this truism, execution of judgments is still another deficient area of the Ethiopian justice system. This is also a fact duly noted in the World Bank Study (WB, 2004). At times, execution of judgments takes much more time than the actual civil proceedings. The following factors are generally identified to be the main problems associated with execution of judgments:

Authorities entrusted with execution of court judgments do •not follow a uniform practice, nor do they have rules to that effect; Procedural impediments make it arduous to transfer title of •property ownership of the judgment debtor, or selling such property; It takes a prolonged time to make estimation of the property •of judgment-debtors and have it liquidated; Courts frequently adjourn execution proceeding for no •justifiable reasons;The process itself is costly and those involved in the exercise •are not always immune from corruption and other forms of impropriety;Interference by powerful political groups and by those having •close connections to them is not an uncommon phenomenon; and There are no separate units within the justice system entrusted •with the responsibility of execution of judgments.

17 Art.378 of the Ethiopian Civil Procedure Code, 1965

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There were, of course, respondents, though few in number, who stated that execution of judgments in Ethiopia is as smooth and efficient as could be expected under the circumstances. It should, however, be noted that delays and inefficiencies in the execution of court decisions and orders have tremendously eroded the confidence of the public. Reform measures to restore this confidence are, therefore, in order, if not long overdue, if any meaningful exercise is to be undertaken to build confidence and allow the true development of the private sector.

The Role of an Independent Judiciary for Private Sector Growth

“A tolerable administration of justice, along with peace and low taxes, is all that is necessary to carry a state to the highest degree of opulence.”(Adam Smith in Tilahun T. 2004, p.22)

That we need to nurture our judicial system if we aim at ensuring the rule of law is undisputable. The rule of law for its part is an essential instrument for ensuring respect of human rights and bringing about social development.18 And as such, contemporary economists propagate that an efficient and independent judicial system plays an important role in facilitating economic development. There are studies that have confirmed that weaknesses in the judicial system entail serious damage to development. To cite an example, the World Bank in 1997 conducted a study on 3,600 business enterprises in 69 countries, in which they reported that 70 percent of those who responded to the questionnaire had stated that the main constraint their businesses faced was a result of the flaw within their respective judicial systems.19

Where there is an efficient judicial system, the right to property guaranteed by law will be protected, contracts will be properly executed/enforced, long-term agreements will be signed for the undertaking of large construction projects that will in turn contribute to economic growth and development, and bureaucratic bottlenecks and performance constraints will also be significantly reduced.20 Stated differently, when judges are free to decide cases in accordance with their unbiased and uninfluenced interpretations of the law the public can expect more predictable decisions, for the outcomes of a legal proceeding will not be based on the whims of those with money or power.

18 Ibid.19 World Bank, 2004 20 Ibid.

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That Ethiopia needs foreign capital for its development is undeniable. One important area of consideration that any foreign investor takes into account when making a decision to invest abroad is reliability of the legal system and predictability of its process (Tilahun T. 2004). The 16th century English philosopher Thomas Hobbes indicated that without such a judicial system traders would be hesitant to even enter into contracts because of the possibility that promises could be dishonoured. In his own words: “[h]e that performed first has no assurance the other will perform after because the bonds of words are too weak to bridle men’s ambitions, avarice, anger, and other passions without fear of some coercive power.”21 Only a well operating legal system and judiciary encourages technological progress and investment. The proper functioning of courts would, therefore, have a market enlargement effect, which in turn brings about technological spill over and diffusion of knowledge through the transmission of sound marketing, financing and managing practices (Pinherio, 1996, p.10).

A number of judges, lawyers and prosecutors were asked to evaluate the prevailing Ethiopian judicial system in light of a private sector-led growth. All seem to agree with the theory that an independent and strong justice system is critical to enhance the growth of the economy in general and the private sector in particular. Most of them, however, admit that the justice system as it stands now is not strong enough and well attuned to help realize rapid private sector development. They were of the opinion that the judicial system is one of the weakest links on Ethiopia’s road to development.

When faced with a weak and overloaded judicial system, resorting to alternative dispute resolution (ADR) mechanisms becomes no more of a luxurious exercise. Putting in place the necessary legal and institutional framework for such ADR mechanisms as arbitration, mediation and conciliation will thus be of great benefit both to the judicial system and the society as a whole (Tilahun T. 2004).

Briefly stated, ADRs pertain to: “...any processes that may be used within or outside courts and tribunals to resolve disputes, where the processes do not involve traditional litigation processes. The term describes processes that are non adjudicatory, as well as adjudicatory, that may produce binding or nonbinding decisions and includes processes described as mediation, evaluation, case appraisal and arbitration” (South African Law Commission, 1997).

21 Quoted in Menberetsehai Tadesse, 2006

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Given the increasing number of disputes brought to courts, the length of time one is likely to spend to have his/her case finalized, excessive costs of dispute resolution, the utility of ADR becomes increasingly paramount. Respondents to this study’s questionnaires indicated that ADR mechanisms are not commonly employed in Ethiopia. They stated that many people are not aware of their significance either. They pointed out that the following benefits could be derived from ADR mechanisms.

a) Minimise the role of the courts, avoid backlog of cases and save time and energy.

b) Encourage parties to amicably solve their dispute in accordance with their customs.

c) Avoid winner-lose situation and any adversarial process.d) Avoid partiality and biases.

The Ethiopian legal system is not alien to ADR mechanisms. These mechanisms, particularly arbitration, have long served as a device for resolving conflicts. Now that Ethiopia has embarked on the path to a market economy, it is timely that an elaborate legal regime governing such mechanisms of dispute resolutions be put in place (Tilahun T. 2001). The private sector should also take an active role in exploring the potential uses and benefits of ADR mechanisms. In this regard, the current efforts, both by the Government and some civic organizations, to introduce and set up different means of ADR are encouraging.

In the light of these observations and the parameters outlined above the reality in the present day justice system leaves much to be desired.

The increasing openness by Ethiopia’s private sector to foreign investors will dictate the need for more objective rules and transparent conflict resolution, be it through formal or informal systems. The implementation of laws and improvements to the overall judicial system and institutions are critical and primary needs, and hinder commercial transactions more than inadequacy of laws (World Bank 2004).

Moreover, domestic entrepreneurs also need an efficient judicial system to have confidence in the system so that, inter alia, enforcement of contracts are attained in a less costly manner, investments and property as well intellectual property rights are protected. Such an environment can be put in place by developing a legal framework for an alternative dispute resolution (ADR) mechanism. This is a prerequisite for any private sector development.

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chapter FourProperty Rights and Private Sector Development

Ever since the publication of Adam Smith’s Wealth of Nations in 1776 economists have been aware that security of property rights against expropriation by fellow citizens or the state is an important condition for encouraging individuals to invest and accumulate capital. Hence, economists have tended to centre their analysis of the deeper determinants of growth on the role of institutions. Emphasis here is placed on factors such as the role of property rights, the effectiveness of the legal system, corruption, regulatory structures and the quality of governance (North, 1990; World Bank, 1997; Olson, 2000; Acemoglu et al., 2001, 2002a; Glaeser and Shleifer, 2002, cited in Snowdon, Vane 2005).

The legal system, particularly the commercial code and the property rights systems are important factors. The importance of this issue has been illustrated by the Nobel Prize winner Douglas North for his institutional analysis. North (1990) argues that the economic development of Western Europe did not seriously begin until the development of property rights which ensured that individuals could reap some of the benefits of their ‘ideas’ and helped to speed up the pace of technological change. The era of modern economic growth, beginning with the Industrial Revolution in Britain, occurred when the institutions protecting intellectual property rights were sufficiently well developed that entrepreneurs could capture as a private return some of the enormous social returns their innovations would create … history suggests that it is only when the market incentives were sufficient that widespread innovation and growth took hold (Jones, 2001, cited in Snowdon, Vane 2005).

In the case of the United States of America, the founders of the US Constitution were eager to ‘promote the progress of science and useful arts’. Therefore an intellectual property clause providing for copyright and patent rights appears in the first article of the Constitution and by 1810 the US ‘far surpassed Britain in patenting per capita’. The failure of the People’s Republic of China to lead the first industrial revolution has also been attributed to that country’s inability to establish a free market, institutionalize property rights, provide an environment conducive to

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emulation and innovation, and to absorb foreign technology (Lands, 1998 cited in Snowdon, Vane 2005).

Thus, according to the new breed of endogenous growth models, “the government has great potential for good or ill through its influence on the long-term rate of growth (Barro, 1997, cited in Snowdon, Vane 2005)”. Economic growth can be influenced not only by policies that affect trade regimes, technology transfer, the provision of infrastructure and financial markets, but also by policies that affect taxation and incentives, the protection of intellectual property rights and the maintenance of law and order.

When a country is as poor as Ethiopia, property rights basically consist of landed property, particularly in rural areas. The three regimes (the Imperial, Dergue and EPRDF) have managed to extract surplus from, and exercise political control over the peasantry owing to the control that they have on land and the land policies that they have adopted. The land issue in Ethiopia is as much political as it is economic. Major regime shifts in the country can be linked to the question of how the land market is handled. The Imperial regime was characterized by private (and church) ownership of land. Political power is largely linked to the amount and quality of land owned. Reward to political alliance was also used to be linked to handing of land by the emperor to the local and regional authorities. The end of the Imperial regime witnessed an active land market both in rural (usually for emerging commercial farms) and urban areas. Following this, one of the major reasons for the 1974 revolution and the subsequent regime shift was the land question. Accordingly, one of the radical policies of the Dergue regime was the nationalisation of both urban and rural lands. This policy effectively put an end to the emerging land market. This policy of public ownership of the land has also been pursued in the third (post-Dergue) period and it has now become as much a political as an economic issue. Thus, prohibitions of land market as well as state ownership of the land are explicitly incorporated in the country’s current Constitution.

In sum, in Ethiopian agrarian society the operation of the land market has a serious bearing on the growth and performance of the economy. The existing property rights regime and the related land market has certainly constrained growth mainly through risk of insecurity, fragmentation of land holdings and lack of commercialization of agriculture.

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The pivotal role of a land market in the development of a country, therefore, needs to be emphasized. It is worthwhile mentioning the following in this regard (Desalegn R. 2004).

Land helps to ensure that land moves from those •who, due to a variety of constraints, cannot use it productively to those who can;It helps to meet the needs of the landless, i.e., landless •peasants will have the opportunity to get access to land through the land market; It provides opportunities for enterprising (and well •endowed) peasants to enlarge their farm operations; and It offers a reliable source of income to poor right •holders who would otherwise be in dire straits.

Land and Property Rights: Brief view of the Legal System, Problems

As indicated in the discussion above, land tenure in the urban areas is governed through a lease-holding system regulated under the Re-enactment for Urban Land Lease Holding Proclamation No.272/2002. The preamble to this Proclamation lists down the justifications that prompted its enactment noting that “…because it is believed that transferring urban land by lease for a fair price, consistent with the principles of free market, will help achieve overall economic and social development and to help build capacity enabling progressive urban development based on the life span that a landed property may have and the period it requires to recover investment costs, the special nature of the investment, and the land use specified in conformity with the Master Plan….”; and “… to remove obstacles of and to expedite the process of permitting and holding urban land by lease based upon an investment plan made in conformity with the Master Plan….and because it has conversely been found necessary to ensure that the order in which the claims of anyone alleging infringement of one’s legal right and benefits is transparent and expedient.”

Thus, with a view to achieving the above stated objectives, the Urban Land Lease Holding Proclamation was issued. The leaser is the Government, while the lessee is the investor. The Proclamation stipulates that land can be given to individuals, outside of the lease system, for purposes of building low cost houses or it may be set aside for purposes of providing social services. Payment for any leasehold is to be determined

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by Regional Governments. The minimum price will be set by the respective Regional Government, and the one who sets the highest bid price will be given the leasehold. In effect, Regional Governments, and the City Administration in the case of Addis Ababa and Dire Dawa, enjoy unfettered and monopolistic discretion to set the price, making it exorbitantly high. Absence of transparency in the allocation of land makes the problem even worse.

The law has also embodied some provisions concerning those lands considered as lawfully held. The relevant authority can decide to clear any person from the land he holds. It can deprive a person of urban landholding when:

The lessee fails to pay his/her due; The manner of use of the land is changed by the unilateral decision of the holder of the land;The land is required for public use; The tenure of the lease expires or is not renewed, or It is decided by the administrative body that the land has been held illegally.22

If the landholder who is asked to clear the land has complaints to register, he/she can only appeal to the one that required his/her removal from the land. Even then, the substance of the complaint cannot dwell on the issue of whether or not the person should have cleared the land; it should rather be limited to the question of demanding compensation or to the inadequacy of the compensation so paid. If the appellant still is not satisfied with the decision, he/she can, within thirty days of the delivery of the decision, appeal to the Urban Land Clearance Appeals Commission or, depending on particular situations, to bodies established for the purpose within the jurisdiction of City or Regional governments. Appeals may be made against the decisions of these organs either to the appellate division of the respective Municipal Court or the High Court, the ruling of which shall be final. The main thing, however, is that even such courts are denied the right to look into the propriety of the decisions made against the person to clear the land he/she holds. The court only looks into questions of whether or not the person cleared from the land should be paid compensation, and if decided that he/she should be paid, whether or not the compensation so paid is adequate (Tilahun T. 2004).

22 Art.15 and 16 of the “Re-Enactment of Urban Land Lease Holding Proclamation No.272/2002”

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Stated differently, the lawfulness or otherwise of the eviction or dispossession is excluded from being a justifiable matter before a court. No doubt, such a procedure puts into question the relevance of the provisions related to landholding security that have been stipulated in the Constitution and the Lease Proclamation themselves. The constitutional right to bring any justifiable matter before any ordinary court is thus compromised. It should also be pointed out that at all levels of litigation, except in the event the amount of compensation is challenged before the court, the Commission is made to be a judge in its own case. The implication of such a law for private sector-led development where the issue of property rights is at the heart of the matter should be obvious.

If the Government is serious about promoting private sector development, it should devise a land policy that promotes efficiency and security. Such land policy should provide a sound and practical judicial framework for dealing with land disputes as well as accord fair protection for right holders to protect their rights in the event that those rights are violated or are threatened to be violated. Such a judicial framework is currently absent, thus inhibiting private sector-led growth. With the current land policy and its management, it would be difficult to think of attracting both domestic and foreign direct investment.

Major Challenges of the Land Lease System and How to Tackle Them

In the Addis Ababa context, the lease price of land varies across different types of activities. The lease price is expensive for businesses and apartments, but it is less costly for residential purposes involving the construction of individual homes or low-cost housing. In order to promote private sector growth, the lease price for industry is moderate. About 50 percent of the leased plots of land were below Birr 500 per square meter, 75 percent of the plots were below Birr 1,000 per square meter and more than 95 percent of the plots of land were less than Birr 2,000 per square meter. When one looks into the significance of land in overall investment costs, it differs from case to case. There are cases in which land cost accounted for about 16 percent of the investment costs, while in most cases, land cost accounted for a mere 3.5 percent of overall investment. More significant is the access to land and its delivery.

Access to land and its delivery in Addis Ababa has been cited as a major constraint by 65-70 percent of the investors interviewed for the AACCSA (2007) urban land lease problems study. Respondents complained that

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land acquisition delays are very long in Addis Ababa, some having to wait for years with the minimum waiting period being between six to twelve months. This does not take into consideration the time it takes the City Administration to prepare a particular area for lease. Once land is acquired, the biggest obstacle reported is the lack of infrastructure, particularly in outlying urban areas. These include electricity, telecommunications, and access roads. This lack of infrastructure seems to be correlated with the fact that revenues from lease and land related taxes account for less than 10 percent of total annual revenue of the City Administration. In short, the implementation of the land lease policy in urban areas is besieged by a number of problems that deter rapid private sector development in urban areas. The urban land question is thus fundamentally a supply and management question, as opposed to an ownership. Some of the major problems identified by the AACCSA (2007) urban land lease study in relation to the implementation of the lease policy include the following:

Emphasis given by the municipal administration to •generate revenue at the expense of the developmental imperatives of the policy; Absence of up-to-date city-wide master plan (which •was later revised) and area specific detailed plans; Supply-side rigidities associated with capacity •limitations to prepare a sufficient number of plots of the right size and shape at the appropriate location; Poor coordination between municipalities that are •responsible for the land delivery and para-statal organisations in charge of infrastructure and service delivery; Lack of an objective basis to determine lease prices •for plots to be advertised for possible holding under lease arrangements;Limited awareness on the part of the business •community about the advantages of the lease arrangements; Creation of artificial demand as strategy to pre-empt •potential takeover of already occupied plots by other investors and also speculation in land transactions; Rigid payment modalities that pertain to interest rates •and duration of payment;Reliance on traditional systems of savings and credit •systems by the business community; and

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Absence of well-developed mortgage (financial) •markets.

Consequently, the implementation of the urban land lease policy was typified by a vicious circle --- high lease prices for land, coupled with shortage of basic infrastructure and services leading to low demand for urban land, hence limited investment and sluggish local economic development (Stepper, 2000). Thus, there is a need to address these problems to ensure expedited access to developed land. This would contribute to the lowering of transaction costs that would otherwise be incurred by potential investors and, hence, ensure improved competitiveness for business establishments.

The issue of whether or not a given sectoral activity, including land ownership, is best undertaken by the public, private or other sectors, or some form of partnership between them, is best determined by the nature of the activity concerned and local considerations that apply at the time rather than political dogma. This suggests that it is important that regular reviews are undertaken by all urban development agencies to stimulate a wide range of supply options and assess the costs and benefits of each, together with other stakeholders, namely developers, landowners, NGOs, Community-based Organisations (CBOs), and local residents. Indeed, it is amply clear from the findings of the AACCSA study that the central issue in urban land is not whether or not it is owned by public, private or some form of partnership between them. Rather, it is how it is administered and managed.

Land administration relates to the improvement of the efficiency of land administration systems through registration and titling as well as formalising and securing land transactions and the regulation of land markets. Sound land administration involves the establishment of systems for land registration and titling of existing rights, cadastral services, land surveying, and capacity building in local communities to support these activities. It further requires the institution of simple and fair procedures for land transactions and their formal registration, mechanisms for regulation of land markets, maintenance of land information systems, and regular land valuation exercises. Land management, on the other hand, involves land redistribution and resettlement, including compensation of landowners facing expropriation, provision of infrastructure, support to services and productive support in newly settled areas. It further involves the restitution of land rights taken away from original owners or users as well as the establishment of new institutions and structures

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with responsibility for land acquisition, administration, and conflict resolution.

As made amply clear from the above, it is of critical importance that, when considering a question as important as land and any policy and changes to the land tenure system, it is best perceived as the outcome of a broad political process that has gathered views in a representative manner. Equally important is recognizing the roles of different stakeholders in the process of implementing land policies.

Urban land policy reforms take time to be implemented in a proper manner going through a series of successive phases and requiring an interactive approach. These policy reforms are also complex undertakings which require firm political commitment by the state and support from society at large. While it is the responsibility of Government to provide a system of land administration which is accountable, transparent, and cost-effective, responding to the diverse needs and characteristics of all stakeholders remains a major challenge. The role of each of the stakeholders that will help in the development of an efficient urban land policy in Ethiopia is briefly outlined below.

The Role of Government

Clearly, the drawing up of policies, legislation, administrative structures, and procedures for the protection of property rights is in the state domain. In this regard, land and property rights are pivotal in ensuring a fair and secure distribution of rights to land, which is at the heart of economic, social, and political life. Given the central nature of land rights and policy, consultation and review of policy and subsequent legislative, structural and procedural provisions become important. While it is the duty and prerogative of Government to set priorities and to choose from among set priorities, the exercise will benefit from broader public debate and inputs from a wide range of interested parties and stakeholders. Such an approach would help the Government to muster clarity in the priorities it wishes to set and the nature of choices to be faced.

Current processes of decentralization in Addis Ababa create new roles for local government in supporting participation in policy formulation and implementing effective systems of land administration befitting local conditions. Addressing land issues constructively and minimizing possible conflicts requires responses adapted to realities at the local level and a legal framework flexible enough to deal with specific local conditions. It is however essential that legislation establishing and enforcing

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adequate controls to ensure the impartiality of local authorities and the consistency of their decisions with national policy is firmly put in place. It is further essential that coordination between the different ministries and public departments involved in land issues is ascertained to remove inconsistencies between sectoral policies. In designing and implementing land policy that helps promote private sector development, it is the Government’s responsibility to provide an efficient land administration and management system.

The Role of the Private Sector, Civil Society Groups, and Local Communities

When considering a question as important as land, it is critical that any policy and changes to the land tenure system be perceived as the outcome of a broad political process that has gathered views in a representative manner. Setting the process right and transparent is essential for avoiding disputes and accusations of partiality.

Even where participatory consultation processes are widely used in such areas as the introduction and review of new policy proposals, these exercises often are largely known to be of limited significance. This is because of the lack of commitment on the part of Government to respond to remarks received. Under the circumstances, governments tend to find it easier to rely on foreign experts and consultants to formulate plans and policies. Although foreign experts can provide vital technical information for policy-making, they cannot replace public debate and the knowledge and experience of stakeholders who can greatly contribute towards identifying key issues and providing appropriate solutions. Hence, strengthening public debate is the best way to build ownership and ensure that policy reforms promote the interests of all stakeholders. The private sector, civil society groups, and local communities must be considered as primary stakeholders in the exercise.

Effective alliances with the private sector, civil society groups, and local communities are also essential for the implementation and design of sound land reforms. Indeed, such an alliance can engage stakeholders in facilitating the provision of support services, including infrastructure development. Decentralized approaches involving civil society participation could also serve as an effective instrument in increasing advocacy in land administration and management processes.

Private sector, civil society groups, and local communities should contribute not only to designing and implementing policy, but must also

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be closely involved in monitoring and reviewing the way the new rules, administrative structures, and procedures are performing. Importantly, external monitoring and evaluation involving research institutions, civil society, private sector, and beneficiaries could serve as powerful instruments for ensuring independent assessment and improving the effectiveness of new policies that have been introduced.

Ethiopian urban land policy is sound in principle but is besieged by implementation and administrative problems. Policy reforms to address these implementation and administrative problems can broadly be divided into three categories, namely, Urban Land Management, Promoting Good Urban Governance, and Decentralization.

1) Urban Land Management

To create conditions for adequate urban land for residential, industrial and other uses and to improve the economic efficiency in urban land supply, the following list of policy actions should be considered.

a) Improve the Efficiency and Transparency of Land Markets

Mechanisms that can be employed to improve the efficiency and transparency of land markets include:

i) Improved mechanisms for land transfer (cadastral mapping, land titling, and registration);

ii) Land information systems for the benefit of private and public interests;

iii) Deregulation/relaxation of avoidable land-use controls; and

iv) Institutional and legal reforms that would permit urban land to be used as collateral in the full amount. Such policy and technical reforms would help increase the rate of investment while, at the same time, contribute to improved property-based tax revenues.

b) Rationalize/Strengthen Institutional Framework for Land Administration and Capacity Building

The framework for land administration needs to be rationalized in the context of decentralizing responsibilities currently in place for urban land management. This may require merging land development public agencies that operate at the national level with local governments. Some of the priority areas that need to be addressed in capacity building

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include training in management skills, especially in response to demand-led provision of services; development of expertise in performance monitoring; financing of investments; evaluation of development proposals; coordination of spatial planning and sector investments; and use of community resources. Key elements in the task of rationalizing/strengthening the institutional framework for land administration and capacity building include:

i) Defining Clear Roles and Functions. An important aspect for improving urban land management is the institutional structure that is in place for planning, financing, and delivering services and other functions of government. Responsibilities for delivery of a desired service need to be assigned clearly to a single level of government, but where feasible should include the participation of the private sector, and the community. The principal problem in this regard is that service delivery for the urban sector involves many government departments with poor coordination among them in the policy-making as well as the implementation process. The growing importance of the private sector is further placing new demands on the public sector which is already constrained by shortages of skilled personnel. It is important for city government (urban land policy makers), therefore, to thoroughly review responsibilities for service delivery before inviting the private sector to participate.

ii) Upholding Government as Facilitator. Government needs to adopt an enabling role in support of the private sector by:

Setting policies and making choices in the private sector’s •priorities; Monitoring private sector operations in service delivery;•Supporting the economic health of the city (urban sector);•Protecting the community against threats to urban life •quality, including pollution, congestion, overcrowding, and damage to scarce resources, and Establishing a new relationship that encourages public-•private partnerships in land and property development, as well as service delivery.

iii) Fostering Skills Training and Other Capacity-Building Schemes. The lack of skilled human resources is a major constraint to developing the necessary structures for improving urban land administration and management in Addis Ababa and in other urban areas. The

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relatively low status and pay, and lack of incentives offered by most local governments are the principal causes for attracting and/or retaining qualified staff to enable the city to fulfill its mandates.

(c) Improve Efficiency in the Delivery of Serviced Land and Public Services

There is a need to improve efficiency in the delivery of public services such as access to roads, water, drainage, and electricity through:

Developing efficient, transparent and simplified land delivery mechanisms, including cadastral systems, land registration mechanisms, land transactions, legal frameworks, land valuation and taxation as well as land consolidation and readjustment;Delivery and regulation of public services in partnership with private profit and non-profit organizations, including civil society organizations (CSOs), CBOs and NGOs to sites with or without such services;Promoting integrated, inter-sectoral planning and land management;Improving the effectiveness and efficiency of local revenue collection from taxation on land and buildings; Capacity-building activities aimed at strengthening local capacity;Treating land as an asset in an investment portfolio to secure funding and provide security for private sector partners; and Using land pooling mechanisms as part of public-private partnerships, using techniques such as joint ventures for commercial property development, land readjustment, and low cost housing schemes.

(d) Improve Spatial Planning and Urban Planning Systems

Improved urban planning and regulation help provide strategic guidance for urban expansion and renewal policies and to address the externalities arising from land development. Such approaches may include:

Use of flexible zoning techniques through which the •private sector provides social/offsite infrastructure in exchange for fast-track planning/building approvals;Controlling the supply of land to prevent low-density •urban sprawl and to limit the fragmentation of urban land with a view to reducing costs for the provision of

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infrastructure at the periphery. This is best done through taxation, long-term strategic land use planning, and control measures, and appropriate fiscal incentives; and Private-public partnership in land management fostering •co operation between the public sector and private profit and nonprofits organisations, including CSOs, CBOs and NGOs.

(e) Establish Procedures for Public Participation and Civic Engagement

In respect of civic engagement and participation, the objective is to encourage civil society to actively contribute to the common good. This requires empowering civil society to participate effectively in the decision-making process.

Effective procedures are vital for public participation in decision-making on the use of land and location of infrastructure investments. There should be procedures for an interactive process of plan development and project implementation. Mechanisms to be developed and put in place to ensure public participation in the urban land management and administration processes include:

Encouraging participatory approaches to land policy; Instituting participatory decision-making in land management; Instituting legal authority for civil society to participate effectively through such mechanisms as development councils and neighborhood advisory councils; Developing local land use planning at the sub-city level based on dialogue with affected people; Empowering people to assert land rights through information campaigns and sensitization;Strengthening existing and new civil society movements to facilitate participation of communities/individuals in land issues; and Implementing environmental planning and management methodologies based on stakeholder involvement.

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2) Promoting Good Urban Governance

Four principles for achieving good governance underlie all policies for strengthening urban land management. These are accountability, participation, predictability, and transparency.

a) Accountability: If officials and staff in urban administration are to be held accountable to policy makers and stakeholders alike, their work needs to be assessed using performance indicators and benchmark criteria. This holds also true for the delivery of services by the private sector.

b) Participation: Greater participation by all stakeholders, especially by a growing number of interest groups that would like to have more say in urban land policy development and implementation, is an essential prerequisite of good governance. Participatory approaches are particularly relevant for enhancing the role of the private sector. Community participation will enhance improved service delivery.

c) Predictability: In situations where cities are growing faster than the institutional capacity to manage such growth, administrative and legal procedures are often applied erratically and to the disadvantage of stakeholders, particularly in respect of streamlining administrative and legal procedures. In relation to urban land management and administration, streamlined procedures for land registration and the validity of titles ensure predictability and confidence for households and businesses. Potential private investors in the delivery of city services need confidence that the legal system is adequate in terms of contract law, dispute procedures, and clear allocation of responsibilities.

d) Transparency: In dealings between the private sector and local governments, transparency is often lacking. A good example is the deprivation of freely available data on land markets, resulting in increased costs to the potential developer and corrupt practices. The institution of computer-based land information systems facilitates the storage and dissemination of data freely, promoting transparency and accountability in the process.

Clearly, the accountability of local authorities to civil society is a fundamental tenet of good urban governance. Transparency and accountability are further essential to local government credibility

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and stakeholder understanding of local government viewpoint on who benefits from government decisions and actions. Access to information is fundamental in this exercise. Applied to urban land management, the principles of accountability, participation, predictability, and transparency require:

Regular, organized, and open consultations with civil •society and the private sector on all matters concerning land;Ensuring transparent management of an open land market •by removing administrative and procedural incentives for corruption;Ensuring transparent, comprehensive, and accessible •systems in land rights transfers and security of tenure; and Establishing codes of conduct, enhancing ethics of service •to the public, putting in place adequate remuneration to public servants; creating public feedback mechanisms; and providing access to information on urban land administration and management.

3) Decentralisation

Decentralisation is a commitment to sustainable development that empowers local governments through greater authority, responsibility, and resources to implement urban development projects and better delivery of urban services. A prudent decentralisation programme would include: -

The simultaneous decentralisation of responsibilities, resources, and autonomy;Strengthening of local government capabilities, powers, and responsibilities;The collection and diffusion of information on local government services; and Review of city government employees’ remuneration, incentives, and career structures.

There are compelling reasons for the Addis Ababa City Administration (and the urban areas in the country at large) to pursue decentralisation policies which, if properly conceived and implemented, will greatly improve the management of urban land and support improved delivery of urban services. Decentralisation is not a goal in and of itself, but is

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an instrument for achieving more effective service delivery systems, opening institutions to wider civic participation, and increasing public trust in government. Effective vertical, lateral, and internal co-ordination is needed to support the decentralisation process. In this regard, the decentralisation effort must heed the following:

a) Vertical Coordination: Vertical coordination is an important component of urban management as the central government remains responsible for the legal framework of the public sector and the performance of various other critical functions. On the other hand, responsibilities for services, including urban land management, should devolve to the level of government whose boundaries best incorporate the beneficiaries of those services.

b) Horizontal Coordination: Horizontal coordination is important among public sector stakeholders involved in city development as well as public-private sector coordination. In addition, cross-border coordination will be needed where there are large adjoining urban areas composed of numerous local governments.

c) Internal Coordination: Internal coordination mechanisms are critical to overcome poor coordination of interdepartmental, sectoral, spatial, and financial planning; poor coordination of service provision; inadequate staffing; and unfamiliarity in dealing with the private sector in service delivery.

4) Private Sector Involvement

The introduction of market-based principles and private sector expertise into the urban sector, including land management and administration, can bring a variety of benefits, in larger cities like Addis Ababa, particularly in introducing:

a) Market-based Approaches: The adoption of market-based approaches and private sector expertise would enable public agencies to deliver better and self-financing services. Allowing the private sector to operate a service, either on a contractual or an ownership basis would lead to improved services, increased operational efficiency, and access to private financial resources.

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b) Regulatory Framework: At the local level, regulations will need to address the quality and required reliability of services to be rendered. Public agencies need to gain understanding of what the situation demands so that an environment conducive to attract the private sector can be created. Furthermore, in forging agreements with the private sector, the rights of the urban poor to enjoy equitable access to land and basic urban services needs to be protected.

c) Providing Accurate and Up-to-Date Information: Private sector and civil society groups have differing potentials and capacity to influence the policy process and ensure its transparency. Through their formal and informal networks and organization, the private sector and civil society groups could play a crucial role in initiating reforms or accelerating their pace and overcoming the resistance of those groups opposed to land policy reform by providing regular, accurate and up-to-date information. This would involve the commissioning of studies on a regular basis that would track urban land market behaviour, price trends, supply and delivery of urban land as well as infrastructure. Such studies could be made by the Chamber of Commerce independently or in partnership with the city administration.

Other Major Issues of Property RightsTax Law and Its Management

The power to tax is essentially an inherent attribute of sovereignty. It thus belongs to every independent state as a matter of right. While exercising this inherent right, the Government should abide by the salient principles of taxation. For instance, tax equity is very important in the distribution of burdens among citizens.

The current Ethiopian tax system seems devoid of such equity principles viewed in the light of the outcry of the public on the excessive amount of tax imposed on each taxpayer. Tax administration in Ethiopia is generally weak, because it is poorly organised. Tax assessment is carried out in a fairly rudimentary level of sophistication. Consequently taxpayers have to wait for a decision on their liability for a considerable period of time after submitting all the necessary information to the tax authorities. It is not also uncommon to receive a new tax assessment notification after waiting for so long.23 There is little in the way of standardised procedures. 23 Over the past few years, however, the tax authority is making several attempts to modernize its tax

assessment system, particularly in the collection of the VAT.

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The principal objective of tax administration should be the establishment of voluntary compliance of each taxpayer to effect his/her tax obligations in a timely manner. Creating a tax administration that promotes voluntary compliance is very difficult and requires an administrative system that is both fair and consistent. The tax administration in Ethiopia is inefficient, inconsistent, and above all, detrimental to the establishment of voluntary compliance. A fragmented tax administration thus only collects the revenue that “walks in the door” of the local tax office. This situation appears to be improving lately after the Federal Inland Revenue Authority (FIRA) established a payments system utilizing banks that enable taxpayers to effect tax payments in a timely manner. By requiring payments to be made through the banking system, tax administration reduces the collection burden and enables the tax authorities to focus on other more serious policy issues.

The Income Tax Proclamation that had been in place from 1961 has been replaced by the Income Tax Proclamation of 2002. Under the old law, the seizure as well as the sale of any property of the taxpayer used to be carried out in a court-supervised manner,24 but the new law vests the power of levying, assessing and implementing tax decisions to the Federal Inland Revenue Authority (FIRA). The new law’s Art.77(1) thus stipulates that if any person liable to pay tax imposed by this proclamation is in default, it shall be lawful for the FIRA to collect such tax by seizing any property belonging to such person. This power of the FIRA is strengthened by the provision that authorises it to sell the seized goods by public auction or in any other manner approved by the FIRA not less than 10 days after the seizure.

Hence, when it comes to payment of taxes, the plaintiff, the judge and the executor of judgment is the same body empowered to collect taxes. There is therefore room for FIRA to abuse its power, as there is neither a statutory restriction nor a court intervention to protect the interest of the taxpayer and third parties who have a stake in the property being sold by auction. Even when the amount of the tax assessed by the FIRA is not acceptable to the taxpayer, the plaintiff will proceed to rule on the “guilt” of the latter without any intervention of an impartial judicial organ.

The Power of Sale Foreclosure Law and Its Administration

If banks are to play their role in the economy and nurture a good business culture by supplying interested borrowers with fair and adequate loans,

24 Art. 61(b) of the “Income Tax Proclamation No. 173/1961”

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an efficient and adequate mechanism that enables them to collect their credits from debtors needs to be devised. This mechanism, called the power of sale foreclosure, has now been introduced into the Ethiopian legal system in order to strengthen the financial capacity of banks by enabling them to collect their loans from debtors effectively and to create a conducive environment for business.

Proclamation No.65/97 enacted to amend the Civil Code introduced the power of sale foreclosure into the Ethiopian legal system. Later on, this Proclamation was repealed by Proclamation No.97/98 which maintains the power of sale foreclosure as a means of recouping loans by auctioning properties mortgaged or pledged to banks. It is stated in the preamble of Proclamation No.97/98 “…it takes rather too long a time to obtain judgment, from courts of law, for sale of property mortgaged or pledged with banks and to subsequently have it executed.” Accordingly, the Proclamation, by introducing the power of sale foreclosure, envisaged that it would avoid the problem of taking too long a time to obtain a judgment from the courts of law thus facilitating the sale of property mortgaged or pledged with banks. An amendment has also been introduced to Proclamation No.97/98 under the “Property Mortgaged or Pledged with Banks (Amendment) Proclamation No.216/2000.

The theme of these proclamations is that, when banks decide that the loans they granted have not been paid on time, they can sell the property mortgaged or pledged and use the proceeds to settle the unpaid amount without being required to take the case to a court of law.

Expropriation of Private Property

The term expropriation is a very wide concept and could be defined as “the right or power of a sovereign state to appropriate private property to particular use for the purpose of promoting the general welfare.” (John L. 1990, p.3) Expropriation is therefore the power of the sovereign state to take or to authorize the taking of a private property for public use without the owner’s consent, conditioned upon the payment of just compensation.25 This power of expropriation is not, however, without any limitation. One of the well-recognized limitations on the power of the law of expropriation is public purpose. This limitation helps to reconcile the tension that may exist between government interest and that of the individual.

25 American Jurisprudence, 2nd ed., 1966 Vol. 29, p. 362

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Public purpose cannot be defined in the abstract, though. Despite the Constitution’s restriction of an act of expropriation only to be done when public purpose demands it so, no strict guideline has been set to effectively prevent the administrative organs from circumventing this requirement. Consequently, this has resulted in the arbitrary eviction and divesting of the private property of citizens. There is no law that exists in Ethiopia that exhaustively lists down all possible circumstances that may be considered as constituting “public purpose”. This has in turn given rise to a recurrent fear and actual dispossession of private property. Worse, the road to the courts is closed with the finality clause attached to some enabling proclamations, which has further exacerbated the problem. In short, what constitutes “public purpose” invites wide room for discretion, and hence abuse. It should however be noted that expropriation is not something to be done as a matter of principle, it is rather the exception. Exceptions thus need to be interpreted very narrowly to avoid the risk of making them the principle.

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chapter FIveCompetition Law and Private Sector Development

Institutions for Promoting Competition

The virtues of competition have been acknowledged, particularly by industrialized economies, as an important driving force to bring about economic growth. Competition creates initiatives for increasing productivity, and the growth of productivity in the economy by providing incentives for managers to reduce costs, innovate, reduce slack, and improve the institutional arrangements in production. The underlying assumption is that a robust competitive market is automatically efficient. The exit of less efficient firms frees up resources which can then be used by more efficient firms.

It is also argued that competition – domestic and international – provides incentives for institutional change by modifying the behavior of existing institutions. Competition can also act as a substitute for other institutions. For instance, there is evidence that competition can substitute for an effective bankruptcy system because it exerts pressure on inefficient firms to go into liquidation. International trade reform itself can be viewed as institutional reform, since it changes the rules of the game for those affected. Openness to international trade also helps exert pressure on governments to reform those domestic product and factor market institutions that undermine the ability of firms to respond to competitive pressures from abroad. International trade is particularly useful in promoting competitive markets in developing countries, where there are information difficulties, inadequate contract enforcement mechanisms, and human capital constraints.

Competition, however, is best administered under a freely operating market system. To realise the benefits of competition, therefore, a number of institutional measures promoting free markets, and hence removing barriers to competition have to be in place. Broadly, and largely in the context of industrialised economies, competition laws may deal with such issues as monopolistic trends; concentration of means of

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production and distribution; trade practices such as hoarding, supply of hazardous products, misleading and deceptive advertisement; mergers and acquisitions; unfair sales practices such as tie-up sales and rivalry competition; dumping; copy right, design, patent, and trademarks; consumer protection; and the establishment of enforcement authority.

Competition and Developing Countries

Despite the strong theoretical arguments and intensive pressure by industrialized nations and international organizations (WTO, IMF and the World Bank) on developing countries to introduce competition, the relationship between competition and economic development remains controversial, both in economic theory and in relation to empirical evidence. Thus, the positive link between competition and increased effort by economic agents is both theoretically tenuous and has little empirical support. This is aggravated by weak implementation capacity in most developing countries where competition laws were only introduced in the 1990s. Consequently, the enforcement of competition laws has not been very effective. Institution building takes time and resources. It takes about ten years for countries to acquire the necessary expertise and experience to implement such laws effectively (World Bank, 2002). Moreover, effective competition requires complementary institutions that would facilitate enforcement, such as courts, well-established information processing systems for the regulator, property rights, infrastructure, etc., which are incomplete in most developing countries.

Notwithstanding the developing countries’ lack of experience with competition policies and the general skepticism about the optimality of perfect competition for long term productivity growth; there are good reasons to suggest the importance of establishing formal competition policies for developing countries. This is because:

i) Development itself requires some form of measured domestic competition to keep the learning curve of entrepreneurship rising;

ii) Structural changes, which have occurred in developing economies, as a result of privatisation and deregulation as well as greater integration with the world economy, requires introducing appropriate competition policy; and

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iii) The huge international cross border merger movement invariably calls for the introduction of competition. Developing countries are clearly affected by the monopoly power effects of international mergers when a foreign multinational company acquires a domestic firm. However, they are also affected indirectly even when mergers take place outside their jurisdiction, as this reduces the contestability of markets and is especially harmful to the interests of newly industrializing countries whose firms are in the process of building up their capabilities to compete in international markets.

The question however is: what kind of competition policy would be most suitable for developing countries? This primarily depends on the objectives of these countries for introducing competition. The purpose of competition policy in a developing country cannot simply be the promotion of competition as a good thing per se, but to foster economic development. This would, in some instances, require restriction of competition and in others its vigorous promotion. In order to raise the living standard of their people, developing countries need high rates of investment to achieve a high growth in productivity. High rates of investment in turn require reasonable, if not high, rates of profits in order to maintain the private sector’s propensity to invest. This consideration leads to the view that there may at times be too much competition rather than too little. Competition would be too much if it leads to price wars, sharp falls in profits, capacity underutilization and subsequent closure of firms, all of which are likely to diminish the corporate desire to invest.

Developing countries should consider competitive opportunities for small-and medium-size firms with the general notion of fairness. Hence, equity objectives as well as other factors such as employment and measures that encourage cooperation among small- and medium-size firms have to be considered. Furthermore, joint ventures, mergers, and other collaborations may be necessary to enhance technological progress and enable firms to compete effectively in global markets.

In the real world of imperfect markets, which is particularly the case in developing countries, it may require government coordination (and promotion) of investment decisions to prevent over capacity in one sector and under capacity in the other. A developing country, therefore, cannot afford to have maximum competition; rather it must operate with an optimal degree of competition or with an appropriate blend of

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competition and cooperation to achieve its long-term goals of faster and sustained economic growth.

Therefore competition policy cannot be a unique, “one-size-fits-all” policy which is appropriate for all developing countries. The optimal policy will differ between countries depending on their stage of development, effectiveness of their respective governments, and the quality of institutional framework supporting competition.

Competition and Competition Policy in the Fast Growing Economies of Asia

In the newly industrialized Asian countries, their export-oriented policies exposed firms to competition in foreign markets. Moreover, governments in these countries organised contest-based competitions for state subsidies which were conditioned on the achievement of certain performance standards (such as export targets, foreign exchange earnings, technological upgrading, introducing new products, etc) with the winners receiving greater public sector support.

The argument that faster economic growth and development is achieved through domestic and foreign competition in free markets relegates the role of the state as a provider of only a conducive environment, and no more. However, as it has been evidenced (World Bank, 1993), these countries did not have maximum competition in product, capital or labour markets, but rather strived to achieve an optimal degree of cooperation and competition. Thus for example, the Japanese and Koreans implemented selective import controls; fostered close relationships between government, business and finance; and, at times, even discouraged foreign investment while importing technology from abroad by other means.

The experience of China too, which for the last two decades has had one of the fastest growth rates in the world, is consistent with the East Asian story. The Chinese economy has been able to register high growth rates, despite its segmented product markets and highly imperfect capital and labour markets. It is possible to attain the benefits of competition – greater efficiency and innovation in product markets --- with some degree of competition, but competition by a large number of firms is not always required (World Bank, 2002).

The industrial policy of Japan had the upper-hand over the competition policy adopted. One of the main objectives of the industrial policy was to

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ensure a high rate of profitability and investment in Japanese industry. The government was therefore always concerned with questions of ‘ruinous competition’ leading to reduced profits and a lower propensity to invest. As a result, a wide variety of cartels (such as recession cartels, export cartels, technology cartels, etc) were commissioned by the government. It also sequenced investments by firms and intervened in the exit and entry decisions of firms, all of which contributed to the high concentration ratios observed in the Japanese economy.

However, the Japanese government did not just thwart the competition codes and objectives, but it also implemented an industrial policy that encouraged contest-based competition between oligopolistic firms where the rewards were access to cheap credit and foreign exchange as well as, where necessary, protection from international competition. As noted above, these rewards were contingent on the relative and targeted performance of domestic firms. The result was that rivalry between firms in Japan was extremely intense, with the intensity of competition in Japan’s manufacturing sector said to be greater than that of the US manufacturing sector (Ajit Singh, 2002, p.24).

Thus Japan followed a policy that promoted dynamic efficiency (in the sense of maximizing long-term growth of productivity) through an institutional structure that combined both cooperation and competition between firms. This is fully in accord with the analytical consideration for an appropriate competition policy for developing countries and consistent with the latest advances in economic theory.

Therefore, a suitable combination of competition and cooperation is more likely to enhance societal welfare than pure competition alone. Furthermore, recent theoretical developments suggest that, in relation to innovation, inter-firm co-ordination even among horizontal competitors can bring substantial welfare benefits.

Hence, an appropriate competition policy for developing countries must at least be able to:

i) Primarily promote economic development;ii) Restrain anti-competitive behavior by domestic large

firms, while simultaneously introducing fair and active competition;

iii) Limit abuses of monopoly power and dominance by mega-corporations created by international mergers.

To obtain greater efficiency and innovation in product markets, some degree of competition, but not always competition by a large number of firms, is needed. What is required is measured competition. Moreover, it is not just the market structure but also the threat of entry – either by firms or by products – that determines the degree of competition in the domestic markets.

Therefore, development enhancing competition policies need to have different objectives from those normally posited for advanced economies. Furthermore, such policies also need to be specific to the stage of a country’s economic and industrial development as well as its institutional and governance capacities. Accordingly, the developmental dimensions of competition policy have to consider:

The need to emphasise dynamic rather than static •efficiency as the main purpose of competition policy from the perspective of economic development;The concept of optimal degree of competition (as opposed •to maximum perfect competition) to promote long-term growth of productivity;The related concept of optimal combination of competition •and cooperation to achieve fast and long-term economic growth;The critical significance of maintaining the private sector’s •propensity to invest at high levels and hence the need for a steady growth of profits; the latter in turn may necessitate government coordination of investment decisions so as to prevent over-capacity and falling profits;The concept of simulated competition, i.e., contests, for •state support which can be as powerful as real market competition;The crucial importance of industrial policy to achieve the •structural changes required for economic development; this in turn requires coherence between industrial and competition policies.

Even if developing countries adopt appropriate domestic competition policy, the serious threat of multilateral competition policy poses problems to developing countries. Owing to inadequate development of the legal and institutional framework, lack of information and difficulties of proving that prices are being manipulated by international cartels, developing countries would still need international assistance to restrain

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anti-competitive conduct of dominant multinationals as well as to limit the adverse effects of mega-mergers, irrespective of adopting development friendly national competition policies.

Competition and Competition Law in Ethiopia

The centralized economic management of the Dergue, which lasted for a decade and a half, nationalised all land, rented urban houses, and major medium and large scale manufacturing enterprises, thereby marginalising the private sector to petty economic activities and stifling the entrepreneurship capacity of the business community. Also, by regulating all markets and controlling prices, the regime effectively eliminated all forms of competition.

The liberalization undertaken onwards reinstated private actors into the modern sector of the economy and a market-based economic management model has been introduced. The partial deregulation of markets/decontrolling prices, partial liberalization of foreign exchange, the opening up of the external sector and privatization of state-owned enterprises reintroduced some elements of competition into the economy. The Government has established Trade Practices Investigation Commission and an enforcement authority, the first of its kind in the country.

Notwithstanding the effort to build a competitive economy, there are still a number of missing and inappropriate institutional factors that hamper the creation of a fair competitive environment.

i) Public sector dominance: As an integral component of the structural adjustment programme initiated early in the 1990s, the Government of Ethiopia launched the privatisation of state owned enterprises, largely nationalised enterprises by the preceding regime. Since then, a number of enterprises have been privatised. Privatisation supports the development of the private sector, and hence is commendable. However, privatisation in the Ethiopian context seems to be understood as “getting rid of relatively small enterprises in the private sector while maintaining large ones under state control.” Irrespective of the number of enterprises privatised, the Government still controls over 50 percent of the total value of production of medium and large scale enterprises. Large and important manufacturing enterprises, which could enhance domestic competition, are still state-owned. The public sector still holds a significant monopoly and dominance, not only in industries where

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a natural monopoly prevails such as energy, telecommunications, postal service, water supply, railway and airways, but also in other industries such as cement, sugar, tobacco, textiles, banks and insurance. High economic rent and inefficiency prevails in most of these industries.

ii) Price control: There are still product markets that are fully or partially regulated.26 For instance, the rental price of nationalised urban houses, minimum deposit rates on savings, passenger transport fares, exchange rates, etc., are administratively fixed. In the case of housing, for instance, while, on the one hand, nationalised urban houses, particularly in the capital, are still under the control of the Government and rental prices are fixed low over the years, on the other hand, private sector real estate development and market-based rental prices are allowed to operate in the same market. What prevails is a housing market policy which is not quite consistent and which does not encourage competition. There is a need to harmonise such segmented markets as they could retard competition in such areas like the housing sector.

iii) Distortion in the labour market and corruption: Competition requires an open Employment policy. However, securing employment, particularly for senior public posts, on non-merit criteria, not only retards competition in the labour market but also has the potential to breed corruption. It is obvious that corruption undermines the development of a competitive market environment. Thus, there is a need to address corruption now before it gets out of hand and reversing it later will be a difficult task.

iv) Lack of transparency: Transparency and fairness are central in building private sector confidence, and encouraging competitiveness. Government is the single largest purchaser of goods and services. As such, its actions in the markets can be instrumental for strengthening competitive domestic markets. However, contractual awards of public projects/works and procedures for procurement by tendering are far from being competitive and transparent in Ethiopia.

v) Lack of property rights for land: The failure to provide strong property rights for land reduces both entry and exit into land related sectors. State ownership and control of land has significantly contributed to the lack of easy access to land, its lack

26 Some prices, such as the price of oil, may be justifiable from the point of view of social welfare.

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of marketability and unreasonably high cost. Access to bank credit has been constrained by legal problems involving the use of land-lease rights for collaterals (ECC, March 2007).27

vi) Distorted financial market: Undue intervention, such as directed credit, which partially, led to excessive non-performing loans of the state owned banks, over liquidity, and distortion of the financial system, deters entry of firms, thereby limiting competition. Also, banning the entry of foreign banks indefinitely, even on a limited scale, strongly undermines competition, and the development of the financial sector. Its adverse effect has been on keeping foreign investment in the real estate sector at bay, thus constraining the growth of a competitive environment and eroding business confidence.

Moreover, the power vested in banks to administer the sale foreclosure law may strongly deter investment through bank loans, thereby reducing the development of competitive factors markets. There is also a great suspicion of the fairness of its application. At least until now no state-owned or endowment enterprise has been foreclosed, despite the fact that they are the ones which are heavily indebted and incurring repayment defaults, while a number of private enterprises have not been so protected by the state. Such suspicion further undermines the private sector’s confidence and discourages investment.

vii) Tax regulations: Other institutional elements deterring market entry are tax regulations. Currently lack of government capacity to enforce the newly introduced Value Added Tax (VAT) has created two categories of business enterprises, having similar annual turnover, but registered for different types of indirect taxes – the VAT and the turnover tax (TOT), with different tax incidences. While it is easier to trace VAT registered enterprises and enforce tax payments, it is relatively difficult to estimate and collect tax from those registered for TOT. This grossly distorts the market, driving agents registered for VAT out of a competitive market. Similarly, the archaic and subjective evaluation method of the tax base for “category C” income tax payers has created an outcry thereby adversely affecting the functioning of competitive markets (ECC, March 2007).

27 Forthcoming

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viii) Lack of a strong contract enforcement mechanism: As discussed in detail under the section on the judicial system, the most pressing institutional issue for competition is related to the judicial system. According to the World Bank (2003) “the enforcement of contracts and property rights constitutes the institutional basis for markets to operate…. A proper justice system that ensures proper enforcement of contracts and property rights contributes to economic growth whereas lack of enforcement of contracts leads to retardation… and eventual underdevelopment.” Therefore, the lack of independence of the judiciary poses a critical constraint for establishing a competitive economy in the country.

ix) Sectional interests: A further challenge to private sector development is the unfair anti-competitive practices of endowment companies and enterprise owners with good connections to the Government. The Diagnostic Trade Integrated Study reported that importers interviewed have stated that they are facing unfair competition from such endowment based firms (World Bank, 2003). A related problem with such firms is their access to Government and policy makers as well as their monopolistic position in the market which is hurting private sector operators.

As observed above, a great deal more has to be done to strengthen domestic competition. Competition is a cumulative effect of a multiplicity of issues. Other institutional issues discussed in all of the chapters of this study address the influence of competition, directly or indirectly. Therefore, effective measures to overcome institutional hurdles noted above have to be undertaken. Creating a competitive market requires not only dealing with institutional issues, but also establishing effective implementation mechanisms. The following sections discuss the existing competition law in Ethiopia and the competition authority established to implement the provisions.

The Ethiopian Competition Law

Following the liberalization measures and to lay the groundwork for WTO accession, the Government issued a Trade Practice Proclamation (No. 329/2002) to promote competition in the domestic markets, the first of its kind in the country. Its major objectives include securing a fair competitive environment through the prevention and elimination of anti-competitive and unfair trade practices and safeguarding the interests of

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consumers through the prevention and elimination of restraints on the efficient supply and distribution of goods and services.

Key elements of the Competition Law• : The key components of the proclamation are anti-competitive practices, unfair competition and abuse of dominance.

Anti-competitive practices• : Any agreement that restricts, limits, impedes or harms free competition in the process of production or distribution is regarded as anti-competitive activity. It includes jointly fixing prices, collusive tendering, market or consumer segmentation, allocation of quotas of production and sales, refusal to deal, sell and render services, etc. However, whether such practices are regarded as anti-competitive is left to the discretion of the Ministry of Trade and Industry. If the Ministry believes that such an agreement has a national advantage outweighing its disadvantages, then the practice could be authorized to be continued. Thus, there is no any hard and fast rule of deciding on whether a practice is anti-competitive or not. It involves a great deal of subjectivity.

Unfair competition• : In the conduct of commercial activities, any practice that aims at eliminating competitors through different methods is considered as an unfair practice. The different methods include, among others, causing confusion with respect to the products or services offered by an enterprise; damaging the good will of another enterprise unjustifiably; misleading the public with respect to the activities or products or services of an enterprise; restricting, impeding or weakening the competitive production and distribution of any commercial good or service rendering; importation of goods at prices less than the actual market prices in the principal market of the country of origin with the intent to destroy or injure the production of such goods in the home country; trading in goods imported for humanitarian purpose, etc.

Abuse of dominance• : Unfair imposition of excessively high or low selling price or service fee or withholding

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supply or any pre-emptive behaviour to impede entry into markets; misleading commercial statement or notice; hoarding, diverting or withholding goods from normal trade channel; selling at a price that does not cover production cost to eliminate fair competition, etc., are regarded as abuse of dominance. The proclamation also deals with other miscellaneous matters related to competition such as, for instance, indication of prices of goods, labels on goods, distribution of basic goods, issuing and keeping receipts, etc.

Special provisions• : Certain provisions of the proclamation may not be applicable in the following cases. This depends on the discretion of the Commission established to follow up the implementation of the proclamation:

- Commercial activities that are, according to the investment proclamation which has been changing frequently in the last ten years, exclusively reserved for the Government;

- Enterprises having significant impact on development and designed by the Government to accelerate growth; and

- Basic goods and services that are subject to price regulations.

In addition, the Ministry of Trade and Industry has the power to regulate prices of basic goods and services upon the authorization of the Council of Ministers.

The Competition Authority

The Ministry of Trade and Industry is the highest body authorized to deal with the implementation of the proclamation. An Investigation Commission, under the Ministry was also established to follow up the day-to-day implementation of the provisions. The Commission receives and investigates complaints and suggests measures in line with the Competition Law. The Commission has the right to make or develop rules and directives consistent with the proclamation for executing its

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tasks effectively. The Ministry has the authority to take administrative measures (even using the police force if necessary).

The Commission is composed of government and private sector representatives as well as member of consumers associations. The chairperson is appointed by the Prime Minister upon the recommendation of the Ministry of Trade and Industry. That said, it does not specify the number of representatives from each group.

The Investigation Commission is accountable to the Ministry of Trade and Industry. Its mandate is to make investigations upon a formal complaint from a commercial entity and submit the result of its verdict to the Ministry with suggestions on administrative measures or penalties to be taken on offending partners. Hence, the Commission has no final say on competition matters. The Ministry can either fully accept, or alter, or totally ignore the decision and recommendations of the Investigation Commission. A party found guilty of an offence has the right to appeal to the Federal High Court within 30 days upon receiving the verdict from the Ministry.

The Way Forward for Competition Policy, Private Sector Development

A full-fledged competitive economy is a direct reflection of a private sector-led industrialized economy. Private sector development and a competitive market economy are simply two sides of the same coin. As such competitiveness is a reflection of the stage of development of an economy.

This implies that the process of creating a competitive economy requires updating competition policies regularly and strengthening the implementation mechanisms. Although the Competition Law is in place, it needs to be reviewed regularly in the light of the development of the Ethiopian economy and the number and nature of the complaints received by the Investigation Commission.

A major issue in this regard is the need to explicitly articulate mergers, takeovers and other forms of concentrations/conglomerations. Some of the possible adverse effects of concentrations have been alluded to earlier. The issue of mergers itself, and its broad potential impacts, however, are not explicitly addressed in the Competition Law.

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Given the relatively small size of most enterprises in Ethiopia, and the advantage that very large firms have in a competitive world, addressing issues of mergers at this stage of economic development would be beneficial to the small and medium-sized enterprises. For instance, EU member countries consider that joint ventures, mergers, and other collaborations may be necessary to enhance technological development and to allow European firms to compete effectively in global markets. Similar actions are also taken in the newly industrialized Asian countries (see Chapter nine). It is up to the Competition Authority to decide on whether or not to prohibit such mergers (World Bank, 2002).

Given that Ethiopia is a member of the Common Market for Eastern and Southern Africa (COMESA) block, and inevitably future member of the Free Trade Area (FTA), and also in light of its aspiration to join the World Trade Organization (WTO) in the near future, it would be to its advantage to address mergers under the Competition Law and allow the Competition Authority (the Investigation Commission) – to decide on whether to allow mergers on a case-by-case basis.

Moreover, though some issues relevant to competition are treated in isolation in other documents such as the commercial code, industrial regulations, cross-border issues, provisions to protect the environment, consumer protection, etc., are not comprehensively addressed in the law.

Finally, many of the articles contained in the law are stated in general terms --- lacking specificity and creating ambiguity which is unhelpful for decision-making.

Regarding the composition and structure of the Competition Authority, the central issue is the independence of the Commission. Given the specific nature of enterprise ownership structure in Ethiopia, i.e., where it is difficult to dissociate the ownership of endowment enterprises from the government in power, it is essential to avoid elements of doubt arising with the Commission. The Commission has to be structurally independent of the influence of the Government. To this end the following changes might be introduced:

The composition of the Commission has to be broader •than what it is now, and include labour unions and representatives of civil society. Moreover, the number of the representatives of each group has to be specified.

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A minority representation from the non-government sector might compromise the perception of fairness and independence of the Commission by the private sector.

The Competition Authority should be independent of •any government ministry and should have its own budget. In a country like Ethiopia where democratic governance is not well established and greater transparency is required, independence of the Competition Authority is essential. Sixty three percent of industrial countries and 59 percent of developing countries surveyed by the World Bank have competition authorities independent of any government ministry.

It creates more confidence if the chairperson of the •Competition Authority is appointed by Parliament; and the former reports its activities to the latter.

The Competition Authority and the private sector •(individual firms and Chambers of Commerce on behalf of their members) should have the authority to lodge suits.

All decisions passed by the Investigation Commission •should be made available to the public. Public availability of such decisions has a deterrent effect on potential future violations of the Competition Law and helps ensure the fairness of the proceedings.

Finally, the central role of competition in a developing economy is to expedite economic development. This implies encouraging fair and strong competition in the domestic market, i.e., among domestic enterprises, while simultaneously protecting these enterprises from external abuse. The staffing of the Commission with trained and professional experts is also an important issue in overseeing the introduction of greater competitiveness within the Ethiopian economy.

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chapter SIxCorporate Governance and Private Sector Development

Governance Institutions for Firms and Corporate Governance

Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also defines the relationships among the many players (the stakeholders) involved. The principal players are the shareholders, the management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.

Corporate governance is only part of the larger economic context in which firms operate, that includes, for example, macroeconomic policies and the degree of competition in product and service markets. The corporate governance framework depends on the operating legal, regulatory, and institutional environment. In addition, factors such as business ethics and corporate awareness of the environment and societal interests of the communities in which a company operates can also have an impact on its reputation and its long-term success.

Governance institutions include commercial codes, of which corporate governance is a central element, product market institutions (such as regulators responsible for competition), labour market institutions, financial (capital) market institutions (such as financial intermediaries, and the judiciary).

The basis for corporate governance is commonality and predictability. Or in other words, corporate governance only makes sense if applied by most of the corporate actors – at least all of them who want to do business with each other – and if it is applied consistently and from business to business. Applied this way, corporate governance provides important benefits for doing business.

First, corporate governance is a basic condition for acquiring capital for a business on a broader basis. All kinds of investment in a business

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need agreed rules. Therefore, corporate governance can be considered as an instrument important for the small family company as for the big multi-stakeholder corporation. Capital acquisition on a broader basis from partners, shareholders, banks or exchanges need predictable and controlled corporate behaviour. Corporate governance helps and guides businesses to maintain adequate standards and norms and provides them with a language of communication with stakeholders and potential partners.

Second, when business conduct is reliable, stakeholders – particularly financiers – perceive lower risks for their participation by consequently lowering the “risk premium” and the cost of capital. This benefit applies to both small and big companies. Several studies indicate that companies with good corporate governance have lower costs for accessing credit as well as equity capital.

Third, corporate governance creates explicit relations between key organs of the corporation – the shareholders, the board of directors and the executive management – which reduces the risks for unexpected corporate failures and improves company performance in general. Again, corporate governance contributes to an efficient management climate in big as well as small companies.

Finally, corporate governance increases the sensitivity of the corporation in relation to employees, suppliers and customers. It contributes to loyalty to the company by the key stakeholders, which in turn facilitates the long term success and survival of the company.

In principle, all enterprises, irrespective of size and ownership structure, need some governance principles to conduct successful business. However, firms of different sizes and ownership structure may require different sets and complexities of governance institutions. Therefore, governance institutions for large and small firms and for single or multiple ownerships differ.

In smaller firms, with concentrated or sole ownership, the principal governance issues concern the implicit or explicit contracts that the owners have with traders and suppliers, with employees having firm-specific skills, and with banks and other financial institutions. Hence, there is not a strong need for complex legal protection.

As the size of a firm increases, day-to-day control and overall management tasks are delegated to non-owners. The division between

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owners and managers makes governance issues more complicated. There is a correlation between the strength of institutions that support information flows and provide legal leverage to the nature of financiers, and ownership structures. The remainder of this chapter examines the nature of corporate governance in Ethiopia and suggests some measures that need to be taken to enhance good corporate governance practices and its benefits to private sector development.

Types of Governance Institutions

Two broad categories of institutional approaches of corporate governance institutions can be identified: private (non-legal or informal) and legal (formal).

Private Governance Institutions

Private corporate governance institutions are non-legal approaches for directing and controlling firms. The advantage of private governance institutions is that they do not rely heavily on state imposed legal sanctions and enforced contracts. Such a governance system uses networks and social connections.

There are three main kinds of governance institutions that are not formal, viz., ownership, concentration, business groups, and business associations. These institutions affect the amount of information available to all parties involved with a firm, contract enforcement, and accountability of entrepreneurs and managers to those who invest in the firms.

i) Ownership concentration: Ownership concentration affects governance institutions. In developing countries firm ownership tends to be highly concentrated. Large firms controlled by management and owned by a diverse group of small shareholders are the exceptions rather than the rule. In such countries small and medium-size firms controlled, directly or indirectly, by single or few owners are dominant. There is little or no separation of powers between ownership and control (management). There is a strong relationship between ownership structure and the size of firms. Concentrated ownership prevails where the size of firms is not large. Concentrated ownership gives investors information and control, ensuring that their resources are used in their best interests. Concentrated owners have the ability to halt the diversion of resources

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without having to resort to courts. In such an ownership structure, legal institutions would not be of particular concern. The primary advantage of more concentrated ownership is that it motivates the owners/shareholders to monitor the managers of the firm directly and provides the owners with leverage over the managers.

ii) Business groups: Groups of companies do business in different markets under a common administration or central control. Business groups may be of different sizes. Equity holdings across companies and common directors serve as a coordinating mechanism within groups. But such group-affiliated businesses may also be made through family or social relations. The formation of business groups substitute for less developed governance institutions. For instance, without relevant and strong governance institutions for financial and information intermediaries, capital markets function poorly in providing a source of capital investment. But group affiliated firms can create an internal capital market and other inputs where markets fail to provide them.

iii) Business associations: Formal business associations – voluntary long-term, renewable partnerships among firms – are another set of private institutions that can facilitate exchanges and expansions of business activity. They do this by improving information flows, enhancing reputation penalties, and lowering the costs of dispute resolution.

In general, such private governance institutions are important in developing countries where the development of laws, internal governance institutions, well-developed financial and information intermediaries, effective regulators, and enforcement mechanism are limited. In such economies, where there are few limits on arbitrary state actions, weak enforcement of contracts, and poor provision of information, private institutions rather than legal governance institutions are likely to dominate. They will substitute for the lack of effective formal publicly provided alternatives.

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Legal Corporate Governance Institutions

The term “corporate governance” has come to mean a process by which companies, where separation of ownership and control prevails, are directed and controlled. In corporations, shareholders delegate decision rights to the manager to act in their best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. As a result of this separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of the managers with those of shareholders. Relationships between stakeholders include all related parties, the most important of which are the owners, managers, directors of the board, regulatory authorities, and to a lesser extent suppliers, employees, creditors, and customers.

The advantage of the legal corporate governance approach is that it can expand wealth creating opportunities, making it possible to assemble significant resources needed for large enterprises and facilitating entry into markets. Identification with a network is not required to pursue opportunities; and new entrants do not need to have social connections or large amounts of initial wealth to start a business. With formal corporate governance institutions, there can be specializations in delivering the functions of governance.

Some institutions, such as disclosure laws, auditing firms, and financial and information intermediaries, focus on bridging information gap. Other institutions, such as corporate and bankruptcy laws and their associated enforcement institutions, specialise in lowering the costs of dispute resolution. Yet other institutions, such as boards of directors, specialise in managing outstanding incentive problems stemming from information gaps between entrepreneurs and managers. Moreover, the laws that limit the authority of entrepreneurs and managers must be enforced efficiently by an independent judiciary with competent and impartial judges. The role of a state is crucial in this regard. Not only do state actors directly determine the costs of dispute resolution, but are closely involved in bridging information gaps by setting specific standards (auditing and accounting standards), and by affecting the incentives of private information intermediaries. The absence of complementary formal institutions such as enforcement mechanisms may make legal reforms difficult.

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i) Boards of Directors as a check on insider authority: The board of directors of a firm is in a position to play a pivotal role in defining its strategic direction. The board’s responsibility for executive recruitment and for setting compensation policies and rights over dismissal gives it leverage over managers. The role and duty of board members depend on national laws and company statues.

Recently, private sector organizations, mainly in industrialised countries, have issued codes of “best practices”, to have better control on company managers. The Organization for Economic Cooperation and Development (OECD) has also recently promulgated international corporate governance standards. However, there is no single model for good corporate governance; but some common elements that underlie good corporate governance can be identified. Applicable corporate governance institutions for different economic systems and degree of development have to be designed and evolve in the light of changing circumstances. Similarly, governments have an important responsibility for shaping an effective regulatory framework that provides sufficient flexibility to allow markets to function and to respond to expectations of shareholders and other stakeholders. It is up to governments and market participants to decide on how to apply these common elements in developing their own frameworks for corporate governance, taking into account the costs and benefits of such regulations.

ii) Institutions that provide investors with information: In formal corporate governance systems, laws and boards create potential limits to the diversion of resources. But investors also require timely, accurate, and reliable information on which to base their decisions. Accountants and auditors are the primary providers of information for capital market participants.

Corporate Governance in Ethiopia

A study conducted by the Private Sector Development (PSD) Hub Programme of AACCSA on corporate governance noted that the revision of the 1960 Commercial Code is underway by the Ministry of Justice.

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The revision of the Commercial Code is a vital part of improving and upgrading of corporate governance standards in Ethiopia.

A certain level of standardised accounting and auditing is a prerequisite for corporate governance. The AACCSA PSD-Hub, in cooperation with the Office of the Federal Auditor General (OFAG) and the Ethiopian Professional Association of Accountants and Auditors (EPAAA), is undertaking important work to standardise the accounting and auditing practices in the country.

Modernising and computerising the Company Register is another important input and requirement for engendering good corporate governance. This task is being undertaken by the Ministry of Trade and Industry (MoTI) with the support of the PSD-Hub Programme and the business community.

Strengthening the organisations of the business community, the national level Ethiopian Chambers of Commerce and Sectoral Associations (ECCSA), as well as the corresponding city level institutions such as AACCSA, make important contributions to the institutional environment for supporting corporate governance. The ongoing discussion regarding the establishment of a risk-capital trading institution is another element which has direct implications for corporate governance.

The Ethiopian business community, the state as well as the private sector, conglomerates and companies in the field of finance, insurance, production and services are well aware of the importance of corporate governance and are very positive towards any efforts to improve corporate governance in Ethiopia.

Corporate governance in the current Ethiopian context

Existing Ethiopian legislation provides a number of important elements for good corporate governance. However, these elements are fragmented in terms of legislation covering different periods of time and for different purposes. The Commercial Code (1960) deals substantially with forms of business association. From a governance perspective the Code has most relevance for “share companies” while for other forms of business associations its applications are very limited. Specific legislation has been enacted for regulating the financial sector such as banks and insurance companies, namely the Banking Business Proclamation and the Insurance Business Proclamation respectively. The State Owned Enterprises are regulated similarly under specific rules by the Public

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Enterprise Proclamation and the Public Enterprise Supervision Authority Proclamation.

The Ministry of Trade and Industry is the main organ of the Government for monitoring, regulating and directing the business sector of the country. The most important instrument for socio-economic development and for overall governance of the economic entities, including the business sector, are the Poverty Reduction Strategies and Plans agreed between the Government and a number of international and bilateral organizations.

Beside a limited number of corporations and share companies, most of the Ethiopian business undertakings are different forms of family-based associations. Due to this situation, the Ethiopian business community is regarded as an “insider” economy where the control of companies is held by a limited number of families and their close circle of partners.

There are large numbers of small enterprises in Ethiopia. The estimated numbers vary from the Commercial Bank of Ethiopia’s estimate of 100,000 business clients to an OECD report which reckons that there are 65,000 small and medium size enterprises. The VAT registered enterprises account for over 30,000 units which would be the most realistic number for companies with some form of corporate governance obligation. The vast majority of the business undertakings are found in services and trade. The major part of both economic value and employment is generated by the bigger units – particularly the State Owned Enterprises which account for 70 percent of all manufacturing and 25 percent of services.

Since 1994, the Government has established a programme and an agency for the privatisation of State Owned Enterprises. To date, around 200 enterprises have been privatized. However, 145 of the biggest enterprises, including the major utilities such as the electricity and telecommunications companies remain in the ownership of the State.

The privatised companies normally have been absorbed in business groups such as the MIDROC group of companies and other private holding companies. Most of these companies have been transformed to forms of association generally applied in the groups – usually Private Limited Companies. Some former state owned enterprises have been acquired by their employees, many of them remaining as “share companies”.

The State Owned Companies are administrated and managed by the Public Enterprise Privatization and Supervisory Agency. This body applies the principles of two-tier governance, meaning that corporations

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belonging to the group are supervised by Boards of Directors appointed by the Agency.

In certain regions, development conglomerates such as the EFFORT group in Tigray play an important role in the business sector. These groups are governed by Boards of Directors, appointed by their mass organisations affiliated to the ruling party. The units of these conglomerates are spread over different sectors of the regional economy, from transport to commodity production, and their businesses are organized mainly as share companies (endowments).

A few multinationals and foreign companies are operating in Ethiopia and can be found in sectors such as hotels, construction, petrol distribution, etc. While the importance of these companies from the corporate governance point of view is limited, their experience – particularly in their mother organizations – can be emulated to improve corporate governance. The Shell group of oil, gas and petrochemical products company, for example, is a multinational enterprise operating in Ethiopia under its own brand that applies a Global Corporate Governance Policy. Experiences from the application of such a policy can possibly be made useful in the formulation of an Ethiopian Code for Corporate Governance.

Dominance of Private Corporate Governance Institutions in Ethiopia

As noted above, Ethiopia has established basic governance institutions such as the Commercial Code as early as the 1960s. It includes corporate laws, bankruptcy law, disclosure law, auditing, and basic structure, duties and responsibilities of shareholders, board of directors, and managers. Hence the foundation of legal corporate governance institutions has been in place for almost five decades. Moreover, private governance institutions have also been in place for a long time.

Private Governance Institutions in Ethiopia

i) Ownership concentration: As in many developing countries, the vast majority of firms in Ethiopia are small in size and ownership structure is highly concentrated. Considering, for instance, Large and Medium Scale Manufacturing (LMSM) firms, half of the total employs less than 25 workers per firm, and another 20 percent employ between 25 and 50 workers per firm (EEA/EEPRI, 2005). Capital per firm of all LMSM industries is, on average, about 1.4 million U.S. dollars. These

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firms are overwhelmingly dominated by sole proprietorships and private limited companies with few partners. Enterprises engaged in services are also similar to those engaged in manufacturing. One way or another, owners are directly involved in the management of the firms. In fact, many firms (even medium size ones) do not even keep proper books of accounts.

Share companies in Ethiopia, are the exception rather than the rule. Recently established companies, particularly private financial enterprises, such as banks and insurance companies have publicly sell shares but there are no stock markets. As there is no secondary securities (stock) market, these financial companies are operating in a sort of clandestine manner. Although some large state enterprises are being restructured as share companies, in practice, they are still state dominated, and operate as such.

ii) Business groups: The emergence of business groups in Ethiopia is a recent phenomenon. A case in point are endowment groups, MIDROC and its sister companies. These enterprises are engaged in different economic activities, but controlled by a centralised management structure. Technically, state owned enterprises may be regarded as business groups. It is likely that the formation of business groups will further expand, primarily as a survival mechanism, and also as an instrument to become more competitive in the market.

iii) Business associations: Business associations have been operating in Ethiopia for a long time. Currently there are about 45 business associations covering a wide range of economic activities - manufacturing, transport, export trade, etc. They are voluntary associations set up by entrepreneurs working in similar and interrelated activities to create business opportunities and coordinate their endeavours in the promotion and advocacy of private sector interests, focusing on the different needs of their members.

These associations are established under the Proclamation 148/1978. However this legal regime was repealed by Proclamation 341/2003, which requires these associations to be reorganised in line with the existing political/administrative structure. It also demands a change in the composition of

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these associations, requiring them to include as members economic actors engaged in diverse and micro economic activities. Whether such a reorganisation is beneficial in the Ethiopian context has to be studied, with lessons drawn from international experiences.

In general, private governance institutions have a more dominant and important role than formal corporate governance institutions in Ethiopia. Given the current ownership structure and the size of private firms in the country, the existing corporate laws do not pose a systematic constraint towards the formation and operation of formal share companies in the country. Moreover, the Commercial Code is currently under revision, and one has to wait and see how the new version addresses institutions for promoting good corporate governance practices. Thus a detailed study of corporate laws at this juncture may be premature and of limited benefit. However, there are some issues related to corporate governance that needs to be noted even before dwelling on complex governance institutions, including inter alia, the privatisation approach, state-enterprise governance, and the corporate governance infrastructure.

i) Ownership Structure in Privatization: Expanding Basis for Formal Corporate Governance

Privatisation in most countries has been propelled by the inefficiency of state-owned firms and the resulting search for significant improvements in performance. But it is likely that inefficient use of resources by state enterprises could be replaced by private actors, through deterring competition, particularly if the modality of privatization concentrates on asset sales to single investors thereby increasing ownership concentration. It has, thus, become clear that regulations and competition as well as ownership diversification are essential complements to successful privatisation.

Ownership structures chosen at the time of privatisation by political actors reflect economic and political concerns. The two predominant forms of privatisation in most countries are to use public share offerings, which are more likely to result in wide share ownership and asset sales. These are usually associated with the sale of a majority stake to a single investor.

In Ethiopia, the dominant privatization modality is an asset sale to single investors or business groups. To date, no known

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enterprise has been privatized with share offerings to the general public. Initially, under a system known as the safety-net programme, part of the IMF structural adjustment programme meant to minimize privatization-induced unemployment, workers of some enterprises, largely service enterprises such as transport and trade were allowed to retain the enterprises, under future payment arrangements. Such an approach still constituted an asset sale and not the sale of shares.

Perhaps, the ongoing modality of privatisation – asset sales to single investors – might relate to the size of enterprises (most of these are small or medium-sized by international standards) and/or procedural simplicity (low cost). However, the Government could have taken this opportunity to diversify ownership structure, introducing share companies and the system of formal corporate governance into the economy.

Enterprises that are in the pipeline to be privatised are relatively large with asset sales going to single investors thus further consolidating ownership concentration. Perhaps, in the upcoming privatisation exercise, it might be more useful to offer shares to the general public, and expand the shareholder base in the country. Thus, privatisation could be used as a policy instrument to develop the private sector with an appropriate and optimal corporate governance structure.

(ii) Governance of State Enterprises

Some state owned enterprises incorporated as share companies are expected to operate under formal corporate governance approaches. Currently such enterprises have boards of directors and separate managers. Even though the need for a corporate governance structure is not strong, introducing boards of directors, separating the owner (the state) from managers, is commendable. The question is whether these boards of directors are trained and experienced professionals and independent from the intervention of the Government. The answer to this is generally not in the affirmative. This is a similar issue that can be raised for a number of public entities such as the National Bank of Ethiopia, the Commercial Bank of Ethiopia and other state-owned banks. For a board to be independent from any external intervention or influence, its

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composition and professional status of its members need to be addressed. If all or most members of a board are employees of the Government and their selection is on a non-merit basis, then there is little room for the board to be independent of the influence of its employer – the Government.

If state-owned enterprises are seen as public property and Government as accountable to the general public, then having civil servants alone as members of the board of directors would make little difference to the previous system where managers are accountable to an official, a minister, a commissioner, etc. Members of a board must be selected on a merit basis from governmental and non-governmental entities, the private sector and civil society organizations, while ensuring that all board members have no conflict of interest. This will create better transparency and introduce a system of formal corporate governance in practice. Such a structure will also create a potential level ground for private sector actors in working side-by-side with publicly owned firms and institutions.

(iii) Corporate Governance Infrastructure

Corporate governance is relevant even for poor countries like Ethiopia. What distinguishes developing countries from that of developed countries, in general, is that the cost of operating good corporate governance practices in smaller firms is relatively high. Moreover, corporate governance is still at its initial phase of development in the developing countries. This does not mean that efforts to improve corporate governance in developing countries should be abandoned, but rather that they should be improved. Such efforts should focus on establishing a sound corporate governance infrastructure. This includes:

a) Awareness creation: As an initial step, training on corporate governance should be conducted for the business community, relevant civil servants, including the judiciary. Awareness is bound to be the single most important corporate governance reform activity. Awareness ensures the buy-in of public officials and the effective enforcement of corporate governance rules.

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b) Simplifying the rules: Due to the high costs of implementation and compliance with good corporate governance norms, rules need to be simple to be understood and enforced effectively. The simpler the rules, the more likely their effective enforcement, with a lesser need for training and resource usage. Rules perceived as irrelevant cannot be credibly enforced. The Commercial Code which is under revision has to take these into account.

c) Improving the information base–disclosure and transparency: This ensures the availability of pertinent information, e.g., reliable annual accounts (at a high accounting standard), high auditing standards, good ownership and material facts disclosure, etc. All this information has become inexpensive in the current digital age. It is more a question of attitude than cost of generating the pertinent information as such. Stronger regulation has to be in place requiring all enterprises, at least medium and large ones for a start, to maintain proper books of accounts.

d) Reform of other relevant institutions discussed in this document, such as governance, the judicial system, property rights, the financial market, competition etc., and the enforcement mechanism, is an important prerequisite.

It is shown that the Ethiopian scene in this regard is dominated by the private (usually family-owned) governance structure. Moreover, compliance and/or enforcement appear to be weak or non-existent. Thus, for the Ethiopian private sector to reap the benefits of effective corporate governance there is a need to strengthen the corporate governance structure and enforcement mechanism of the regulatory institutions. The role of the courts in this regard cannot be over-emphasized. Privatisation can

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also be used as one of the policy instruments employed in realising this objective. It is important to restore the confidence of the average private sector actor, such as the shareholder, in the institutional infrastructure and the judicial system to help him/her enforce his/her rights. In the next section of this chapter, a road map for corporate governance in Ethiopia has been outlined.

The Road Map for Corporate Governance in Ethiopia

The Choice for Modality of Corporate Governance

There are a number of choices that need to be made to develop corporate governance in Ethiopia. This list includes the issue of whether it should be mandatory or voluntary; whether it should be general or specific, narrow or broad, and how to tailor it to small family business conditions which dominate the business scene in Ethiopia.

The current PSD-Hub activities, Company Register Modernization, Revision of the Commercial Code and the Accounting and Auditing Standards, Capital Market Development, and Competition Policy projects which the Ethiopian private sector is striving to implement in cooperation with the Government and with financial support of donors (particularly Sida) will greatly improve the framework for corporate governance in Ethiopia. But corporate governance is far wider than what these instruments may cover. Thus, the first consideration for initiating further development of corporate governance and its “code” is to determine to what extent the code shall be voluntary or be included in laws and proclamations and hence made mandatory. Taking into consideration the present stage of corporate governance in the country and the diversity of the dominant forms of business associations in the country it is suggested that a realistic approach would be to introduce corporate governance as a voluntary framework. Voluntarism has been the leading principle in most countries for the introduction and/or upgrading of corporate governance. At later stages, along with the introduction of institutions such as stock exchanges and share brokers, etc., certain corporate governance rules may be confirmed, formalised and their compliance by business associations and companies made mandatory.

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The code of corporate governance may be developed as a set of general standards. This could be recommended for all companies in the business community. Alternatively, it could be formed exclusively for specific sectors such as the finance sector or the state owned companies sector. Legislation in Ethiopia is at present mainly sector-oriented. However it is suggested that in view of further privatisation and liberalisation of the economy, the framework for corporate governance could be developed on the basis of general (across sector) application. In reality, corporate governance will be applied gradually in the business community, with some sectors such as the finance sector, the state-owned companies sector or/and private conglomerates as the leading actors.

Due to the present corporate structure in Ethiopia, which is dominated by small and family businesses, it is necessary to develop a “business case” for corporate governance that appeals to family-owned and close circle-controlled companies. There are a number of important reasons for corporate governance for these types of companies:

Even in family circles there is an obvious need for rules •of fairness between the owners, e.g., equal treatment of shareholders; Any time a company needs capital infusion in the form of •loan or share partnership, a record of standardised and transparent financial information is a major advantage; In general, checks and balances between a non-executive •part and executive part of the company’s leadership improves efficiency in management and reduces risks (a primary role of the board of directors); and Rules of good governance in relation to stakeholders such •as employees, customers, suppliers and the local community are as important for family-owned undertakings as for big corporations.

It is, however, necessary that big corporations take the lead in the application of the principles of corporate governance. State-owned enterprises, financial corporations and institutions and share companies are the prime groups that should take the initiative to demonstrate to the smaller businesses the concepts, standards, methods and benefits of corporate governance.

Finally, the code for corporate governance may be defined narrowly and be limited to deal with basic shareholders, and board of directors

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– executive management relations, or it can be defined more broadly, including the relationship of the company with stakeholders and society in general. It is recommended that the Ethiopian code be developed on a broad basis and include standards for key areas of corporate social responsibilities in Ethiopia.

Drivers and Supporters of Corporate Governance in Ethiopia

The Government, and particularly the Ministry of Trade and Industry, will play an important role in the development of a corporate governance framework for the country. Such an interest has been expressed by the Ministry, the Office of the Auditor General and the Ministry of Justice. In fact, all these entities are keen to obtain advice from the business community as well as from international experts that work on corporate governance.

Private Banks and insurance companies in Ethiopia are also keen on the development of and adherence to corporate governance principles, particularly on transparency and quality of financial information and reporting. The general lack of reliable information makes the work of financial institutions costly, increases their dependence on real assets as collaterals for loans and, eventually results in a higher cost of capital. The bank and insurance institutions are, thus, keen to participate and contribute to the development and application of corporate governance.

The conglomerate of state-owned companies, under the administration and leadership of the Privatization and Public Enterprises Supervising Agency (PPESA), is well aware of the need as well as the benefits of good corporate governance. The PPESA has introduced different governance instruments, including performance evaluation of the board of directors of the state-owned companies. It will certainly take an active role and leadership in the corporate governance development process in the country. In the individual corporations, corporate governance has not been explicitly a subject. However, the boards of directors of these companies prepare substantial annual reports on finances as well as other activities of their companies.

The MIDROC group, which represents a progressive commercial investor embracing good commercial management practices in the country, is keen to introduce world-class standards in its newly-acquired companies. The MIDROC group executives are conscious of the gradual change process and its management needs to change corporate culture in units operating in many different sectors of the economy. The executives take a

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keen interest in the governance issues in the business community and the group as well. Its leaders will be an important source for knowledge and the drive to introduce and upgrade corporate governance in Ethiopia.

Small and medium sized companies see the potential benefits and have expressed their interest in corporate governance. Elements such as better financial and operating control, use of independent directors in company boards, principles for establishing and conducting relationships with stakeholders as well as to the physical environment are important issues at the “frontiers” of their businesses.

Finally, business associations like the Ethiopian and the Addis Ababa Chambers of Commerce and Sectoral Associations as well as the Association of Manufacturing Industries regard corporate governance as a natural part of their mandate and will be important promoters of its development.

In sum, there is an impressive level of interest and commitment to the development of good corporate governance in the country by the Government, by institutions and by the leading actors of the business community. However, this positive attitude should not lead to complacency and an underestimation of the time, resources and engagement needed for development, introduction and adherence of good corporate governance principles in Ethiopia. As mentioned earlier, the vast majority of the Ethiopian business undertakings are small and medium sized companies. VAT registered numbers are around 30,000 and may represent the category of primary importance for corporate governance. The general awareness and interest in corporate governance among these companies is very limited or even non-existent. To bring these companies on-board in adopting good corporate governance principles, will represent a major challenge for the Ethiopian business community. It would need substantial efforts and time and a specific strategy to get these companies to participate in the application of agreed corporate governance principles.

The recommendation of the Road Map study is that the Code of Corporate Governance (CCG) should be voluntary. This means that the Code will represent a framework for “best or good practices”. However, this basic voluntary approach does not exclude that substantial parts of the CCG is reflected in legislation and proclamations of the Government and that adherence is observed and acted upon. Thus, the status of the CCG would be established through the following possible steps:

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Discussions and agreements on the extent of inclusion •of the CCG’s minimum threshold behaviour in the country’s legal instruments;Coordination of the work and process with ongoing •efforts of the revision of the Commercial Code, the accounting and auditing standards and other work related to corporate governance;Assessment of the possibilities and practicalities of •monitoring corporate behaviour and compliance with the CCG. International and regional experiences would have to be taken into consideration;Review and agreement on differentiated principles of •adherence such as the “comply or explain” principle for state owned enterprises, financial corporations and share companies. Use the CCG as “recommendations” for Private Limited Companies (PLC); and Create positive elements of rewards, appreciation and •public image for good or excellent compliance with the CCG by both big and small companies. Make awards and give publicity for good corporate governance performers; for good annual reports; and for good corporate social responsibility. Establish the Ethiopian Society for Corporate Governance as an “exclusive club” for good corporate governance performers.

The project also needs to have an implementation strategy to ensure success. The strategy of implementation should be an integral part of the project, formulated preferably in the beginning of the process and adjusted successively during project implementation.

The following are some key elements for consideration in the context of the strategy for implementation. The list includes:

Getting the support of the Government by clear statements on the highest political level for the need, process and adherence to corporate governance principles;Getting the recognition of the corporate governance development effort in Ethiopia by international organizations and networks such as the Global Forum for Corporate Governance, Pan-African Network for Corporate Governance, etc.;

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Allowing a long period for “maturation” of the corporate governance framework by the different business actors, but keep a constant activity level for information, publicity, training, international relations and visits, etc.;Developing a publicity and mass media strategy for introduction, explanation and information about corporate governance for citizens, for universities, for training institutions, and for NGOs of all kind;Engaging key corporate actors and business leaders in popularizing corporate governance as a basic principle for doing business in Ethiopia. Increasing the awareness of the general public about how good conduct and governance is linked to good business; and Developing training programmes in cooperation with educational institutions for business leaders, for government officials, for local government etc. Developing instruments (applying existing instruments) for monitoring and assessing level and compliance of good corporate governance.

As part of the implementation strategy there is a need for having an institutional framework for corporate governance. The introduction of and compliance with corporate governance in the business community in general will be a long term process which needs continuous institutional support. The project should create the basis for such institutionalization even though the actual building and maintaining of the institution(s) may fall outside of its term.

A permanent arrangement is needed for organizing, coordinating and backing corporate governance in Ethiopia. Such a permanent arrangement can be an autonomous body created for the purpose or a “semi-autonomous” body attached to an existing association of Ethiopian business. The major requirement for such an arrangement is that it covers the entire business community at the national level without any exception of sector, ownership or affiliation.

The National Corporate Governance Forum can serve as a “general assembly” for the Institution - or the Institute for Corporate Governance. The National Forum would elect trustees for the Institute. The trustees would then function as the Board of Directors for the Institute. It is

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suggested that while the Institute should have limited staff employed, a full time Executive Director should be appointed by the trustees who would prepare an annual activity plan and submit a budget for the approval of the trustees.

The Institute should acquire long-term funding for its activities. The project should prepare a Foundation Document for the purpose of attracting long-term finance for the Institute. Such finance should be committed for at least five years with an option for an additional five years or being an endowment from which the core expenditures of the Institute can be covered. Such an endowment could be made jointly by key stakeholders of corporate governance in the Ethiopian business community and donor organizations with an interest in supporting business and private sector development in Ethiopia. The role and tasks of the Institute would be to:

Promote the concept and compliance with the CCG •in Ethiopia by information, publications and general publicity;Arrange and implement training programs, seminars •and workshops for the Government, business and civil society organizations on corporate governance and related subjects;Cooperate with organizations and associations for •further development and deepening the corporate governance framework in Ethiopia;Monitor compliance with the CCG in the business •society in general and for leading corporations and institutions in particular; and Cooperate with regional and international •organizations and networks in order to make Ethiopian businesses attractive and respected as business partners.

In performing the above tasks, the Institute must rely on existing resources from academia, communication companies, training institutions and international organizations. In creating and establishing the Institute, the project, or at a later stage the elected trustees should consider close cooperation with one or two selected institutions with similar set-up and mission such as the Institute of Directors or Pan African Corporate Governance Network. It is hoped that this framework will help lay the foundation for a modern corporate governance structure in Ethiopia.

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chapter SevenThe Financial Sector and Private Sector Development

Finance is the core element of any investment process. The financial sector in Ethiopia has been weak in supporting the private sector. Stringent collateral requirements to get access to credit from banks both for big and small firms are major impediments. The banking system is very poor in using current technology and providing an efficient service for its customers. This is complicated by the weak regulatory capacity of the country’s central bank which can potentially make the banking sector vulnerable to a financial crisis. Hansson (2004) cited some of the problems in the financial sector that can hamper the growth of the private sector.

A problem that used to exist in the Ethiopian financial sector was the narrow interest rate spread between lending and borrowing rates. There is now a new situation where there is a legislated floor on the rate of interest for deposits, 3 percent, whereas the lending rate is up to the individual banks. However, the Government banks have a leading role in this process through their State ownership that can also be used as a regulator of the activities in the private sector. However, the current legislation prohibits foreign banking institutions from operating in Ethiopia. This is a severe restriction on the financial sector’s possibility to serve the private sector more effectively in financing relatively risky projects.

Financial sector strength and private sector development are found to be different sides of the same coin as far as their growth is concerned. One of the functions of financial institutions mobilising resources, particularly savings, is carried out with the ultimate objective of channeling financial resources to would-be investors.

As recent development history shows, the role of finance in the development of the newly industrialized countries of Asia was central. As elaborated in detail in chapter nine, the government in these countries established four functions: development banking, local content management, selective seclusion and national firm creation. Two principles guided this policy: (i) to make manufacturing attractive to the private sector through subsidies

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and (ii) inducing such firms to be result-oriented (see Amsden, 2001: 125 and chapter nine of this document for detail). These are important principles that need to be examined and adopted to alleviate the financial problems of the Ethiopian private sector. In the newly-industrialized Asian countries, the government’s role in long-term credit allocation to the private sector through development banks was significant. When necessary, the entire banking sector was mobilised to steer long-term credit to targeted industries, all banks acting as a surrogate development bank. In some cases, tax rebates, instead of credit concessions were also used. What is interesting, and perhaps a lesson for Ethiopia, is the fact that the policy of addressing the financial problems of firms through concessional credit was accompanied by policies where the provision of credit was conditional upon performance, i.e., it was result-oriented. It was provided to target industries, and finally the targets and the use of the credit were closely monitored by the government in terms of export orientation, local content, performance and related indicators (see Amsden, 2001).

In line with this and to assess whether the Ethiopian financial sector is adequately serving the private sector, the strengths and the weaknesses of all financial institutions should be scrutinised. The financial sector needs to be strengthened and ultimately stand on its own so that it can adequately serve the private sector. In the same vein, to strategize as to how the financial sector can be strengthened, there is a need to have a clear picture of the institutional set-up of the Ethiopian financial system and identify its major problems. The institutional set-up in turn depends on the historic as well as the economic regimes that the country has experienced (Alemayehu, 2008).

Regime Shift, the Financial Sector and Private Sector Development

The Dergue Regime

During the Dergue regime (1974-1991), banks and other financial institutions were nationalised and thus executed the economic plans as outlined by the central planning organ. Since the financial institutions were under the control of the Government, their contribution to the growth of the private sector was not significant. During this regime, there was also a capital ceiling on private investors which limited the expansion and the growth of private business. Such a structure had far-reaching implications for the current feeble status of many of the private firms in the country.

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Such stringent control has also resulted in the dismal performances of both the financial sector and the private sector. Thus, there was very little growth in both sectors for the simple reason that their apex has been prone to the ceiling limit which was set by the central government during this period. The dull performance of this regime is also reflected in the nature of financial institutions which remained ill-equipped in their capital accumulation potential, expertise to provide quality service, technical efficiency and innovative financial intermediation. Thus, the command economy regime of the Dergue has left a long-lasting negative impact on the growth and expansion of the private sector (both financial and otherwise).

The EPRDF Regime

The National Bank of Ethiopia (NBE), the Development Bank of Ethiopia (DBE), and the Housing and Saving Bank (HSB) were in operation during the Dergue regime. In addition to these, there were also two other financial institutions: the Ethiopian Insurance Corporation (EIC) and the Pension and Social Security Authority (PSSA). Much emphasis during the Dergue regime was on financing public projects.

The current Government has made a major departure in transforming the centrally planned economy into a more liberalised one. Both the financial sector and the private sector have benefited from this paradigm shift. However, the institutional set-up and the functioning of banks (even the privately-owned ones) have not yet been fundamentally changed.

This new change in policy brought about some changes in the functioning of the financial sector. Not only was the financial sector focusing on serving the private sector which had hitherto been demonised, but new private financial institutions were also emerging. At the same time, the role of Ethiopia’s central bank, the National Bank of Ethiopia (NBE), was also reformulated. Thus, the restructuring of the financial sector was at the top of the new EPRDF Government’s agenda (Alemayehu, 2008).

Other measures implemented included the passage of the financial leasing legislation, establishment of a credit information bureau within NBE, establishment of interbank money and foreign exchange markets, progress with micro finance regulation and the supervision, implementation of the Foreclosure Law. Strengthening foreign exchange reserves management operations and related procedures are also in progress.

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The current Government used the strategy of the gradual opening up of private banks along with strengthening domestic capacity of the private investor. In undertaking this task the Ethiopian Government adopted a strategy of gradualism: gradual opening up of private banks and insurance companies alongside public ones, gradual liberalization of the foreign exchange market; and strengthening domestic competitive capacity before full liberalisation, i.e., restricting the sector to domestic investors, strengthening the regulatory and supervisory capacity of the NBE, giving the banks autonomy, and opening up the interbank money market ( Alemayehu, 2008).

Current Structure and Performance of the Financial Sector

The structure and performance of the financial sector has a direct impact on private sector development. A well-functioning structure and well-performing financial sector can meet the demands of the private sector and can make it competitive and profitable thus facilitating its growth. Currently, the Ethiopian financial sector consists of:

The National Bank of Ethiopia (NBE), which is the •central bank;Eight deposit taking commercial banks, of which •the two are the state-owned CBE and Construction and Business Bank, while the remaining six are domestically owned private commercial banks established since 1994;The state-owned Development Bank of Ethiopia;•Nine insurance companies – all, except the state-•owned Ethiopian Insurance Company, being domestic privately-owned companies;22 microfinance institutions (MFIs);•An estimated 600 small saving and credit associations •(SCAs); and Pension funds.•

The NBE is actively involved in the direct control of all financial institutions by fixing both deposit and lending interest rates, directly controlling the foreign exchange and credit allocation which is done in a discriminatory manner, by favoring the public sector institutions, and directly financing the Government deficit (NBE, 1998). Bank supervision and regulation is largely limited to the sporadic inspection of a few branches.

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Proclamation No. 84/1994 that allows the private sector (owners have to be Ethiopian nationals, however) to engage in the banking and insurance businesses marks the beginning of a new era for the financial sector in Ethiopia. Following this Proclamation, the country witnessed a proliferation of private financial institutions. Despite the increase of such privately owned companies, their relative share remains small but has been gradually rising (accounting for 13 percent and 35 percent of total deposits and credits respectively by 2000/2001. This has grown recently to about 30 percent and 46 percent respectively by 2007. The dominant position is still held by the CBE although its market share is increasingly in decline. Disaggregating the disbursed credit by institutional category shows the increasing role of the private sector28 that can chiefly be attributed to the ongoing liberalization (Alemayehu, 2008).

The existing data reveals that the dominant position is held by CBE, which also shows the fast growth of the new private banks, both in attracting deposits and disbursement of credits. The trend shows that the share of the private banks both in deposit attraction and lending could increase significantly in the years ahead. Similarly, the share of disbursed credit to the private sector has reached about 54 percent while the Government’s share was 34 percent, in 2007. This is a clear demonstration of the effect of the liberalisation policy pursued over the last two decades.

As noted above, despite the proliferation of privately-owned companies, their relative market share is still small but growing. This can be seen from Table 10. A summary picture of the share of banks in deposit attraction and loan disbursement in the pre-and post-reform periods shows that the dominant position in terms of savings mobilization is held by the public sector in general and the CBE in particular. The public sector’s share did, however, fall from 96 percent in 1996/97 to 80 percent in percent in 2002/2003 (the figure for the year 2007 being about 60 percent). While the share of the private banks rose from 4 percent to 20 over the two periods (the year 2007 figure being about 40 percent). This private sector’s share was highest for time deposits followed by saving and demand deposits.

A similar pattern is observed in terms of disbursement of loans, loans outstanding, and loan collection. In general, in terms of loan disbursement, the share of the public sector --- the CBE being the dominant bank, accounting from more than 95 percent of the public banking sector,

28 Among the new private banks the most important one is the Awash International Bank followed by Abyssinia and Dashen banks. In fact the share of Awash International Bank in total disbursement of credit is even larger than one of the public banks (The Construction and Business Bank).

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followed by DBE---declined from 93 percent in 1996/97 to 44 percent in 2002/2003 and up to 54 percent in 2007. The share of the private banking sector first increased from 7 percent to 56 percent and then declined to 46 percent in the three periods, respectively. In terms of loan collection, the public banks share declined from 94 percent to 60 percent during the two periods, and then increased slightly to 65 percent in 2007; while the share of the private sector increased from 6 percent to 40 percent, and declined to 35 percent in 2007. Outstanding loans were highest in the public sector, being 96 percent in 1996/97 and declining a little to 82 percent in 2002/2003 and 68 percent in 2007 (the corresponding figure for the private banks increased from 4 percent to 18 percent and 32 percent in each of the corresponding periods).

Table 10 provides a snapshot picture of loan disbursements, collection and outstanding loans by bank and private-public sector for 2007/2008. Total outstanding credit of the banking system, including credit to the Government, reached Birr 46.7 billion at the end of September 2007. Of the total outstanding credit, credit to the private sector accounted for 54.3 percent, followed by credit to the central government, 34.5 percent, and credit to public enterprises, 7.5 percent. Sector wise, about 15.2 percent of the outstanding credit went to the industrial sector followed by international trade (12.9 percent), domestic trade (9.1 percent), housing and construction (8.6 percent), agriculture (8.1 percent) and transport and communications (5.5 percent). In sum, the private banks are catching up relatively quickly with the public banks in almost all banking activities. Disaggregating the disbursed credit by institutional category also shows the increasing role of the private sector which can chiefly be attributed to the liberalisation policies.

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Table 10 Breakdown of Loans and Advances of the Banking System by Clients, for the Fourth Quarter of 2007/2008 ended on September

30, 2007 (in Millions of Birr)

ParticularsLoan Disbursement

% ShareLoan Collection

% Share 2Outstanding Loan

% Share 3

Public Banks 2117.47 54.18 3254.84 65.37 31856.51 68.19

Central Government* - - - - 15475.84 48.58

State Enterprises 315.61 14.91 350.95 10.78 3491.42 10.96

Cooperatives 665.24 31.42 1723.31 52.95 1408.4 4.42

Private Enterprises 1136.61 53.68 1128.1 34.66 11276.57 35.4

Inter-bank Lending - - 52.48 1.61 204.3 0.64

Private Banks 1790.6 45.82 1724.33 34.63 14861.34 31.81

Central Government* - - - - 654.8 4.41

State Enterprises - - 1.24 0.07 24.05 0.16

Cooperatives 20.38 1.14 103.08 5.98 80.33 0.54

Private Enterprises 1770.22 98.86 1620.01 93.95 14102.16 94.89

Inter-bank Lending - - - - - -

Grand Total 3908.07 100 4979.17 100 46717.85 100

Source: NBE of Ethiopia, Quarterly Bulletin (2008)Note: *Refers to Government Bonds and Treasury Bills holdings

Both Table 10 and Table 11 below show the increasing domestic borrowing of the Government. Government can resort to bank borrowing, mainly to make up for the income-expenditure deficits. The conditions, modality and limits of government borrowing from banks are normally regulated by law. Central Government’s borrowing from the NBE and its total debt for commercial banks is defined by law in Ethiopia (Proclamation 83/1992). Within the defined boundary and in tune with the outlined objectives, i.e., monetary and financial stability as well balanced economic growth, the National Bank’s discretion on the level of lending to the Government plays a critical role in the management of financial resources for development as well as maintaining macroeconomic stability. However, the National Bank is facing serious difficulties in regulating Government domestic debt – both its own credit and claims of commercial banks. Table 11 illustrates the trend of claims on Government. Between 1999/2000 and 2005/2006, banks net claim on Government increased, on average by 15.4 percent annually. The National Bank’s claim on the Central Government has increased by 20 percent, which is equivalent to twice the GDP growth rate. The claim of commercial banks, most of which is held by the CBE, increased by a staggering 43 percent between the two

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periods. For the seven year average, the NBE and CBE claims on the Government amounted to about a quarter of GDP, of which two-third is owed to the National Bank.

Table 11 Banks’ Claim on Central Government

Description 1999/0 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 Average

Gross domestic outstanding debt 31.8 2.40 -0.5 2.6 11.8 31.5 20.6 14.3

Gross banks claim on gov’t 53.6 -1.3 4.7 9.8 12.1 15.8 14.1 15.5

Gross NB claim on gov’t 69.2 -29.6 -8.6 8.9 -4.3 103.3 -0.1 19.8

Gross CBs claim on gov’t -11.4 224.1 27.5 10.9 32.0 -61.5 80.0 43.1

Gross banks claim on NGOs 10.0 7.6 -7.1 -7.7 11.4 58.4 28.7 14.5

Domestic banks claim /GDP 42.4 42.3 44.1 41.6 37.8 43.1 43.7 42.1

Banks claim on gov’t/GDP 24.6 23.7 26.0 26.2 23.9 24.0 23.0 24.5

NB claim on gov’t/GDP 21.9 15.0 14.4 14.4 11.2 19.7 16.6 16.2

CBs claim on gov’t/GDP 2.7 8.7 11.6 11.8 12.7 4.2 6.4 8.3

NB claim on gov’t/total banks claim on gov’t

88.8 63.4 55.4 54.9 46.9 82.3 72.1 66.3

NBE direct advance to gov’t /average ordinary revenue

84.0 43.3 41.2 54.6 45.6 124.8 ----- 70.0

Sources: IMF Country Reports No. 05/28, January 2005; No. 06/122 April 2006; No. 06/159 May, 2006NB: Government debts do not include private sector claims.

In any given year, the National Bank’s direct advance to the Government should not exceed 15 percent of average annual ordinary revenue of the Government for the three fiscal years immediately preceding that year (Proclamation 83/1994). However, at no time, not even for a single year, was the Government’s outstanding direct advance anywhere near the limit of 15 percent. The minimum outstanding direct advance was 41 percent and the maximum 124 percent of average ordinary revenue in the last decade or so. On average the annual direct advance was 70 percent of ordinary revenue. Though the condition for the Government to take a direct advance requires repayment in full of the previous year’s borrowing, this has never been the case in practice. This has an implication

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for the private sector. First, there is a possibility of private sector being “crowded out” from the credit market by public borrowing (in short this money could have gone to the private sector). Second, and perhaps most importantly, this level of borrowing, more than five times the legally stipulated rate, is a recipe for disastrous macroeconomic instability (inflation being the major one) and inefficient financial intermediation which is harmful for private sector investment and development.

Given this general picture, it is important to closely examine the financial problems of the Ethiopian private sector and what needs to be done in terms of ensuring that an adequate level of liquidity is available for sustained development of the private sector. A healthy financial environment is vital for the smooth operation of the private sector. The discussion that follows focus on the micro-level financial problems of the private sector: credit and lack of financial instruments.

The Ethiopian Financial Sector and its Implication for Private Sector Development

Noting the problems of the financial sector briefly outlined above, it would be instructive to draw the implications for private sector development in Ethiopia. The implications need to be guided by the objective of establishing strong linkages between the financial sector and the private sector and ultimately achieving the sustained growth of the private sector in a financially stable environment.

The World Bank conducted a survey in 2006 on the factors that explain the growth and development of the private sector for most developing countries, including the newly emerging economies of East Asia. The results of the survey, relevant for Ethiopia, on the basic financial indicators are summarized in Table 12 below.

Table 12 Access to Finance in Ethiopia

Finance Ethiopia Region All countries

Percentage of firms with bank loans/line of credit 46.03 24.71 33.54

Percentage of firms using banks to finance investments 10.95 13.88 16.09

Percentage of firms using banks to finance expenses 40.7 23.16 27.34Value of collateral needed for a loan (% of the Loan Amount) 178.59 145.89 140.66

Percentage of firms identifying access/cost of finance as a major constraint 44.24 48.97 30.29

Source: World Bank Study, 2006

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The survey results in Table 12 indicate that a number of firms face serious obstacles in getting access to credit from financial institutions. Constraints imposed on credit facilities are found to exceed the world average for the selected sample firms in Ethiopia although the country is better off compared to regional standards. The table also shows that only a few firms use bank credit to finance their investment projects (10 percent). The data also indicates that the collateral requirement to get access to credit by far exceeds the loan amount and is very large by regional and developing countries standards. This creates a disincentive for private sector economic agents to apply for loans. In addition, those who are in need of finance would be adversely affected by the banks’ selection criteria. Due to this fact, most projects that can contribute to the economic growth process fail to materialise. Particularly innovative private sector entrepreneurs with excellent ideas, but limited collateral, fail to exploit their entrepreneurial talent. Had there been inexpensive and reliable financing mechanisms and a risk-sharing arrangement which is designed to enhance the growth of the private sector, its contribution to the growth process could have been immense.

The information in Table 12 also clearly indicates that most of the firms use bank loans to finance their operating expenses rather than their capital investment projects. This is consistent with the fact that firms get access to credit if, and only if, they meet the collateral requirements. Firms which fulfill these requirements are those with strong financial bases and those which have been operating in the market for a relatively long period of time. Thus, most of the time the banks do not encourage the development of the new players in the private sector, but rather continue to support those who have a historically strong financial record. Notwithstanding these problems, however, the Government is also attempting to offer access to finance to firms that do invest in the sectors designated as priority sectors, in particular to those engaged in exporting.

a) Deepening Reformation of the Financial Sector

To redress the problems of the financial sector discussed in this chapter and tune the financial sector to efficiently serve the private sector, an all-round restructuring of the financial sector is warranted. There is a need to reorient the ideology of public sector dominance in the financial sector towards a market-based system where the public and the private sector actors will be judged by their performance in the market where there is a level playing field. In addition, it is important to develop new instruments and institutions to strengthen the financial sector. Beginning

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with the NBE (regulator), it is imperative to enhance capacity by experts to ensure the prudential regulation of the financial sector in order to prevent a potential crisis in the sector that could easily spill over to other sectors, such as the private sector. There is also a need for a legal and governance infrastructure to ensure the autonomy of the NBE, strengthen its research, regulation and other crucial departments through appointing staff, including the Governor, on a merit basis. A critical factor is the need to put in place a sensible incentive structure for the staff so as to attract the most talented and retain the best and the brightest. It is only when such a reformist strategy is pursued that the private sector will be guaranteed that it is operating in an environment where bank and financial sector crises are less likely, that it can provide macroeconomic stability and policy credibility – factors that are a prerequisite for investment and private sector development.

With regard to the banking sector, the following policy directions could be pursued in order to promote healthy competition between the state owned commercial bank and the newly emerging private banks from which the private sector could benefit:

The full provisioning by banks for non-performing loans and other doubtful assets in line with best international practices;Ceasing all lending to borrowers with non-performing loans;Strengthening the credit approval and monitoring process for all new loans;Transferring lending authority from the board of the CBE to its management;Include private sector representatives as CBE board members;Giving autonomy to the management of CBE in decision making; and Full compliance of CBE with the NBE provisioning directives.

While some progress has been achieved, such as an increase in the capital adequacy ratio, a marginal decline in non-performing CBE loans, and a marginal decline in the asset and loan shares of the CBE, the major problems of the financial sector have yet to be solved and some key financial sector objectives have not been met. Investments in the financial system are still not fully liberalised, the banking system still carries the legacy of

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past central-planning, and the overwhelming majority of financial sector assets and deposits are held by the CBE. A competitive market-oriented financial system has thus not yet emerged.

Given the critical role that the financial sector could play to the development of the private sector, further restructuring of CBE in line with the road map briefly outlined above has to be carried out. Most of all granting full management autonomy to allow the CBE to operate on a commercial basis is essential. In the short term, this would be better served under a management contract with an internationally recognised firm, as had been planned a few years ago but never implemented. In the medium to long-term, however, a sustainable solution can only be secured with the opening up of CBE for private sector majority shareholding, including foreign minority shareholding. It is believed that this will also help democratise economic governance in the country.

The issue of opening the financial sector to foreign operators has been a sensitive issue between the Ethiopian Government and international financial institutions, in particular the IMF. Although the Government’s hitherto policy of gradualism in liberalisation is commendable, there is a need to set a limit for how long domestic banks should be sheltered from foreign competition. What matters most in practice is that, regardless of the legal form of their presence, foreign banks have to be initially licensed to carry out those activities that the host country banks are unable to do, and engage on those activities where host country supervisors are familiar with and are able to monitor properly. At the same time, the licensing rules should not be too rigid, and supervisors should continuously upgrade their capacity to monitor banks’ activities on a consolidated basis.

Many countries have installed different mechanisms to overcome the adverse impacts of foreign bank entry into their domestic markets. Various considerations were taken into account to determine the modality, extent and scope of foreign bank entry. A range of restrictions were also imposed to protect domestically owned banks, i.e., minimize the cost and/or maximize the benefits of foreign bank operation in the domestic markets. The experience of China and other countries are therefore instructive. China used foreign banks as a platform to learn and master the trade, while simultaneously offsetting their adverse impact on domestic banks. So the issue is not whether to allow the entry of foreign banks, but the modality of entry and the extent of penetration given the degree of development of domestic financial institutions, particularly

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commercial banks. A policy of “no entry” has a strong deterrent effect on foreign investment.

b) The Need for the Development of New Financial Markets and Instruments

The financial sector in itself is one potential area for private investment. Stock markets are non-existent in Ethiopia, and even the interest rate offered by the banks on deposits is not attractive. Agents usually prefer to use bank facilities from a security perspective not as an option for investment as the real interest rate on deposits is often negative. The lack of alternative financial products for both private and public sector operators is the sin-qua-non of the Ethiopian financial sector. The development of both the primary and secondary markets such as a stock market for financial instruments is long overdue. Such markets cannot develop by themselves. It needs planning, in-depth study and the establishment of a legal, institutional and information dissemination infrastructure. The Government could build on the experience of the recent Commodity Exchange to set up a framework of markets for financial instruments such as a stock market. Such markets not only ensure the efficient use of financial resources but help the development of the private sector by offering an extensive source of financing.

Such financial markets can be looked at from two angles: direct investing and indirect investing such as mutual funds, or investment companies. Direct investing in turn can be divided in three important categories (Elton et al, 2003):

Money Market Instruments (treasury bills, commercial papers and repurchase agreements, etc);Capital Market Instruments (with maturity greater than one year, such as treasury notes and bonds, Federal and Municipal securities, corporate bonds); and Derivatives (securities whose value derives from value of an underlying security or basket of securities such as options and futures).

It is obvious that all these financial markets and instruments cannot develop overnight in Ethiopia. Some of them require a higher level of economic and institutional development to be effective. In fact the existing literature and empirical evidence show that the development of a stock market is strongly associated with the level of development of an economy. The development of a stock market usually emerges either as a product of macroeconomic development and/or the evolution in

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the corporate financing decision of firms. In general, the development of a stock market follows the development of commercial banks and other financial intermediaries (Capasso, 2008). However, it is possible to develop some of these markets in a very short time by the combined efforts of the Government, the private sector and development partners of the country. The recently established Commodity Exchange is a testimony to this effort. However, the Government and the private sector need to come together to pick exchanges and markets that are the most important for the private sector’s development and could be handled in a less costly and timely manner. At least three markets/institutions that need the attention of the Government, namely the secondary market for securities, venture capital, and investment banking discussed below.

i) The Secondary Market for Securities: There are a number of ways to classify financial markets. One such classification is between primary and secondary markets. The former refers to security markets where new issues of securities are initially sold and provide a direct flow of cash for the issuing entity. This seems to exist informally in Ethiopia (witness the various share offers by private banks). A secondary market, on the other hand, is a market where securities are re-sold --- the New York Exchange is a secondary market (Elton et al, 2003; Kohn, 2005). Such a market is absent in Ethiopia but it is most likely that the demand exits (witness how fast private banks’ share are sold and the problems faced by an investor of selling such shares when she/he is illiquid).

A good secondary market is less important for short-term securities because they mature quickly, thus, a normal repayment turns them into cash relatively quickly. On the other hand, repayment is far into the future with long-term securities, especially for bonds. The secondary market is the only way to turn them into cash. Such secondary markets are divided into wholesale markets and retail markets. In wholesale markets professional and large investors are engaged while in the retail market the individual investor buys and sells securities (Kohn, 2005). These securities are traded in what are called exchanges or stock exchanges as well as over the counter (OTC) markets. Therefore, the secondary market is an important market that needs to be developed in Ethiopia.

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ii) Venture Capital: The majority of Ethiopian firms are small in size. Such firms are normally unable to float a public issue of bonds or similar instruments by themselves to raise equity funding. An alternative usually used in other countries is what is called venture capital. This is equity funding provided by specialised institutions that generally also demand some degree of control over the management of the firm. Such venture capital is usually provided by small independent venture capital companies which manage small funds. Venture capitalists raise money mainly from pension funds, insurance companies and non-profit institutions and subsidiaries of big corporations (Kohn, 2005). According to Kohn, venture capitalists in the USA have been very successful – Intel, Apple, Microsoft, and Federal Express, were all backed by venture capital. These successes compensate for the more frequent failures (half of all new firms fail within two years) in the US economy.

Given the nature of the Ethiopian private sector which is dominated by small firms with a huge demand for capital, and given the inefficient use of the Ethiopian pension and insurance funds, there is much scope for developing venture capital funds. The Government needs to set up a framework for the provision of such services by the private sector to the private sector. Apart from the pension funds and insurance companies, the Government can also raise such funds for venture capital using other instruments such as “municipal bonds” or “minis”, where local governments/municipalities can raise funds using bonds and pass them on to the private sector through small venture capital firms. This could be money raised for particular projects of the municipality in question (for instance low-cost housing) or for any private sector venture. This approach also helps to create what are called ‘institutional investors’ such as the pension funds, mutual funds and insurance companies. This requires setting up the institutional and legal framework as soon as possible. This also needs to be done in collaboration with the private sector and development partners.

iii) Investment Banking: A related institution that can be easily developed from the existing banking system or added to the functioning of the existing banking system is what is

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referred to as “investment banking”. Such banks normally provide medium and long-term finance for industry and they have played a significant role in the industrialisation of many developing countries such as India. The banks purchase large blocks of new corporate issues of stock and bonds and resell them in smaller amounts to individuals or institutional investors, most of whom will purchase significant portions of, or the entire, new issues of corporate securities. Investment banks can also be combined with the existing banking system (the “deposit-taking banking system”) in Ethiopia -- such combined banks are usually referred to as “mixed banking” (Seth, 1981). There is significant potential to develop mixed banking in Ethiopia.

In summary, through the deepening of financial sector reforms and introduction of new financial innovations such as venture capital, capital market and investment banking, much more resources can be mobilized for use in the private sector. Some of the immediate tasks to this effect include:

Addressing the issue of resource mobilization for both private and public sector firms through a combination of various measures targeted at different sources and instruments of savings (bank deposits, pensions/provident funds, insurance funds, international remittance, etc.);

Improving accessibility of existing financial instruments (e.g. accessibility of bank deposits, T-bills and bonds to urban savers – the existing minimum denominations of birr 5,000 and 2 billion for treasury bills (T-bills) and bonds respectively puts them beyond the reaches of individual savers) and channeling that to the private sector. Moreover, dollar-denominated T-bills that target the Ethiopian diaspora are an experiment worth exploring;

Increasing the range of savings instruments available; example, introduce government bonds of longer maturity, municipal bonds, etc.

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Establishment of a corporate bond market and channeling that for the private sector;

Improving the returns on financial assets through tax exemptions (on contributions to pensions and life insurance and return on their investment funds), stable inflation at a rate commensurate with GDP growth, improved alternative investment outlets for pension and insurance funds, more professional management of pension and related funds, etc.;

Legislation designed to set up venture capital companies, investment banks and capital market/secondary market for securities; Introduction of policies designed to attract greater flows of international remittances and discourage their use for non-productive activities;

Limit government credit to the legally stipulated level, not only to avoid the “crowding out” of the private sector but also to ensure macro and financial sector stability; and

Ensure access to credit for targeted private sector operators based on performance and productivity and with Government maintaining close scrutiny (Weeks et al, 2004).

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chapter eIght

Challenge of the Macroeconomic Environment, the Global Trading System for Private Sector Development

The Macroeconomic Environment & Private Sector Development

Macroeconomic stability of a given economy is a precondition for the development of the private sector. Maintenance of prudent fiscal and monetary policies not only helps to provide the much needed infrastructure and human capital for use by the private sector, but also provides a stable and predictable macroeconomic environment. Ethiopia has only a limited source of government revenue to finance government spending on the provision of public utilities. Thus, the Government uses borrowings as an option to finance spending on public projects which in turn raises its stock of debt. To service this debt, the Government is expected either to reduce its spending on infrastructure in subsequent periods or be indebted again, thus leading to a vicious cycle of higher and higher debt. Moreover, monetisation of such a large amount of public spending could lead to inflationary pressures which would undermine private investment.

Some fundamental problems faced by the private sector in Ethiopia from a macroeconomic perspective have been cited by Melese and Abera (2005). According to their empirical study, macroeconomic instability (usually characterized by high inflation, high public deficit, high balance of payments deficit and unemployment), weak institutions and institutional arrangements, weak and inefficient financial markets, and the political environment are found to be the major problems inhibiting the growth of the private sector. Among all these factors, they noted fiscal policy and its implications on the development of the private sector as the most important one. The authors argue that when the Government is in fiscal deficit, the private sector economic agents expect future tax increases, which is called the “Ricardian Equivalence” by economists, or money creation (inflation tax) that in turn negatively affects decisions on private investment.

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The implication of the macroeconomic environment on the private sector is not limited to fiscal imbalances alone. It also comes through exchange rate instability and inflation pressure as well. A good example is the current inflation and exchange rate volatility. Such an environment is harmful for private sector agents because they cannot plan one to two years ahead as they are unable to foresee at what cost/price they will buy goods and at what prices they will be selling their products. In addition, they are unable to predict with a reasonable degree of confidence, the net worth of their savings, debt, and related physical and financial assets in the years ahead. Moreover, such inflationary pressures and exchange rate volatility erodes the private sector’s confidence on the economic governance ability of the Government.

Instability in the exchange rate as well as in goods prices erodes the confidence of private investors as to whether a certain project or investment would be profitable or not. Investment by its very nature is a forward-looking activity whose outcome is uncertain ex-ante. In an environment of exchange rate instability and inflationary pressures, as is currently the case in Ethiopia, a private economic agent cannot predict the profitability of projects. The agent will thus be less motivated to engage in productive investment projects particularly in those projects with a longer maturity period. In such a macroeconomic environment, speculative investment and inflation hedging might turn out to be more important than productive investment for private sector economic agents.

Macroeconomic stability in Ethiopia may not be related to economic policy issues alone. An economy characterised by frequent wars and periodic civil unrest and political instability can have a detrimental effect on macroeconomic stability and hence on the behaviour of private economic agents. It is hypothesised by some economists (see Collier and Gunning, 1999, for instance) that economic agents can be uncertain about their investment decisions in an economic environment that prevails in Africa, which might have a detrimental effect on growth. A regime characterised by frequent wars, drastic policy changes, and where the economy is vulnerable to shocks (such as excessive rainfall or drought) can have a negative effect on the behaviour of its economic agents. The imperial regime in Ethiopia (the regime before the 1974 revolution) was characterised by relative political and economic stability. Economic agents had relatively less risk both in terms of policy shocks and natural disasters such as drought. This had resulted in a fairly buoyant economy with respectable GDP growth rates.

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In contrast, the Dergue regime was actively engaged in eliminating private economic activity. Private ownership was legally prohibited, and entrepreneurship was openly discouraged. This was a huge policy shock, which as good as condemned the private sector to obscurity. This was compounded by natural shocks (the 1974 and 1984 droughts) that devastated the peasant economy. All efforts and policies were geared to strengthen the public sector. That policy, however, was not successful. The private sector’s response to these harsh policies was a drastic decline in private investment, no entrepreneurship development to speak of, and a decline in output, especially in agriculture.

While the EPRDF regime has reintroduced the market paradigm of the imperial regime, it has nevertheless created its own risk factors (Alemayehu, 2007). These are challenges that the Government and the private sector need to squarely address to ensure sustained investment and growth in the country.

The Challenge of the Global Trading System to Ethiopia’s Private Sector

Ethiopian economic activity, and hence its exports, are extremely dependent on the agricultural sector which contributes about 90 percent of exports, and the lion’s share comes from the private sector. The world market has been changing very fast both in size and composition of goods traded. The Ethiopian private sector, thus, needs to take cognizance of these changes to seize opportunities afforded by the world trading system. However, Ethiopia’s private sector is not adequately equipped to take full advantage of these opportunities.

The problem that the private sector faces in the context of the global trading system can be classified as external and internal. External competition in the form of excessive dumping, particularly from the East Asian tigers, problems of market access, stringent requirements to comply with the international market, and rising input prices that in particular follow the volatility of the US dollar, are some of the external factors. While the internal factors include dependency on a basket of goods that contains only a few items, a weak incentive structure, utilization of outdated technologies in production and processing, its stage of infancy when compared to international companies, lack of skilled manpower both in management and processing, lack of information about the world markets, and limited capital to acquire the latest technology in

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production and processing are challenges that continue to negatively impact on Ethiopia’s private sector.

Internal Factors or Domestic Supply Constraints

Various studies indicate the importance of internal factors in shaping the development of the private sector. Some of these factors include:

a) Composition of marketable items

A study by Haile, Alemayehu, and Daniel (2005) noted that the Ethiopian export sector is characterised by a high concentration on a few products for a long period of time. The concentration of exports in agricultural products and on few products within agriculture, particularly coffee, has not changed much over the years. Coffee accounts for about 60 percent of export revenue, although this has been declining in recent years.

Private investors in Ethiopia remain passive, being dictated to by world demand rather than actively engaging in research and development, and the processing and production of new export products. Haile et al (2005) noted that there is no much interest by the private investor in the manufactured goods export sector. They further noted that manufactured products are not among the largest export items and their share of the overall exports is very small. The changes in both the composition and the volume of exports in general, and that of manufactured products in particular, have been very limited despite the reforms undertaken since the early 1990s. For instance, the dominance of food items in the composition of exports declined from an average of 71 percent to 70 percent and that of manufacturing increased from 13 percent to 19 percent of total exports.

To grow successfully, the private sector has to expand its range of exportable products and at the same time exploit the opportunities afforded by the relatively favourable environment provided by the Government’s investment policy.

b) Weak incentive structure

Given the nascent private sector in Ethiopia, the sector needs much more support from the Government if the country aims to achieve a high sustainable growth rate led by the private sector. To accelerate the development of the private sector and to enable it to play a more active role in both domestic and international markets different incentive schemes have to be developed by the Government. One of these would

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be the introduction of a tax holiday on any activity deemed a priority by policymakers. Although the Government is providing a tax holiday for selected sectors, expanding it to others is worth considering. A different kind of support scheme has to be provided for infant industries, but such incentives need to be result-oriented.

c) Credit facilities

Most firms face major financing constraints both at their initial stage of development and later in the form of working capital. Unless the Government can provide these firms with better access to credit facilities, they will not be in a position to compete in international markets.

A survey by Haile et.al (2005) identified the two main reasons why firms work below full capacity as: an absence of credit facilities (48 percent) and the shortage of supply of raw materials (20 percent). Curiously, respondents in this survey did not seem to believe that lack of market demand is an important factor for their sub-optimal operations.

Table 13 Stated Constraints for Lack of Full-capacity Utilization in Percentage

Reason 2000/2001 1998/99

Shortage of supply of raw materials 19.6 27.8

Shortage of supply of spare parts 2.1 3.6

Shortage of market demand 6.5 8.3

Absence of credit facility 48.0 36.6

Shortage of foreign exchange 7.1 5.3

Lack of adequate skills 3.7 3.3

Others 0.3 0.8

Not stated 12.7 14.2

Total 100.0 100.0

Source: CSA Statistical Bulletin, 1998/1999 and 2000/2002.

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d) Using outdated technologies in production and processing

Most Ethiopian firms, which are engaged in international markets, are using outdated technologies thus hindering their success in the world market. Had these firms been in a position to add value to the goods they are exporting by using modern technology, their earning potential would have been greater. Using new technology they would have been able to develop at a faster pace as commercial entities and improve their chances of succeeding in the world market. The weak capacity to add value to export commodities by the Ethiopian private sector is forcing the country to re-import (in processed form) what has already been exported as raw commodities.

For instance, given the size of the Ethiopian livestock herd (the largest in Africa and tenth in the world); one would expect Ethiopia to have a significant share of the world market in leather and leather products. But that potential has yet to be fully exploited. In fact, instead of increasing its world market share, the sub-sector exported less in 1998 than in 1990. The volume of leather exports decreased and leather imports increased during this period. Consequently, Ethiopia was a net importer of leather products.

e) Lack of skill in marketing, management, and production

Lack of skills, either in management and/or in the production, makes Ethiopian firms less competitive in the international market particularly in the manufacturing sector. Thus, the food and beverages sub-sector, leather and leather products, and wood and furniture have low import intensity. On the other hand, manufacturing activities that require relatively high skills and/or capital (for instance, basic iron and steel, rubber and plastic, motor vehicles, trailers and semi-trailers, metallic products, tobacco, machinery and equipment and chemicals) indicate very high import intensity. Owing to unskilled, weak or an inefficient labour force in the manufacturing sector, most Ethiopian firms engaged in the food and beverages sub-sector, leather and leather products, and wood and furniture sub-sector are losing a significant part of their potential market share in the international market.

f) Lack of information as well as inability to utilise and process world market information

Another important factor which has become a challenge for private sector development in Ethiopia is their inability to process and utilise

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world market information, either due to lack of information or access to these information, as well as an inability to appropriately use it in a timely fashion if it is obtained.

g) Focus on short-term benefits and the domestic market

Most Ethiopian private firms are short-sighted. Their primary objective to stay in business is only to cater for the domestic market. Private firms in Ethiopia hardly have any plans of competing for market share in the world market, unlike most East Asian firms. They generally focus on the domestic market with the aim of getting short-term benefits. Unless these firms change their inward looking perspective to an outward looking one and start to seriously look to the world market to grow their businesses, it would be difficult for the Ethiopian private sector to expand, become more efficient and be a player in regional or international markets.

External factors

In addition to the internal problems outlined above, Ethiopian private firms suffer from external factors too. This list includes the following major ones that also undermine their growth and performance.

a) Problems of market access

As can be seen in Table 13, in terms of the destination of exports, the bulk of Ethiopia’s exports go to industrialized countries (Germany, USA, Italy, France, UK, Japan and Saudi Arabia in particular). This pattern seems to have remained unchanged over the past ten years. The only exception is the increasing importance of Asian countries (in particular China and Japan).

It should also be noted that a few countries, such as Germany, Japan and Italy, and recently Saudi Arabia, are increasingly becoming important destinations for exports from Ethiopia. Table 13 shows the need to increasingly diversify the destination of exports in order to avoid overdependence on a few countries.

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Table 14 Percentage Share of Exports by Destination (1989-2005/06)

Share of Total Exports

After Reform: Share of Total Exports

(1988/89) 1992 1993 1994 1995 1996 1997 2001/02 2002/03 2003/04 2004/05 2005/06

USA 12.4 3.9 9.1 6.5 6.4 6.1 11.4 4.3 8.2 4.9 5.3 4.8

Germany 23.2 9.7 19.7 31.7 29.1 29.7 20.6 11.3 8.5 10.8 14.6 10.1

Italy 6.5 6.5 7.6 8.1 8.6 7.4 7.8 10.1 4.4 5.9 5.2 5.5

France 4.9 5 3.7 4.9 5 3.4 3.2 2.9 6.6 1.9 1.7 2

UK 1.9 16.3 4.6 3.5 3.6 3.1 2.9 3.6 1.9 3.5 3 2.7

Other European countries

- 5.1 6.7 5.8 6.4 7.2 14.3 14.8 13.6 21 17.7 17.2

Japan 15.1 21.5 19 14.5 13 12 11.2 7.6 4.5 10.2 7.6 7.8

Saudi Arabia

15.1 20.1 9.9 5.3 9 10.6 8.6 5.9 4.4 5.7 6 6.1

Africa 7.2 13.4 9.1 11.5 12.4 13.2 10.7 19.1 17.6 14.1 16.8

Rest world

- 4.8 6.3 10.5 7.3 8 6.8 28.8 28.8 18.5 24.8 27

Total 100 100 100 100 100 100 100 100 100 100 100

Source: Computed from data obtained from National Bank of Ethiopia

In terms of the destination of exports, about 70 percent of Ethiopia’s total exports go to industrialized countries, of which Germany and Japan are the main trading partners. The share of exports that goes to developing countries is relatively small and most of that goes to Middle Eastern countries.

b) Compliance with stringent requirements from the importing countries

Firms with a desire to export are required to comply with internationally accepted regulations and criteria which are difficult to satisfy given their current level of development and sophistication of production. Some of the requirements are disguised non-tariff barriers imposed by the importing countries. It should also be noted that the Generalized System of Preferences (GSP) has been greatly eroded by the conditions introduced by GSP-offering countries. In many cases, various international standards like environmental safeguard measures, sanitary and physiosanitary conditions, rules of origin criteria and protection of child labour are applied by the GSP-offering countries so that selling in these markets has increasingly become tougher for developing countries like Ethiopia. Firms are faced with difficulties in penetrating new markets and even

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maintaining their historic market share in the traditional markets due to deficiencies in complying with such international standards.

c) Rising input prices

Most of the private firms in Ethiopia are unable to cope with the rising world input prices, following the fluctuations in oil prices in the international market. Prices for most of the inputs for the Ethiopian exporters have been steadily increasing. Most firms, thus, struggle to withstand such shocks from the international market given their current relatively weak position.

d) Unfair competition brought about by “liberalization”

The liberalisation of the world markets following the Uruguay Round of Multilateral Trade Negotiations and the establishment of the WTO have brought about a new challenge to developing countries like Ethiopia. Under the Lome conventions and the GSP arrangement, Ethiopian exports, like those of other developing countries, have had preferential access to the markets of the developed countries. But the world market has now become more competitive with the application of the most-favoured-nation (MFN) principle of the WTO, which has essentially extended the preferences to non-developing countries, thereby forcing developing countries to compete with developed and newly industrialised countries on an equal footing. The preferential market advantages developing countries have been enjoying from bilateral and multilateral trading arrangements are, therefore, in jeopardy due to global liberalisation. Such a global trend is quite pervasive for countries such as Ethiopia because it suffers from major internal supply constraints alluded to above.

e) Subsidies and protection in the international market

Most privately-owned firms trading in the international markets are getting either price supports or subsidies from their governments and hence can sell their products at a relatively low price whereas private firms in developing countries, like Ethiopia, cannot even get the breakeven price that would allow them to compete with such firms. Such unfair supports create serious problems for private firms in Ethiopia, undermining their endeavours to compete effectively in international markets.

f) Trade negotiations and WTO accession

To benefit fully from the Multilateral Trading System (MTS), Ethiopia needs to build the competitiveness of its domestic industries and increase

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the export capacity of its firms. In this regard, building the capacity of existing manufacturers and other exporting firms in a bid to improve their efficiency and productivity becomes critical. To this effect, tariffs for strategic manufacturing exports such as textiles and garments, leather and leather products need to be bound at a relatively higher level in order to allow the Government to take measures to increase the competitiveness of these sectors through increased productivity. It is important, therefore, that the various flexibilities in WTO Agreements for less developed countries (LDCs) are thoroughly explored for effective use during accession negotiations. On the positive side, WTO accession can provide a framework for reviewing and improving trade support institutions that impact the private sector. Joining the WTO may open access to foreign markets, signal the commitment of the Government to further liberalisation, but is less costly than negotiating trade deals with individual countries, and can help to lock-in certain beneficial liberalisation policies and help avoid policy reversals. These benefits may not be obtained, however, if the Government and the private sector fail to do their homework in improving their competitive positions before firms from developed countries begin showing up in the Ethiopian domestic market.

g) Neglecting to take anti-dumping measures against some Chinese firms

Competition from China is becoming stiff even for most developed countries, let alone for the nascent private sector of Ethiopia. The Government, in consultation with the private sector, needs to be cautious about the long term impact of the actions of Chinese and Indian companies.

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PART IIIchapter nIne

Lessons for Private Sector Development Strategy from the Newly Industrialised Asian and Successful African Countries

There are controversies over the issue of what contributed most to the success of the East Asian economies in exporting and attaining fast growth. According to the surveys by Lawrence and Weinstein (2001), Krueger (1993), Hughes (1992) and Balassa (1971), the principal contributor to the East Asian rapid growth was the openness to trade and governments’ willingness to limit protection and ensure that “incentives were largely neutral”. Contrastingly, among others, Amsden (1989) and Wade (1988) show that the emphasis given to interventionist policies in these economies has changed comparative advantage by “getting prices wrong”, while duly acknowledging that the trade performance of the economies was vital. Still another group, represented by Roderick (1995), argues that industrial policies played the most important role by creating a particularly favourable environment for domestic investment. The World Bank (1993) takes an intermediate position in the debate. Although it recognises that performance in the manufactured goods industry played an indispensable role in stimulating growth, it challenges the view that selective intervention (such as selective industrial policies) was essential in promoting the export competitiveness of industrial policies. As Lawrence and Weinstein (2001) noted, although the World Bank (1993) acknowledges the role of exports as a channel for learning and technological advancement, it fails to recognize similar benefits that accrue from import and export competition. Their study finds that the role of imports was far more superior to the role of exports in determining greater productivity growth.

At the centre of this controversy lies the role of the private and public sectors in this growth surge and economic development. Details about such a strategy and the role of the private sector in that process from experience of countries with a success story can help policy-making on the formulation of a private sector development strategy in Ethiopia. Thus it is worth examining the experience of such success stories from Asia and Africa to draw lessons for Ethiopia.

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Taiwan and South Korea

The growth success of some Northeast Asian countries (Taiwan, Korea and Hong Kong), and later the Southeast Asian countries (Malaysia and Indonesia in particular) is unprecedented in the history of industrialisation and development. Moreover, their fast growth is accompanied by an unusual equal distribution of income, which was not the case during the industrialisation period of the developed countries (Wade 2004). In short, in one generation, they moved from agrarian to industrial economies. What is the story behind this success, what was the role of the private sector --- government relationship in this process and are there any lessons for Africa in general, and for Ethiopia in particular?

There are a number of dimensions to the Asia’s miracle growth. Those include initial conditions, trade and industrial policy making, the political economy of trade policy-making and the role of the state, and the dynamics of exporting industries and the role of foreign firms (Alemayehu, 2005). It is in the context of such a variety of explanations that it is necessary to understand the private sector – government relationship and hence the strategy for private sector development.

Amsden (2001) noted that the current industrial structure and export success in South Korea owes its origin to the industrialisation advances during World War I and accelerated with the Manchurian incident in 1931. Following WWI and the associated cut-off of supplies from Europe, Japanese industries failed to satisfy the demand in its colonies. This led to the relaxation of the policy that restricted the creation of industries in South Korea that were competing with those of the Japanese. Following this policy relaxation, the following pattern is observed. First, Japanese business groups became major actors in South Korean industrialization. Second, Japanese investments were much larger in scale than those of the Koreans, and the large Korean-owned corporations made an early appearance in the industrialization process. Third, small industries concentrated on food processing while larger industries covered multiple industries, including iron and steel. Fourth, most of the capital for expansion came from Japan. Finally, most Koreans were working in Japanese firms at different capacity and the colonial government invested on their education while Japanese firms invested on their training. Thus, South Korea had accumulated considerable manufacturing experience (workforce, managerial elite, government bureaucracy, cadre of entrepreneurs with project execution skills, and production know-how) by the 1960s (Amsden, 2001: 100-105).

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Like that of Korea, Taiwan’s industrialisation and export success owes its origin to extensive manufacturing experience before 1960. Taiwan benefited not only from Japanese mentoring but also from an influx of a large number of experienced workers, managers and entrepreneurs from mainland China in the 1950s. Like that of South Korea, the Japanese-led industrialisation of Taiwan in the 1930s was aimed at helping Tokyo’s expansionism. (Amsden, 2001: 105).

a) Trade & Industrial Policy Making in Fast Growing East Asia

Taiwan’s policy makers had a blueprint in the 1960s that partly explains the growth and export success story in that country. During that time, Taiwan used to import twice the value of its exports which was largely financed by USAID. This was perceived as alarming aid-dependency by Taiwanese policy-makers. One of the strategies to get out of this dependency was the development of exports (Hsueh et al, 2001). This gave the impetus for the export promotion policy that included devaluation of Taiwan’s currency (the NT dollar), import tax rebates, low-interest export loans, the establishment of export processing zones, and the legislation for encouraging investment. Similar export promotion policies were also pursed in South Korea (see Hsueh et al 2001, Collins 1990). These policies, among others, led to the development of the private sector in both countries.

By the early 1970s the export promotion policies remained in place and some were extended but the government focused on strengthening heavy industries. This was motivated by both economic (ensuring secure supply of intermediate goods) and political (secured supply of inputs was a political security, issue especially in Taiwan) factors. Both Taiwan and South Korea targeted particular industries for development, but South Korea turned to private firms while Taiwan relied on state-owned enterprises for this purpose (Hsueh et al, 2001).

According to Park (1990), even though South Korea and Taiwan share a number of common traits in that both adopted export-led industrialisation strategies and that the governments of both countries actively participated in a manner that transcended the traditional role of correcting market failures, the involvement of the governments and their interaction with the private sector took different shapes. Whilst the Taiwanese were inclined to be supportive rather than interventionist, the South Korean government, on the other hand, was collaborative and at times coercive in its relations with the private sector. The governments of both economies

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struggled to keep pace with the changing circumstances once the export-led industrialisation regimes were put in place and thus experienced brief episodes of inefficiencies. While the Taiwanese government confined its role to providing social and physical infrastructure and other public goods and its interactions were characterised by mutual adjustment on the part of the private and public sectors, the Korean government provided a sort of institutional cocoon for its private sector that provided domestic market protection and an implementation of industrial targeting (Park, 1990). Both countries on the other hand, attempted to maintain stable macroeconomic environments through prudent macroeconomic policies.

Summarising the experiences of Asian countries, Krueger (1990) contends that even though the growth and export performance of the East Asian countries, and particularly South Korea, Hong Kong, Singapore and Taiwan, was a tremendous achievement initially, but was less than impressive when compared to their per-capita GNP growth performance. The author notes that the countries had earlier experiences with inward-oriented trade policies and quantitative controls over imports, but in each case, the change in trade strategy was followed by a sizeable increase in the rate of growth of output and the marginal productivity of capital as measured by the incremental capital-output ratio (ICOR). Krueger (1990) argues that the reasons for the congruent performances of national output and export performance lie in the fact that the government was strongly committed to a policy of growth through exporting and to that end it altered the real exchange rate received by exporters, the import regime as it affected re-exporters, and infrastructure, were all geared towards export drives and towards guaranteeing the profitability of successful exporting firms. Kruger also noted that the profits made through import restriction were channeled towards exporters in the early years of the export-oriented strategy. Governments made no attempt to restrict the choice of which products to export, and therefore as a rule made efforts to encourage exporters of any sort. This is mainly derived by the fact that the countries had small export bases and this led the private sector in the two countries to focus on exporting.

As Krueger (1990) indicated, although the aforementioned factors were important unifying threads, there were also noteworthy differences in the country experiences, notably the differences in firm size in South Korea, Singapore, Taiwan and Hong Kong, on the one hand, and the treatment of private foreign investors on the other. The author provides

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four plausible explanations that contributed to the export-GDP growth of these economies. The first explanation is a typical trade theory story that the economies made a transition from a highly protective trade regime to an export-oriented strategy and in the process realized their comparative advantages. Second, the measures towards export orientation resulted in an increase in the capital-output ratio and guaranteed faster growth even at a constant savings rate. Third, outward-orientation resulted in the realisation of economies of scale and the exhaustion of indivisibilities. The fourth explanation is related to the avoidance of the stop-go policies associated with balance of payments difficulties. The study further indicated that it is difficult to disentangle the contribution of trade and export policies to growth because other policies adopted by the super-exporters were also conducive to growth. The study also supports the fact that the same policies have different costs at different stages of development of their economies. At low levels of income, most economic activity takes place in agriculture and the costs of control over trade, industry and the factor markets are fairly small. Until mechanisms are found that permit the satisfactory growth of agricultural output and productivity, there can be very little economic growth. This implies that a prerequisite for satisfactory growth lies in the provision of infrastructure and incentives for agriculture. But once those are in place, a given set of restrictions over trade will exact an even more slowly growing set of industrial activities.

There was also a political-economy dimension to the success story of both Taiwan and South Korea. The private firms in South Korea (the Chaebols) were owned by Koreans who had close ties to the government and over time came to be major supporters and financers of the governing party and its president. This was not the case in Taiwan, however. Rather the government, which was mainly mainlander Chinese, expanded its economic power through the formation and expansion of state enterprises (Hsueh et al, 2001).

In both Taiwan and South Korea, the role of the state in the industrial economy and promotion of exports was very large, and this included protecting the domestic market. One factor which is apparent in Taiwan in particular, is the fact that the leading sectors after the 1960s were all major exporters and most of them were privately owned. Government policy played a critical role in ensuring a boom in export manufactures (Hsueh et al, 2001). In the 1980s, the emphasis in industrial policy shifted away from heavy to technology intensive industries and the issue

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became one of how to upgrade Taiwan’s industry so that it remained internationally competitive. Scientific research was also geared from basic academic research towards applied scientific research that included the establishment of Taiwan’s Science-based Industrial Park, a reversal of a brain drain by introducing appropriate incentive schemes, and a science and technology research plan, including the required budget that the government demanded to be drawn by each relevant ministry. This process was basically similar in South Korea too (Hsueh et al, 2001). This helped to strengthen both public and private firms in the two countries.

According to Park (1990), the institutional cocoon built during the import substitution era of South Korea nurtured an industrialist class a little too much, as it was unable to develop knowledge of foreign markets, and hence was unprepared to take higher risks in selling to export markets. It also complicated the intended leap to an export-oriented economy in the 1960s. The government of South Korea was thus forced to support a selected few large producers in the targeted industries since the efficiency that is required in export-orientation meant taking on increasing returns to technologies that conflicted with the poor resource base that the country had. In the absence of such an elaborate market mechanism, the banking system was used to channel resources to these large firms. The government was drawn into the business decisions of these firms and saw to it that these large firms became successful exporters and consequently expanded into industrial groups that dominated manufacturing industry. Although South Korea’s industries could perhaps, according to Park (1990), have succeeded on their own, the government’s control over industry grew and some of the power that the government exercised over the industry was justified as the concentration of economic power in the hands of few a private conglomerates, even though necessary for efficiency, meant that distributive equity was compromised. The government’s support of industrial groups also created a moral hazard problem as government’s role as a de facto partner meant that possible government bailouts induced excessive risk-taking. Park (1990) labeled the “interweave” of government and the private industrial conglomerates that continued to develop after the 1980s as “development mercantilism”.

Contrastingly, according to Park (1990), the Taiwanese economy exhibited high rates of savings, trade surpluses, a conservative stance on fiscal and monetary policy, and an egalitarian development philosophy, and, most importantly, an industrial structure characterized by a large number of medium and small-sized firms in manufacturing. This meant that policy makers were mostly denied the possibility to exercise two instruments

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of industrial policy: the control over credit and budgetary allocation for development purposes. The political leadership was also determined to avoid the concentration of domestic productive resources in the hands of few private businesspersons and therefore the public sector accounted for half of manufacturing value-added during the 1950s. Park also concedes that Taiwan took up export-promotion of labour-intensive manufacturing products, just as South Korea did, but the choice of technologies for Taiwan was not similar to South Korea’s increasing returns since they had at their disposal a large pool of experienced entrepreneurs. Park’s study shows that the Taiwanese industries with their small size of an average of 300 employees accounted for about 60 percent of the manufacturing value-added while the equivalent share was around six percent in South Korea. This meant that the South Korean experience of direct intervention could not be adopted and therefore the policy makers in Taiwan took measures to provide uniform incentives on the basis of export performance.

Park also noted that in Taiwan, problems related to scale economies, collection and dissemination of information on foreign consumers’ preferences and technological developments were bridged by a large number of traders from mainland China. The latter frequently came with large orders that are subdivided among small firms that gave the Taiwanese access to a large volume of small orders and specialized products with relatively small demand that South Korean firms were reluctant to accept. However, the Taiwanese did not emulate the South Korean success in import substitution, as Taiwanese entrepreneurs were unable and unwilling to commit large capital investments with long gestation periods. Furthermore, the Taiwanese industrial policy regime was not ambitious enough to match South Korea’s scheme and the attempt to circumvent these problems involving the setting up of an automotive industry by the public sector failed to bear fruit.

The important lesson from Park’s study is that there is no ideal model for the role of government and the private-public sector relationship in the development process. Institutional and structural characteristics of the two countries have contributed more than the policy activism itself. The differences in the technologies adopted by the two countries bears testament to the fact that structural and institutional forces in the two economies have shaped the form of government intervention. Park also concedes that even though there is no sufficient evidence to believe that government intervention was efficient after the mid-1970s, it is difficult to believe that the private sector alone could have achieved a sustained export drive without direct government intervention. In sum, as noted

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by Amsden (2001), the developmental state in the Asian countries was crucial for the countries’ industrialisation and export expansion. The state set four functions for itself:

Development banking, Local-content management, Selective seclusion (opening some markets for foreign transactions and closing others), and National firm creation.

Two principles guided this effort:

To make manufacturing profitable enough to attract private entrepreneurs, Induce enterprises to be results-oriented and to redistribute their monopoly profit to the population at large (Amsden, 2001: 125).

Similarly, judicious targeting and organisation to ensure the efficacy of public policy to encourage primary product diversification and process, exporting and domestic capacity creation (through training, infrastructure provision including research, subsidies, credit provision, etc.) was made by the governments of Southeast Asian countries (Jomo and Rock, 2003).

The dynamics and structure of exporting firms and their interaction with foreign-owned firms in Asia were also interesting issues that need to be examined when attempting to draw lessons for Ethiopia’s private sector development. By the 1990s high technology products, many produced in the Hsichu Science-based Industrial Park in Taiwan, were playing a larger part in the export and industrial sector of the country (Hsueh et al, 2001). There were also virtually no state-owned firms active in exporting as they were focusing on import substitution. The government had also played, through privatisation, a crucial role in identifying firms which became the foundation for large enterprises in Taiwan. The government and USAID financing were also crucial for the development of these firms. USAID for instance offered significant capital for about 440 firms between 1952 and 1958 to the tune of 23.7 percent of all the capital of these firms (Hsueh et al, 2001).

The industrial structure and the management of Taiwan’s industries in general, and its exporting firms in particular, are quite small and usually family-owned. The small family firms of Taiwan were not strong

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enough to survive in a global market. They survived within a network of subcontracting medium to large firms which got their orders from foreign buyers, and subcontracting these jobs was done through a pyramid of hierarchical firms. The central firms were either manufacturing or trading firms. These had the advantage of pooling limited resources to accomplish large production and export tasks, making the whole network strong even if individual firms were weak (Hsueh et al, 2001). This can be seen from the experience of the Li-Wei Trading Firm given in Box 1 below. Taiwan politicians were also forced to leave the management of the most important parts of the state-owned sector to competent technocrats and to exclude politics and rent-seeking because the country could not afford to retain failing public firms.

Box 1: Network of Exporting Firms in Taiwan – the case of the Li-Wei Trading Firm

Li-Wei originated as a trading company. When it began, it specialised in designing and assembling final products, and contracted out the production of parts and components of the machines to twenty to thirty satellite firms. In this way, Li-Wei minimized the use of its own resources and achieved a large volume of business. When Li-Wei grew, the number of satellite firms increased to around 150, and some of these satellite firms also grew substantially in size along with Li-Wei. Their relationship was maintained and strengthened through business ties as well as through personal friendship. Except in special cases that required strict specifications or delivery dates, no formal contracts were necessary….Li-Wei rewarded good satellite firms by giving them bigger orders and a short turn-around period for payment. As Li-Wei’s sales volume grew, in order to improve control mechanisms and to upgrade its production, the company gradually increased its own production capability. For those parts requiring higher technology, strict delivery dates and related requirements, Li-Wei decreased the portion contracted out. In contrast to the 100 percent outside contracting in the early 1980s, by the 1990s Li-Wei contracted out only around 25 percent of its production to satellite firms. (Hsueh et al, 2001: 95-96).

The role of foreign firms, especially those from Japan, in the export performance of the newly industrialized countries of Asia was also crucial in the success of their growth and exporting capabilities. This could be seen from the pattern of foreign direct investment (FDI) in the region.

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Urata’s (2001) study investigates the changing structure of foreign trade and FDI in East Asia and its impact on economic growth. Urata claims that two factors contributed to the significant expansion in foreign trade and FDI inflows in East Asia. He classified them as internal and external factors. The principal element in the first was the liberalization of both trade and FDI, and the stability in the macroeconomic environment signaled by a relatively stable price levels and an abundant supply of well-disciplined, low wage labour that contributed immensely to the expansion of exports and the attraction of FDI inflows. The latter was represented by substantial realignment of exchange rates and technical progress achieved in information technology. Another element that constituted a marriage between the two factors was the increase in foreign trade and FDI that was facilitated by the increased competition among multinational firms that resulted from liberalisation and deregulation in various sectors of the economy. In particular, Urata observed that the East Asian economies became the sole beneficiaries of a growth in outward FDI by Japanese firms motivated by what Urata dubs “wealth effects” that are created by the increase in the value of collateral and liquidity in Japan. The increase in liquidity that was introduced into the Japanese economy in a last ditch attempt to catapult the economy out of recession caused by the decline in exports that pushed up the prices of shares and land, and created the “bubble economy” resulting in asset price inflation further promoted Japanese FDI by making it easier for Japanese firms to obtain loans. The “bubble economy” also contributed to the expansion of exports from the East Asian economies by creating Japanese demand for imports. Japan’s contribution to the rapid expansion of FDI in East Asia and export growth was unprecedented. An investigation into the patterns of intraregional trade and FDI in East Asia from the early 1980s to the mid-1990s shows that intra-East Asian trade in world trade increased significantly from 5 percent in 1980 to 12 percent in 1997. The study also shows that a large part of that trade took place between Japan and other East Asian economies, amounting to more than half the level observed for East Asia as a whole. But intraregional trade between the Asian NIEs and for ASEAN was quite dismal amounting to 0.9 percent and 1.3 percent of global trade, respectively, in 1997.

According to Jomo and Rock (2003), the link between some of the firms in fast-growing Asian economies and foreign companies, was largely successful in boosting the output of agro-industrial firms and their exporting capacity. Such firms not only were able to acquire new technology and managerial as well as marketing skills from their foreign partners, but also managed to penetrate the markets of developed

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countries such as Japan. The example of the Charoen Pokplahan (CP) Group of Thailand is a case in point and detailed in Box 2 below.

Jomo and Rock also made a subtle distinction between the Northeast and Southeast Asian experience in industrialisation and exporting. They noted that unlike Northeast Asian (Japan, South Korea and Taiwan) companies, firms in Southeast Asia did not have their own industrial, technological and marketing capabilities to produce exports on their own. Instead their export markets came from subsidiaries or companies vertically linked to foreign multinational corporations that had relocated within the region to lower production costs or to overcome import restrictions. Hence, FDI was much more important to Southeast than Northeast Asian countries. While exporting firms in Northeast Asia developed from import-substituting industries, such firms in Southeast Asia were weakly linked to the rest of the host economies and largely resembled exporting enclaves (Jomo and Rock, 2003: 165).

Box 2: Rise of Agro-processing Exporting Firms in Partnership with Foreign Firms

The Charoen Pokplahan (CP) Group in Thailand got its start in 1921 as a trading company importing seeds and vegetables and exporting pigs and eggs. In 1976, CP moved into poultry farming, following an announcement by the Board of Investment that promotional privileges were available for this activity. CP entered a joint venture with an American company, Arob Acres. The latter provided and continued to provide CP with chicks. CP also established a joint venture with Japanese firms to market frozen chicken meat in Japan. CP pioneered contract farming in Thailand, including guaranteeing loans for farmers from the commercial and related banks. By 1979, CP controlled 90 percent of poultry exports and 40 percent of the domestic animal feeds business. CP also used the Board of Investment privileges to establish its own trading company, CP Intertrade, and to establish plantations for growing mug beans and maize (Jomo and Rock, 2003: 149).

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Botswana and Mauritius

a) Botswana

Despite many explanations for Africa’s continued demise, Acemoglu and Robinson (2001a, 2001b) noted that Botswana had the highest per-capita growth in the world in the last 35 years. They investigated what made Botswana different from other African countries. Their study noted that Botswana achieved rapid development following good policies. However, the authors noted that Botswana was an exception because good policies were complemented by good institutions --- what they refer to as institutions of private property. The study criticises earlier studies that claimed that policies might have been better in Botswana because it is a more egalitarian country [Alesina and Roderick (1994), Persson and Tabellini (1994), Benabou (2000)]. However, Acemoglu and Robinson argued that inequality, both of assets (primarily cattle) and income was high in Botswana and that it bordered that of South Africa and countries of Latin America, such as Brazil and Columbia. They also reject the claim that “good policies are just a reflection of the fact that government intervention in Botswana was limited” [Krueger (1993)]. Acemoglu and Robinson detailed planning and massive government expenditure as being the essential characteristics of the Botswana economy and the degree of socialisation of the economy [central government expenditure to GDP ratio] was estimated to be around 40 percent , higher than the African average. In fact, according to Freeman and Lindauer (1999), Botswana exhibited most of the features that are raised as explanations of Africa’s growth problems. It is land-locked and mineral dependent --- parameters that figure negatively in Sachs and Warner’s growth study on Africa. According to Harvey and Rosen (1990), cited in Freeman and Lindauer 1999), at independence [in 1966] and prior to its economic take-off, Botswana’s pool of well-educated citizens was low; and apart from its rail links to South Africa, the country’s infrastructure was poorly developed. Its Gini coefficient of 0.54 indicated a high degree of inequality by any standards, while for the better part of the three decades it was surrounded by economies that were embroiled in civil unrest that limited its access to imports and harboured an ominous influx of refugees (Freeman and Lindauer, 1999).

Acemoglu and Robinson’s study claims that what perpetuated the growth in per-capita income all these years is found in institutions of private property. Four factors have contributed significantly to the formation and preservation of these institutions. The first was that Botswana

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possessed relatively inclusive pre-colonial institutions that put bounds on how the political elite functioned. The second was the minimal impact of British colonialism on the traditional institutions that scrutinized how the elite behaved. The third factor was that, after independence, the elite in Botswana found it in their best interest to preserve the institutions of private property. While the fourth and important factor was that Botswana was rich in diamonds, the export profits created enough rents so that no group found it in its best interest to challenge the status quo. But, the study notes, these factors alone did not determine the fate of the nation and emphasised the role that the critical decisions of post-independence leaders assumed. The authors note that the argument that the success of Botswana depended on good institutions (“referring to political institutions that allowed commoners to criticize chiefs, enabled an unusual degree of participation in the political process and placed restrictions on the political power of the elites”) is only a proximate answer to why Botswana was successful and that one should ask the question: why had Botswana such good institutions when the rest of Africa was devoid of them?

According to Acemoglu and Robinson, well-enforced property rights were in the interest of Botswana’s political elites in the aftermath of independence when the strongest economic and political interest groups in Botswana were cattle owners. Upon independence, the only real prospect for any sector of the economy to develop was ranching and this was done successfully by exploiting the European Economic Community (EEC) market and the subsequent development of infrastructure increased ranching incomes. The study notes that the primary beneficiaries of government policy were the organised elites. By the mid 1970s, the income from diamonds outstripped that of ranching income, but the elite did not rush to expropriate the income from diamonds for, particularly, two reasons. One was that the elite did not feel threatened by the prospects of growth, and the slim chance that the elite became political losers deterred them from working towards the destruction of the good institutions. The little risk that the Botswana elite faced in pursuing developmental policies was not shared by other African countries, where developmental policies only worked to dispossess traditional political institutions [chiefs for instance] of their power. The second factor was that the constraints placed by institutions such as the Kgotla29 may have ensured the accountability of institutions and forced the elite to opt for the enforcement of their property rights. These institutions assured that

29 Acemoglu and Robinson (2001a), p. 23

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there were no political instabilities. Colonial rule, however minimal, did not deter post-independence leaders such as Seretse Khama and Quett Masire from forging an unlikely coalition between tribal chiefs, cattle owners and the ruling BDP coalition.

Acemoglu and Robinson noted that the income from diamonds consolidated the institutions of private property and a relatively democratic polity. The BDP coalition guaranteed that the rents from diamonds were distributed widely so that the opportunity costs of undermining the good institutions and therefore the costs of further rent-seeking, for the majority, were strongly forcing a resolute allegiance to the status quo. The study concludes that the adoption of good policies was an essential element of Botswana’s growth, which promoted rapid accumulation, investment and a socially efficient exploitation of resource rents. It is noted that these policies resulted from a framework of quintessential institutions of private property that encouraged investment and economic development. Hence, Botswana’s growth has been a juxtaposition of good institutions-good policies-resource rents [primarily the export of diamonds, and export incomes from cattle ranching prior to the 1970s].

In addition to this, Roderick (1997) ascribes Botswana’s success to prudent fiscal and macroeconomic policies, well-developed human resources and an early demographic transition that reduced the dependency ratio, apart from the gains from diamond exports. Roderick notes that the first factor contributed the most as it accounted for more than half of Botswana’s good performance compared to the sub-Saharan average. The government, by deploying a set of adjustment policies, managed the diamond boom in an exemplifying manner. The dividends to good governance in macroeconomic management spilled over to other sectors as well. There was a consistency in the designing of sensible macroeconomic policies with little or no urban bias. Although the set of measures that Botswana’s government put together were largely the reason for its success, the government never operated on the philosophy of laissez-faire (the large degree of socialization, that is, Government expenditure to GDP, which stood at 50 percent, as noted above, by the early 1990s, was one of the highest in the world30). What is perplexing about Botswana’s growth is that its initial conditions were not favourable, as also noted above. 30 Although Roderick labels Botswana’s degree of socialization as one of the highest in the world,

the OECD average was around 41¼ percent, with experience ranging from 29 percent in South Korea to 59 percent in Sweden. Figures for the year 2003 show that Austria, France and Belgium have ratios of public expenditure to GDP of 51.6 percent, 54.4 percent and 49.7 percent respec-tively

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A part of the riddle that Harvey (1992) had figured out is the rural origin of political leadership that contributed to export agriculture escaping the ‘wrath of tax policy’, unlike other countries of sub-Saharan Africa where the social origins of the elites are urban and export taxes are exorbitant. Another element of Botswana trade is that it was part of the South African Customs Union (SACU) and therefore did not operate under an independent trade policy. The Botswana government is said to have had a share of customs revenues collected by the South African government that amounted to a fifth of Botswana’s imports. What is more important is that government officials had no control over the revenue on a day-to-day basis and that they did not possess the ability to interfere with the flow of goods from neighbouring South Africa, which meant that domestic products gained little from policy-makers in terms of unfair favours. The absence of the capacity on the part of officials to grant lobbying groups favours of any sort had important policy implications on other fronts as well. Roderick (1997) cites the case of the large drop in diamond prices in the early 1980s that called for the devaluation of the currency and avoid exchange controls was accomplished swiftly due to the absence of ‘entrenched urban interests’.

According to Harvey and Lewis (1990, cited in Freeman and Lindauer 1999), Botswana’s growth success, despite unfavourable initial conditions, can be attributed to a number of important issues that can be summarised as:

That economic policies matter. Botswana chose a •prudent fiscal and macroeconomic direction (in 1998, Botswana ranked among the 50 top countries by The Wall Street Journal’s Index of Economic Freedom); Heavily dependent on revenues from its diamond •mines, but avoided “Dutch-Disease” by not engaging in excessive spending of export windfalls which would have led to an appreciation of the real exchange rate and hurt both agricultural and non-mining industrial growth;It managed a stable exchange rate;•Its participation in the SACU limited lobbying for •favours in the trade arena, and spared it from some of the rent seeking and inefficiencies that characterized import substitution schemes elsewhere in sub-Saharan Africa (Roderick (1997); and

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The public sector allocated resources based on •economic and social returns and was successful with foreign investors; and state investment in education, especially at the primary level, was among the highest in the region.

b) Mauritius

According to Roderick (1997), Mauritius’s prospects for growth in the 1960s were slim. Mauritius’s success largely depended on an export-boom in garments to European markets and an associated investment boom at home. The nation’s economy constituted a successful export processing zone (EPZ) and a highly protected domestic sector with average effective rates for the manufacturing sector reaching a staggering 89 percent, making Mauritius a country following a “two-track strategy”. Policy makers faced resistance from import substituting industrialists in their attempt to relax the trade regime. Local industrialists were granted tax holidays and protection from imports via tariffs and tariff reforms that contributed to a boost in export growth.

According to Nath and Madhoo (2003), the early import substitution strategy of Mauritius was followed by an export-led growth strategy. This led to the growth of the economy in the 1970s which was basically fuelled by the favourable conditions for the Mauritian sugar industry in the world market. This in turn led in 1973 to an increase in proceeds and hence money supply. This increase in liquidity gave an additional boost to the plans initially set by the government. The EPZ and the tourist industry were further being enhanced due to the investment of the large profits by sugar companies in joint ventures with foreign investors. The effectiveness of the policies implemented, such as tax holidays, exemptions from import duties and preferential access to European markets, the purchase of new machinery and equipment and hiring consultants, foreign direct investment (FDI), and the purchase of new technology licenses for domestic production of new products or the use of new processes, was reflected in the excellent economic performance that resulted from these policies. The number of enterprises in the EPZ increased to 88 in 1977 and EPZ exports rose to 20 percent of total exports. FDI from Hong Kong, France and Britain has contributed a great deal to the development of the Mauritian EPZ (Gray 1994). International technology transfer took place and local investors also joined in the process. EPZ textiles

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and clothing firms were largely owned by local investors (55 percent), followed by joint ventures (35%) and those that were fully foreign-owned (15 percent) [Fowdar, 1994, cited in Nath and Madhoo, 2003]. The local investment was largely financed from the surpluses of the sugar boom. The average annual real growth of the economy was about 8.2 percent for the period 1971-77 with the peak real growth rate of 16.6 percent in 1976.

In response to the critical economic situation that began in late 1970s, a typical structural adjustment programme supported by a standby arrangement with the IMF was adopted in 1979. The main policy measures implemented were fiscal stabilisation, exchange rate realignment, cautious wage policies, trade liberalisation, financial consolidation and sectoral/supply side policies. Following these measures, the current account of the balance of payments changed from a deficit of 15 percent of GDP in 1983 to a surplus of 5 percent in 1987. The inflation rate dropped to 0.6 percent in 1987 rendering the EPZ more competitive. With such favourable conditions, the number of EPZ enterprises increased to 591 in 1987.

In two decades, Mauritius transformed itself from a mono-crop economy, solely dependent on sugar, to a diversified one comprising strong manufacturing and services sectors. In 1989, a financial offshore centre was also set up, which attracted more than 4 billion USD of offshore funds. The Stock Exchange of Mauritius (SEM) started to operate in the same period. Stimulated by the EPZ, the Freeport was created in 1992 as part of its strategy to develop as a regional trade centre. In 1997, tourism increased by 10 percent, the EPZ by 6 percent, financial services by 5.9 percent and sugar by 5.5 percent. Thus, Mauritius was ranked 29th in the World Competitiveness Report of 1999 outperforming some “Asian Tigers” and first among African countries. Similarly, a study by Gray (1994) noted that over a quarter of a century, Mauritius managed to quadruple its per capita income and virtually eliminate unemployment. Gray noted that with a population of 1.1 million, heavily dependent on external trade and a rather slender industrial base, Mauritius sought to follow through the Hong Kong-Singapore path to growth that was built on the foundations of a competitive regulatory framework and nurtured technology support services to create a dynamic private sector-led business environment.

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Policy Making Process and the Private Sector in East Asia

One distinguishing feature of the private-public sector relations in Taiwan and South Korea, was the tradition of research, planning, implementation and monitoring of proposed policies based on an in-depth study by the best and the brightest brains in each of these countries. The Council for Economic Planning and Development (CEPD) of Taiwan is a case in point (and the South Koreans had similar institutions as well). CEPD had over 300 professional and non-professional staff. Of these, 250 had university qualifications, of which engineers made up 20 percent, economists about 40 percent, the rest being accounting, finance and statistics graduates. The staffs were divided into seven departments: overall planning, sectoral planning, economic research, urban development, performance evaluation, financial administration, manpower planning, personnel and financial administration. The Economic Research Department had 50 professionals each of whom monitored one sector in addition to other duties.

As an advisory body of the cabinet, the CEPD is outside the ordinary machinery of the government that allowed it to pay higher than normal civil service salaries to its staff, and could recruit higher-quality talent by offering relatively better terms. Not only is CEPD staffed by the best and the brightest in the country, but also it was chaired by powerful figures such as the premier and later by the president of the country. Such a joint public-private advisory group is critical to ensure the sustained development of the private sector in Ethiopia through a joint Government-private sector partnership.

The Lessons for Private Sector Development in Ethiopia

What are the lessons from these experiences in developing a strategy for private sector development in Ethiopia?

Any lesson drawn from the Asian, in particular Taiwan and South Korea’s experience, needs to take into account the difference between Ethiopia and the successful Asian exporters in terms of variation in initial conditions, the institutional and political differences between the two, as well as the global environment such as the Cold War which shaped the foreign relations of Taiwan and South Korea and its impact on their success story. Notwithstanding such differences, we can draw the following lessons that may help the design and implementation of

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a private sector development policy or export development strategy for Ethiopia:

First, there is a need to note the link between trade and industrial policies and private sector development. Trade and industrial strategy cannot be developed in isolation and need to be set in the context of a country’s development strategy and the role of different economic agents such as the state and the private sector. In this process, outward-orientation will help realise economies of scale and the exhaustion of indivisibilities for domestic firms. It also helps to avoid stop-go policies associated with balance of payments difficulties when exporting is a problem.

Second, the role of government in ensuring success in exporting may go beyond policy-making. The government not only needs to create the enabling environment but also may need to alter the incentive structure for public and private firms in the operation of a free market to ensure the success of industrialisation and exporting.

Third, financing, especially of exports, is one of the most important policy instruments that could be employed by the government to nurture the private sector. However, financing may differ at different stages of development, such as at shipment and production, and need to be based on performance.

Fourth, it seems crucial that agricultural development in Ethiopia is a prerequisite for growth and industrialisation to proceed smoothly. Both in the growth process and when embarking upon an industrialization and exporting strategy, the government also needs a labour market policy that is compatible with the planned growth. It also needs to keep the price of food and housing at subsidised prices to maintain labour costs for the private sector low and make firms competitive, as was the case in South Korea.

Fifth, the same policies have different costs at different stages of development of economies. At low levels of development, most economic activities take place in agriculture and the costs of control over trade, industry and factor markets are fairly small. Until mechanisms are found that permit the satisfactory growth of agricultural output and productivity, there can be very little economic and export growth. This implies that a prerequisite for satisfactory growth lies in the provision of infrastructure and incentives for agriculture. However, once those are in place, a given set of restrictions over trade will exact an even more slowly growing set of

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industrial activities. Thus a successful strategy should put in place a set of frameworks that result in the adoption of efficiency and growth-enhancing policies that are compatible with different levels of development.

Finally, our discussion in the previous section showed that Taiwan adopted a policy of export-promotion of labour intensive manufacturing products, just as South Korea did, but the choice of technologies for Taiwan was not similar to that of South Korea. Taiwan took the dominant role of its small firms into account in the design of its policy. The differences in the technologies adopted by the two countries bears testament to the fact that structural and institutional forces in the two economies have shaped the form of government intervention. Thus, export and industrialisation development strategies need to depend on the structural and institutional context of the country in question – in short there is no “one-size-fits-all” policy for all countries.

Like that of Taiwan and South Korea, there are also lessons that we may draw from the success stories of some African countries whose experience is discussed at length in the previous section.

First, as the experience of Botswana shows, rents from diamond exports were distributed widely so that the opportunity costs of undermining the good institutions and therefore the costs of further rent-seeking for the majority, strongly forced a resolute allegiance to the status quo. In the process, Botswana adopted good policies which promoted rapid accumulation, investment and a socially efficient exploitation of resource rents. Thus, fair or socially optimal distribution of rent income, at least among the elites, seems essential for adopting and sustaining success in growth. Similarly, the memberships of Botswana in SACU has served to lock-in some of the good policies and served to avoid rent-seeking. Perhaps the lesson from this is the importance of regional groupings such as regional integration schemes and agreements (e.g. COMESA), as well as WTO accession that could serve as agencies of restraint to live up to commitments by member countries.

Second, the experience of Botswana and Mauritius shows that good economic policies matter. Stable macro polices (including optimal labour policies that monitor productivity and wage growth) are central for successful growth. However, such policies are extremely important once a certain level of growth is attained. Thus, the level of growth needs to be taken on board in assigning weights for policies of macro stability, especially if deviation from such policies (such as inflation financing)

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could have some better benefits. Moreover, the public sector needs to allocate resources based on economic and social returns. It also needs to make wise use of rents from booming sectors.

Third, partnership with foreign firms and countries is central for successful industrialization and export development strategy. This will help not only to get access to the markets of the developed countries but also as a tool in facilitating technology transfers especially for a country with a brief industrial history and limited technological capability such as Ethiopia. Such markets could also serve as sources of growth, provided that export rents from such preferential arrangements are not disproportionately taken by firms from the preference offering countries.

Fourth, the role of government is central for a successful industrialisation and export development strategy. This is particularly required in the design and implementation of growth strategy that may include the development of export processing zones (EPZs), industrial zones, etc. Government intervention is also required to make firms forward-looking in creating a private sector-led business environment, in the diversification of exports, in building productive capacity through enhancing competitiveness and attracting foreign investment. This can be seen from the contribution of FDI in the Asian and African success stories.

Finally, the institutions of private property, good policies and the competence of governments in economic governance are also found to be central in the growth and development process of countries such as Botswana.

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