JIMMA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS

THE DETERMINANTS OF EXPORT DIVERSIFICATION IN

ETHIOPIA

A RESEARCH PAPER SUBMITTED TO DEPARTMENT OF

ECONOMICS TO UNDERTAKE RESEARCH DESIGNED AS
A PARTIAL FULFILLMENTS FOR DEGREE OF BA IN
ECONOMICS

BY: ABRAHAM TSEHAY

ADVISOR: TOFIK SIRAJ (MSc)

JUNE, 2013
JIMMA, ETHIOPIA

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2
 ABSTRACT

This study analyzes the main determinants of export diversification in Ethiopia.

According to the study, the result reveals that industrial production and trade
openness are crucial factors to induce export diversification both in long run and
short run. In contrast budget deficit and real effective exchange rate are found to be
the constraining factors for export diversification experience of Ethiopia which are
not expected priory. The main reason for the deficit as constraints is the cause of the
deficit that is high recurrent spending that do not have direct impact on productive
capacity of the economy. The adverse effect of exchange rate on diversification
implies that the export based is remain and hence depreciation added a fuel for
more concentration or the depreciation is symptom of macroeconomic instabilities,
which further restrain deepening of diversification, investment, income and inflation
turned out to be insignificant determinants of Ethiopia’s export diversification
process. In addition there is also other factor that constraining exports includes both
supply side (endogenous) and demand side (external factor) that inhabit
diversification process.

The key lesson from this study is that increasing industrialization through raising
manufactured product and increasing openness through various trade related
measures are the key ingredients for deepening diversification, on the other hand
increasing government expenditure in recurrent activities and a depreciating
currency are not supportive of diversification process. In line with this, Ethiopia
should follow a strategy that would support establishment of higher value added
resource based industries and gradually shift production and export customer
product to more dynamic ones. Directing government expenditure to productive
activities sectors and expand the export base are also some of the way forward for
achieving diversification.

With regard to source of data, secondary data is entirely used with their respective
sources. Descriptive analysis was used to show structure of the export, performance
of the export and trends in export diversification.

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 ACKNOWLEDGEMENT

First and for most, I would like to thank my sole creator the almighty God who
helps me in every direction to complete this research paper. Next my
appreciation goes to my senior essay advisor Tofik Siraj (MSc) for his invaluable
advice throughput the successful completion of this senior essay. Also it gives
me great pleasure to take this opportunity to express my heartfelt gratitude to
my family for their support in my life and my special thanks also goes to
Firehiwot Yimer who assisted me by writing and printing this research paper
by devoting her invaluable time.

Finally, I am also grateful to all whom in one way or another helped me in my

study.

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 ACRONYMS

ECA _ Economics Commission of Africa

EEA – Ethiopian Economic Association

NBE – National Bank of Ethiopia

GDP – Gross Domestic Product

HOS – Helksher Ohlion Samuelson

REER – Real Effective Exchange Rate

NIE _ newly Industrialized Economy’s

EP – Export Promotion

IS – Import Subtitution

IMF – International Monetary Fund

WB – World Bank

SAP – Structure Adjustment Program

GCF _ Gross Capital Formation

PCI – Percaptial Income

MOFED – Ministry of Finance and Economic Development

OECD _ Organization for Economic Cooperation and Development

WWII _ Second World War

TABLE OF CONTENTS

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Table of Contents
ABSTRACT................................................................................................................................................I
ACKNOWLEDGEMENT........................................................................................................................II
ACRONYMS............................................................................................................................................III
TABLE OF CONTENTS........................................................................................................................IV
CHAPTER ONE.......................................................................................................................................1
1. INTRODUCTION................................................................................................................................1
1.1 Background of the Study.........................................................................................................1
1.2 Statement of the Problem........................................................................................................3
1.3 Objective of the Study...............................................................................................................6
1.3.1 General objective..................................................................................................................6
1.3.2 Specific objective..................................................................................................................6
1.4 Significance of the Study.........................................................................................................6
1.5 Scope of the Study.....................................................................................................................7
1.6 Limitation of the Study.............................................................................................................7
1.7 Organization of the Paper........................................................................................................8
CHAPTER TWO.......................................................................................................................................9
2. LITERATURE REVIEW....................................................................................................................9
2.1 Theoretical Frame Work...........................................................................................................9
1.2.1. Diversification Regimes..................................................................................................16
2.1.2 Types of Export Diversification.....................................................................................17
2.2 Empirical Review......................................................................................................................19
2.3 Review of the Ethiopian Trade Policy and Export Sector.............................................22
2.3.1. Trade Policy Regime: A review.....................................................................................22
2.3.2. Export Development Strategy, the Institutional Framework and Export
Incentive Schemes.......................................................................................................................29
CHAPTER THREE................................................................................................................................32
3. DATA SOURCES AND METHODOLOGY..................................................................................32
3.1 Sources of Data.........................................................................................................................32
3.2 Methods of Data Analysis......................................................................................................32
3.3 Structure and Performance of the Ethiopia Export Sector..........................................32
3.3.1. Commodity structure of the exports..........................................................................32
3.4 Geographic Structure of Exports.........................................................................................35
3.5 Performance of the Export Sector........................................................................................37
3.6 Trends in Export Diversification (Specialization)............................................................41

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CHAPTER FOUR..................................................................................................................................43
4. RESULT AND DISCUSSION.........................................................................................................43
4.1 Interpretation of the Result...................................................................................................43
4.1.1. Main Determinants of Export Diversification.............................................................43
CHAPTER FIVE.....................................................................................................................................47
CONCLUSIONS AND RECOMMENDATIONS...............................................................................47
5.1 Conclusions................................................................................................................................47
5.2. Recommendations...................................................................................................................49
Bibliography......................................................................................................................................51

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 CHAPTER ONE

1. INTRODUCTION

1.1 Background of the Study

The importance of export expansion is a key factor in promoting economic

growth has been much emphasized among the advocates of export oriented
policies. According to this line of argument export expansion raises factor
productivity and leads to economic growth by giving rise to various benefits
such as more efficient use of resources and adoption of technological
innovation, resulting from foreign competition, greater capacity utilization and
gains of scale associated with large international market (D.Moshos, 1998).

Low developed countries export sector suffer from absence of diversification

even among the agricultural commodities, the income and price in elastic
nature of export, large amount of domestic consumption slow growth rate of
population in LDCs, dealing demand for the LDCs products with some
exceptions like rubber and petroleum. Furthermore, the technological changes
that taking place in the north have led to the supply side problem of the
substitution of primary product with synthetics. Other things being constant,
this implies that there is limit scope for the LDCs to expand their exports
significantly and hence to grow and develop (Zewdu Belete: AACC 1995: P.
243).

The Ethiopian economy is mainly a primary sector economy. The tragedy of it is

economy of past years is revealed in it is trade structure indicates that import
were so much greater than export nearly for the past years and the consequent
negative balance of payment in General and trade balance in particular had
great influence on macro economic performance of the country for the last
years. The export structure of Ethiopian has been characterized by great

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concentration on few agricultural export, such as Coffee, Oil seeds, Hides and
Skins was the major non-coffee including chat from the total export of the
country. Coffee was the dominant export commodity accounting for about 54%
of total export on average from 1970/71-2007/8. Hides and Skins was the
major non-coffee export commodity accounting for 11.3% of total export
followed by oil seed and chat other in the review period.

Commodity structure of Ethiopian export sub-sector is a mirror reflection of

the country’s overall economic structure at large. The nation output and export
are highly concentrated in Agriculture commodities. In 2007/8 Agricultural
production accounted for 44% of GDP and Agricultural export more than 70%
of total exports. After this year share of Agricultural in GDP is 43% relatively
decline while that of Agricultural export remain high as that of previous years.

The overall performance of the export sector were unsatisfactory during the
1970/71-2011/12 as evidenced by the lower export to GDP ratio and the
declining share of exports in import financing.

The export to GDP ratio has declined from the 1970/71-1973/74 an average
level of 7.1% to 6.8% in 1974/75-1990/91 and further to 6.3% in 1991-
2009/10. Also the share of export in import financing export (import ratio) has
contracted from 1970-1973/74 average level of 88.5 percent to 50.6 percent in
1974/75-1990/91 and 34 percent in 1991/92-2009/10.

Furthermore commodity diversification index (Hirschman index) during the

period 1980-2009/10 averaged 0.3549 which indicates heavy concentration of
export sector on few products.

Depending on few commodity especially primary commodity suffer two major

problem, first these products are susceptible to the vagaries of nature and
international price movement and hence are unpredictable source of foreign
exchange. Second commodity export are not supportive of technology transfers
unlike merchandise export (Brook, 1999:7).

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Both trade and domestic economic policies must of necessity of target
structural transformation. A country must initiate a dynamic comparative
advantage in the production process. As long as Ethiopia continues to produce
primary commodities it will export these also but there is no future in primary
commodity trader.

1.2 Statement of the Problem

Should countries focus on diversify their export product or should they instead
specialize their exports according to their existing comparative advantage?
Various literature greater export diversity as good for economic growth and
development. Before WWII the position in neoclassical economies has been that
countries should specialized in producing and exporting according their
comparative advantage. But after WWII diversification rather than
specialization was advocated.

Export diversification reduces the fluctuation of export earning and rise the
growth of both exports and domestic output (Bond and Milen, 1987: 98)

The key argument was based on the view that developing countries depend on
primary commodity production and export leave them vulnerable to commodity
shocks price fluctuation and declining term of trade especially since the income
elacity demand for primary commodity is low.

The Ethiopian economy like other developing countries which is commodity

dependent it is extremely vulnerable to variation in export earning due to
volatile terms of trade for its major export earning especially change in coffee
price. Moreover, despite the diversification measure under taken in the
beginning of the 21st century the country has been unable to register any
sustainable movement towards deepening diversification through the
introduction of new products or horizontal diversification and/diversification
out of traditional product by moving towards the high end of production chain
or vertical diversification.

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Looking at the overall performance of export sector during 1970/71-2011/12
was unsatisfactory as evidenced by the lower export to GDP and declining
share of the export in import financing. For last three decades the export
structure of Ethiopia has been characterized by greater concentration on few
traditional export such as Coffee, Pulses, Hide and Skins, Chat and Oil seed.

The export/GDP ratio has declined from 1974/75-1990/91 average level of

6.8% to 6.5% in 1991/92-2002/03 and further to 5.9% in 2002/03-2011/12.
Also the share of the export in import financing (export/import ratio) has
concentrated from the 1970/71-73/74 average level of 101.7% to 58.6% in
1974/75-1990/01 and further to 34% during the 1991/92-2009/10 period.

The burden of all this poor performance is reflected in the deficit balance of
payment. For example by 2007/08 Ethiopia record a deficit of USD 263 million
compared to USD millions 2 years earlier. This was due to increase in import
and slow moving export. By 2007/8 import went up by 32.8% to USD 6.8
billion while export share in GDP fall to 5.5% from 6.1% 2006/07 indicating
the need for diversification of exports to reap the benefit of competitiveness
(National Banks of Ethiopian 2007/08).

The Ethiopian export sector is primary commodities from the particular

agricultural product contribution to export earning is more than 90 percent for
the last three decades. This indicates lack of diversification is observed not only
in export items but also in destination of the export items, that is export
destination are limited to few countries in Africa, Europe, USA and Asia.

Such unsatisfactory performance given government endeavor to increase the

country’s foreign exchange by pursuing concrete policy measures and incentive
schemes calls for specific studies concerned with systematic identification of
factors constraining or determining export diversification.

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The 2007 report of ECA focuses on export diversification in Africa countries in
general by taking a sample of 18 countries, providing a stylized facts and the
determinant of diversification and causes of the lack there of. Ethiopia was not
a sample country. The report found that diversification experiences in Africa
fall into four major categories. Hence, this diversity raises the question of what
factors drive diversification and what policies can faster diversification in the
medium term and in the long-term.

According to the ECA report diversification in general is affected by investment,

income, trades openness, industrialization, inflation, exchange rate and
country risk. These variables are subject to variation across countries in their
significance to determine (explain) diversification, for example investment
inflation and country risk have not played significant role in diversification out
comes for Kenya but investment, exchange rate and inflation played significant
results for Tunisia, while the country is negatively and significantly related
with income per capital, trade and country risk. For Nigerian case the result
are inconsistent with the continental result especially with regard to the
influence of investment, income, trade, exchange rate, and country risk, in the
case of Burkina Faso and Sudan the result does not indicates any possible
economic inference and the data plots have not clear patterns.

For the above evidence, it is inferred that accepting the finding of ECA to
specific country is not correct and it might lead to a capital mistake if used for
policy purpose.

Accordingly the question of what factor drive diversification and what policies
can faster diversification in Ethiopia are crucial questions to be answered.
Hence, due to the above reason the researcher is motivated to conduct this
study.

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1.3 Objective of the Study
1.3.1 General objective
The main objective of this study is identifying the determinants of export
diversification in Ethiopia.

1.3.2 Specific objective

 To assess the structure and performance of export sector.
 To investigate the determinants of the country export diversification.
 To assess the finding of ECA for the case of Ethiopia.
 Highlight policy intervention areas for promotion of depending
diversification
 And finally to give recommendations based the result of the study.

1.4 Significance of the Study

So far many researchers have dealt with the relation between trade structure
and economic growth, but much less attentions have been paid to the
underlying determinants of export diversification. While the study is conducted
it is expected to identifies the factor that inhabit export diversification
empirically is expected to provide valuable research and policy
recommendation. Regarding the room for active government intervention and
their expected out come.

Moreover the study is significant, as it uses the used for Africa as a whole to a
specific country; Ethiopia and it is an up-to-date investigation of the research
problem.

Furthermore to intiate other researchers and researcher organization to

focuses on the topic and for subsequent studies.

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1.5 Scope of the Study

Ethiopia like other developing countries is facing the problem of down ward
trend in export earning and in terms of trade. Actually these have been the
concern of policy makers even today the problems are not solved. So the study
is focuses on the determinants of Ethiopia’s export diversification and it is
expected to propose ways of export diversification by examining the
composition of export.

The study is also investigates the diversification at a whole without

differentiating vertical and horizontal diversification.

The study covers the period from the 1970/71 to 2011/12 for this is the period
for which published data is available from the mentioned sources.

1.6 Limitation of the Study

Data’s are disaggregated and vary from source to source, another problem to
conduct this study starting from data collection up to final report writing.

The major limitations were the following:

 Misplacement of secondary data or documents.

This would be a cause for consuming more time and required more
finance to find data beyond the budget allocated.
 Some source of data were costly. For example, using internet services to
find the data would be costly because of networking problems.
 Shortage of finance to facilitate the overall activities etc.

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1.7 Organization of the Paper

The study has been organized into five chapters; the first chapter contains
background of the study, statement of the problem, objective of the study,
significance of the study and scope of the study.

The second chapter deal with the theoretical framework and previous empirical
works on export diversification, the third chapter deal with source of data and
method of data analysis and chapter four also deal with the result and
discussion of the finding and the last chapter five provides concluding remarks
and recommendations.

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 CHAPTER TWO

2. LITERATURE REVIEW
2.1 Theoretical Frame Work

The main aim of any economic management in any country is to improve the
living standard of the people overtime. In the economic sphere this aim is
fulfilled through high rate of growth, increased employment opportunities and
equitable distribution of incomes, stable price, balanced inter-regional
development and sustainable balance of payment.

To achieve this objective there are diverse measure to be taken, foreign trade is
one possible instrument and means to achieve these objective through trade a
country acquires those good and service that are essential to accommodate its
current needs as well as build up its productive capacity but are not available
from domestic sources. Among these good and services are the broad ranges of
consumer goods and services, ideas and knowledge, skills, capital goods and
raw materials.

In nation like Ethiopia, international trade can play an important role in its
economic growth. Haberler (1904) pointed out that trade can lead to full
utilization of otherwise under employed domestic resources, that is through
trade, a developing nation can move from an inefficient internal demand to
appoint on its production frontier with trade.

What a country imports are dictated by its comparative advantage it will

produce those good and services that use its most abundant resources and
therefore relatively cheaper than those of its competitor and import those good
and service that require inputs that it either does not have or are scarce. In
other word a country does not export from its own sake but also enable the
acquisition of those products, it need but can’t produce. This might explain
why Ethiopia exports primary agricultural commodities and imports industrial

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goods. Many literatures argue that international trade is closely tied to living
standard, when the growth of exports achieving high level of productivity
contributes to the growth of national productivity; however the ealier
characterization of a counties export is out of data. The composition (structure
of export matters much than the export share; porter (1990) noted that the
particular mix of export is most important a national average export share.
Arising sophistication of export can support productivity growth even if over an
export are growing slowly

One of the earliest ideas in the theory of economic development is that of the
degree of specialization or diversification of a country’s production and trade
structure is important for it economic development. From Adam Smith
recognition of the importance of the division of labor and specialization for
economic growth and development, to the standard Hecksther-Ohlin
samuelson (HoS) model of international trade, the position in neo classical
economics has been that countries should specialize in producing and
exporting according to comparative advantage.

However after the WWII with reconstruction of Europe and increasing

independence of many former colonies one of the earlier idea in the emerging
new discipline of development economics was that economic diversification, not
specialization may be good for economic growth and development, active
government intervention in industrialization and export diversification was
encouraged, seminar contributions in this regard include the Prebisch Singer
thesis (Prebisu 1950, Singer 1950) and the “big push” argument developed by
Rosenstre in (1943), the key argument was based on the view that developing
country dependency primary commodities production and exports leaves them
vulnerable to commodity shocks price fluctuation and declining terms of trade,
especially since the income elasticity demand for primarily commodities is low,
this in turn results in a country foreign exchange reserves and thus its ability
to afford imported inputs, becoming subject to fluctuation and uncertainty.
During the 1980 and 1990 four stands of literature stressed the potential
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benefit of export diversification for economic development one stand proposed
that countries should produce and export goods of which the world demand is
increasing and that irrespective of whether or not.

A country produces primary goods or manufacturing goods it is this

compatibility with world demand that will determine the extent to which a
country exports will grow.

This idea of literature is strongly based on the view that export are good for
economic growth and that export led growth (as experienced by Japan and East
Asian tigers) is the most appropriate development path of or the developing
world Alexander and Warwick 2007) in this view the impact of export
diversification is conditional for the types of goods that are exported and its
consistency with world demand.

The second stand of literature has its base the endogenous growth theory
which sees diversification of export from primary commodities in to high.
Skilled high technology goods desirable because trade in those products allows
for more scope growth through productivity gains than traditional commodity
exports. There are more opportunities for spillover effect in manufactured trade
than in primary commodity trade (Herzer and Nowak, 2006). Spillover effects
are partly due to skills and technological up grading (learning by doing and
learning by exporting) which have more positive externalities than in primary
commodity production (Peterson 2005). Menegistae and Pattillo (2004) for
instance find that manufacturing exporting forms in Africa are up to 17% more
productive than non exporter’s primary due to learning by doing effects.

A third stand takes portfolio theory approach. Brainerd and Cooper (1968)
propose that risk averse countries should diversity their export taking into
consideration the covariability of different export goods world prices. It
recognize that merit in the neoclassical HoS trade model recommendation that
a country should specialize according to comparative advantage, but points out
that this might not hold under certainty and that uncertainty will reduce

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overall world trade as risk averse producers of primary commodities reduce
their production there of (Ruttin 1974 De Rosa 1991). Diversification in
exports in needed to offset uncertainty it financial institutions that can provide
insurance are lacking as if for instance the case in many African countries
(Chang 1974 Osakwe 2007), using cross country data Strobl (2005), finds that
trade liberalization results in greater variability in export earnings and that
there are significant welfare gains for countries in diversifying into a more
optimal export structure although the precise magnitude of these gain the
country specific.

A fourth stand of literature where diversification is advocated originated from

among the explanations of African countries poor economic growth in the
1980’s, here it was observed that countries that have a rich endowment of
natural resources and tend to depend on exporting one or a few highly valued
nature resources such as ail minerals or coffee like Ethiopia tend to grow
slower than countries with, a more diversified non-resources based export
structure (Arezkiand Vander Ploeg 2007), Sachs and Waner (2001) term this
the natural resources curse. Three main reasons have been advanced as to
why a rich endouwment of natural resources, would be bad for economic
growth, Dutch-disease affects where by the real exchange rate appreciates
during resources booms (Bonoglia and Fukasaku, 2003), increasing rent
seeking behavior and corruption and civil conflicts over these valuable
resources.

The above a literature motivate the apparent need of diversification and the
benefit of diversified export base has been well established in literature, but
there exists no united theoretical framework to rely on when it come to uncover
the macro variable drivers of export diversification. Furthermore trade research
treats diversification from a socially aggregate stand point, while the decision to
diversity is made by individual from the macerate sector provided the
government has no influence on export markets, as it is the case in most
countries (Ricardo and Danial, 2005). But this proposition has no relevance in
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this case where the government has role in promoting export sector. Thus the
argument in favor of export diversification is said to be conclusive and correct.

Systematic identification of factor constraining export growth and

diversification is quite important in the design and effective implementation of
export growth enhancing policies. Available literature revealed the existence of
two contrasting school of thought on what has been constraining factor in
developing countries exports, one school of thought the “trade pessimists
ascribed the export set back to the difficult condition in export markets
especially the protectionist reaction by the industrialized countries.
Structuralist on the other hand blame supply side constraints within the
developing countries as the main factor that inhabit exports growth and
diversification (Berhanu 2004).

According to Wilson (1989) the issue of who is correct depends on the price
elasticity of export supply and on the relationship between export and domestic
market production, the further argue, the structuralisms view will be valid in
condition of low price elasticity’s of export supply and when there exists a
negative relationship between exports and domestic market production.

More recently, diversification and specialization have been studied as the part
endogenous outcome of a country’s stage of development (e.g. Acemogly and
Zilbotti, 1997); IMB and Wactiarg, 2003). While this literature focuses on a
country’s production structure it has implication for if export structure, given
that there is a relation between what countries produce and what they export.
Once such implication is that a country’s sector diversification will benefit the
development of it financial sector (by spreading risk), and that development of
it financial sector will inturn support further diversification (Acemoglu and
Zilibotti, 1997).

Ramacharan (2006) finds that alone standard deviation increase in

diversification is associated with above a 0.81 standard deviation increase in
the level of credit to the private sector. Thus, diversifying the sectoral

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composition of the economy will benefit financial development which in turn,
as shown by change 91991) may allow a country to engage in more
specialization of exports, given that developed financial market may provide
insurance against risk. This reasoning may lead onto infer that a country’s
export structure may go through phases, from less to more diversified, followed
as the financial sector development deepens, by a phase of less diversification
and more specialization (saint-Paul, 1992) Saint Paul also argue that due to
incomplete markets economic con led to diversify for insurance purposes and
to specialize again as financial market deepen.

Thus diversifying the production structure of the domestic economy may

therefore be a prerequisite for export diversification and later for export
specialization. This does not necessarily imply that we are back at the infant
industry argument for protection trade policy has been found not to be the first
best policy to address this (Venable, et al, 1999).

Better ways that have been indentified include financial sector development
(credit intervention (Krugrman 1987), coordination of investment between
sectors (Murphy and et. al, 1989 and Krugman 1991) and science and
technology policy to raise the rate of creativity (innovation) and information
spillover in a country in order to find dynamic comparative advantage
(Redding, 1999).

Diversification may also result more endogenously from a growing demand for
a variety of good as a country increases (Imbs and Wacziarg, 2003). This inturn
suggests that low income countries with a specialized export structure should
aim to maximize the benefits of such exports for household income and
demand. It implies that an unequal distribution of income may act as
constraint on diversification (Wim Naud and Riaan 2008).

A large number of cross sectional and country specific study have been
undertaken to examine the relationships between exports and economic
growth. The result of the studies has broadly classified economists into those

14
that support the hypothesis that export growth has positive and significant
impact on economic growth and those that support the hypothesis that doubt
the existence of such relationship. Adam Smith’s theory of international trade
assumed that a previously isolated country about to enter into international
trade possesses as a surplus productive capacity above the requirements of
domestic consumption. Hence, a surplus productive capacity suitable for
export appears as a costless means of acquiring import and expanding
domestic economic activity (Myint, 1958).

There are abundant literature that suggests that there is a two way
relationship between exports and growth. However, an important aspect of this
evidence is that it is not just the level of export that leads to growth but also
the level of diversified export or products. There are two important channels of
how diversification may influence growth or income. First, diversification may
be considered as an input (a production factor) that increases the productivity
of other factor of production (Romer, 1990).

As t Acemoglu and Zilibotti (1997), the second route is that diversification may
increase income by expanding the possibilities to spread investment risks over
a wider portfolio of economic sectors.

Thus, the above argument suggests that diversification is pivotal in sustaining

high economic growth rate and in reducing growth volatility. Theories of
economic development did advocate import substituting industries in order to
increase productivity and diversity the production structure. But the growth
registered in this strategy failed to be sustainable and emphasis is shifted to
export led growth (Economic focus, 1999).

“Today the emphasis has shifted to improving export performance. It has been
increasingly, recognized that, given the limited size of domestic market and the
dependence on the import of intermediate and capital goods. Expanding export
capacity and increasing international competitiveness are vital for rapid growth
and development.” Supporting the above argument, Kavouess (1984) and

15
Mashus (1987) argues that export expansion raises factors productivity and
leads to various benefits such as more efficient use of resources and adoption
of technological innovation, resulting from foreign comptetion, greater capacity
utilization and gains of scale effects associated with large international
markets.

1.2.1. Diversification Regimes

The diversification regimes are the results of policy action that a country has
set in place over a given period of time these regimes should not be viewed as a
steps or as a continues that a country must follow as it move from a
concentrated to a diversified economy.

According to economic commission of Africa report of 2007 five diversification

regimes can be identified from African experience. The particular region that a
country falls in to is likely to be the result of a mix among the various
diversification determinants. The regions that can be identified in Africans
diversification effort are described below.

1. Little-economics Diversification
These are those that have not achieved much in terms of diversification,
these are countries which, without experiencing any conflict, have been
unable to achieve any significant diversification exemplify experience of
countries like Benin, Burkainafaso and Malawi.
2. Countries that started the process but have not made any significant
breakthrough.
These are countries that have not made major breakthrough in their
diversification efforts over the last 20 years.
3. Deepened diversification process
This is a regime that is characterized by both horizontal and vertical
diversification. A strong diversification regime is one that has the

16
 potential to be sustainable. Turisia and Mauritian can exemplify this
regime.
4. Backsliders in the diversification process
Those countries that started well and were registering positive
diversification gains but later fell back are included here it cover
countries that, offer the economic crises of the early 1980’s concentrated
on internal factors. A major factor in putting those countries in to this
regime might be the Dutch disease effects export booms based on a
single commodity play a part in the diversion of factors of prediction
away from other tradable especially the exportable, Gabon and Nigeria
are those countries where by the traditionality of petroeum related
exports continued and new sectors were unable to emerge and thrive.
5. Conflict and post conflict countries
Countries exhibit diversification efforts but conflicts have undermined
this effort are grouped here. Republic of Congo and Liberia are taken as
an example. Though theorizing without data is a capital mistake,
Ethiopia is expected fall within the first two regimes. This is because the
overall economic structure and level of developments of countries in the
3rd regime like Tunisia is different from Ethiopian case as much as there
is no reason to expect Ethiopia out of the first two regimes of
diversification.

2.1.2 Types of Export Diversification

There are two types of export Diversification that may take place in developing
countries: they are horizontal and vertical Diversification Horizontal
Diversification, as to Aye (2008) can be materialized through (i) a larger mix of
diverse and complementary activity within agriculture, and (ii) a movement of
resource from low value agriculture to high value agriculture. On the other
hand an economy is said to be vertically diversified if and only if that country

17
starts processing and exports value–added products that would have previously
been exported in new forms.

Vertical diversification involves radical change in export structure and

additional uses of existing and new innovative export products by means of
valued added actions such as processing and marketing. As to Hirsthman
(1958), Vertical diversification can be linked with higher learning possibilities
that result in greater dynamic externalities than that of horizontal
diversification. Backward and forward linkages in production are likely to
provide stimulus to the creation of new industries and expansion of existing
one in the economy.

Both vertical and horizontal diversifications have interrelated objective but they
vary in their requirement. As to Aye (2008, PP-11), “… are targeted to attain
three interrelated objectives stabilizing earning. Expanding export revenue and
upgrading value added. However, requirements for the two could vary
considerably in terms of technological, managerial and marketing skills.
Accordingly it is vertical integration that requires more advanced technology,
skills and initial capital investment than horizontal diversification. Hence
significant amount of investment on human capital through education and
high rate of physical capital formation either by raising domestic saving or
through FDI are pre-requisite for a country a country especially to achieve
vertical diversification. On the other hand horizontal diversification is achieved
by producing nontraditional dynamic exports such as cost. However, as it has
been started to be largely produced in Kenya, Uganda and Ethiopia to
supplement or partially replaced the traditional exports like coffee and tea.”

Even if the two types of diversification vary in their requirements, they aimed at
achieving a common objective hence, pursuing both types is crucial to growth
of an economy.

18
2.2 Empirical Review

The notion that developing countries can accelerate their economic

development by expanding exports and in particular exports of manufacturing
has become conventional wisdom. Many economists have demonstrated at
least in broad terms, the contribution of trade to growth and development.
Many developing countries now recognize the importance of trade for efficiency,
a healthy balance of payment and the exploration of comparative advantage in
resource endowments (Pan out surplus, 1992).

The developing countries that have expanded and diversified their exports of
primary product and have become engaged in manufacturing have gained in
growth of export earning and stability. According to panutsopoulos (1992),
Exports of manufacted good have been the most rapidly growing components of
export sector, capturing an increasing share of these markets. The industrial
economies provides demand for these products, absorbing more than 60%.

There is an observation that concentration in primary products has pervasive

effects on trade and economic growth. For example the secular concentration of
Latin American exports in primary products has been highlighted as a major
drawback for development prospects of the region. Adverse and volatile term of
trade, slow productivity growth, and relatively low value added are some of the
issues that been raised against this primary product dependence (Ricardo,
2005). In addition to reducing the dependence on fluctuating commodity
prices, diversification in to other factors especially to those more intensive in
technology is prone to trigger knowledge spillovers from the exposure to
international markets.

Diversification and policy variables constitute a two way process in that

diversification is not only influences, policy out comes but is itself influenced
by policy variable, thus varies empirical researches were made to search for

19
those economic and non-economic policy actions that are likely to affect the
level and rate of diversification in a country.

IMBs and Wacziary (2003) using cross-sectional and cross country data find a
u-shaped relationship between the degree of sectoral concentration in a
country’s production structure and the level of development (as measured by
per capital income). This evidence is consistent with the view that countries
will diversify and then specialize in their production (and exports) over their
stage of development.

Hommel et al (2001) and Yi (2003) give further support to the notion that
countries at further stage of development may tend to specialize also in their
exports structure, by indentifying the importance of vertical diversification
(when a country, specializes in a specific stage of production rather than in the
production of the whole products in global trade vertical specialization, for
example, has been responsible for 50% of the growth in USA trade since 1962
(Yi, 2003).

African countries also fit into this theory of a u-shaped stage of diversification.
The result of economic commission of Africa (2007), suggest that as income per
capital increase, there is a tendency for African economies to experience
improvement in their diversification processes. This result shows consistency
with the two stage of diversification. The first stage is one increased
diversification and is explained in the same way portfolio theories in finance
are used to explain the character of investors, who diversity their portfolio
holdings in order to minimize risk exposure (Acemoglu and Ziliboli, 1997).

In the same way economies through the first stage of diversification would be
expected to minimized the effects of possible shocks to the economy by
avoiding over reliance on one particular sector. For this first stage to be
beneficial to the economy in the long run, it must result in deep diversification.
Only after attachment of deep diversification would the second stage that tends
towards specialization not lock an economy in to low income equilibrium.

20
Unfortunately the transition point between the two stages for African countries
has been at low per capital income equilibrium. ECA (2007) reported that the
turning point for African at a mere $ 10,667 did not occur at a point when deep
diversification had been achieved. Other studies have reported the turning
points of other countries (e.g. Imbs and Uhaciziarg, 2003). For example,
Singapore’s occurred at $ 2500 per capita, while for Cyprus at $5800, Ireland,
other hand experienced this turning point at per capita income of $7000.
Indeed, for meaningful results, the bench mark per capita income is
approximately $9000 if two-stage diversification process is to yield lasting and
positive development result.

Investigating determinants of export diversification in Africa, ECA (2007) found

that macroeconomic stance is crucial to diversification outcome. Two important
indicators of macroeconomic stability, depending on the macroeconomic policy
in operation are inflation and real effective exchange rates and these are found
to be among the most critical determinants of diversification outcome in Africa.

High level of inflation damage diversification prospects and the tendency under
such circumstances is for increased concentration with little opening up to new
export sectors. A high inflation environment is not conducive to the
development and maturation of new sectors nor is it supportive of an
environment that fasters others determinants of diversification so that they
have significant impact. Ordinarily, it is reasonable to expect that high inflation
could lead to diversification as an economy diversifies away from sector,
specific income shocks. Due to incomplete market economics can be led to
diversify for insurance purpose; and to specialize again as financial markets
deepen (Saint Paul 1992).

The effect of the exchange rates depend on existing export potential. The theory
of international trade argues that depreciation underpinned by appropriate
macroeconomic fundamentals should increase and ease potentials exportable
into new markets (Pilbeam, 2001). But empirical evidence on African country

21
by ECA might appear to be counterproductive of this theory. The result shows,
the exchange rate affects diversification prospects as there is a significant
relationship between the two. The positive relationship between the exchange
rate and the diversification index suggests that a depreciating currency is not
always supportive of diversification efforts or depreciation does not lead to
deepening of diversification.

Previous works exploring similar issue like Gutierrez Depinores and Fertantion
(1997) analyze the successful Chilean experience since the Mid-1070’s and
found a positive effect of real exchange depreciation and trade reforms on
export diversification. Similarly Manuel R. et.al., (2009), found that real
exchange rate over valuation has a negative effect, though not significant.

In contrast, economic commission of Africa (2007) found that depreciation of

REER does not head to deepening of diversification at continental level.

Traditional trade theory, as HO model, high lights the benefit of openness to

those sectors in which a country has comparative advantage by increasing its
production and the reward to the factor used intensively in that sector. But,
empirical evidences of Manuel R. et.at., (2009) and ECA (2007) reveal robust
evidence that trade openness induces higher specialization and does not favor
export diversification.

2.3 Review of the Ethiopian Trade Policy and Export Sector

2.3.1. Trade Policy Regime: A review

Traditionally, trade strategies are considered to fall in either of the two

categories i.e., import substitution (IS) or inward looking promotion (EP)
outward orientation strategy on the other. This broad categorization is based
on the types of support that either the import substitution or the export sector
receives. If more support (incentives) are provides to IS than to EP activities the

22
strategy is regarded as one of inward oriented one. The country’s trade policy is
reviewed as follows beginning from imperial regime to current one.

I. Pre-1974/75

In the 1950s and early 1960s, following the singer Pirebisen hypothesis many
developing countries adopted inward-looking import substitution rather than
export promotion policies. But by mid of 1960s, many developing countries
abandoned the import substitution strategy as the strategy could not provide
what had been thought it would. The consensus was that the ISI strategy
encouraged rent seeking and in efficient use of resources that left the protected
industries totally unfit for the perceived competition at a later stage.

In Ethiopia during this period the foreign trade sector was governed by a
relatively free market oriented policies with the private sector (mainly foreign
capital) occupying the lion share in both export and import activities. In this
period much concern was given to import substitution strategy, the concern
over export diversification at least, explicitly, started with the first five year.
Development plan (1957-1961) that presented the economic instability
consequences of the dependence on few products.

As indicated in the first five year plan, the volume of the country’s exports. The
balance of payment position and the level of budgetary revenue depend on the
price movements and the extent of demand for the three main export
commodities coffee, hides and skins and oil seed.

Thus, it calls for a diversified structure of export by exploiting the numerous

live stocks, the products of agro-industries such as sugar, canned meat and
leather and minerals to secure average annual export growth of 9 percent and
11 percent share of exports in national income (imperial government of
Ethiopia, 1955).

The second five year development plan started the export-sector to rely mainly
on traditionally exports such as coffee, hides and skins, oil seeds and others. It

23
also stipulated an important role to be played by new export products of
industrial origins and mining products. The plan also set the share of
agricultural exports to exhibit a decrease of 93.6 percent in 1961 to 72.3
percent in 1966 while that of manufactured products expected to pick-up from
5.2% to 24.2% during the same period. Thus, the second five year plan (1962-
1966) placed great emphasis on structural change and export diversification to
achieve higher level of foreign exchange earnings (imperial government of
Ethiopia, 1962).

To implement this plan incentive like tax holiday, export trade licensing
simplification, restructuring and strengthening of champer of commerce and
others were offered for investors who engage themselves in the production of
non-traditional exports.

In pre 1974/75 period geographic diversification of exports of traditional

exports such as coffee, livestock products and oil seeds as well as the
development of non-agricultural exports was the concern of the third five year
development plan (1968-73). Agricultural products exports were expected to
decrease to 75 percent in 1973/74 from that of 86% in 1967/68). Through the
addition of new agricultural products in the export basket, the share of coffee
was envisaged to fall from 55 to 40 percent at the end of the plan period. In
sum, although attempts were made in all the three development plans of the
imperial government of Ethiopia, these did not bring the anticipated export
promotion and diversification.

Thus, it can be said the economic reasoning behind the trade policy of the
imperial regimes was the classical goals of mobilizing government revenue by
imposing tax on export and import maintain the balance of payments at a
sustainable level as well as providing the domestic economy with the degree of
protection deemed necessary.

24
 II. 1974/75-1990/91

The revolution of 1974 went beyond the simple changing of the guards; there
was a fundamental shift in ideological outlook, what changed under the
military regime was to the three objective of the imperial regime a fourth
objective was imposed the control and gradual extinction of the private sector
and most impotently the socialization of economic activity.

Important institutional arrangement was also made with import and exports,
while private importers were driven out of business in favor of state trading
enterprises, exporters were prohibited from exporting traditional export
commodities.

The export objective of the ten years perspective plan of the Dergue regime
were increasing foreign exchange earnings, reducing the dependence of the
country’s export sector on limited export market, increasing the amount and
composition of manufacture exports and increasing the socialization of export
sector (provisional Military Government of Ethiopia, 1985).

Geographic diversification of exports towards the markets of socialist countries

and neighboring African countries as well as diversification toward
manufactured products to a greater extent were the agendas of the perspective
plan. The plan stipulated the share of traditional exports to decrease from 72.5
percent in 1985/86 to 53.2 percent in 1994/95, while the share of other export
products to rise from 26.5 percent to 46.8 percent in the plan period.

In order to achieve it objective, the government had employed a multitude of

strategies like provision of favorable tax, tariff and foreign exchange rate
measures, improving export interims of quality, quantity and variety and
providing current information on world market prices and others factors in the
international market to exporters and producers. In addition to country
balance the negative effect of distortionary policies and hence to secure growth

25
in export, the government introduced was not sufficient interm of coverage and
amount to neutralize the prevailed anti-export bias incentive structure.

To summarize, despite the measures taken by both the imperial and the
Dergue regime to diversify the export basket and promote exports the Ethiopia
export products remain undiversified and are still concentrated on very few
primary agriculture products as to Debel (2004). This is because both regime
used overvalued exchange rate, high rate of tariffs and other trade restrictive
commercial policies that developed strong anti-export bias and strongly inward
oriented trade policies favoring, import substitution (IS) than export promotion
and diversification.

III. Post 1990/91

The decade of the 1990’s coincided with major revolution both in the world and
in Ethiopia. The dissociation of the Soviet Union eliminated the bipolar global
political arrangements in favor of a unipolar world (EEA, 2000).

At home, the Ethiopia people democratic front (EPRDF) ousted the military
socialist regime and inherited an economy which has been exhausted by in
appropriate policies and devastated by civil war.

In the 1991 the transitional government of Ethiopia (TGE) together with the
IMF and the World Bank has undertaken liberalization and structural
adjustment program to address the internal and external imbalances of the
economy. The policy of the TGE acknowledged the importance of increasing
and diversifying the country’s exports to cash foreign currency shortage along a
free market-based economies path. The government aimed at increasing
exports and foreign exchange earnings by minimizing the role of the state in
foreign trade sector and by ensuring adequate private capital participation in
the export business. The measures undertaken include devaluation of Birr,
provision of fiscal’ incentives to exporters, the replacement of quantitative
restrictions with tariffs, encouraging export oriented investment, minimizing

26
administrative and bureaucratic producers and promotion of the use of trade
information were highlighted.

The major purpose behind the reform were idea espoused by both the IMF and
WB where by an open economy helps to increase and diversity exports, renders
the domestic economy more efficient and competitive and results in vigorous
and sustained growth (EEA, 2000).

In executing the market based economic policy and the associated structural
adjustment program (SAP) which was launched in October 1992, a number of
policy measures have been formulated that aim to stimulate export growth and
diversification. The major measures in this respect include:

 Devaluation of the Birr and step by step liberalization of the foreign

exchange market.
 Easing (streamlining) of export licensing procedure and abandoning of
the bureaucratic trade licensing chains.
 Abolishing all taxes on exports and subsides to parastatal exporting
enterprises as of December 1992 and beginning from April 2000
exporters were waived from the 6.5 percent coffee export tax.
 Removing coffee price differential system as of February 2002 allowing
coffee exporter at whatever price they fetch in the international market.
 Eliminating foreign exchange surrender requirement and replacing it
with a confession requirement.

In pursuant of the reform an export development strategy was promulgated,

export support institutions were established and export specific incentive
system was institutes. The strategy adopted to promote export growth and
diversification since the reform period has the following broad aims.

 Maximizing the gains from surplus venting through productivity

improvement (by undertaking small investment in agriculture) and
cultivation of unused land.

27
  Expansion of exports of manufactured goods, grounded on the country’s
comparative advantage of labor (clothing, leather and leather products
textile products)
 Utilizing the advantage of natural resources for export of high value
agricultural products (horticultural products, including vegetable,
flowers, fruits and fresh /chilled meat) and
 To discover exportable minerals and fuel deposits

As presented in the Ethiopian economic association publication of 1998, for the

purpose of attaining these broad aims, strategic intervention of general and
specific nature have been designed with the intention of implementing the
strategy and that of encouraging the development of the private sector.

The general intervention includes:

 Maintaining a reasonable exchange rate

 Easy and market based access to urban and rural land
 Effective enforcement of contract
 Encouraging small holders to produce cash crops for exports, through
schemes for out growers and contract farmers.
 Aggregation of activities to be able to reap the benefit of large scale
operation.

The specific intervention that aims to encourage the private sector includes:

 Duty exemption/drawback to encourage (potential) exporters of

manufactures (that requires importing inputs)
 Financing of imported inputs through a back-to-back issuance L/C
imports arrangement.
 Pre-shipment finance through financing of domestic inputs by local
banks, against committed L/C of exports.
 Post-shipment finance

28
  Price verification with the intention of providing information and/or
preventing under invoicing of exports.
 Crop quality certification to standardize quality
 Export brokerage to be able to get market out lets externally, export
commodity exchange to secure the best prices for the country’s exports
on a sustainable basis.
 Re-discount window which is a scheme whereby some banks likes’
development and commercial bank of Ethiopia are entitled to borrow
from National Bank of Ethiopia (NBE) at discount to finance loans for
investment in export production and related working capital.

2.3.2. Export Development Strategy, the Institutional Framework and

Export Incentive Schemes

I. Export Development Strategy

The current government of Ethiopia has promulgated an export development
strategy in February 1998.

The objective of the strategy is to ensure sustainable agricultural development

and competitive industrial development and to earn foreign exchange (ministry
of trade and industry, 1998). The scope of the strategy is to focus on sector and
products which have reliable markets and thus contribute to the foreign
exchange earning of the country and which have tangible impact on the overall
economic development of the country. The targeted products from agriculture
are coffee, cotton, fruits, vegetables and flowers, live stock and livestock
products; from industries, textiles, especially garments, leather and meat other
export product will continue to get general support and will benefit from over
all export development programs and macroeconomic policies. Guiding the
export promotion endeavor in an organized manner is also a component of the
strategy, to this effect an export promotion agency has established.

29
 II. Export Support Institutions
Based on the foreign economic policy of Ethiopia, proclamation for the
establishment of the “Ethiopian Export Promotion Agency” was approved in
1999 and begun operation.

The agency has the responsibility of enhancing the competitiveness of local

entrepreneurs in the international market. The Ethiopian trade point is now
incorporated with EPA and is a source of trade related information on business
and market opportunities, potential clients and suppliers trade regulations and
requirements.

The other action taken in support of export sector is the establishment of

leather technology institute which aim to address issues of skilled human
resource of the sector and the animal products marketing agency which is
concerned with the development of the livestock sector in general.

As to Berhanu et.al., (2002), in a country like Ethiopia where the private sector
has a very limited capacity in supplying export services and in view of the fact
that the provision as well as use of export support services is a its infancy, the
creation of institutional framework conductive for the sector by the government
is a step forward in the right direction.

III. Export Incentive Schemes

A dynamic export promotion program would invariably focus on a number of
key policy variables including; creating an enabling environment for exporters;
establishing an effective a partnership between government and private
sectors; creating appropriate institutions in support of the sector; improving
infrastructures and appreciating the difficulties of exporters operating in a
globalized and liberalized world economy (economic focus, 1999). The export
incentive mechanisms employed by the current government are listed below.

 Export trade duty incentive scheme

o Duty draw back scheme

30
 o Vouches scheme
o Bonded manufacturing ware house
 Export credit guarantee scheme
 Foreign exchange retention scheme
 External loan and suppliers or foreign partners’ credit

In addition to this, currently tax imposed on exportable commodities (export

tax) is null.

31
 CHAPTER THREE

3. DATA SOURCES AND METHODOLOGY

3.1 Sources of Data

The data has been collected entirely relies on secondary sources. Therefore, the
data source of study is the publications and report of central statistical
authority, the national banks of Ethiopia, the Ministry of finance and economic
development, Ethiopian custom Authority and Ethiopian Economics
Association.

In addition, this study is possibly use data, from other relevant offices and
publications.

3.2 Methods of Data Analysis

In order to achieve the objectives of the study descriptive method is used to

describe and interpret the data. Data result has been organized and
summarized in tables percentage, ratio, bar graphs and others, so that
meaningful interpretation of the result has been make so as to draws
conclusion and recommendations based on the finding.

3.3 Structure and Performance of the Ethiopia Export Sector

3.3.1. Commodity structure of the exports

The reason why focus on the structure of the export sector of an economy is as
any sector of an economy the structure of the export sector to a large extent
determines the performance of the sector. This in turn affects the economic
growth of the country. The issue will be highly significant in the case of less
developed country, where their primary, need of export is foreign earning in
sustainable manner which is needed for the imports of goods and services
necessary for their economic development.

32
Most economies of LDCs are oriented towards the production of primary
products (agriculture, fuel, forestry and raw materials) as opposed to secondary
(manufacturing) and tertiary (service) activities. These primary commodities
from their main exports to other nations (both developed and less developed).
For example, in 1990 for all not Asian Third world countries, these primary
products accounted for over 70% of exports. Except in those countries blessed
with abundant supplies of pertcoleum and other valuable mineral resources
and few leading exporters of manufactured goods must LDCs exports consists
of basic food staffs, non food cash crop and raw materials. In Sub-Saharan
Africa for example, primary product accounted for over 92% of total export
earnings (M. Todaro, 1994).

In line with above explanation the case of Ethiopian economy and export sector
is similar to other LDCs. Being under developed economy that heavily depends
on agriculture the commodity structure of Ethiopian exports is dominated
agricultural products which alone accounted for more than 90% of the export
proceeds of the country.

The commodity structure of Ethiopian export sub-sectors is said to be a mirror

reflection of its overall economic structure. The export structure has been
dominated by primary agricultural commodities such as coffee, hides and
skins, oil seeds, pulses and chat while the share of non-agricultural products
in total merchandise export is almost in significant.

For the last 40 years covered by present study, the five traditional commodities
(i.e. coffee, hides and skins, pulses and chat) accounted for 81% of the total
exports on averages, signifying low level of diversification and the fact that
Ethiopia depend largely on few traditional products for it badly needed foreign
exchange earnings.

The percentage composition of Ethiopia export trade over the period 1970/71
to 2009/10 is show in table below. In these periods coffee along for about
53.78% of the total export proceeds. The average percent age share of coffee in

33
the total merchandise export was 42.7%, 60.9% and 46.15% for the imperial,
Dergue and EPRDE regimes respectively. The figures do, however, indicate a
tendency for coffee export share to decline in recent years. For instance it went
down from 43.5% in 1990/91 to 39.3% in 2000/01 and further to 34.9% in
2011/12.

Following coffee, Hides and Skins, oilseeds, ‘chat’ and pulse as the second,
third, fourth and fifth important export products of Ethiopia accounting for a
respective share of ’11.4%, 6.4%, 5.2% and 4.8% average share in the
1970/71-2009/10 review period.

Revenue secured from leather and leather product (Hide and skins) is currently
rising for example export earnings from hide and skin by 2007/08 has
increased by 10.7% reaching USD of 99.2 million and but by 2009/10 it
registered U.S.D of 75.5 million. This is solely on account of fluctuation in
international price due to global financial crisis.

The export commodity whose share increased significantly during the last four
decade is ‘chat’ its share in total export earnings was 0.8, 2.2 and 9.11 percent
during the emperial, military and current government respectively. Despite a
modest decline in the volume of exports, the income from chat increased by
17.5% and reached U.S.D 118.3 million in 2009/10 and 140.7 million in
2011/12 fiscal year ‘chat’ export is expected to grow even without government
intervention because of strong demand in neighboring countries (Ibid).

The above five commodities on average account for more than 80% of the
country’s export earnings in the period covered by this study. The 20% is
distributed among fruits and vegetable, gold, meat products live animals,
sugar, flower and others.

34
 Table 1: Percentage Composition of Ethiopian Export Item (in%)
commodity

1970/71-
1970/71

1980/81

1990/91

2000/01

2002/03

2004/05

2006/07

2008/09

2009/10

2009/10
Export

Coffee 58.6 61.5 46.9 39.8 37.1 39.56 35.5 35.6 35.9 53.78
Hides and skin 7.8 10.9 16.13 16.2 7.26 7.9 7.49 7.55 6.71 11.32
Oil seed 9.8 3.4 0.7 6.8 13.75 14.7 21.13 15.82 14.9 6.35
Pulses 6.5 2.7 2.75 1.88 3.76 4.18 3.69 5.92 9.77 4.6
Chat 0.7 2.6 3.57 13.2 14.6 11.82 8.9 7.81 7.33 5.15
Fruit and 1.9 0.43 21.0 1.18 2.12 1.88 8.8 7.82 7.33 5.15
vegetable
Meat and meat 2.4 0.75 0.17 0.36 1.4 1.7 1.84 1.29 1.43 6.63
product
Gold -- -- 12.9 6.07 8.11 7 6.47 8.26 5.38 6.45
Others 11.9 17.6 14.8 14.6 11.8 11.08 13.72 16.2 17.69 10.15
Total 100 100 100 100 100 100 100 100 100 100
Source: Own Competition based on Data from NBE

The above commodity structure analysis shows the greater commodity

concentration and the mono culture nature of country export. Available
literature associates such higher concentration to the increasing export earning
instability problems thus arguing in favour of more diversification.

3.4 Geographic Structure of Exports

The destination of exports and the origin of imports into the country had
remained conspicuously loyal. Going as far back as 1980 and even further in
time, the major trading partners remain Europe, Asia and the Americans (both
Latin and North America). Europe has retained its predominance as the
destination for exports of Ethiopia. The market however remains small in
number like Germany, Italy and France.

In early 1970, and even in 1980s America used to be the second most
important destination of exports, however, after 1980’s America ceded its

35
second position as export destination to Asia currently the share of America
reached 8.4% in 2009/10 and 4.9% during the third quarter of 2011/12.

The Asian markets have increased its share a buyer of exports its share has
increased from 17.2% in 1980 to 29.7% in 1995 and further to 36.1% in
2009/10 fiscal year. Currently Asia took the head from Europe to be the largest
markets for Ethiopia’s export. During the third quarter of 2011/12 Asia,
imported 40.2% while Europe shares constitute 39.8% of total export. The
major markets in Asia, currently is china 38.4% of 40.2% total share went
here.

Unlike the case before 1990, the share of Africa as export destination is
increasing. Africa takes the third position. Its share has increased from 12.6%
in 1990 to 13.2% in 1997 and further to 32% by 2003. During the third
quarter of 2011/12 this share registers on average around 15.8%. At individual
country basis, the most important markets for Ethiopia were nation like
Germany, USA, Japan, Saudi Arabia, Djibouti, and Italy and currently China
becomes main partners of Ethiopia.

Looking at the composition of products exported in those continents and

nations, the researcher found that they are mainly primary agricultural
commodities.

This fact implies that there is structural rigidity in geographic structure of

Ethiopia’s exports. This has a serious risk of exposing an exporting country to
fluctuations in demand of importing nations. For example one way by which
LDC’s suffer from the current global economic crises is due to fall in effective
demand of industrialized country, which leads to a fall in price of exportable
commodities and the consequent shortage of foreign currency, needed to meet
import requirements.

In our case, the effects of global economic crises began to show negative
impacts to Ethiopia’s export trade toward the end of the 2011/12 fiscal year.

36
Export earning which used to grow by an average rate of about 20% over the
past few years grow by just 1.8% during the ten months of 2011/12. Decline in
the international prices of major export items following the global economic
crisis contributed to the slowdown in export earnings (NBE, 2011/12).

Thus, there is a need for diversification of our exports out let as the country is
strategically located to invade the richest markets in the world.

3.5 Performance of the Export Sector

Ethiopia has a long history in the field of international trade but the country
has no benefited from it as much as expected. This is due to the poor
performance in value and volume of exports. The export sector of the nation
shows fluctuation in value and volume highly in the early regime and
moderately in the current regime. For example, as shown calculated data from
NBE, the value of coffee in 1970/71 is about 58.6 percent again in 1980/81
rise up to 61.5%, then declines to 46.9%, it also decline to 39.8% in 2000/01
and 35.9 % in 2009/10. As well as the value of chat in 1970/71 is 0.7%, again
it increase to 2.7% percent in 1980/81 and it also increase to 4.58% in
1990/91 and rise up to 13.2% in 2000/01, then decline to 7.33% in 2009/10.
This problem may arise because the nations export is highly dominated by a
few primary commodities which are exposed to international price fluctuation
(law demand of primary commodities, increase oil price at the international
market) and environmental hazards (i.e. drought, epidemic diseases, etc).

However, since 2002/03 the early dominant export item’s share to the total
export sector gets lower and lower. This is due to the impact of export
diversification. That is, the establishment of new export areas took over some
portion of the total export sector from the dominant export commodities. This
may provides a safe guard of a risk of fluctuation in the total export. The share
of newly introduced export commodities like fruit and vegetable, and flower
increasing at alarming rate from time to time thus export diversification play a

37
significant role in stabilizing export fluctuation and keep the trend of export
consistent and stable.

The performance of the export sector can be evaluated in various ways. Some
of these ways are

 Exchange earning capacity

 Import financing capacity
 Export to GDP ratio

1. Exchange Earning Capacity: it refers to the ability to generate foreign

exchange from the exportable products; various literatures argue that
countries that export primary agricultural products are expected to receive
a lower price relative to those countries that export more of manufactured
products. This is because of the high value added in industrial products.
Primary agricultural product. Commodities are also known to have a lower
income elasticity and vulnerable to change in weather condition of
exporting country.
Looking at the export statistics of Ethiopia for past years, the study
found that Ethiopia export sector is not as such competitive in
generating revenue, but relatively growing.
2. Export to import ratio: is used to measure the share of export revenues
in financing the import requirement of a nation. There will be diverse way
of obtaining foreign exchange requirements of a nation, but some of these
alternative ways like loan are hazardous and further put pressure on the
whole economy while servicing the principal debt with its interest. Thus,
measuring the performance of the export sector from its ability to finance
import bill is reasonable.
Looking at the past 37 years (1971/72-2007/08) the export to import ratio
averaged out to be around 51%. This means is that the value of exportable
commodities has able to finance only 51% of the value of imported goods,

38
 the rest 49% of import value is met by other sources like net for inflow,
from service, loan and transfer.
The ratio shows a fluctuating pattern, it reached a minimum of 15% in
1991/92, this was due to unstable political environment that prevail in the
country. A maximum of 129.8% was registered in 1973/74; this was owing
to the inward oriented (Import substitution) policy of imperial regime.

Table Share of Export in Financing Imports on Average

Dergue (1974/75- EPRDF (1991/92-

Imperial
1990/91 2007/08
Export/Import 101.74% 58.6% 33.9%
Average
(1971/72-2007/08 51%
Source: Own Computation based on NBE Data

3. Export to GDP ratio: this indicator reflects among other thing, the
country’s competitiveness in and the integration to international markets.
The ratio implies that a higher overall productivity helps developing new
lines of production or implies diversification. At the same oppositely, it
may imply a better knowledge and the increasing exploitation of increasing
return to scale via export specialization (Ricardo and Daniel, 2005).

Hence, export to GDP ratio is used as a proxy variable for measuring country’s
diversification outcome. It can be seen that export contributed on average
6.67% to GDP during 1971/72-2007/08 period. The following table shows that
the share of export in GDP during the past and current governments.

Imperial 1971/72-
Dergue (1974/75- EPRDF (1991/92-
Year 1971/72— 2007/08
1990/91 2007/08
73/74
X/GDP (%) 7.642 6.799 6.368 6.67

39
It was said that the ratio can be used as a proxy variable for diversification of
export. Hence, the growth in the ratio shows the growth in diversification
outcome of a nation.

As such the figure below reveals the growth trend in export to GDP, there by
diversification

Figure 2: Trends in GDP

RATIO of Export to GDP

9
8
7
6
Exp/GDP

5
4
3
2
1
0

Source: Own Computation based on NBE Data

The figure show that a fluctuating patten of ratio of export to GDP from year to
year. The ratio reached a maximum of 8.95% in 1979/80 and a minimum of
1.67% in 1991/92 this was due to unstable political environment prevail in the
country. Then the ratios start to rising and reached maximum of 8.47% in
1997/98.

40
 3.6 Trends in Export Diversification (Specialization)

Despite changes within the relevant years, there was not continuous and
sustainable change in the degree of export diversification over the 1980/81-
2011/12. Comparison of the various times period suggest that diversification
level as measured by Hirschman Herfindal Index (HHI) was of low level before
mid 1990’s relative to the period since then. Hirschman Herfindahl index as it’s
the easiest to program and the most widely used in the export diversification.
The index is computed as follows.

n
xi
HHI =∑ si2 where Si = is the share of export
i ∑ xi
Line in total export with xi being the value of the exported good i.

Hirschman Helfindahl index (HHI) is one of a measure of the degree of export

diversification. It is a measure of dispersion and it varies between 0 and 1. The
value declines with increase in the number of export items.

However, the diversification outcomes was not permanent it signify a great

fluctuation from period to period. For example in 1980/81 the HHI stood at
around 0.4043, by 1991/92 it shows some improvement, though it is small to
be around 0.3780. After the index increases (specialization) from year to year
and reached a maximum of 0.612 in 2004/05 while the period since the
beginning of the 21st century has registered an improvement in the
diversification index (HHI) in contrast to 2004/04 fiscal year the subsequent
year of 2006/07 and 2008/09 shows HHI of 0.1931 and 0.1865 respectively.
By 2009/10 the index is around 0.1853.

The statistical analysis above depicts the fact that the export sector is less
diversified and suffers from great fluctuations. Moreover, the HHI for the
commodity on average from 1980/81-2009/10 is 0.35491, which is too large.
Looking figure 3 it can be inferred that the country’s diversification outcome is
not deepened on and suffer from fluctuation.

41
Analyzing the diversification index and the structure of the top ten export
commodity (sec, section 3.2) over the last decade can provide some useful in
sights to defined the diversification regime that characterize Ethiopia.

Ethiopia has started the process of diversification but has not made any
significant breakthrough. The country have not managed to achieve deep
horizontal diversification that encompasses high value export commodities,
vertical diversification might have occurred leading to new agriculture related
exports as the case of flower currently. Thus, as to the classification made by
ECA Ethiopia fall in the second diversification regime, which is not a deepened
(sustained).

Figure 3 Trend in export diversification (specialization) index

Trend in Diversification index

0.7
0.6
HERFINDHL INDEX

0.5
0.4

0.3
0.2
0.1
0

81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
80/ 82/ 84/ 86/ 88/ 90/ 92/ 94/ 96/ 98/ 00/ 02/ 04/ 06/ 08/ 10/
19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20
YEAR

Source: Own Computation based data from NBE

42
 CHAPTER FOUR

4. RESULT AND DISCUSSION

4.1 Interpretation of the Result

In investigating the determinants of export diversification, Ricardo N. and

Daniel (2006) tried to answer how macroeconomic affects export diversification
outcome. This investigation incorporates only macro variables.

Other methodological, Frame works have been developed by economic

commission of Africa to examine the determinants of export diversification in
Africa. To meet one of the objectives of this study, the study uses the data
developed by ECA, to explain the diversification outcome in case of Ethiopia, so
the interpretation of the determinants is as follows.

Accordingly, the diversification process is influenced by physical variable,

policy variable and macro variables. The physical variables investment and
GDP per capita, the policy variables are trade openness and industrial
production and the macro stance variables are inflation, exchange rate and
fiscal balance. Hence, it is hypothesized that these variables are significant
determinant of Ethiopian diversification outcome.

4.1.1. Main Determinants of Export Diversification

i) Description of Determinant Variable

A) Gross Fixed Capital Formation (GCF)

The inclusion of investment in the determinants of export diversification as

measured by gross capital formation as percentage of GDP is based on the
notion that unless a country commits a sufficient portion of its national income
to build capital stock, it is unlikely to be able to diversify (ECA, 2007). The
expected result is positive.

43
 B) Per Capital Income (PCI)

It was pointed out that the degree of export diversification may be related to a
country’s stage of economic development (Imbs and Wacziarg 2003). Countries
tend to diversify at first as their income rises before they later begun to become
more specialized when developed. Since PCI of Ethiopia is not as that of
developed one (high) income is expected to lead to specialization thus, there is
positive relation between PCI and export diversification.

C) Industrial Production (IP)

Taking industrial production as a proxy for industrialization, this fits within

the established theoretical development process where a country moves from
specialization through industrial deepening before starting to specialize again
(ECA, 2007).

D) Trade Openness (TOP)

In specifying the determinants of export diversification, trade openness is

incorporated because trade policy question dominate much of the debate in
this era of globalization (Rodrick and Rodriguez, 1999). Conventional trade
theory postulate that openness helps in increased exports, there by
diversification. In contrary some empirical evidence reveals that trade openness
does not necessarily lead to deepening of diversification. Thus, the result or
sign of trade openness is indeterminate priority.

E) Real Effective exchange Rate (REER)

The inclusion of REER in the determinants of export diversification is due to

the fact that exchange rate affects diversification prospects as there is
significant relation between them. In the literature it is acknowledged that
depreciation of the REER has positive contribution for increased exports while
real appreciation has the inverse result. Thus maintaining a realistic exchange

44
rate is being propagated as a policy prescription to endure competitiveness of
exports (Prosad, 1992).

F) Inflation (INF)

High level of inflation damage diversification prospects and the tendency under
such circumstances is for increased concentration with little opening up to new
export sector (ECA, 2007). A high inflation environment is not conducive to the
development and maturation of new sector, nor if it supportive of an
environment that fosters other determinants of diversification so negative
result is expected from high inflation of export diversification.

G) Budget deficit (BD)

Macro stability plays a role for the success of diversification efforts a proactive
fiscal policy especially in terms of promoting public investment, can support
effort towards diversification. Budget deficit as percentage of GDP will have
positive relation with diversification.

A budget deficit that arise due to recurrent expenditure has a negative impact
on diversification process, as the scarce resource is shifting from directly
productive activities, like wise a depreciating currency had protected Ethiopia
from deperecing diversification by affecting the export base or other
macroeconomic variables negatively.

Besides the above determinant of export diversification, there were other

factors that constraint export that is supply side factor which include internal
factors and demand side factor concerns the external factors. The internal
factors include factors that determine the level of production and supply of
export, the ability of services, the level of domestic consumption, export tax
rate domestic economic policies foreign exchange rate and any internal
situation that can affect the export sector unlike internal factors, the external
factors are exogenous which emanate from the general nature and condition of
the importing nation or countries.

45
The likely increase the value of export in Ethiopia is highly associated with
good agricultural season or good production the adverse effect of this to the
economy is drastic price fall in the domestic market. One way to avoid this has
been from the experience that dumping i.e. the sale of exports on a foreign
market at price below it marginal cost so that we can avoid home price fall and
income of production. But this affect terms of trade and export earning
negatively.

In addition, the limited demand in growth in world market for primary

products. As Engle’s law, the proportion of income spent to agricultural
commodities (particularly food, decline as income increase and the revenue will
happens to manufactured export (Graham, 1995). The implication of this case
the increase in agricultural export lack of demand will reduce their price so
that export earnings will decline: as a result the demand for primary
commodity in international market constraints export diversification among
traditional commodities.

46
 CHAPTER FIVE

CONCLUSIONS AND RECOMMENDATIONS

5.1 Conclusions

The incentive for a diversified export had become core point in development
efforts of a countries; this has both a theoretical and empirical evidences. As
such the incentive to investigate the determinants of export diversification and
explore performance of export sector is crucial to design a feasible policy, aim
at changing the export structure and whole economy structure.

The study confirms that the structure of export item is less diversified and of
mainly traditional agricultural products that suffer from abrupt variations in
foreigners demand. Likewise, the geographic structure of export destination
can be said as less diversified and mainly directed to delivering the raw
material (export), if not with little semi processing. The geographic
concentration has its own implication for risk minimization. The role of the
export sector can be seen from it ability to generate foreign currency needed to
import capital goods and contribution to GDP. Accordingly, the ability of the
sector to finance import that fallen tremendously and its contribution to the
economy (GDP) shows a fluctuating pattern. The trend in diversification index
(HHI) reveals the unsustainable nature of diversification outcome and it is low
level. Even though Ethiopia has long history in international trade, the country
has not benefited from it much as expected. This is due to poor (unsatisfactory)
performance of export diversification.

As stated of the out sets, the objective of the study was to indentify the
determinants of country’s export diversification and highlight possible
intervention areas for diversification. In this respect, gross capital formation,
real effective exchange rate, industrial production, inflations trade openness,

47
per capital income and budget deficit were considered as the main
determinates for export diversification. In addition, the supply side problem
(endogenous factor) and demand side problem (external factor) were also the
major constraint in export diversification.

According to the study, the significant of manufactured value added is in line

with the theoretical framework, were country move from specialization to
diversification by producing industrialized products before it specialty again
openness favors more of diversification in contrast to some other empirical
findings. This was explained by the component of openness i.e. export that
favor concentration and import that stimulate diversification. Thus, the result
implies that the import component has dominated the export component of
openness. Thus rational for import to be on the side of diversification is that,
the imported goods are mainly of capital goods that are not produced
domestically and used to process and produce exportable goods or goods that
can be used by other export sector.

Generally, looking at the structure and performance of Ethiopia’s export sector

it is indicate that traditional agricultural commodities are dominating with the
consequent implication for it poor performance. Accordingly export
diversification play a significant role in stabilizing export fluctuation and keep
the trend of export growth consistent and stable.

48
5.2. Recommendations

Export diversification is one of the measures for structural solution and a

prerequisite achieving a sustained and rapid economic development. Based on
the finding of the study several key policies and recommendation are presented
below. The recommended diversification policies include macroeconomic, trade
and sectoral policies and industrial polices.

Policies for achieving Diversification

 Macroeconomic Policies for Diversification

 Macroeconomic stability is important for the diversification of an
economy to take root stability through programmatic fiscal and monetary
policies is needed to ensure the deepening of diversification.
 Avoiding effects of macroeconomic instability on exchange rate
movement.
 Trade and Sectoral Policies
 Trade policies of liberalism should be supported (active participation
in international trade is important).
 Promoting dynamic, adaptable and sector specific strategic trade
policies.
 The export base needs to be broadened to reduce effects
depreciation.
 Industrial Policies
 Dynamic industrial policies that include adoption of sector-by-
sector, bottom-up strategies, from downstream to upstream, in order
to deepen horizontal diversification from intermediate good up to
capital good.

In addition to the above recommendation, the following are also suggested to

help the diversification effort in general.

49
 Exporters should be informed and technologically oriented and they
should be flexible to meet the requirements of the market in terms of
quality and quantity (product differentiation). Here also considerable
effort should be done in implementation of cost reducing methods of
product (i.e. technology), which is essential to fetch the increase
global competition.
 Creating favorable condition for private exporters is necessary for the
promotion of export.
 Strengthening institutions like promotion agency and investment
authority.
 Government should engage in aggressive export diversification
endeavor, through organizing sponsored trade missions, undertaking
product specific market research.
 Strengthening the existing export incentive scheme.
 Attracting foreign investment through promotion about the resource
base of Ethiopia.
 Long run and short run empirical analysis the export sector of
Ethiopia like that of Birhanu, L (2004) shows that export
diversification, and preferably horizontal diversification
(diversification within agricultural exports) can be a solution in the
short run. Horizontal diversifications reduce uncertainty associated
with the fall in price of the dominant export commodity of coffee and
there by ease the balance of trade deficit. In long run however,
vertical diversification (radical changes or a shift in structure of
production and trade towards income elastic products including new
innovative export products through either value addition into the
primary products or total produce manufactures is advisable.

50
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