FDRE, Policy Study and Research Center

Industrial Development Policy Study and Research

Department

Foreign Direct Investment in Ethiopia:

Challenges, Opportunities and Policy
Options for Effective Use to Stimulate
Industrialization

FDRE, Policy Study and Research Center - PSRC

and
Ethiopian Development Research Institute

Addis Ababa, Ethiopia

Mulu G/eyesus (PhD)
April, 2017 Birhanu Beshah (PhD)
Girum Abebe (PhD)
ii
 Copy right © 2009 E.C
FDRE, Policy Study and Research Center
Industrial Development Policy Study and Research Department
Addis Ababa, Ethiopia

ISBN 978-99944-74-37-0
All Rights Reserved

iii
 Foreign Direct Investment in Ethiopia:
Challenges, Opportunities and Policy Options
for Effective Use to Stimulate Industrialization

APRIL, 2017

FDRE, Policy Study and Research Center

Industrial Development Policy Study and Research Department

iv
 FDRE, POLICY STUDY AND RESEARCH CENTER

About PSRC
FDRE, Policy Study and Research Center (PSRC) founded in March 2014 as a government policy and
strategy research center. It is established by recognizing the need for policy related researches and
knowledge based decision making process in the fast growing and transforming economy of Ethiopia.
The PSRC is expected to be the major think tank center in Ethiopia that analyses policy
implementation, structural and programmatic issues, and generate policy and strategy proposals. The
PSRC has five major departments and one is Industrial Development Policy Study and Research
Department (IDPSRD). For more information as well as other publications by PSRC and its affiliates,
go to www.PSRC.gov.et

FDRE, Policy Study and Research Center

P.o.box 1072/1110
Tel: +251-11-6613767
+251-11-6610462
Fax: +251-11-6621821
E-mail: policy.s120@gmail.com
Website: www.psrc.gov.et

ABOUT THIS RESEARCH REPORTS

The FDRE, policy study and research center (PSRC) research reports contain research materials
from PSRC and/or its partners. The research is circulated to the concerned Ministries and related
sectors in order to stimulate discussion and critical comment. The opinions in this research are
those of the authors and do not necessarily reflect that of PSRC’s. Comments may be forwarded
directly to the IDPSRD and the authors through e-mail: amarematebu@yahoo.com.

Report Citation:
It is cited as Industrial Development Policy Study and Research Department (IDPSRD) and
Ethiopian Development Research Institute - EDRI. Foreign Direct Investment in Ethiopia:
Challenges, Opportunities and Policy Options for Effective Use to Stimulate Industrialization.

v
 Acknowledgement

This report is an outcome of a research project on “Foreign Direct

Investment in Ethiopia: challenges, opportunities and policy options”,
which is financed by the Policy Study and Research Centre (PSRC) of
the Federal Democratic Republic of Ethiopia (FDRE). This study has
also benefited from the continuous engagement of PSRC leaders and
Research staff members as well as a couple of stakeholders’
workshops.

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 Preface

Ethiopia is embarking on a mission to join the middle income country group by 2025. As specified in
the Second Growth and Transformation Plan (GTP II), Ethiopia is committed to tuning its growth
direction from agriculture-led to industry-led economy. It has set a target for 2025 to increase the
share of the industry sector to GDP from the current 13% to 27% and the manufacturing sector from
current 4% to 17%. Massive expansion of investment in manufacturing both from domestic and
abroad is expected to achieve these targets. Hence, huge investment should be mobilized not only
from the domestic investment but also from foreign investment. Similar to many developing countries,
Ethiopia faces capital shortages, deficiency of knowledge/technology, industry management skill,
market access and others which are needed to transform and make the industry competitive. Foreign
Direct Investment (FDI) can help to bridge these gaps and generate multiple benefits.

The Ethiopian industrial development strategy formulated in 2002/03 has made clear the relative role
of domestic and foreign owned firms in the industrialization process. Domestic investors are regarded
as the main engine towards the industrial development. However, they are constrained with shortage
of capital, technology, and marketing knowledge to penetrate international markets. FDI is thus
envisaged to play a significant role in bridging these gaps among domestic investors. But the purpose
of attracting FDI is not to substitute local investors but to help build their capacity and fill their gaps.

Despite this outstanding vision, Ethiopia’s main focus has been on attracting FDI while little attention
has been given to maximizing the benefits from FDI. Hence, Ethiopia needs to sufficiently be prepared
not only to attract quality investment but also develop robust policy systems to maximize the benefits
from FDI. It appears that no consensus, including among Ethiopian policy makers and high officials,
with regard to the benefits and risks of FDI as well as the management of it. Thus, the major objective
of the study was to prepare policy scenarios and alternatives that promote the flow of FDI into the
manufacturing sector and maximize the advantages and opportunities that the country could possibly
acquire from their involvement in the economy. The study has explored specific and strategic
manufacturing sectors for FDI, new investment options or opportunities for FDI, identifying
mechanisms for Knowledge and technology diffusion from FDI to domestic enterprises, assessing the
possible options to create product value chain linkage between FDI and domestic enterprises.

The FDRE Policy Study and Research Center, Industrial Development Policy Study and Research
Department believes that the research output of this study would help the government officials and all
stakeholders to acquire clear development directions for FDI in Ethiopia to maximize its benefit.

Amare Matebu Kassa (PhD)

Lead Researcher and Coordinator
Industrial Development Policy Study and Research Department

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Contents

ACKNOWLEDGEMENT .................................................................................................................................................. V
CONTENTS ................................................................................................................................................................. VII
LIST OF TABLES .............................................................................................................................................................XI
TABLE OF FIGURES ......................................................................................................................................................XII
ACRONYMS ................................................................................................................................................................XIII
PART ONE: INTRODUCTION AND BACKGROUND ........................................................................................................... 1
1. INTRODUCTION ....................................................................................................................................................... 1
1.1. BACKGROUND AND OBJECTIVES OF THE STUDY .................................................................................................................... 1
1.2. THE STUDY SCOPE AND APPROACH ................................................................................................................................... 3
2. OVERVIEW OF THE ETHIOPIAN INDUSTRIAL AND FDI POLICIES ................................................................................ 5
2.1. OVERVIEW OF THE ETHIOPIAN INDUSTRIAL POLICY AND DEVELOPMENT.................................................................................... 5
2.2. THE EVOLUTION OF FDI AND GUIDING POLICIES IN ETHIOPIA ................................................................................................ 7
PART TWO: REVIEW OF THE FDI LITERATURE AND INTERNATIONAL BEST PRACTICES ................................................. 11
3. FDI LITERATURE REVIEW: THE THEORY AND EVIDENCE.......................................................................................... 11
3.1. DEFINING FOREIGN DIRECT INVESTMENT......................................................................................................................... 11
3.2. MOTIVATIONS OF OUTWARD FDI ................................................................................................................................... 11
3.3. FDI AND STRUCTURAL TRANSFORMATION ........................................................................................................................ 13
3.4. THE IMPACT OF FDI ON HOST COUNTRY DEVELOPMENT: REFLECTION OF THE DEBATES .............................................................. 15
3.5. REVIEW OF THE SPECIFIC MECHANISMS FDI CAN AFFECT THE HOST COUNTRY .......................................................................... 19
3.6. SOME REFLECTIONS ON THE RISKS OF FDI: ENVIRONMENTAL AND SOCIAL CONCERNS................................................................ 22
3.7. DETERMINANTS OF INWARD FDI .................................................................................................................................... 25
3.8. THE ROLE OF INVESTMENT PROMOTION IN ATTRACTING FDI ................................................................................................ 27
4. BENCHMARKING INTERNATIONAL BEST PRACTICES OF FDI ................................................................................... 30
4.1. CHINA ...................................................................................................................................................................... 31
4.2. SINGAPORE ............................................................................................................................................................... 38
4.3. MALAYSIA ................................................................................................................................................................. 47
PART THREE: FDI IN ETHIOPIA: BASIC PATTERNS AND DOMESTIC LINKAGES............................................................... 55
5. BASIC PATTERNS AND DISTRIBUTION OF FDI IN ETHIOPIA ..................................................................................... 55
5.1. INTRODUCTION .......................................................................................................................................................... 55
5.2. FDI WITH REGIONAL PERSPECTIVE .................................................................................................................................. 56
5.3. FDI IN ETHIOPIA: BASIC PATTERNS ................................................................................................................................. 59
5.4. SECTORAL DISTRIBUTION OF FDI .................................................................................................................................... 62
5.5. REGIONAL DISTRIBUTION OF FDI .................................................................................................................................... 67
5.6. SOURCES OF FDI IN ETHIOPIA ....................................................................................................................................... 70
6. LINKAGES BETWEEN FDI AND LOCAL FIRMS ........................................................................................................... 78
6.1. FDI AND DOMESTIC FIRMS: A SIMPLE COMPARISON........................................................................................................... 79
6.2. LINKAGES AND TECHNOLOGY TRANSFER ........................................................................................................................... 86
6.3. INVESTORS’ PERCEPTION ON FDI AND LINKAGES ............................................................................................................... 96
I. BASIC CHARACTERISTICS OF FIRMS .................................................................................................................................. 96
II. FDI DOMESTIC FIRM LINKAGES ...................................................................................................................................... 98
A. Domestic Firms ...................................................................................................................................................... 98
B. FDI firms ............................................................................................................................................................... 100
III. SUMMARY............................................................................................................................................................... 102
IV. NOTES ON METHODOLOGY......................................................................................................................................... 105

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7. MAPPING TECHNOLOGICAL CAPABILITIES OF THE PRIORITY SECTORS ................................................................. 107
7.1. TEXTILE AND APPAREL INDUSTRIES ............................................................................................................................... 109
7.2. LEATHER AND LEATHER PRODUCTS INDUSTRIES ............................................................................................................... 114
7.3. METALS AND ENGINEERING INDUSTRIES ........................................................................................................................ 117
7.4. AGRO-PROCESSING INDUSTRY ..................................................................................................................................... 121
7.5. CHEMICAL INDUSTRIES............................................................................................................................................... 124
7.6. PHARMACEUTICAL INDUSTRIES .................................................................................................................................... 127
7.7. ELECTRICAL AND ELECTRONIC INDUSTRIES...................................................................................................................... 129
7.8. SUMMARY OF THE FINDINGS ....................................................................................................................................... 130
PART FOUR: REVIEW OF ETHIOPIA’S FDI POLICY AND REGULATORY FRAMEWORK AND IMPLEMENTATIONS .......... 136
8. REVIEW OF THE CURRENT FDI POLICY AND REGULATORY FRAMEWORK ............................................................. 136
8.1. POLICY FRAMEWORK ................................................................................................................................................. 136
8.2. THE REGULATORY FRAMEWORK FOR FDI IN ETHIOPIA ...................................................................................................... 139
8.2.1. Sectors open to foreign nationals ............................................................................................................... 139
8.2.2. Ownership limitations and requirements ................................................................................................... 141
8.2.3. Investment Incentives ................................................................................................................................. 141
8.2.4. FDI treatment and protection ..................................................................................................................... 143
8.3. THE INSTITUTIONAL FRAMEWORK SUPPORTING FDI: PROMOTION AND COORDINATION......................................................... 145
8.3.1. Organizational transformation of the EIC ................................................................................................... 145
8.3.2. Changes in the promotional direction......................................................................................................... 147
8.3.3. Promotion and Coordination ...................................................................................................................... 151
8.4. NATIONAL DETERMINANTS OF INVESTMENT FLOW AND MAJOR OBSTACLES ..................................................................... 152
8.4.1. FDI attractive factors .................................................................................................................................. 152
8.4.2. Major obstacles and bottlenecks ................................................................................................................ 153

9. TO WHAT EXTENT HAS ETHIOPIA BENEFITED FROM THE PRESENCE OF FDI?........................................................ 156
9.1. FDI AND FINANCING ................................................................................................................................................. 156
9.2. FDI AND EXPORTS ..................................................................................................................................................... 158
9.3. FDI AND TECHNOLOGY/KNOWLEDGE TRANSFER .............................................................................................................. 160
9.4. JOINT VENTURE AND TECHNOLOGY TRANSFER ARRANGEMENTS .......................................................................................... 165
10. SUMMARY AND OVERALL ASSESSMENT OF FDI IN ETHIOPIA ............................................................................... 167
10.1. POLICY FRAMEWORK ............................................................................................................................................... 167
10.2. REGULATORY AND INSTITUTIONAL FRAMEWORK ............................................................................................................ 167
10.3. PATTERNS IN FDI INFLOW TO ETHIOPIA ....................................................................................................................... 170
10.4. CHARACTERISTICS OF THE MANUFACTURING FDI AND THEIR LINKAGE WITH LOCAL FIRMS ...................................................... 172
10.5. TECHNOLOGICAL CAPABILITIES OF THE PRIORITY SECTORS ................................................................................................ 173
10.6. TO WHAT EXTENT HAS ETHIOPIA BENEFITED FROM THE PRESENCE OF FDI? ......................................................................... 174
10.6.1. Bridging the capital gap: FDI and Financing ............................................................................................. 174
10.6.2. Bridging the trade balance gap through enhancing exports .................................................................... 175
10.6.3. Bridging technology/knowledge gap: FDI and technology/knowledge transfer ...................................... 176
10.6.4. Joint venture and technology transfer ...................................................................................................... 177
10.7. SUMMARY: PERCEPTIONS ON THE STRENGTHS AND BOTTLENECKS ...................................................................................... 177
PART FIVE: POLICY AND STRATEGIC OPTIONS FOR EFFECTIVE USE OF FDI IN ETHIOPIA ............................................ 179
11. OVERALL FDI STRATEGIC DIRECTIONS AND KEY PRINCIPLES ................................................................................ 179
11.1. THE SIGNIFICANCE OF DESIGNING A UNIFIED FDI POLICY AND CONSENSUS BUILDING ............................................................. 179

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 11.2. THE FDI POLICY AND OBJECTIVES NEED TO BE BASED AND ALIGNED WITH THE OVERALL INDUSTRIAL DEVELOPMENT OBJECTIVES AND
STRATEGIES ........................................................................................................................................................ 180
11.3. FDI AS COMPLEMENTARY AND A WAY TO DEVELOP LOCAL CAPABILITIES ............................................................................. 183
11.4. CONTINUOUSLY IMPROVING THE COUNTRY’S ABSORPTIVE CAPACITY AND AIM TO AVOID THE MIDDLE-INCOME TRAP ................... 185
11.5. USING THE INDUSTRIAL PARKS AS A MAJOR MECHANISM TO ATTRACT AND BENEFIT FROM FDI................................................ 186
12. FDI PROMOTION AND TARGETING....................................................................................................................... 187
12.1. IMPROVING THE INVESTMENT CLIMATE ......................................................................................................................... 187
12.1.1. Addressing the binding constraints with appropriate instruments ........................................................... 187
12.1.2. Exploit the overall economic progress to attract more and quality FDI .................................................... 192
12.1.3. Improving the coordination among relevant institutions ......................................................................... 193
12.2. TARGETED FDI PROMOTION STRATEGY..................................................................................................................... 197
12.2.1. Sector targeting ........................................................................................................................................ 197
12.2.2. Source country targeting .......................................................................................................................... 200
12.2.3. Targeting anchor investors ....................................................................................................................... 202
12.2.4. Investment promotion modalities ............................................................................................................. 202
12.2.5. The role of incentives ................................................................................................................................ 203

13. UNLEASHING THE BENEFITS OF AND REDUCING THE RISKS FROM FDI ................................................................. 205
13.1. BRIDGING THE CAPITAL GAP: FDI FINANCING AND CAPITAL FLIGHT ...................................................................................... 205
13.2. BRIDGING TRADE BALANCE GAP: FDI AND EXPORT .......................................................................................................... 211
13.2.1. Improving the poor trading logistics ......................................................................................................... 212
13.2.2. Reducing the anti-export bias ................................................................................................................... 215
13.2.3. Attract adequate mass of efficiency-seeking FDI ...................................................................................... 217
13.2.4. Instituting the right incentive and penalty system .................................................................................... 219
13.3. BRIDGING THE TECHNOLOGY GAP: FDI AND TECHNOLOGY TRANSFER.............................................................................. 222
13.3.1. Appropriate channels of technology transfer should be chosen for specific type of technology .............. 224
13.3.2. FDIs attraction, evaluation, and selection should base on their contribution to technology transfer to the
domestic firms ......................................................................................................................................................... 224
13.3.3. Pro-active policy to encourage the formation of joint ventures ............................................................... 226
13.3.4. FDIs should be continuously measured and monitored in terms of technology transfer performance .... 227
13.3.5. Knowledge and technology transfer should also be in the field of trading and marketing in addition to
production processes and products ......................................................................................................................... 228
13.3.6. Domestic firms should be supported to improve their technology absorptive capacity and links with FDIs 229
13.3.7. Institutional arrangement and coordination to enhance technology transfer from FDIs ........................... 231
13.4. REDUCING THE NEGATIVE ENVIRONMENTAL IMPACTS OF FDI ........................................................................................... 234
13.5. FDI AND EMPLOYMENT CONDITIONS ........................................................................................................................... 237
REFERENCES .............................................................................................................................................................. 243
APPENDIX 1 INVESTMENT AREAS OPEN TO FDI WITH THE RESPECTIVE INCOME TAX EXEMPTION IN YEARS. ........... 255
APPENDIX 2: OPERATIONAL PROJECTS IN DIFFERENT SECTORS BY COUNTRY OF ORIGIN, SELECTED COUNTRIES (2007-
2015)......................................................................................................................................................................... 259

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 List of Tables

Table 1: Interviewed Institutions ........................................................................................................... 4

Table 2: Pattern of inward and outward FDI and export competitiveness ......................................... 14
Table 3: Sectorial composition of capital invested, levels of temporary and permanent employment
created by FDI projects (1992 up to March, 2017) ............................................................................. 63
Table 4: Sectorial distribution, capital invested and employment created by operational FDI and
domestic private projects from 1992 to March, 2017 ......................................................................... 65
Table 5: Top 21 source countries of inbound FDI to Ethiopia (FDI stock from 1992 to March 2017)71
Table 6: All licensed projects in five year intervals by country of origin............................................. 72
Table 7: FDI projects by country of origin for selected countries ....................................................... 74
Table 8: Number and share of licensed FDI projects in the manufacturing sector by country of Origin
from 1992-2015 ................................................................................................................................... 77
Table 9: Enterprise performance, technology and marketing practices by ownership type in 2013 . 81
Table 10: Employment and wage by ownership type 2013 ............................................................... 84
Table 11: FDI-domestic firm linkages and competition in the product market 2013 (% of enterprises)
............................................................................................................................................................. 89
Table 12: FDI-domestic firm linkages and competition in the labour market..................................... 90
Table 13: FDI-domestic firm supply and customer relationships ....................................................... 91
Table 14: Business changes and technology use .............................................................................. 93
Table 15: Performance indicators by linkage type 2013 .................................................................... 94

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 Table of Figures

Figure 1: Inward FDIs in China (UNCTAD) ........................................................................................ 32

Figure 2: Inward FDIs in Singapore (UNCTAD) ................................................................................. 38
Figure 3: Inward FDIs in Malaysia (UNCTAD) ................................................................................ 48
Figure 4: Annual FDI stock in Ethiopia and selected East African Countries .................................... 57
Figure 5: Annual flow of FDI in Ethiopia and selected East African Countries .................................. 58
Figure 6: Annual FDI stock in Ethiopia from 1992 to 2014. ............................................................... 60
Figure 7: Annual number of FDI project and levels of temporary and permanent employment created
............................................................................................................................................................. 61
Figure 8: Annual number of FDI project by investment status ........................................................... 62
Figure 9: Annual FDI flow and stock in the agricultural and manufacturing sector from 1992 to 201467
Figure 10: Regional distribution of FDI stock aggregated from 1992 to March, 2017 ....................... 69
Figure 11: Regional distribution of annual FDI flow from 1992 to 2014 in the four largest FDI attracting
regions ................................................................................................................................................. 70
Figure 12: Labour productivity dispersion of FDI and local firms (2013) ........................................... 82
Figure 13: Major problems that led the firm to produce below capacity ............................................ 85
Figure 14: Labour productivity dispersion of supply-linked and un-linked domestic firms and FDI firms
(2013) .................................................................................................................................................. 95
Figure 15: Labour productivity dispersion of labour-linked and un-linked domestic firms and FDI firms
(2013) .................................................................................................................................................. 95
Figure 16: Textile and Apparel Vertical Value Chain ....................................................................... 110
Figure 17: Ethiopian Leather and Leather Products Industries’ Value Chain.................................. 114
Figure 18: Metal and engineering industries value chain................................................................. 118
Figure 19: Agro-food Value Chain .................................................................................................... 121
Figure 20: Chemical Industries ......................................................................................................... 125

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Acronyms
 MIT- Ministry of Trade and Industry
 LIUP- Local Industry Upgrading Programme
 NEP- New Economic Policy
 GLC- Government Linked companies
 NEM- New Economic Model
 ASEAN- Association of Southeast Asian Nations
 FIDA- Federal Industrial Development Authority
 MIDA- Malaysian Industrial Development Authority
 HICOM- Heavy Industries Corporation of Malaysia
 MBC- Malaysian Biotechnology Corporation
 HDC- Halal Industry Development Corporation
 FDI- Foreign Direct Investment
 BIT- Bilateral Investment Treaties
 TNC- Trans National Companies
 PTI- Processing Trade with Imported Materials
 PTS- Processing Trade with materials Supplied by clients
 WTO- World Trade Organization
 FIE- Foreign Invested Enterprises
 IFDI- Inward Foreign Direct Investment
 EDB- Economic Development Board
 SME- Small and Micro Enterprises
 IE- International Enterprises
 MNE- Multi National Enterprises
 R&D- Research and Development
 GDP- Gross Domestic Product
 EIC- Ethiopian Investment Commission
 EPSRC- Ethiopian Policy Study and Research Centre
 EDRI- Ethiopian Development Research Institute
 UNCTAD- United Nations Conference on Trade and Development
 CSA- Central Statistics Agency
 IFPRI- International Food Policy Research Institute
 MVA- Manufacturing Value Added
 EPRDF- Ethiopian People’s Revolutionary Democratic Front
 MLSM- Medium and Large Scale Manufacturing
 ADLI- Agricultural Development Led Industrialization
 IDS- Industrial Development Strategy

xiii
 MSC- Multimedia Super Corridor
 VDP- Vender Development Programme
 ILP- Industrial Linkage Programme
 PSDC- Penang Skills Development Centre
 SMIDEC- Small and Medium Industries Development Corporation
 GSP- Global Supplier Programme
 PDC- Penang Development Corporation
 SAP- Structural Adjustment Policies
 IMF- International Monetary Fund
 SOE- State Owned Enterprise
 DBE- Development Bank of Ethiopia
 METEC- Metal and Engineering Corporation
 LIDI- Leather Industry Development Institute
 MIDI-Metal Industry Development Institute
 TIDI- Textile Industry Development Institute
 SHF- Small Holder Farmers
 AFOA- African Growth Opportunity Act
 EBA- Everything but Arms
 COMESA- Common Market for Eastern and Southern Africa
 EEPCO- Ethiopian Electric and Power Corporation
 SKD- Semi Knock Down
 CKD- Complete Knock Down
 MIGA- Multicultural Investment Guarantee Agency
 NBE- National Bank of Ethiopia
 EIA- Environmental Impact Assessment
 BOI- Board of Investment
 TIN- Tax Identification Number
 OSS- One Stop Services
 ERCA- Ethiopian Revenue and Customs Authority
 MoST- Ministry of Science and Technology
 PPESA- Privatization and Public Enterprises Supervisory Agency
 JV- Joint Venture
 NEP- New Economic Policy
 SEZs- Special Economic Zones
 IP- Industrial Park
 UNIDO- United Nations Industrial Development Organization
 ESLE- Ethiopian Shipping and Logistics Enterprise

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 EIIDE- Ethiopian Industrial Inputs Development Enterprise
 TI- Technology Incubators
 CRGE- Climate Resilient Green Economy
 GEF- Global Environment Fund
 TEDA- Tianjin Economic-Technological Development Area
 SDG- Sustainable Development Goals
 MOLSA - Ministry of Labour and Social Affairs
 ILO- International Labour Organization
 ACFTU- All-China Federation of Trade Unions

xv
Part One: Introduction and Background

1. Introduction

1.1. Background and objectives of the study

Ethiopia is embarking on a mission to join the middle income country group by 2025.
The industry sector and specifically manufacturing is entrusted to play a significant
role in the envisaged economic structural transformation. Ethiopia has set a target
for 2025 to increase the share of the industry sector to GDP from the current 13% to
27% and the manufacturing sector from current 4% to 17%. Massive expansion of
investment in manufacturing both from domestic and abroad is expected to achieve
these targets and drive the industrial development as a result. Such huge investment
cannot, however, be mobilized from the domestic economy alone. Similar to many
other developing countries, Ethiopia faces two types of capital shortages arising from
the investment-saving and export-imports gaps. It also suffers from the deficiency of
knowledge/technology which is critically needed to transform and make the industry
internationally competitive.

Foreign Direct Investment (hereafter, FDI) can help bridge these gaps and generate
multiple benefits to the host country, among others, as a source of foreign (saving)
capital, technology transfer (technical knowhow, business expertise and knowledge),
and employment. The global experience shows that with adequate policies aligned
with the country’s development objectives, FDI can provide significant economic and
social benefits to the host country.

In recognition of this and the required massive investment to meet the targets set,
the Ethiopian government has renewed its interest to attract FDI. In 2012, it enacted
a new investment proclamation under which the Ethiopian Investment Commission
(hereafter, EIC) has been reorganized and made to assume more power and
responsibilities. Correspondingly, the government has recently started to focus on
the development of industrial parks to boost Ethiopia’s attractiveness for FDI.

Ethiopia is already becoming the preferred destination for FDI in the sub-Saharan
Africa. FDI inflow has shown an increasing trend, for example, from USD 135 million
in 2000 to USD 953 million in 2013. As a result, the FDI stock increased form USD

1
487 million to USD 5.21 billion in the same period. Moreover, the country has
witnessed a big jump in the FDI inflow particularly in the last 2-3 years presumably
because of massive inflow from emerging countries such China, Turkey and India to
the manufacturing sector.

The Ethiopian industrial development strategy formulated in 2002/03 has made clear
the relative role of domestic and foreign owned firms in the industrialization process.
Domestic investors are regarded as the main engine towards the industrial
development. They are, however, constrained by shortage of capital, technology,
and marketing knowledge to penetrate international markets. FDI is thus envisaged
to play a significant role in bridging these gaps among domestic investors. But the
purpose of attracting FDI is not to substitute local investors but to help build their
capacity and fill their gaps.

Despite this grand vision and similar to many other developing countries, Ethiopia’s
main focus has been on attracting FDI while little attention has been given to
maximizing the benefits from FDI. Pulling in investors and benefiting from their
presence are different endeavors likely requiring different policy tools. The country
thus needs to sufficiently be prepared to not only attract quality investment (in
sectors where most needed) but also develop robust policy systems to maximize the
benefits from FDI. However, there appears to be no consensus, including among
Ethiopian policy makers and high officials, with regard to the benefits and risks of
FDI as well as the management of it.

In recognition of this, the Ethiopian Policy Study and Research Centre (EPSRC) has
prepared a TOR and work with the Ethiopian Development Research Institute (EDRI)
to undertake a study on “Foreign Direct Investment in Ethiopia: challenges,
alternatives and opportunities”. The main objective of this study is to prepare policy
scenarios and alternatives that promote the flow of FDI into the manufacturing sector
and maximize the advantages and opportunities that the country could possibly
acquire from their involvement in the economy. The research project specifically
aims at exploring specific and strategic manufacturing sectors for FDI, investigating
new investment options or opportunities for FDI, identifying mechanisms for
Knowledge and technology diffusion from FDI to domestic enterprises, assessing
the possible options to create product value chain linkage between FDI and domestic

2
enterprises, understanding the behavior and characteristics of investors in the
sector, and investigating major factors that affect the growth and development of
FDI.

1.2. The study scope and approach

In contrast to other sectors, the manufacturing sector offers greater opportunities to

accumulate capital, exploit economies of scale, and acquire new technologies.
Ethiopia’s primary sector for attracting FDI is therefore the manufacturing sector.
Correspondingly, the primary focus of the proposed study is the manufacturing
sector.

This research project was tasked to deliver two basic and concrete research outputs;
(i) a standard report constituting the review of literature and best international
practices as well as situation analyses of the FDI in Ethiopia and (ii) a proposal of
alternative FDI policy scenarios to promote quality FDI and effectively use them to
advance the development objective the country possesses. Accordingly, the team
has completed both of these deliverables. The drafts were presented in
stakeholders’ workshops and the feedbacks have been incorporated in the final
report, which we hereby submit it.

This report is divided into five parts and 14 sections. The first part is divided into two
sections in which section one introduces the background and rational of the study,
while section two provides overview of the Ethiopian industry and FDI policies. Part
two is also divided into two sections; the review of literature on FDI (section 3) and
benchmarking of international best practices (section 4) both of which aim to extract
useful international lessons regarding the management of FDI. These are primarily
based on a desk review and the benchmarking focuses on three countries; China,
Singapore, and Malaysia. Part three consists of three sections; the pattern of FDI in
Ethiopia and its contribution to the economy (section 5), FDI and domestic firms’
linkages (section 6), and mapping of the technological capability of selected
manufacturing industries (section 7). Part four consists of three sections that provide
critical review of Ethiopia’s FDI regulatory framework (section 8), examine if the
expected benefits from FDI have been achieved (section 9) and summarize the main
findings (section 10).

3
The situation analyses in part three and four are based on desk review of literature
and policy documents, field survey, and primary and secondary data analyses. We
use multiple data sources; i.e., from (i) United Nations Conference on Trade and
Development (UNCTAD) to illustrate the pattern of FDI inflow in comparison with
regional countries, (ii) Ethiopian Investment Commission (EIC) to analyze basic
characteristics of FDI committed in the country, and (iii) Central Statistics Agency
(CSA)/IFPRI’s data set collected in 2013/14 to describe the attributes of FDI in
contrast to domestic firms and existing linkages. We have also collected our own
data particularly focusing on qualitative information and perceptions from a sample of
40 medium and large manufacturing firms (26 domestic and 14 FDI) in Addis Ababa
and the surrounding. The use of these various data sources provides a good sense
of the characteristics of FDI in Ethiopia. We have also conducted key informant
interviews with about 15 government organizations listed below. These interviews
have also provided us with broader insight into the existing FDI related opportunities
and challenges.

Table 1: Interviewed Institutions

Industry development institutes and Other government institutions

corporations
1. Chemicals and Construction Materials 1. Ethiopia Investment Commission
Development Institute (EIC)
2. Chemical Industry Corporation 2. Ministry of Industry (MoI)
3. Leather Industry Development Institute 3. Ministry of Foreign Affairs (MoFA)
(LIDI)
4. Metal Industry Development Institute 4. Ministry of Science and Technology
(MIDI) (MoST)
5. Textile Industry Development Institute 5. Privatization and Public Enterprises
(TIDI) Supervisory Agency (PEPSA)
6. Meat and Dairy Technology 6. National Bank of Ethiopia
Development Institute
7. Food, Beverage and Pharmaceuticals 7. Development Bank of Ethiopia
Industry Development Institute
8. Sugar Corporation

The last part (part 5) tries to sketch the FDI policy alternatives to promote the flow of
quality FDI and maximize the advantages and opportunities that Ethiopia could
possibly acquire from their involvement in the economy. It also tries to indicate
necessary institutional arrangements and organizational capabilities to implement
the FDI policy. This policy and institutional arrangement proposal is based on

4
thorough analysis of Ethiopia’s development strategy, examination of the FDI policy
implementations and challenges, as well as best and relevant international practices.
Part five is divided into three sections; section 11 sets the overall FDI strategic
direction and key principles; section 12 discusses FDI promotion and strategic
targeting, section 13 provides mechanisms to unleash the benefits and reduce the
risks from FDI.

2. Overview of the Ethiopian industrial and FDI policies

2.1. Overview of the Ethiopian industrial policy and development

Industry in the modern sense in Ethiopia emerged only at the turn of the 20th century
following the establishment of the strong central government. The industry has
undergone a number of reforms under different regimes that ruled the country. The
1950s was a notable period marking the start of the first conscious effort to promote
industry in the country. The industrial policy during the imperial period between 1957
and 1974 materialized through three consecutive five-year plans.

Industrial development was envisaged to be achieved through the development of

import substituting light industries. Investments in manufacturing were directed
towards creating high input-output linkages with agriculture such as textile, leather
and other agro-industries. Underlying the lack of capital and entrepreneurial skill, a
package of incentives were designed to promote private domestic and foreign
investment. The plan anticipated that foreign direct private investment would play the
leading role in financing the investment capital required for the sector. As a result,
most the large scale manufacturing enterprises (about 65 per cent) at this period
were owned or operated by foreign nationals signifying that ownership and
management of the sector continued to remain in the hands of foreigners and its
employment generating capacity was “unimpressive” (Eshetu, 1995).

The coming into power of the military junta, otherwise known as the ‘Dergue’, in
1974 radically changed the structure of ownership and management of the economy.
The Dergue nationalized virtually all the large-scale industrial enterprises owned by
foreigners and Ethiopians alike one year after the Revolution. Private sector
development was deliberately discouraged and it was allowed to operate in small-
scale industrial activities only. In contrast the state became the sole responsible

5
organ owning and operating medium and large scale manufacturing activities. For
example in 1985, the State Owned Enterprises accounted for 95 Per cent of the
Manufacturing Value Added (MVA) and 93 per cent of the employment of all medium
and large-scale industrial enterprises. The dominance of the public sector in the
manufacturing sector continued until the last years of the military regime
(Gebreeyesus, 2013).

In 1991, the Ethiopian People’s Revolutionary Democratic Front (EPRDF)-led

government reversed the command economy system and has since adopted various
liberalization measures towards a market-driven economy. The domestic policy
environment was improved and the stage was set for the re-entry of the private
sector into the manufacturing. As a result, the manufacturing sector and the
economy in general were revitalized. In the first five years following the reform (i.e.,
between 1990/91-195/96), the number of Medium and Large Scale Manufacturing
(MSLM) establishments more than doubled and the share of private sector firms
correspondingly increased from 47.6% to 74.3% (Gebreeyesus, 2013).

In the mid-1990s, the EPRDF government formulated its development vision known
as Agricultural Development Led Industrialization (ADLI). The basic premise of this
strategy is that agriculture development plays a leading role in the industrialization
process by preparing various conditions for full-fledged industrialization through
supplying inputs to the industrial sector, generating foreign exchange for importing
industrial inputs, and creating (demand) market for industrial output. Moreover, an
outward looking strategy to promote export and to attract FDI was made to be the
central focus of the strategy. As a result in 1998, the Ethiopian government adopted
an export promotion strategy aimed at promoting high value agricultural exports (e.g.
horticulture products and meat) and labour-intensive manufacturing products
(clothing, textile, leather and leather products).

In 2002/03, Ethiopia formulated a full-fledged industrial development strategy (IDS),

designed based on ADLI. One key element of the industrial strategy is the inter-
sectoral linkage between industry and agriculture. Another core element of the IDS is
that a sustainable and fast industrial development can only be ensured if the sector
is competitive in the international market. Hence, the export oriented sectors should
lead the industrial development and be given preferential treatment. In addition, the

6
industrial policy gives special focus for the labour intensive sectors to maximize the
employment impact and the comparative advantage in unskilled labour. Accordingly,
the sectors that have strong linkages with agriculture, are labour-intensive, and
export-oriented have been given special treatments. This includes the textile and
garment; meat, leather and leather products; sugar industry, other agro-processing
industries, and the construction industries. Two major mechanisms: such as,
creating conducive environment for industrial development and investment and
providing direct support and guidance to the preferred sectors, have been identified
to materialize the strategy.

The industrial development strategy was put into action through the consecutive five-
year development plans each carrying specific targets for the industry development.
As a result, Ethiopia has seen major improvements in economic and social
development indicators in the last decade or so. Between 2003/04 and 2013/14, the
country’s GDP grew by about 10.7 and the industry sector by about 13.7% annual
average. Despite this, the contribution of industry at large and the manufacturing
sector to GDP remained small, below 14% and 5% respectively. In recognition of this
and to speed up the industrial development process, the Ethiopian government has
formulated a long-term Industrial Development Strategic Plan (or Road Map) that
covers 2013 – 2025. The overall goal of the industrial development strategy is to
bring about structural change in the country’s economy through industrial
development by increasing the share in GDP of the industry sector from the current
13% to 27% and the manufacturing sector from 4% to 17% by 2025.

2.2. The Evolution of FDI and Guiding Policies in Ethiopia

Foreign investors played a prominent role in the start of modern manufacturing

activity in Ethiopia in the 1920s. For example, most of the 25 manufacturing
establishments (including wood and clay factories, tanneries, soap and edible oil
plants, ammunition factories, brewery, tobacco processing plants, cement factory,
grain milling, and salt plants) that were operating in 1927 in the country were owned
by foreigners including from Armenia, Greece, Italy, and India. From 1928–1941, not
less than ten manufacturing industries were set up by Armenian and Greek settlers.
The period 1941-1953 also saw the establishment of a number of enterprises that

7
heralded Ethiopia’s long-standing relationship with the United States of America and
the United Kingdom (Afro Consult & Trading Plc, 2002).

The end of the Second World War marked in the Ethiopian history the first attempt of
guiding the economy through deliberate policies and comprehensive plans. The first
successful conscious promotion of the industrial sector was made in the latter years
of the 1950s with the beginning of the launch of the First Five-Year Plan that covered
the period 1958-1962. The Plan anticipated that foreign direct private investment
would play the lead role in financing the investment capital required for the sector,
accounting for nearly 50% of the E$57.1 million planned investment in the
manufacturing sector. Various policy measures were introduced to encourage
investment in the manufacturing including protection of the domestic industry through
high tariff and banning of certain imports, fiscal incentives and provision of credit.

A number of investment decrees that include income tax exemption and holidays
had been enacted in the 50s and 60s to encourage foreign investment1. Foreign
investors were allowed to invest in all areas without restriction and could own land
required for their investment.2 The efforts of the government during this period to
attract private investment and the investment climate created thereof was generally
viewed as “favourable” and “welcoming to foreign private investment”. As a result,
the country was able to attract considerable foreign investment into the industrial
sector (World Bank, 1985). A number of new industries which had significant
contribution to the development of the national economy were established during the
three year period of 1952-1954; for instance, the Wonji Sugar factory, which was
established with a joint venture agreement between the Ethiopian Government and
the Dutch firm N.V Handelsvereeniging (HVA), a new textile factory, two new wood-
processing plants and three leather and shoe processing industries (Shiferaw, 1995).
Italians and Japanese investors also participated in textiles and Greeks in the shoe
and beverage industries.

However, the incentive structure in the Imperial regime was criticized for disfavouring
domestic investors owing to the unaffordable (for domestic investors) minimum
investment capital required by the government to qualify for the incentives. As a
1
In fact, the government’s deliberate effort to attract foreign investment goes back to the 1940s. For
example, two proclamations were enacted in 1944 and 1949.
2
Source URL: http://www.abyssinialaw.com/study-on-line/item/487-history-of-investment-law.

8
result, by the end of the imperial period (mid-1970s), more than 65 per cent of the
manufacturing establishments were foreign owned, signifying that ownership and
management of the sector continued to remain in the hands of foreigners (Eshetu,
1995).

With the arrival of the military regime in 1974/75, most of the MLSM enterprises were
nationalized and later reorganized under state corporations. The government also
introduced various restrictions on the private sector and the market. The
nationalization not only led to the exodus of foreign nationals and shrinking of the
role of the private sector in medium and large scale manufacturing but also
simultaneously closed the door for the possible import of new technologies, and for
the learning process and advancement in technological capability along with it.
Consequently, the manufacturing sector exhibited a sharp decline particularly in the
first few years following the revolution.

Foreign investment in the manufacturing sector was almost absent following the
nationalization of private enterprises in 1975. In a renewed interest to attract foreign
investment in 1983, the government adopted a Joint Venture Proclamation that
invites foreigners to participate with the Ethiopian government in a joint venture in
which the government holds at least 51 per cent of shares (World Bank, 1985). The
proclamation was revised in 1989 allowing majority foreign ownership in many
sectors. Unfortunately, neither of them was able to restore the confidence of
foreigners and attract investment.

In March 1990, the Dergue regime adopted a mixed economic policy to shift the
country from one of a centrally managed economy to a modest liberal economy
(UNIDO, 1991: 12). According to this policy statement, the private sector was
allowed to participate in the economy without capital ceilings and SOEs survival to
depend on their own financial performances with no more preferential treatment. The
policy also indicated its intention to remove the bias against the private sector in the
tax system and create a level playing field for both private and state-owned
industries. This reform initiative was, however, too late and short-lived without
bearing fruit, as there was regime change in May 1991.

9
The overthrow of the Dergue regime in 1991 opened a new chapter for the Ethiopian
manufacturing industry. In 1992, Ethiopia embarked on a liberal economic policy and
introduced a number of reform measures including, among others, privatization,
trade opening, market deregulation, and revision of investment and labour laws. In
an effort to create favourable condition and promote private investment, the
Transitional Government enacted Investment Proclamation No. 15/1992 in May
1992. In Ethiopia, the foreign direct investment rule is customarily part of the national
investment law. The Ethiopian Investment Office responsible for approving FDI
projects was also established by this proclamation.

The 1992 investment proclamation signifies a fundamental departure from the hostile
attitude against FDI in the period of Dergue regime. But it was relatively restrictive to
attract FDI sufficiently to the country. First, there were relatively a large number of
sectors whereby foreign investors are not allowed except only jointly with
government. It also imposed higher capital requirements for foreign investors and the
incentives were not sufficient.3 The investment code has been amended several
times (for example, in 1996, 1998, 2002, 2003, 2008, 2012, and recently in 2014) to
rectify this and other limitations. The revisions generally tend to further liberalize the
investment regime and remove remaining restrictions particularly to foreign
investors. The revised investment laws also increasingly introduced generous
incentives particularly to those that intend to invest in the export sectors. Moreover,
the list of sectors not allowed for foreign investors have been shrinking through time.
Foreign investors are also being offered increasingly improved investment
guarantees.

Some of these investment law revisions are major ones. The recent major revision
was made in 2012, which is the present regulatory regime governing FDI with the
exception of minor revisions made in 2014 to add some new articles related to
industrial development zones. The discussions on the current regulatory investment
environment and institutional setup in section eight will, therefore, mainly rely on the
2012 investment proclamation.

3
The proclamation also contains some strange requirements towards foreign investors. For example,
USD 125,000 in blocked account was a minimum requirement for foreign investors to invest in
Ethiopia.

10
Part Two: Review of FDI Literature and International Best Practices

3. FDI Literature Review: the theory and evidence

3.1. Defining Foreign Direct Investment

Foreign direct investment (FDI) can be defined as an investment made by a

company outside its home country. It is the flow of long-term capital based on long-
term profit considerations involved in international production (Caves, 1996). The
international investment can take two forms; portfolio or direct investment. The
portfolio investment involves buying some non-controlling portion of the stock, bond
or any other financial security, while making direct investment typically involves a
significant degree of influence and control over the company into which the
investment is made. The direct investment by multinationals is believed to contribute
more to economic growth than the portfolio investment.

3.2. Motivations of outward FDI

The theory of FDI has been initially developed around the Industrial Organization
economics and specifically the theory of firm internationalization which tries to
explain the growth of Transnational Companies (TNCs) and their motive towards
outward investment. Hymer’s (1976) work was seminal in this regard.4 He argues
that local firms must always be better informed than foreign firms about the local
economic environment. Hence, for FDI to take place two conditions are necessary.
The first is that the foreign firms must possess certain specific advantages in a
particular activity including control over technology, proprietary rights to brand
names, economies of scale (by operating in more than one national markets), and
other intangible assets derived from organizational and managerial expertise internal
to the firm. Second, the foreign firms must have monopoly advantage to be able to
exploit the benefits of the specific advantages, which only takes place in a market
with imperfect competition.

4
Other people have also made important contribution to the theory of FDI in this period. For example,
Vernon (1966) uses the production cycle theory to specifically explain certain types of FDI made by
USA in Western Europe in the aftermath of the World War II. Kindleberger (1969) shows that FDI
would no longer exist in a world characterized by perfect competition and necessitates a market with
imperfect competition. Hennart (1982) developed a theory of FDI based on vertical and horizontal
integrations.

11
Dunning (1981, 1988), in his eclectic paradigm, mixes three different theories of FDI
under which the TNCs enter into internationalization of their production. (a) The first
arises from ownership advantage of intangible assets. (b) The second condition is
that it must be more advantageous for the company to own these intangible assets
and use them in production abroad under equity ownership instead of sell or rent
them to other foreign firms under license or franchise arrangements. (c) The third
condition is that it must be profitable for the company to use these specific assets in
combination with other (low cost) factors outside the country of origin, i.e. location
advantage.

Dunning (1993) classifies the motivations of FDI into four types; resource seeking,
market seeking, efficiency seeking, strategic asset or capability seeking FDI.

 Resource seeking FDI refers to investment projects by TNCs with the main aim of
acquiring host countries’ natural resources of a higher quality at a lower real cost,
cheap and well-motivated unskilled or semi-skilled labour, as well as good
transport and communication infrastructure.
 Market seeking FDI refers to investment projects by TNCs in a particular country
or region to supply goods and service to the market in the host country and/or its
neighbouring countries or regions. Such type of FDI depends on market size,
policy incentives and products distribution channels in the host country.
 Efficiency seeking FDI takes advantage of difference in the availability and
relative cost of factor in different countries and taking economies of scale and
scope between countries with similar economic structures and income level.
 The strategic asset seeking FDI is motivated by TNCs long-term strategic
objectives, which is sustaining or advancing their global competitiveness or
weakening their competitors.

These motivations of outward FDI have far reaching implications on the host
country’s development efforts. The resource-seeking FDI which often focuses on the
extractive sectors such as oil and minerals could have significant effect on balance
of payments and government tax revenue. However, FDI on extractive sectors is
often found to have less impact on domestic learning and to harm domestic industry
competitiveness due to an overvalued exchange rate which is known as the ‘Dutch
Disease’ in the Economics literature. It is also criticized for causing widespread rent-

12
seeking practices and deterioration of overall quality of institutions in the host
country.

Efficiency-seeking FDI in manufacturing is often thought to have a more desirable

impact on economic development (for example, in terms of productivity spillovers
and learning) than FDI in extractive sectors. There is, however, significant differential
impact on the host country between those oriented towards protected domestic
market (market seeking) and those that serve markets exposed for international
competition (often the export market). The export oriented FDI that becomes an
integrated corporate supplier network offers the host country clearer advantage over
the FDI that serve protected domestic host-country market versus the market
seeking FDI. In the former case, the parent companies tend to design their
subsidiaries to capture all economies of scale and use cutting edge technology and
quality control procedures on a continuous basis. Whereas in the case of FDI
oriented towards host country domestic market, the TNCs do not use the same
technologies and quality control procedures as the world class plants. Instead, their
subsidiary plants are often smaller in size and use inefficient production techniques
(Moran, 1998).

3.3. FDI and structural transformation

Ozawa (1992) was among the first to conceptualize FDI in terms of industrial
upgrading and economic transformation. He notes that the TNCs are the prime
movers behind the industrial dynamism of many of those rapidly developing Asian
countries. In his effort to explain what types of investment activities of TNCs and the
ways in which they can facilitate a process of industrial upgrading and growth in the
developing host country, Ozawa developed a dynamic paradigm based on following
five-key structural characteristics of the global economy as underlying determinants.

i. Inter-economy divergences in supply (factor endowment and level of

technological competence) and demand conditions (consumers’ needs and
tastes)
ii. Firms as creators and traders of intangible assets

13
 iii. There is a hierarchy of economies (leader and followers) with respect to
economic development, i.e. individual countries are at different stages of
industrial upgrading and per capita income
iv. Natural (stage-compatible) sequencing of structural upgrading and
development
v. A strong trend away from inward looking towards outward looking orientation
in trade and investment policy and where government play positive role
augmenting the market systems.

According to Ozawa, the existence of a hierarchy of economies in terms of stages of

economic development and national wealth is a necessary condition. But in order to
achieve those hierarchical externalities, the developing country must align its pattern
of comparative advantage and its stage of development with advanced countries. In
this regard, Ozawa (1992) recognizes three stages of development (factor-driven,
investment-driven, and innovation-driven) adopting Porter’s (1990) “stages theory of
competitive development” to explain the pattern of outward and inward FDI as well
as particular pattern of export competitiveness.

Table 2: Pattern of inward and outward FDI and export competitiveness

Production
Stage activity Exports Inward FDI Outward FDI
1. Factor Natural resource Has trade Attract factor Trade-supportive
driven based activity or advantage in (resource or resource seeking
labour intensive either primary labour) seeking
manufacturing goods or FDI
labour
intensive
manufacturing
2. Investment Manufacturing Has scale Attract investment towards low wage
driven of intermediate based in capital & countries in
and capital advantage intermediate goods labour intensive
goods and (large scale industries (market manufacturing
infrastructure and capital seeking) and resource
building intensive extraction abroad
goods) (low cost labour
seeking)
3. Innovation Human capital R&D based Attract investment Towards
driven abundant and advantage in in technology intermediate
active in R&D high tech intensive industries goods industries
manufacturing (market/technology
seeking)

14
3.4. The impact of FDI on host country development: reflection of the
debates

The development impact of FDI is fraught of contentious ideological debate. This

debate ranges from radical stance that is hostile to FDI to a non-interventionist free
market stance.5 The radical view, which is on the retreat since the collapse of
communism by the end of the 1990s, sees the TNCs as an imperialist tool for
exploiting host countries. According to this view, no country should allow FDI. The
free market view, which has been spread by the Bretton Wood institutions, argues
that deficiency in capital is the fundamental cause of underdevelopment. TNCs can
bridge the capital gap and be an instrument for increasing the overall efficiency of
resource utilization. The policy implication of this neoclassical view is that
governments should not interfere with the price and free market system, i.e. no
regulations, industrial policy, or any other measures to allocate investment or
redistribute income and wealth is needed.

The pragmatic view, which is between the two extremes and is pursued by most
countries, sees FDI as having both benefits and costs. The policy implication is,
pursing policies designed to maximize the benefits and minimize the costs of FDI
that include restricting FDI where costs outweigh benefits, bargaining for greater
benefits, and aggressively courting beneficial FDI by offering incentives.
There are, however, divergent views and emphasis on the likely benefits and costs
associated with FDI. Moran (1998) summarized the benign and malign models about
the impact of FDI on host developing country’s development. The benign model view
is that in a host country mired with cycle of underdevelopment (i.e. low level of
productivity low wages low savings low level of investment low level of
productivity), FDI can break the cycle by complementing local savings and by
supplying more effective management, marketing, and technology to improve
productivity. According to this macro view, under reasonable competitive condition
FDI should raise efficiency, expand output, and lead to higher economic growth in
the host country. The emphasis is that, FDI brings new resources (capital,
technology and management) that address constraints to development and set the
limit to long-term growth.
5
The Political economy of foreign direct investment (chapter 7) McGrow Hill International Business
Edition (2003) http://www.mhhe.com/uop/hill3e/student/olc/ch07s_cs.html

15
The malign model, on the other hand, argues that FDI firms operate in industries
where there are substantial barriers to entry, enjoying and perhaps increasing
market concentration. The argument continues that;

 Instead of filling the gaps in domestic savings, foreign firms may lower by
extracting rents from the domestic economy,
 Instead of closing the gap between investment and foreign exchange, they might
drive domestic producers out of business and substitute imported inputs, i.e.
repatriation of profits might drain capital from the host country,
 Instead of generating favourable impact on income and distribution and social
development, their operation might support a small oligarchy of indigenous
partner and suppliers and their inappropriate capital intensive investment may
produce jobs only for the elite but less employment opportunities for the unskilled
labour
 Their tight control over technology, higher management functions, and export
channels may prevent the beneficial spillovers and externalities hoped to
generate from FDI.

Critics of inward FDI argue that there are adverse economic and political effects on
the host country. There are complaints that foreign firms exploit local labour and the
environment. The malign model also perceives that FDI can negatively affect the
host country politics. FDI can cause a decline in the local authorities’ autonomy.
Many of the TNCs are so large in terms of their control over assets and employment
enabling them to influence the political and economic decisions of the host country’s
authorities. Pressures exerted by multinationals on local authorities to achieve gains
in their operations can also be observed and these may result in policies that are not
favourable to host country’s economic growth but only benefiting foreign investors
(Zhang, 2001).

FDI firms may also engage in predatory practices, collusion, and political lobbying to
reduce domestic competition, allowing them to capture monopoly or oligopoly rents.
Particularly FDI businesses find operating in protected markets highly lucrative as it
generates monopoly rent that tends to obstruct reforms. The Brazilian and Mexican
automobile industries, for example, attracted Multi-National Companies (MNCs) that
were weakly anchored in the local economy, had higher production costs and did not

16
employ modern technologies and transferred only inferior technologies that could not
survive international competition. The rents to the MNCs were so high that Mexican
car makers were vehemently opposed to the liberalization of the automotive industry
describing the industry as a “cash cow” (Samuels 1990, P48). Moreover, in Brazil,
while the industry substantially expanded and had a multiplier effect on the growth of
other related sectors, it had limited effect in spawning the production of parts and
components by domestic investors. The protection for the auto industry was
envisaged to augment the domestic part and components industries that would be
connected with the FDI downstream producers. Instead, however, FDI firms chose to
buy out or cast aside local producers in favour of vertically integrating their
production processes or sourcing from other FDI businesses (Shapiro, 1989). This
led them to capture the entire rent accruing from protection at the expense of
domestic producers. Many studies, however, show that such negative effects often
arise in an environment where the domestic trade and investment regulations
(including laws governing FDI operations) and related policies are either wholly
absent, heavily distorted or poorly implemented.

What is the evidence so far in this regard? FDI flows to developing countries have
been concentrating in few countries mostly in Asia, suggesting that these countries
are successful in attracting FDI. However, it is not straightforward to pinpoint which
countries have been most successful in benefiting from FDI. This is because benefits
of FDI do not accrue automatically and equally across counties and sectors.
Moreover, the economic impact of FDI is difficult to measure with accuracy. Two
major approaches have been generally used to assess the development effects of
FDI. The first is a qualitative analysis based on country/sector case studies without
any attempt at calculating a precise relationship or rate of return. The evidence is,
however, mixed. Only few countries (for example, China, Singapore, Ireland,
Malaysia, Mauritius) have successfully used FDI for their development, while the
majority of the developing countries remained unsuccessful.

The second approach is econometric analysis regarding the relationship between

inward FDI and various measures of economic performances based on country or
cross country data. The empirical results regarding the relation between FDI and
economic growth are mixed. Several studies have reported positive relation between

17
FDI and economic growth (e.g. Blomstrom, 1986; De Gregorio, 1992; Borensztein et
al., 1998; Lensink and Morrssey 2006), while others (Haddad and Harriosn 1993;
Jovorcik 2004) have found no evidence of positive relation. Several review papers
(e.g. UNCTAD, 1999; Vissak and Roolaht, 2005; Moura and Forte, 2010) show that
the number of studies that show positive effect of FDI is much higher than otherwise.
The existing studies regarding productivity and technology spillovers of FDI are also
inconclusive. Although most studies confirm the fact that foreign firms are more likely
to be more productive than their local counterparts, the spillover effect on
productivity growth of domestic firms is mixed (Gorg and Greenaway, 2001; Lipsey,
2003).

What are the explanations for the mixed results? The mixed results are partly due to
difference in methodologies and variables used to estimate the impact as well as
heterogeneous sample of countries. Another explanation is that the causal
relationship between FDI and economic growth might also be the opposite. For
example, economic growth may encourage FDI inflow when FDI is seeking
consumer markets, or when growth leads to greater economies of scale and
therefore increased cost efficiency. On the other hand, FDI may affect economic
growth through its impact on capital stock, technology transfer, skill acquisition or
market competition.

The most plausible explanation for the mixed results is, however, that countries differ
in their political and economic conditions, hence, the ability to benefit from the
presence of foreign-owned firms. Although the economic benefits of FDI are real,
they do not accrue automatically. They instead require the presence of appropriate
policy and local capabilities (for example, skill, R&D, infrastructure). Moreover, the
development of institutional capacity to facilitate, regulate and monitor FDI activities
is critical not only to maximize the benefits but also to reduce the risks. All these
point out to the important role policy can play in shaping the ultimate effect of FDI
either by maximizing the benefits or minimizing the risks. Countries that have had
successful development based on FDI handled FDI as part of achieving the
development objectives and designed appropriate policy tools to attract quality FDI.
Quality FDI often refers to high-value added FDI and/or FDI with positive linkages
and spillover effects for the domestic economy (Velde te, 2001).

18
3.5. Review of the specific mechanisms FDI can affect the host country

On a micro basis, the strategic-trade theory argues that FDI may feature rents
(including high profits and high wages), access to privately controlled activities
(including technology, marketing and best management practices), and potential
spillovers and externalities that are of high value to host economies. The literature
identifies several mechanisms (for example, balance of payments, employment, and
knowledge and technology transfer) through which FDI can affect the host country’s
economic growth. Each of these can, however, have positive and negative effects.
Below, we review the debate surrounding each of these mechanisms and the
conditions under which the benefits can be realized.

(i) FDI and balance of payments

Improvement in the balance of payments is one major benefit FDI can bring to the
host country. The increased availability of foreign exchange can fuel growth through
bridging the balance of payment and saving gaps. There are three potential
mechanisms through which FDI can have effect on the balance of payments; (i)
initial capital inflow (ii) substitution for imports and (iii) exports of goods and services.
The counter argument to the above is that FDI can have greater impact on imports
than for exports causing negatively the balance of payments. This is more likely to
happen when FDI engage in low value added activities, such as, assembly which
requires large amount of imported components. Moreover, the effect of initial
investment flow might be counterbalanced through the repatriation of profits,
payment of royalties and expatriate workers’ wages. In the long run, the balance of
payment effect might be negative. This negative effect is more pronounced when
part of the investment is made through credits obtained from host country banks.

(ii) Employment impact

In a country where capital is scarce but labour is abundant, the creation of

employment opportunities is another major perceived benefit from FDI. The
employment effect might be direct when the FDI employs a number of host country
residents or indirect when jobs are created in local suppliers (supporting industries)

19
as a result of investment by the FDI and further economic activities as a result of
spending of the FDI employees.

One skeptics in this regard is that not all the ‘new jobs’ created by FDI represent net
addition to the host country. This is because FDI might displace jobs in local firms,
thus, the net job created by FDI may not be as big as initially claimed by TNC (Hill,
2000).

(iii) Technology and knowledge transfer

The most favourable argument towards FDI is that it can bring new technology and
know-how to the host country. Technology and knowledge transfer is broadly defined
here to include managerial practices, production methods, and other tacit and
codified know-hows by which a firm transforms capital, labour, materials into a
product and marketing it. This means, it includes production, process, organizational
and marketing technologies and knowledge. Technology transfer through FDI is
considered as intra-firm technology transfers from TNCs to their subsidiaries or
affiliates in the host country. Unlike other mechanisms of technology transfer (for
example, export relations, technology licensing arrangement), the TNCs tend to
provide access to the whole range of technological, organizational, and knowledge
assets as well as to marketing expertise and brand names within MNCs (Ivarsson
and Alvstam, 2005). This is particularly true in the case of wholly owned subsidiaries.
Unlike the joint ventures ownership arrangement, the technologies transferred to the
wholly owned subsidiaries are more likely to be new, young and complex (Lado and
Vozikis, 1996; Zander and Kogut, 1995).

There are, however, two cavities in the technology and knowledge transfer
argument. First, for technology transfer to happen, there needs to exist some
minimum local absorptive capabilities. The larger the ‘technology gap’ between the
domestic and foreign owned firms the less learning takes place and low impact on
economic growth. Second, in order to continue to hold their technological advantage,
FDI might be reluctant to transfer the appropriate technology to local firms (Sen,
1998). Third, host country firms may lose interest to engage in technology
development and become increasingly dependent on technologies introduced by
TNCs.

20
Most of the literature recognizes two major channels of technology transfer from FDI:
horizontal and vertical flows.

Horizontal technology transfer

FDI can provide positive technology externalities to local competitors through a

number of mechanisms;

 Demonstration effect: local firms have the opportunity to learn simply by

observation and imitation,
 Labour turnover: employees previously trained by the TNCs may leave FDI to
create or join local firms, thus, transfer important technology or information to
local firms
 Competition effect – entry of FDI leads to severe competition in the host country
market and forces local firms to use their existing resources more efficiently or to
search for new technologies
However, FDI can also have crowding out effect on local firms. This may occur at
least in two ways. First, foreign firms may hire talented workers away from local firms
and may raise wages for all firms in competitive labour markets. Second, if domestic
and multinationals compete in the same sector, the foreign firms may also have an
incentive to prevent technology leakages and spillovers from occurring through
different mechanisms that include formal protection of their intellectual property
rights, trade secrecy, paying higher wages to prevent labour turnover, or operating
only in countries where there is limited capacity. Whether the spillover effect
outweighs the crowding effect largely depends on host country industrial capability,
domestic market size, and policy at large.

Vertical linkages

Vertical technology transfer could occur through both backward (supplier) and
forward (buyer) linkages. The multinationals have less incentive to prevent
technology diffusion particularly to upstream suppliers since they benefit from the
improved performance of intermediate inputs suppliers. The mechanisms of
technology transfer in the backward linkage include;

21
  Direct knowledge transfer from foreign customers to local suppliers
 Imposing higher requirements for product quality and on-time delivery leading
to upgrading management and technology
 Reaping scale economies from entry of multinationals

To reduce dependence on a single supplier, the multinational may establish wide

relationships with multiple suppliers, thus, augmenting the diffusion of knowledge
across the sector. For this reason, the backward linkage is regarded as the main
channel of FDI technology spillovers.

FDI can also help in technology and knowledge transfer not only about new products
or process but also new organizational and marketing arrangements. The
multinationals have the advantage of expertise in marketing, establishment of
networks, and creation and development of international lobbies. Local firms can,
thus, learn from the TNCs and can become multinational suppliers and
subcontractors leading them to engage in exports. Even if the local firms often start
exporting with the TNCs brand name, they can use this connection to independently
export. The increase participation in exports is also believed to improve the local
firms’ productivity.

However, one has to try to avoid captive relations with powerful international buyers.
The captive relationship arises when a few lead firms control many small suppliers
forcing them to link to their buyer under conditions that are set by, and often specific
to, that particular buyer. The captive value chain mostly applies to standard or
labour-intensive consumer goods (e.g. agricultural produces, textile and clothing,
etc.) produced in low-cost regions. Switching costs are particularly high as low-
skilled suppliers depend on dominant lead firms (Gereffi et al.’s (2005). One way of
avoiding captive relations is to devise a multi-market strategy including local,
regional and international markets.

3.6. Some reflections on the risks of FDI: environmental and social concerns

FDI and the environment

There is also a divergent view about FDI’s environmental impact on host developing
countries. The so-called “pollution havens’ hypothesis” states that multinational

22
companies move their operations to less developed countries in order to take
advantage of lax environmental regulations. Certain resource and pollution intensive
industries have particularly a locational preference for areas of low environmental
standards. Competition for FDI and fears about losing competitiveness depress
environmental standards in the host country. Countries may also intentionally
undervalue their environment in order to attract new investment. This is reinforced by
the sentiment that host country demand for environmental quality raises as income
increases, thus, the low income countries should give priority to economic growth
and set standards low and attract pollution intensive and resource seeking FDI. The
low environmental standards in developing countries have been exacerbated by the
liberalization actively promoted by the advanced countries and low capacity to
enforce.

As a result, many countries seem to adopt a “pollute now, clean up later” strategy,
ignoring the significant irreversible costs which result from such an approach. The
weak environmental regulations have caused irreversible environmental effects in a
number of countries. China is a classic case in this regard. China is home to some of
the most badly polluted cities in the world. About half of the country’s sweet water
reserves are toxic from contaminants. The air quality in many areas is threatening
the health of China’s citizens and pollution has made cancer China’s leading cause
of death. According to estimates by the World Bank and China’s Environmental
Protection Administration (World Bank 2007),6 the environmental fallout from China’s
growth miracle may cost the economy as much as 5.8 percent of GDP per year.

The Maquiladora industry zone in the US-Mexico border is another case of

environmental damage caused by lax environmental regulations. The Maquiladora
industry zone, which consisted of mainly assembly plants in electronics, auto parts,
and apparel industries played important role in boosting Mexico’s manufacturing
employment and exports.7 Low wage, low environmental and labour standards were
some of Mexico’s advantages motivating cross-border investment particularly form
the USA. Due to insufficient treatment facilities and poor environmental regulations,

6
World Bank (2007): Cost of Pollution in China – Economic Estimates of Physical Damages. Beijing:
The World Bank and The State Environmental Protection Agency.
7
For example, between 1984 and 2002, manufacturing employment in Maquiladora increased from
180,000 to 1.1 million workers consisting over a quarter of Mexico’s total manufacturing employment.
By 2000, the maqula sector generated about 48% of manufacturing exports (Hanson 2002).

23
the U.S.-Mexican border areas suffered from the severest pollution in Mexico. The
waste generated has negative ramifications for the environment and those living in
the area, including the maquiladora workers. The rivers around maquiladoras are
polluted with industrial and biological waste the biodiversity and human life at risk
(Bolterstein, 2000).

A contrasting view, which is termed as ‘pollution halos’ argues that foreign firms use
better management practices that can pull environmental and other standards
upwards. One motivation of multinationals for doing so is shareholder and consumer
pressure from home countries to harmonize quality standards inside global
production chains. There is some evidence supporting this hypothesis particularly in
those which are energy intensive and require high technology. However, for most
industries’ factors such as age, size and community pressure have been more
important in raising environmental standards than foreign investor involvement. This
suggests that there exists no substitution for host country’s strict enforcement of
environmental regulations as in most cases FDI can’t voluntarily adopt environmental
friendly technologies unless regulated.

FDI and employment relations

Another negative attitude towards FDI is the treatment of workers. Although they are
known to pay more than local firms, FDI firms are criticized for abusing their workers.
The race to the bottom phenomenon is also relevant here, as many governments in
the developing countries minimize the enforcement of workplace regulation in order
to attract FDI. Such motives often cast aside important social issues, such as the
protection of fundamental workers’ rights and the environment. As a result,
investment from emerging economies seems to be particularly attracted to
developing countries partly because of relatively lax regulatory conditions on labour
and the environments. Moreover, while many bilateral and multilateral investment
treaties provide investment protection and trade guarantees for FDI, they do not
often include social obligations for investors. It is only with the existing national laws
that countries deal with social issues in relation with international investors.

However, given the increased pressure from developed country consumers, the
TNCs can no longer ignore the environmental and social issues. In fact, low

24
environmental and labour standards may, in some cases, deter FDI due to investors’
concern about their reputation elsewhere in the world. Many TNCs are increasingly
introducing marketing strategies on the basis of green products and fair labour
relations. Hence, the host country can develop a strategy to flagship the green
production and workers’ rights to attract FDI and access the world market. Moreover,
FDI tend to adopt environmentally ‘cleaner’ technologies that could have positive
spillovers to local firms.

3.7. Determinants of inward FDI

While most of the theoretical literature present market size and relative factor costs
(i.e., price of land, labour and other inputs) as essential determinant of FDI inflow
(Markusen et al. 1995), a number of empirical studies identify political and
macroeconomic stability and the absorptive capacity of the host countries as vital
factors that affect the inflow of FDI. For instance, earlier studies by (Schneider & S.
Frey 1985&Singh & Jun 1995) reveal that the prevalence of political risks in the host
countries have statistically significant negative effect on FDI inflow. Recent studies
by (Reinhart & Rogoff 2003; Fu 2012) have also identified political stability as a
prominent determinant that affect the inflow of FDI to Africa. In line with this, a study
on Chinese FDI in Ethiopia by (Geiger & Goh 2012) also confirmed that a
considerable proportion of the Chinese investors operating in Ethiopia are found to
be motivated to invest in the country due to the prevailing stable political
environment.

On the other hand, it is argued that countries with stable macroeconomic situation
and high growth potential will tend to receive greater FDI inflow than those nations
with a more volatile economy. Studies by (Klein et al. 2001; Wei 2009 & Fu 2012)
demonstrate the positive causality between inward FDI and the economic growth of
nations. A very recent Meta-regression analysis by (Iamsiraroj & Doucouliagos 2015)
on 946 estimates from 140 empirical literature have reached on a robust conclusion
that, on average economic growth is an important determinant of FDI inflow.
Similarly, (Fu 2012) argued that Chinese investors that are engaged in automobile
assembly and other manufacturing activities in Ethiopia are attracted by the
prevailing low market competition and promising growth potential of the country.

25
Thus, Ethiopia’s recent rapid economic growth performance would further attract
more FDIs from other parts of the world if the nation alleviates other obstacles that
can prevent foreign nationals from investing in the country.

Foreign direct investment absorptive capacity of the host country depends on a

number of factors such as, the state of infrastructure, institutional factors (i.e., the
investment legislations and trade regimes), scale factors (i.e., the balance of
payment position and the size of domestic market) and complimentary factors like
human capital and availability of land (de Mello 1996). For instance, the availability
and quality of infrastructures like energy supply, main and feeder roads and the
transportation system play a vital role in attracting FDI and reaping the maximum
possible benefits that can be acquired from such investments. On the other hand,
FDI may also contribute towards the improvements of infrastructure in the host
country (Owusu-antwi et al. 2013).

Institutions are also important factors that influence FDI inflow to host countries.
Busse & Hefeker (2007), using data from a sample of 83 developing nations
identified law and order, democratic accountability of government, corruption and the
quality of bureaucracy as highly significant determinants of inward FDI. In countries
with weak domestic institutions, the confidence and credibility to attract FDI both in
labour intensive and high tech manufacturing industries is questionable as foreign
nationals lack trust to invest their assets in such countries. In this regard, Neumayer
& Spess (2005) indicate Bilateral Investment Treaties (BIT) as an option to fill the
gap related to institutional weaknesses. And they conclude that by signing BITs with
developed nations, particularly those that are major FDI exporters, developing
countries may give up some of their domestic policy autonomy by binding
themselves to foreign investment protection, but they could receive more FDI in
exchange. The same finding is obtained by Saputo (2005).

Several developing nations provide investment incentives to attract inward FDI in the
manufacturing sector, as well as in other sectors of their economy. Such investment
incentives, among others, include tax holiday and custom duty exemption on imports
of capital goods and spare parts. The results from empirical evidence on the
effectiveness of these particular investment incentives in attracting inward FDI are
inconsistent for many developing countries including Ethiopia. For instance, a recent

26
study by Bora (2013) using panel data on ten different investment sectors of Ethiopia
over the period of 1992 to 2012 finds that the tax incentives, particularly tax holiday,
is a statistically significant positive determinant of FDI inflow to Ethiopia. However,
custom duty exemption is found to be insignificant to attract inward FDI. On the other
hand, considering sectoral distribution of FDI, the same study indicates that tax
holiday has a more significant positive effect in the manufacturing sector, whereas
custom duty exemption has significant effect in the construction, electricity and water
supply sectors.

It is argued that developing countries including Africa might improve their

attractiveness for FDI by introducing policies that can scale up local skills and build
up the labour force capabilities. However, the empirical evidence in support of this
argument is scant. Among the few evidences, Noorbakhsh et al. (2001) identified
human capital as the most important determinant of FDI inflow and also argued that
its importance has become increasingly greater. Similarly, Suliman & Mollick (2009),
as cited in Sichei & Kinyondo (2012) using panel data on a large sample of 29 Sub-
Saharan countries have tested whether human capital development defined by either
literacy rate or economic freedom and the incidence of war can affect FDI inflow to
these sample Sub-Saharan nations. Their findings ensure that, inward FDI has
strong positive causal relationship with literacy rate and by contrast, the occurrence
of war event exerts significant negative influence on FDI inflows to these countries.

3.8. The role of investment promotion in attracting FDI

The major rationale to promote inward FDI is the positive impact it generates to the
domestic economy. Foreign investors bring to the host country thousands if not
millions of high paying jobs, produce billions of dollars of exports, and introduce new
technologies. In addition, FDI may also generate positive externalities in terms of
knowledge and technology transfer. Wells and Wint (1990) found that the net present
value of pro-active investment promotion is almost four dollars for every dollar spent.
For this reason, the majority of countries including the developed world provide
locational incentives to slow down the outward investment and attract new inward
investments. The first argument in support of the investment promotion is, thus, the
need to match and offset the growing competition of incentives and preferences to
attract FDI by other countries.

27
But there are other signs of market failures as well that justify intervention on the part
of the host country. First, decision making of investment location of TNCs is based
on imperfect information and distorted risk perceptions. This is more important when
it comes to the perception of investors towards developing countries, specifically in
Africa. According to Moran (2005), investors’ survey consistently show five broad
categories of concern regarding investment in developing countries; cultural factors,
labour regulations, responsiveness of surrounding economy in providing supporting
goods and services, credibility of public sector commitments (about taxes,
infrastructure, regulations), and institutional base of commercial law. Countering
information imperfections and distorted perceptions in the location, decision making
process is one key reason why investment promotion is needed.

Secondly, the parent companies are cautious about constructing new facilities while
information gaps are filled about the long-term interest of relocating to a new host
country, a behavior termed as “stickiness of FDI”. However, the reluctance could be
transformed into enthusiasm once the first movers shift direction and then comes a
remarkable follow-the-leader response. Often a “flagship” investment by a major
company increases the information and reduces the risk for other TNCs
(Loewendahl, 2001). The follow-the-leader and “bunching” in FDI has been observed
by many studies, for example, Knickerbocker (1973), Yu and Ito (1988), Graham
(1978 & 1996), and Flower 1976). The stickiness and rapid bursts of investment
signals a broader market failure and provide a solid theoretical rationale for trying to
attract the first investor and for trying to trigger follow-the-leader behavior. The
benefits of success have been great and the costs of sitting back and waiting for
foreign investors to act on their own is substantial (Moran, 1998).

Loewendahl (2001) developed a framework divided into four for investment

promotion:-

 Strategy and organization (setting the national policy context; setting objectives;
structure of investment promotion; competitive positioning; sector targeting)
 Lead generation (marketing; company targeting)
 Facilitation (project handling)

28
 Investment services (after-care and product improvement; monitoring and
evaluation)

For an effective investment promotion strategy, it is important that there is clarity of

objectives, among others; the main interest of the government and why it is trying to
attract inward investment, sectors of national priorities, modalities of FDI, and the
role and type of incentives. Successful investment promotion also requires clear
strategic direction and effective marketing. In their cross-country analysis, Wells and
Wint (1990) showed that the strongest methods of investment attraction that produce
best results were;

 Sector-specific investment missions rather than general advertising campaigns

on behalf of host country
 Personal contact between host-country officials and individual companies had a
substantially large impact than did impersonal advertising
 Mixed investment missions, including satisfied private-sector representatives and
ministry representatives from the host country, were particularly effective

Loewendahl (2001) argues that although the general public relation campaigns
associated with image building are much weaker in producing investment leads than
company-focused sector targeting, there is strong argument in support of general
campaign when;

 the reality in the country is better than the perceptions held by the international
investment community
 a country has not been a major host for FDI in the past
 domestic policies are reformed providing an opportunity for the agency to change
its image
 there is a change in strategic direction by the IPA, e.g. focus of new sector or
activities

29
No single structure fits all countries as countries might have different sizes and
objectives of attracting FDI. Atkinson and Coleman (1985) highlight three key
preconditions of an effective investment promotion agency:

 The agency has a clearly defined role and value system that supports it and not
represent interest of a particular clientele
 Operational autonomy will be greater if functional responsibilities for a given
sector are clearly assigned to a single agency
 The agency requires independent access to expertise and information in order to
act autonomously from firms and sectoral associations

Loewendahl (2001) have also shown that the investment promotion agencies task do
not end with the issuance of investment licenses. Instead, they have to continue to
play a substantial role in project handling, after-care service and monitoring and
evaluation tasks. Key issues to consider in project handling are ownership, investor
requirements, visit handling, information provision, package offer, and facilitation.
After-care (or post-investment services) is a key area of policy reform that can help
agencies both in generating new investment and upgrading the quality of existing
projects over time. Monitoring and evaluation are also very important activities of
investment promotion agencies.

4. Benchmarking International Best Practices of FDI

The global market for manufacturing is the best conduit for technological learning for
those countries to get into the fast developmental lane. The recent waves of
industrialization in Asian countries have exhibited different paths towards
industrialization. Japan and South Korea have industrialized by nurturing domestic
manufacturers through protecting their markets and restricting foreign direct
investment. ‘Export discipline’ was the most important instrument these countries
have applied to make domestic firms learn from and transfer foreign technology and
compete in the international market. Hence, we cannot learn much from Japan and
Korea regarding FDI attraction and management.

30
In contrast FDI has played an important role in other emerging Asian countries such
as China, Singapore, Taiwan, Malaysia, Thailand, and Vietnam. Each of these
countries introduced different types of policies and achieved different levels of
success in using FDI to transform their economy. These countries can be grouped
into two in terms of using FDI in building national technological capabilities and
transforming the economy; high achievers (China, Taiwan, and Singapore) and low
achievers (Vietnam, Malaysia and Thailand). For benchmarking, China and
Singapore are selected from the first group as they have a high level of technological
capability due to FDI, and Malaysia from the second group.

The aim of this section is, therefore, to take lessons from these practices on the
attraction and retention of FDI. Moreover, it deals with how FDI has been
instrumental in improving domestic technological capabilities from the receiving end.

4.1. China

FDI in China

Note that this sub-section is only earlier and shorter version of the Chinese story. A
separate report is prepared regarding the Chinese experience, which is based not
only literature review but also a site visit.

China declared the economic reforms and called for foreign capital participation in its
economy in 1979. Since then, China received a large part of international direct
investment flows. In 1978, it ranked 32nd and in 2003 it ranked 4th while in 2014 it
became the number one destination with FDI worth about $128 billion (UNCTAD,
2014). This huge inflow of FDI is, however, highly concentrated geographically in the
coastal regions. Total FDI stock into the coastal provinces accounted for more than
80% of total FDI stock in China.

31
Figure 1: Inward FDIs in China (UNCTAD)

In 2014, FDIs are channeled to the Manufacturing (43.2%), Real estate business
services (20.9%) and renting (6.2%), wholesale and retail trade (5.7%) and transport,
storage, telecommunications, postal services (2.0%). The aims of FDIs in those
sectors are triple-fold in terms of technology development – filling in the
technological gaps, introducing advanced technology, and improving the existing
one. Coupled with technology development, FDIs were instrumental for export
promotion of China.

Before the 1990s, the top sources of FDI in China were Hong Kong and Taiwan.
Though it had a declining phase in the succeeding decades, in 2014 Hong Kong
constituted over 70 percent of FDI in China followed by Singapore, Taiwan, Japan,
South Korea, USA, Germany and UK. The dominance of Hong Kong, however, is
somewhat illusory since much FDI nominally from Hong Kong was in reality from
elsewhere. On the other hand, some of what is listed as Hong Kong-source FDI in
China is, in fact, invested by domestic Chinese is “round-tripped” through Hong Kong
(Graham and Wada, 2001).

Whatever measures we use, Chain’s rapid rise as a trading power is considered a

global economic miracle, and FDI has played a crucial role in developing China’s
foreign trade. In the following sections of this study, FDI’s determinants, mechanisms
for technology transfer and finally lessons learned are presented.

32
FDI’s Determinants

The absorption of FDI is part of the policy of opening China to the outside world.
More specifically, the Chinese success could be attributed to its guiding policies and
incentives, privatization policy, availability of market and resources and an easy way
of doing business.

Policies and incentives

In the 1980s, FDI’s inflow was through joint ventures, cooperative enterprises, and
solely foreign owned enterprises. China has aggressively shaped a relatively
complete range of laws and regulations governing those three types of foreign
investment.

A preferential treatment granted to enterprises in various industries has mainly been

determined under the Guiding Directory – guidance for foreign investment
operations. The Guiding Directory divided FDI involved projects into four categories:
projects that were encouraged, allowed, restricted and prohibited.

China has designed certain parts of the country as special economic areas/zones
and each is governed by different policies. Foreign Industry Enterprises (FIEs) enjoy
preferential treatment depending on the region and industry. Furthermore, the
Chinese government has stipulated differential FDI performance requirements
depending on these distinctions. Later on, due to the high concentration of industrial
setup in south east of the country, China has also enforced two polices called
develop China’s West at Full Blast and Strategy of Reviving Rusty Industrial Bases
to encourage FDI into its western and northeast regions.

With export, Chinese FDI policies could be divided into three categories: compulsory,
neutral, and voluntary. Compulsory policies require that FDI shall be able to keep a
balance of exchanges, or make sure the proportion of their domestically made
products in total number of products reaches a certain benchmark, or a certain
percentage of their products must be exported. Neutral polices tried to create fair
conditions for exports to compete internationally. For example, the tariff and VAT
exemptions on re-export processing imports would level the ground for China’s
companies to compete in overseas markets. Voluntary policies to promote exports

33
were encouraged. For example, an enterprise with 70 percent of export products is
entitled to a 50 percent cut in corporate income tax.

Another important policy is Chinese processing trade policy` which exempts input
imports for re-export from tariff and value added tax (VAT). It has improved the
country’s export value tremendously. Two kinds of processing trade exist in China:
processing trade with imported materials (PTI) and processing trade with materials
supplied by clients (PTS).

Chinese policies have two faces – before and after accession to WTO. Most of the
compulsory policies have been waived after its accession to WTO. The conventional
wisdom is that the market has become fairly open and competitive. However, basic
services, like telecom, are still dominated by state-owned companies and no foreign
enterprise has entered the area despite the relaxed policy restrictions. Often
‘recessive’ non-policy impediments are playing an increasingly important role in the
decision-making processes (Han and Wang, 2014).

Privatization

China began its privatization policy by introducing a market economy, that is, by
creating a non-state sector consisting of non-state enterprises. At its broadest level,
the term `privatization' refers merely to the introduction of some private enterprises
into the economy.

China is marked by the government’s piecemeal and gradual approach in its

reforms. The reform of the state-owned enterprises is no exception. Instead of
outright privatization, China concentrated first on productivity improvement by
initiating enterprise governance structures that stressed autonomy and better
incentives and then later by adopting long term managerial contracts with pre-
specified financial targets (such as profits and taxes). Instead of introducing markets
and liberalizing prices overnight, China first created markets at the margin, parallel to
the planned economy, by introducing the “dual-track system” in the state industrial
sector and by lowering bureaucratic barriers to entry to the once state-monopolized
industries. Admittedly, the reforms brought about fundamental improvements in
output and productivity.

34
A distinct feature of China’s privatization is that both its design and implementation
are highly decentralized and are administered by the local governments
(decentralized privatization). China has made substantial progress in reallocating
control rights from the government to private owners; the degree of remaining
government influence on corporate decisions varies significantly across different
privatization methods adopted by the city governments. These methods include
direct sales, either to insiders or to outsider private owners, public offerings, joint
ventures, leasing, and employee shareholdings. Moreover, city governments’
decisions on how to privatize are critically determined by the political and fiscal
constraints they face, and their choice of privatization approaches has a profound
impact on the governance and performance of privatized firms. Specifically, when
cities face less political opposition to labour shedding and have stronger fiscal
capacity, they tend to choose a privatization method that transfers control rights to
private owners more completely.

Market

China has a population of 1.3 billion with a vast potential for consumption. Investors
regard the Chinese market as the last enormous market in the whole world that has
not been developed. Over the past decades or more, the scale of China's economic
reconstruction has been expanding increasingly with the purchasing power of the
people strengthening rapidly and markets becoming increasingly brisk. The general
implication is that host countries with larger market size, faster economic growth and
higher degree of economic development will provide more and better opportunities
for the industries to exploit their ownership advantages and, therefore, will attract
more FDI. China implemented a swap market for technology strategy which
essentially requires foreign investors to import advanced technology in return for
entering the domestic market.

Resource

Labour force, land and natural resources are the most important factors to attract
FDI. The degree of development of host countries is often considered one of the
most important determinants of FDI flows because it is positively related to domestic
entrepreneurship, educational level, and local infrastructure. Chinese labourers are

35
of relatively high quality and there are comparatively numerous technical personnel.
China is also very rich in energy reserve. China is the largest producer of coal.
China’s electric power supply is also experiencing an oversupply problem. Other
major natural resources such as land, iron and other minerals are economically
available (Miglani, 2013)

Efficiency

Efficiency-seeking FDI in China has created a movement from low to high tech
manufacturing industry. Here, we found that efficiency-seeking FDI is positively
related to labour quality and infrastructure development. In China, labour cost is
increasing, across coastal region, compared to inner and western regions. Each
region has different strengths and weaknesses, and specialises in different areas of
industrial activity. The coastal regions received a privileged status which in turn
brought forward comparative advantages in infrastructure, capital, technology and
management skills; today, the coastal regions are leading China in high technology
and high value added manufacturing activity (Liu and Daly, 2011).

Technology transfer/Spillover from FDI

Foreign direct investment contributes to regional innovation in four ways: first, R&D
and other forms of innovation generated by foreign firms and R&D labs of Multi
National Enterprises (MNEs) increases the innovation outputs in the region directly.
Second, spillovers emanating from foreign innovation activities may affect the
innovation performance in the region they are located. Third, FDI may affect regional
innovation capacity through competitive effect. Finally, in addition to greater R&D
investments by MNEs and their affiliates, FDI may contribute to regional innovation
capabilities by advanced practices and experiences in innovation management and
thereby attaining greater efficiency in innovation.

However, spillovers from FDI would depend on either absorptive capacity of the local
firms and organizations, or effective linkages generated between the foreign and
domestic economic activities. The Chinese government addressed the technology
transfer/spillover from FDIs through managing the entry and incentives for research
and development (R&D).

36
The entry modes of foreign firms have evolved from joint-venture in the 1980s to
whole-foreign owned enterprises in the 1990s which accounted for more than 70% of
all FDI projects in the late 1990s. FDI in China occurred through joint ventures,
cooperative enterprises, and solely foreign owned enterprises. However, solely
foreign enterprises were not permitted unless they either adopted advanced
technology and equipment or exported the majority of their products. In 2001, China
removed these restrictions and encouraged foreign owned enterprises to usher in
advanced technology and increase their export volume. At the end of 2001,
manufacturing industry constituted 70 percent of total FDI projects because China
possesses a competitive edge due to lower costs of production and relative energy
ability. In contrast, China has strictly controlled the flow of FDI into the service sector
for a long period.

Since 1999, China’s official FDI policies have encouraged foreign investors to
establish their R&D centres in the country. For example, major polices include:

 Any imported and supporting technology confined to the Foreign Invested

Enterprises (FIE’s) labouratory and used for pilot experiments (not for production)
are exempt from tariff and other import taxes
 Income from the transfer of technology that has been developed solely by an FIE
is exempt from sales tax
 An FIE with technological development expenses of at least 10 percent over its
previous year is entitled to a 50 percent discount of its total technological
development expenses in the current year’s corporate income tax (subject to
approval by the taxation authority)
 FIEs with R&D centres in China are allowed to import and sell a small quality of
high-tech products on a trial basis in the local market, if they are goods produced
as a result of the R&D by their parent companies

Lessons learned

China qualifies all the requirements to attract FDIs – polices, business incentives,
resource, market, and efficiency. The Chinese government has utilized the country’s
comparative advantages for its industrial development. The success of the Chinese
government in attracting FDIs and utilizing it for technological spillovers could be

37
attributed to evolving polices and investment incentives including regulation upon
wholly owned enterprises, joint ventures, cooperative enterprises. Guiding Directory,
establishment of economic zones, go west policy, privatization policy and R&D
incentives are also the predominant polices that shaped today’s Chinese industrial
and economic development. Non-policy variables may also have significant roles in
attracting and retaining FDI.

4.2. Singapore

FDI in Singapore

Singapore, an island between Indonesia and Malaysia, is the smallest country in

Southeast Asia. One of the most densely populated countries in the world – nearly
three-fourths of the residents are Chinese. The modern economic history of
Singapore begins around the period of the country’s independence in 1965. The per
capita GDP of Singapore at that time was US$ 516; in 2014, it was USD$ $64,584, a
remarkable increase in only 50 years.

Figure 2: Inward FDIs in Singapore (UNCTAD)

80
US Dollars at current prices and current

70
60
exchange rates in billions

50
40
30
20
10
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Singapore 15.52 17.01 6.157 17.05 24.39 18.09 36.92 47.73 12.2 23.82 55.08 48 56.66 64.79 67.52
Year

Singapore is an example of a country where economic growth is largely driven by

foreign investments. Inward foreign direct investment (IFDI) has long been an
important feature of Singapore’s economy and Singapore remains an attractive host

38
to FDI. Apart from a brief decline in 2002 and 2008, FDI inflows have generally been
strong. According to the UNCTAD 2014 Global Investment Report, Singapore is the
5th largest recipient of FDI in the world, ranking at the same level as Brazil; and the
3rd largest among the East and South-East Asian countries. In 2014, FDI flows into
Singapore increased by 27% from 2013 onwards, reaching USD 81 billion. In recent
times, the United States, the Netherlands, Japan, the United Kingdom and
Switzerland have been the top sources of FDI in Singapore.

The determinants for Singapore’s success in FDI attraction are attributed to its
proactive policies, business incentives and very good institutional setup for
promotion and retention of FDI. The following sections summarize milestones in the
policies and incentives especially in the early and intermediate stages of Singapore’s
development that resemble the Ethiopian current condition. The contributions of FDI
in technology transfer/spillover and lessons learned are also presented at the end.

Policies and Incentives

Policies and business incentives to attract FDI had never been constant; they were
changing with the changing economic conditions of Singapore. In general, the
industrial development of Singapore could be categorized into three consecutive
stages. In the early stage, the initial emphasis was on labour intensive
manufacturing, over the years the focus in Singapore has shifted to higher value-
added areas and skill-intensive manufacturing activities and then recently
knowledge-based professional services sector activities such as financial services,
ICT services and offshore services are the drivers of the economy.

After political detachment from Malaysia, the Government’s reaction was to protect
the domestic market and enhance import substitution (1965-67) by imposing
protective duties. Obvious limitation of the small domestic market triggered export
orientation (1967-1969). To this effect, government response was two-pronged. The
first was to liberalize tax incentives – the Economic Expansion Incentives (Relief
from Income Tax) Act of 1967, which reduced the tax rate for approved industries to
4 percent (from 40). The incentive could be enjoyed for up to 15 years. Taxes were
also reduced on royalties, license fees, R&D costs payable to overseas enterprises.
Complete tax exemption was granted to interest on foreign loans extended to

39
enterprises operating in Singapore. Tax on interest earned on deposits held in
Singapore by foreigners was reduced to 10 percent. Export incentives were also
given by way of duty-free inputs as well as enhanced tax allowances for market
development expenditures overseas.

The other response was to tackle industrial relations. The struggle for self-
government and, later, independence had bred a very strong left-wing oriented trade
union movement which was often confrontational towards management, resulting in
frequent strikes and labour unrest. Two pieces of legislation changed the industrial
climate dramatically, easing the work of the Economic Development Board (EDB)
considerably in attracting foreign investments: one was the Employment Act and the
other was the Industrial Relations (Amendment) Act, both of 1968. There were two
objectives: one was to give greater discretion to employers in the development and
deployment of their work force. Decisions on promotions, internal transfer; hiring and
firing were to be the sole prerogative of management. The other aim was to reduce
labour costs by limiting the sums payable on bonuses, annual paid leave,
retrenchment benefits and overtime, as well as by increasing the hours of work per
week.

Due to these policies, a large number of multinational companies set up

manufacturing and distributional facilities in Singapore during the 1960s. They
manufactured finished products, parts and components for supplying parent
companies and subsidiaries elsewhere, capital equipment, intermediate products,
and chemicals for offshore oil exploration and for natural-resource-using industries.
In 1971 foreign firms accounted for 26 percent of all firms, 63 percent of
employment, 75 percent of total value-added, and almost 75 percent of
manufacturing exports excluding re-exports.

Consequently, the earlier strategy of attracting low-tech, labour-intensive industries

was changed to emphasize the selection of higher-tech industries. In 1970 the
Economic Expansion Incentives (Relief from Income Tax) Amendment Act was
passed to raise the amount of capital necessary for acquiring pioneer status to about
USD$250 thousand for new firms and to USD$2.5 million for the expansion of
existing ones. For non-pioneer firms, tax exemption of up to 90 percent of the
increase in export profits can be given for five years. Pioneer firms can enjoy tax

40
exemption for up to 10 years, provided their exports exceeded USD$25,000 and at
least 20 percent of their sales. The Government also sought to encourage the
establishment of even larger firms by exempting firms, with fixed assets in excess of
USD$38 million, from income tax for up to 15 years (Tan, 1999).

In the 1980s and beyond, Singapore found increasing competition from other
developing countries, and at the same time, manufacturing in the industrial countries
was graduating into more automation, robotics, computerization, etc. To attract the
newer types of industries meant virtually a ‘second industrial revolution’ in which
industries would be based on science, technology, skills and knowledge. All sectors
of the economy have to mechanize, automate, computerize, and improve
management or relocate their factories.

The EDB’s aim was also to secure industries providing high tech services to the
manufacturing sector which would increasingly produce computers, integrated
circuits, specialty chemicals and various industrial electronic equipment. The
education system was revamped to provide more engineers and supporting technical
staff. Firms were also allowed to recruit such personnel from abroad. The new
industrial thrust was designed not only to move Singapore away from labour-
intensive industries but also to attract industries that were less vulnerable and could
pay Singaporeans higher wages. Singapore was moving up the value-added chain.
(Tan, 1999)

Incentives normally include concessionary corporate tax rates of between 5 to 15

percent or corporate income tax exemptions. Non-tax incentives including grants can
be offered for particular high-value-added sectors, training and R&D. Among the
Government’s support for R&D-related businesses, Singapore Science Park
provides modern infrastructure in its three different locations. The Agency for
Science, Technology and Research also fosters scientific research through, various
initiatives including, large infrastructure projects such as Fusionopolis (for
information and media industries) and Biopolis (for the biomedical sciences industry).
Singapore offers a good policy environment for knowledge-intensive Trans National
Companies (TNCs) including strong Intellectual Property Rights protection.

41
Given its proactive policies and strategic location at the main crossroads of the
world, today, Singapore is the most preferred easiest country for doing business
easily and efficiently: favourable lending to foreign investors, a simple regulatory
system, tax incentives, a high-quality industrial real estate park, economic and
political stability, and the absence of corruption makes Singapore an attractive
destination for investment. Moreover, the country’s extensive network of double-tax
treaties, strategic location within the centre of all major growing markets together
with its extensive connectivity and talent resources, its innovative business
environment, and the immense opportunities for business growth within the
Southeast Asian region, are just a few factors that drive Singapore’s success as a
pre-eminent business centre of the modern global economy.

Institutional setup

From the early period up to the present, Singapore’s inward FDI was predominantly
led by the Economic Development Board of Singapore (EDB). The precursor of the
Economic Development Board of Singapore (EDB) was the Industrial Promotion
Board which had been created by the British colonial regime in 1957 to stimulate the
manufacturing industry. In 1961, the EDB was established with a budget of about
USD$25 million. Its primary function was to promote the establishment of new
industries in Singapore and to accelerate the growth of existing ones. It had four
divisions:
i. Investment Promotion Division: The function of the division was to attract
foreign and local entrepreneurs and to encourage co-operation between
domestic and foreign industries, especially in the field of technical know-how.
This goal was to be accomplished by providing information to prospective
foreign investors about the advantages of locating manufacturing industries in
Singapore by making efforts to reach them in their own countries as well as by
receiving them in Singapore and rendering them assistance.
ii. Finance Division: The Financial division was responsible for the financial
activities of the Board, including its investments and lending.
iii. Projects Division and Technical Consultant Service: The job was to
evaluate the technical and economic feasibility of projects. The Technical
Consultant Service was a central clearing house and repository of technical

42
 and economic information for the Board’s own use as well as to service its
clients.
iv. Industrial Facilities Division: The function of this division was to ensure the
adequate provision of suitable industrial land together with the ancillary
services such as electricity, water, roads and other communications.

The success of EDB can be attributed to its organization, culture and linkage as
briefly explained below:

The EDB was constituted as a Statutory Board – a governmental body that has more
autonomy than normal government ministries. Governed by its own Board of
Directors, it has the freedom to develop its own salary structure, promotional grades
and procedures and conduct commercial affairs without being bound by
governmental rules and regulations. Headquartered in Singapore, EDB maintains
offices in New York, San Francisco, Los Angeles, Chicago, Washington, Boston,
London, Paris, Frankfurt, Milan, Stockholm, Hong Kong, Tokyo, Osaka, and Jakarta.
The Board is organized with international operation, local operation, strategic
business units and services.

The operational strategy of the EDB culture is a combination of a number of factors:

(1) commitment to teamwork in support of the basic mission of developing the nation
without, necessarily, sacrificing individuality; (2) carefully chosen officers who are
bright, articulate, cosmopolitan, technically oriented, highly motivated and are good
at interpersonal relationships; (3) commitment to openness across internal and
external boundaries, moderated by good judgment; (4) decisions reflecting a broad
involvement of all levels with free communication, while at the same time preserving
respect for superiors, especially in public, and accepting guidance and coaching
from superiors; (5) retention of long-term friendships and partnerships with client
companies based on the development of mutual trust; and (6) dedication to learning
and innovation based on a sense of being able to influence outcomes.

The EDB maintains direct linkages to other government bodies such as Urban
Redevelopment Authority, Trade Development Board, Singapore Tourist Promotion
Board, National Science and Technology Board, Monetary Authority of Singapore,
National Computer Board, Singapore Productivity and Standards Board, Jurong

43
Town Corporation, Housing and Development Board, and Telecommunication
Authority of Singapore.

In addition to these linkages, EDB also works closely with all Government ministries
in order to realize a one-stop mission. The networking to accomplish this task is
achieved in three ways. First and foremost, its own Board of Directors comprises
representatives of Government, quasi-government, trade unions and private
enterprises. A second channel of networking comes through the alumni of the EDB
itself – former Board members and employees who now hold key positions in
Governmental bodies and in the private sector. A third channel was created through
the agencies and bodies that originated from EDB’s initiatives or were spun off the
EDB itself. For example, the largest local bank, the Development Bank of Singapore,
was initially the financial arm of the EDB. Likewise, the Singapore Productivity and
Standards Board was originally named as the Technical Consultant Service within
EDB. (Tan, 1999)

Technology transfer/Spillover from FDI

Singapore, in general, aimed at creating favourable conditions to attract and retain

foreign investors for its industrial development. A limited emphasis was given for
technology transfer with very few exceptions like the case of Small and Micro
Enterprise (SME) linkage with the TNCs. SME promotion had gained increasing
emphasis in the 1980s. The 1987 SME Master Plan outlined a goal to develop
indigenous global enterprises by strengthening the capabilities of domestic SMEs.
The Singapore Competitiveness Report in 1998 further strengthened the country’s
focus on developing a strong local SME sector. More recently, the 2000 SME 21
Report set a ten-year strategic plan to create vibrant and resilient SMEs in
Singapore. The report set targets to increase the number of SMEs with significant
sales, improve productivity, and pursue e-commerce. Several broad-based, sector
and enterprise-level strategy initiatives were created to achieve these goals.

A number of public institutions and agencies have been charged with formulating
and implementing SME-related programmes over the years. In 1986, the EDB
created the Small Enterprise Bureau to coordinate a number of programmes to
support SMEs and encourage them to work with TNCs. However, today, most SME

44
initiatives are managed by the EDB, the Standards, Productivity and Innovation
Board (SPRING Singapore) and International Enterprise Singapore (IE Singapore),
all of which fall under the Ministry of Trade and Industry (MTI). Singapore's small
size allows a concentration of administrative responsibilities and resources. This in
turn facilitates a strategy of coordinated targeting for FDI and SME promotion
including the potential to encourage supplier linkages.

The early presence of a significant amount of foreign investment in Singapore

generated strong demand for local partners. At the same time, an early focus on
developing a healthy SME sector through financial assistance and capability
development programmes allowed TNC-SME linkages to take place more naturally.
Government skill programmes to increase the local pool of human capital in
engineering, business management and information technology had additional
importance. These efforts ensured that local SMEs had the necessary absorptive
capacity to create and benefit from supplier linkages with TNCs. Nonetheless, the
Government of Singapore implemented policies that actively target FDI-SME
linkages. Many existing linkages can be traced to the Local Industry Upgrading
Programme (LIUP), initiated in 1986 by the EDB.

Since its inception, the LIUP has helped support the transfer of technology,
marketing, and business process knowledge from TNCs to domestic SMEs. Under
the programme, TNCs are encouraged to “adopt” SMEs in their value-chain, and
government support is provided to both parties through three progressive stages of
SME development. An initial stage seeks to improve efficiency in general SME
functions. During a second stage, new products and processes are transferred to the
SME. The third stage envisions joint research and product development with TNC
partners. Essentially, the LIUP offers various forms of organizational and financial
assistance to upgrade vendor relationships. This flexibility ensures that the
programme meets the specific needs of the TNC and their suppliers.

Lessons learned

There are five imperatives in Singapore which must always be borne in mind when
evaluating its achievements.

45
 The first is that, because the small island-nation lacks natural resources, it has to
optimize its human resources and develop and deploy them to get the best
results. In the early stage, since the focus of the government was on labour
intensive industries, employees’ relation with their management was left-wing.
The Government gave the discretion to the management about employees’
management (hiring or firing) and pays market rates for its employees and
opened the door to foreign talent.
 The second imperative is to keep Singapore relevant to its neighbours and to the
global economy. To achieve this, it liberalized its tax incentives via the Economic
Expansion Incentives (Relief from Income Tax) Act of 1967.
 The third imperative is the organization of Economic Development Board of
Singapore (EDB). There is no question that it has few rivals anywhere. It has
always been dynamic since its inception. It has proved time and again that it can
meet the daunting challenges facing Singapore. It has not only been an excellent
implementer of Government policy, but it has also been instrumental in helping to
formulate policy in light of rapidly changing global conditions. Furthermore, it has
helped to identify opportunities for Singapore and to steer other government
agencies towards the common vision of socio-economic transformation. Its
numerous alumni are now in virtually every sector of Singapore. Several are or
have been ministers. It continues to attract some of the best graduates of
Singapore. Above all other considerations, EDB has been outstandingly
consistent in its ability to deliver what it has set as its mission or goals.
 The fourth imperative is the emphasis on developing key strategic clusters. The
government’s targeted policy helped develop chemical, electronics and
engineering clusters, all of which became key economic engines for Singapore.
More recently, emphasis has been placed on product development, biomedical
research, educational and health care services.
 The fifth imperative is the focus given for SMEs. In the 1980s, SMEs have been
given strategic importance and the government had taken two important
measures to uplift the sector: supporting SMEs to improve their technology-
absorbing capacity and then creating linkages with Transnational Companies
(TNCs).

46
4.3. Malaysia

FDI in Malaysia

Malaysia stands out as one of the economic success stories in Asia over the past
few decades. GDP per capita in Malaysia has grown from 986.48 USD in 1960 to
7304.14 USD in 2014. Malaysia is the most open economy in the world with exports
and imports accounting for most of its total gross domestic product (GDP). Trade
was the life-blood of the Malaysian economy. FDI has long been the backbone of its
economy.

Malaysia has received significant amounts of foreign investment, though its economy
is small sized. Foreign investors stand out prominently in many parts of the
manufacturing sectors, including in the electronics sector, which has been the driving
force behind exports and where foreign investors represent 82% of the capital in
approved projects in 2012. In 1980, FDI inflow was about US$0.34 billion but in
1990, it increased significantly to US$6.5 billion. According to the UNCTAD 2014
World Investment Report, Malaysia is the fifth largest recipient of FDI inflows in East
and Southeast Asia. It is also among the 15 countries most favoured by multinational
companies in 2014-2016. After having reached record levels in 2013 ($12.115
Billion), FDI flows reached $10.799 billion in 2014. The benefits were felt by the
manufacturing, followed by mining sector, oil and gas. Finance and insurance, IT,
and agriculture, forestry and fishing have also received important attention from
foreign investors. Japan, Singapore, Netherlands, and Hong Kong, constituted over
60 percent of the FDI flow to Malaysia.

47
Figure 3: Inward FDIs in Malaysia (UNCTAD)

US Dollars at current prices and current 14

12
exchange rates in billions

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Malaysia 3.788 0.554 3.203 2.473 4.624 4.065 6.06 8.595 7.172 1.453 9.06 12.2 9.239 12.12 10.8
Year

In Malaysia, the majority of FDIs inflow was either due to resource seeking in the
area of the mining sector or oil and gas or efficiency seeking in the manufacturing
sectors because of its convenient policies and business incentives. In the following
sections, the policies and strategies deployed in Malaysia will be reviewed. Then,
efforts made to enhance technology transfer from FDI and finally, lessons learned
will be presented.

Policies and Incentives

Before independence in 1957, Malaysian foreign direct investment activities were

concentrated in mining, plantation agriculture, commercial enterprises and utilities.
After its independence, the pattern of FDI changed as activities in existing sectors
expanded and there was diversification into other agricultural crops and into
manufacturing. During the 1960s, Malaysia’s FDI policy focused on the development
of import-substituting industries (ISIs).

The focus, however, started to change towards export oriented sectors starting in the
late 1960s. In 1967, the government established the Federal Industrial Development
Authority followed by the Government Investment Incentives Act (1968) to promote
manufacturing exports particularly in labour-intensive industries in response to the
problem of internal market saturation faced by the manufacturing sector. The rich

48
assortment of incentives offered to export-oriented FDI by the Act included
exemptions from company tax and duty on imported inputs, relief from payroll tax,
investment tax credits and accelerated depreciation allowances on investment.

This was followed by the introduction of the New Economic Policy (NEP) in 1970
which earmarked the manufacturing sector as the growth sector to spearhead
economic restructuring and employment generation (Abdul Karim, 2003). Further, in
1971, the Free Trade Zones Act which was extended in scope by the Licensed
Manufacturing Act (1975) was developed.

The 1980s saw a rapid expansion of heavy industries in the manufacturing sector.
Steel, cement, petro-chemical and ship building industries were formed between
state owned enterprises and foreign partners described as Government Linked
Companies (GLC). 1987 proved to be the watershed year when the manufacturing
sector’s contribution to the country’s GDP exceeded the agriculture sector’s
contribution for the first time. Thus began the industrialization era of the Malaysian
economy (Shahrin, undated).

This shift of emphasis towards developing Malaysia’s industrial capacity and

capabilities came to bear with the drafting of the First Industrial Master Plan (1986-
1995). This plan was supported by the Promotion of Investment Act 1986 which
provided for tax and other incentives to attract FDI (Shahrin, undated).

The adoption of the Foreign Direct Investment (FDI) liberalization policy was one of
the important factors behind the massive inflows of FDI into Malaysia in the late
1980s and eventually boosted the Malaysian economy tremendously. However,
there has been a persistent decline in the ratio of FDI inflows to the gross domestic
product (GDP) since the early 1990s (Athukorala and Menon, 1996).

The Malaysian government had persuaded other specific objectives such as location
of industries in “development areas”, increasing the use of local inputs, and diverting
investment to certain “priority” industries. Guarantees against nationalization of
foreign assets without compensation are provided by the Constitution, and
investment guarantee agreements have been concluded with several capital
exporting countries (Athukorala and Menon, 1996).

49
FDI is by no means unrestricted in Malaysia. The most notable restriction is on
foreign equity limits: 30% in domestic banks, 70% in insurance companies and
investment banks as well as a 30% Malaysia ethnic (bumiputera) requirement in
retail. In telecommunications, equity limits are being raised to 70%, except for a 30%
limit in Telekom Malaysia.

Malaysia Plan and the New Economic Model (NEM) are in favour of liberalising the
service sector. Since 2009, Malaysia has made great strides to open up the service
sector to foreign investment and once again has begun to offer a more attractive
environment for investors.

In spite of this enviable performance when seen in a long-term perspective, the

Malaysian economy is, nevertheless, confronting numerous inter-related challenges
commonly associated with a middle-income trap. The symptoms of this trap are easy
to find. Growth, which averaged over 9% in the decade leading up to the Asian
financial crisis in 1997-98 has only been 5% since 2000. Net exports as a share of
GDP have also declined steadily since 2000. Private investment, which was running
at 30% of GDP in the early 1990s, has only been 12% of GDP since 2000, although
it grew 22% in 2012, the highest rate of expansion since 2004. Foreign direct
investment (FDI) continued to rise in absolute terms, but has declined significantly
both as a share of GDP and as a share of total FDI in ASEAN since the pre-crisis of
the 1990s. It is now below the share of Malaysia in ASEAN GDP. A large share of
FDI inflows involves reinvested earnings of existing foreign affiliates which suggests
that while established foreign investors are not fleeing the country, there are fewer
new arrivals compared to earlier decades (OECD, 2013).

The Malaysian government attributes this decline in relative FDI flows in part to a
shift towards a more knowledge-intensive investment in line with its promotional
efforts and with Malaysia’s evolving competitive advantages. Malaysia also
continues to rank highly in many investment climate indices as private investment
started to pick up recently.

50
Institutional setup

FDI Promotion, attraction, supports and services are made through the Federal
Industrial Development Authority (FIDA) and Government Linked Companies
(GLCs).

FIDA, established in 1965, was responsible for promoting and coordinating industrial
development activities. In 1979, the Authority was renamed the Malaysian Industrial
Development Authority (MIDA). From then on, MIDA has been the primary
government agency responsible for the large flows of foreign investment into the
manufacturing sector.

MIDA has also been responsible for the after investment service. This function
became even more important in light of the government’s aim to increase re-
investment and expansion by establishing MIDA as an investor whose activities also
extend to providing the private sector with a channel to give feedback on reform
initiatives and measures to further improve the business climate.

A key component of Malaysian economic policy in the 1990s and 2000s has been
the use of specialized GLCs to promote sector-level development. While owned by
the government, these institutions are staffed by industrial experts and other
specialized private sector professionals. These specialized GLCs have been offering
infrastructure, financial incentives, skills and R&D incentives and services as well as
administrative and coordinating services to domestic and foreign investors. These
GLCs may also engage in technology acquisition in order to distribute it to local
firms. They work in cooperation with private sector bodies, public research
institutions, and other programmes and ministries.

To further encourage the development of key heavy industries, the Malaysian

Government encouraged the formation of conglomerates involving TNCs and
government-linked companies (GLCs). For example, state-owned Heavy Industries
Corporation of Malaysia Berhad (HICOM) collaborated with foreign, mostly
Japanese, TNCs in industries ranging from steel and cement production to the
manufacture of a local car, the Proton; the Malaysian Biotechnology Corporation
Berhad (MBC) which aims at maximizing returns from the agriculture sector by
ensuring value-added in downstream activities as well as the Halal Industry

51
Development Corporation (HDC), created in 2006, which sought to make Malaysia a
global leader in the production of Halal products. Perhaps the most significant
initiative by a GLC has been the Multimedia SuperCorridor (MSC) managed by the
Multimedia. However, unlike South Korea, the performance of the conglomerates in
Malaysia has been dismal.

Technology transfer/Spillover from FDI

Technology transfer/spillover from FDI in Malaysia took several forms including

backward, forward and horizontal linkages. It has been supported by different
policies and programmes.

Initially, it is unrealistic to expect foreign firms to forge linkages with domestic

companies. As their operations in the given host country mature, there may be a
tendency for these firms to increase their local purchases, provided the local
business environment is conducive to such behaviour. Since the latter half of the
1980s, foreign firms operating in Malaysia originally procured almost all of their
inputs from abroad. The situation has, however, changed rapidly due to the
government’s policy measures (Athukorala and Menon, 1996).

In fact, the government had some experience with policy measures to link foreign
affiliates with local suppliers. Early initiatives such as the Vendor Development
Programme (VDP) had limited success in the 1980s, primarily due to the limited
capacity of the selected local SMEs to meet the needs of TNCs. Subsequent linkage
programmes have yielded better results as they have sought to give TNCs more of a
role in supplier selection and have provided complementary support for SMEs to
access finance, build their capabilities, and the sale of their products expand to new
markets. Beyond specific linkage programmes, MIDA and SME Corporation also
maintain databases of domestic SMEs that are made available to foreign investors
looking for local partners (UNCTAD, 2011).

Since the mid-1990s, Malaysia has designed other linkage programmes that
incorporate more merit-based selection mechanisms as well as more support for
SME capacity-building, often incorporating certain programmes introduced in
previous sections. These newer linkage initiatives, notably the Industrial Linkage

52
Programme (ILP) and the Global Supplier Programme (GSP), have helped
contribute to several examples of successful SME development.

Created in 1996, under the predecessor of SME Corporation, the ILP originally
promoted selected manufacturing activities, although it is now moving into service
industries as well. The programme seeks to build TNC-SME linkages by offering tax
incentives to SMEs manufacturing eligible products as well as to foreign affiliates
who incur costs by helping to improve SME capabilities. As of 2007, 906 SMEs were
registered under the ILP, of which 128 were linked to TNCs and other large
companies. One of the ILPs recent successes is the increased sourcing of local food
processing SMEs by TNC hypermarkets such as Tesco.

The ILP has been part of the government's efforts to link local food processing SMEs
to foreign-owned retailers. These efforts support the government's objective to
promote value-added activities in agriculture and agro-business after years of
prioritizing industrialization in more heavy and technology-intensive industries. The
sourcing of local food products is particularly important considering that many small
retail outlets, most of which were supplied by local SMEs, began to lose significant
market share when foreign ownership restrictions in the distributive trade sector were
relaxed during the mid-1980s. Tesco and Carrefour now account for 60 per cent of
retail sales and the survival of food processing SMEs has depended on being able to
supply these TNCs.

The GSP funds training and skill development for SMEs in order to make them more
effective participants in global supply chains. Originally created in 2000 as an
initiative by the regional Penang Skills Development Centre (PSDC), the GSP was
quickly expanded at the country-level by SMIDEC (now SME Corporation). Under
the GSP, subsidies are provided to SMEs for training programmes at a variety of
regional centres and institutes. The key element of the GSP in terms of linkage
creation is that TNC representatives design the content of the training programmes
and participants are selected based on TNC criteria. Within its first year, the GSP
had already trained 813 employees from 225 SMEs, with the involvement of 23
TNCs or large domestic companies. Intel, for instance, has made significant use of
the PSDC and the GSP.

53
The Penang Development Corporation (PDC), created in 1969, was effective at
creating infrastructure and incentives tailored to particular TNCs. The State also
acquired a strong reputation among investors for efficient institutions and effective
government leadership. Penang has received some of the highest levels of
manufacturing FDI in the country, particularly in the electronics and electrical sector.
FDI has been used to develop the indigenous industry and SMEs, primarily through
providing a market for local machine tool and contract electronics manufacturers.
The share of TNC procurement from local sources rose from 10 per cent in the early
1980s to 46 per cent in 1996. By 2007, there were over 3,000 SMEs in Penang.

Lessons learned

The success of Malaysia could be summarized into the following factors. The first is
its proactive policies and business incentives. The second reason is MIDA’s
establishment and its services and the Government Linked Companies (GLCs) to
establish heavy industries. The third reason is the emphases given by the
government to build absorptive capacities of SMEs in particular and local industries
in general. The government has also encouraged local SMEs to develop the
capability and technology manufacture intermediate goods to reduce the reliance on
imported intermediate goods. Some of these programmes include vendor
development programmes (VDP), Industrial Linkage Programme (ILP), the Global
Supplier Programme (GSP), technology incubators like the Penang Development
Corporation (PDC). These programmes enabled effective backward, forward or
horizontal linkages with TNCs.

54
Part Three: FDI in Ethiopia: Basic Patterns and Domestic Linkages

5. Basic patterns and distribution of FDI in Ethiopia

5.1. Introduction

There is a growing recognition of the importance of FDI in bridging the financing,

technology and productivity gaps between rich and poor economies. To tap into the
opportunities provided by FDI, policy makers in developing countries have been
reforming their economies, investing in upgrading of their infrastructure, instituting a
myriad of incentive systems and willfully tolerating exploitative and sometimes illegal
trading and labour practices. A growing bandwagon of such forms of reforms and
the removal of restriction on capital flows has significantly increased the international
flow of FDI. According to UNCTAD, for example, the annual inflow of FDI in the world
has grown from 54 billion USD in 1980 to 1.45 trillion USD in 2013 (UNCTAD, 2014).
Countries, such as China, Vietnam, India, and Taiwan have greatly benefited from
this vast flow of FDI in the form of job creation and higher export earnings (Chen,
Geiger and Fu, 2015).

African countries are also increasingly liberalizing their economic regime to both
attract higher levels of FDI and maximize the benefits from FDI presence in their
economies. Between 1980 and 2013, for example, FDI inflow towards developing
countries in Africa has increased from a mere 400 million USD in 1980 to an
astounding amount of 52.2 billion USD in 2013. Some studies report that the
increased FDI inflow has generated large amounts of benefits to the local economy
in Africa, particularly when FDI and domestic firms are connected in supply or
purchase relationships (Amendolagine et al., 2013; Görg and Seric, 2013). Some
other studies, however, are less enthusiastic about the pattern of FDI inflow into the
continent often citing its heavy concentration in the extractive and capital intensive
resource sectors (Zafar, 2007). FDI in such types of sectors often leave the local
economy with limited job creation and technology transfer potentials.

Ethiopia also have benefited from a significant increase of FDI influx; FDI inflow has
grown from 135 million USD to 953 million USD from 2000 to 2013 (UNCTAD,
2014).There are, however, few studies that explore the nature and benefits of the

55
remarkable growth of FDI inflow towards the country. As a result of limited empirical
work on this issue, our knowledge concerning the benefits of FDI to the local
economy and possible policy option that can both further boost FDI inflow and
potentially maximize FDI benefits is highly limited. In this section, we review the FDI
flow patterns, sources of FDI, sectoral contributions, regional distributions, domestic
linkages and FDI’s contribution towards employment, export and technology transfer
using a variety of data sources.8

The rest of this report is organized in the following manner. The next section
describes the evolution of FDI in Ethiopia since the early 1990s. It mainly uses data
from United Nations Conference on Trade and Development (UNCTAD) to illustrate
the pattern of FDI inflow in comparison with regional countries and from the
Ethiopian investment Commission (EIC) to analyze basic characteristics of FDI
committed in the country. Section 3 has two main parts. The first part presents a
simple comparison between FDI and domestic firms using CSA/IFPRI’s data set
collected in 2013/14 as part of the annual Large and Medium Manufacturing
enterprises survey. Using the same data set, the second part explores the density of
linkages between FDI and domestic firms. Section 4 presents descriptive findings
from a rather smaller survey designed to capture the perception of both domestic
and foreign investors in the manufacturing sector. Summary of the key findings are
presented in Section 5. The final section puts forward a brief caveat on methodology
of the study.

5.2. FDI with regional perspective

Following the global trend, annual FDI inflow in East Africa has increased from 197
million USD in 1980 to 14.6 billion USD in 2013 (UNCTAD, 2014).9 Ethiopia’s share
from this stood at 6.5% in 2013. Nearly 40% of all FDI into the region was attracted
to Mozambique in 2013. This is not surprising given that the bulk of FDI inflow into
the country appears to be tied to the resource or extractive sector including coal, oil

8
We define technology transfer as the transmission of production, managerial and marketing
knowhow and improve practices from one firm to the others through direct or indirect links between
the two firms.
9
According to UNCTAD (2014) the regional block labeled as East Africa consists of 17 countries:
Burundi, Comoros Djibouti, Eritrea, Ethiopia, Kenya, Madagascar, Malawi, Mauritius, Mozambique,
Rwanda, Seychelles, South Sudan Uganda, United Republic of Tanzania, Zambia and Zimbabwe

56
and natural gas. To facilitate better comparison between Ethiopia and its regional
neighbours, in the remaining part of this section, we select and focus on five
comparator countries that rely less on the extractive sector to attract FDI. These
countries are Kenya, Mauritius, Rwanda, Tanzania and Uganda.

Figure 4 presents the annual stock of FDI in the six countries from 1992 to 2013. In
the 1990s, while FDI inflow and hence stock was low in the region as a whole,
Ethiopia fared poorly compared even to the level of FDI stock observed in the
comparator countries and throughout the 1990s FDI stock in Ethiopia remained well
below 1 billion USD.

Figure 4: Annual FDI stock in Ethiopia and selected East African Countries

Source: UNCTAD (2015)

Since 2000s, however, FDI inflow towards Ethiopia started picking up rapidly,
overtaking Kenya as early as the year 2000. During the course of the first decade of
the 2000s, Ethiopia remained home to the third largest stock of FDI next to Tanzania
and Uganda. In the early part of 2010s, the majority of FDI entry into Tanzania and
Uganda appeared to be focusing on the vast energy and resource sectors in these
countries. Indeed, this trend is born out in Figure 5. The graph indicates that annual
FDI inflow had picked up drastically for Uganda and Tanzania starting from 2010 and

57
continued with strong upward trajectory throughout the early 2010s for Tanzania and
up to 2012 for Uganda, when it slightly dips in 2013.

In addition to attracting new foreign capital, reinvestment and expansion by the

existing FDI firms in the developing countries is becoming increasingly important.
Since 2010, the growth of the flower industry in Ethiopia, for example, has been
largely driven by the expansion of existing foreign farms. Such trends suggest that
FDI policies are somehow moving from the objective of merely attracting FDI inflow
to better targeting of FDI firms, investment retention and aftercare.

Figure 5: Annual flow of FDI in Ethiopia and selected East African Countries

Source: UNCTAD (2015)

Looking at the past two decades covered in Figure 5, the significant volatility of FDI
inflow across all the six economies is observed. Significant volatility of FDI inflow is
not unique to the East African region; considering a sample of 88 countries over 30
years, for example, Lensink and Morrissey (2001) find that the average year-to-year
volatility of FDI inflow is no less than 50 %. While FDI in general is considered as
relatively less erratic and more predictable form of external financing, its volatility or
rapid decline creates uncertainty reducing future investment.

58
Reducing year-on-year variability and continuously attracting FDI to developing
countries is no easy task. There are several factors that determine the continuous
inflow of FDI; the presence of strong institutional and legal systems, geographical
location, domestic market size, availability of resources, access to factors of
production and raw materials, and the presence of infrastructure facilities determine
the profitability of investment. All these factors have the combined effects on the
ease with which business can be started, operated and expanded thereby affecting
the levels of FDI inflow into the country. In addition to basic business friendly
policies aimed at attracting FDI, studies indicate that the presence of strong and
reliable legal and political institutions, the signing of trade agreements and bilateral
investment treaties as well as economic and political stability stimulates steady flow
of FDI or reduces its volatility considerably (Büthe and Milner 2008).

5.3. FDI in Ethiopia: Basic patterns

This and the subsequent sections rely heavily on the data obtained from the newly
minted Ethiopian Investment Commission (EIC hereon).10 Consistent with Figure 4,
Figure 6 shows that FDI stock in Ethiopia has been rapidly increasing since the early
2000s. Specifically, the FDI stock increased from 4 billion birr (about 487 million
USD) in 2000 to nearly 100 billion birr in 2016 (5 billion USD). Between 2012 and
2013, there also appears to be a big jump in the level of FDI stock, presumably
because of massive inflow of investment from China, Turkey and India in the
manufacturing sector.

10
The Ethiopian Investment Commission (EIC) was re-established in 2014 by the “Ethiopian
Investment Board and the Ethiopian Investment Commission Establishment Council of Ministers
Regulation No. 313/2104”. Before it was renamed EIC, prior to 2014 the Ethiopian Investment Agency
carried out the tasks of issuing licenses and was also in charge of handling incentive and regulatory
issues related with FDI. Unlike EIA, EIC is now bestowed with more mandates and power with its
accountability shifted from the Ministry of Industry directly to the Prime Minister’s office.

59
Figure 6: Annual FDI stock in Ethiopia from 1992 to 2014.

Source: Author’s compilation based on data from Ethiopian Investment Commission.

In the 17 years between 2000 and 2016, the number of operational investment
projects registered under FDI increased from 103 to 2658. As seen in Figure 7 the
number of operational projects followed a similar pattern starting to increase from
early 2000s and then reaching a peak in 2008.11 Figure 7 also shows that FDI
projects that started operation in 2007 and 2009 have contributed the largest to job
creation. The total number of people employed by the FDI sector as of 2016 is
566,000, of which 270,000 is in permanent employment posts. Despite recent
improvements, the levels of jobs created by the FDI sector is not large; the total level
of employment generated by FDI, for example, constitutes a little higher than one
percent of the total labour force, which is estimated at about 45 million people in
2013 (Chen, Geiger and Fu, 2015). Beyond the number of jobs created, the nature of
these jobs is important to determine whether FDI creates good jobs that aid not only
in poverty reduction but also skills accumulation. We will come back to this in the
next section.

11
EIC keeps track of transition of investment from license to operation through the “reporting and
cooperation responsibility”, which is a system of FDI status follow-up. This system requires licensed
investors to report to EIC about the status of their business, including jobs created and capital
invested, on quarterly basis.

60
Figure 7: Annual number of FDI project and levels of temporary and permanent
employment created

Source: Author’s compilation based on data from Ethiopian Investment Commission (1992-2016).

Figure 8 presents licensed FDI projects in three categories, those that are
operational (have started production), those that are in the implementation phase
(are in the pre-production phase or in the process of completing the preparatory
work, such as erecting fences, building factory shaded, installing machine and
equipment) and those that are in the pre-implementation phase (are yet to take any
concrete actions or committed and spend resources to realize their business). As
indicted in Figure 8, the number of projects under the three stages of investment was
few and comparable with each other in the 1990s. Starting from 2002, however, a
noticeable gap emerged between the three, where high levels of licensing appear to
be correlated with a large number of new entrants in the pre-implementation phase.
While the number of operational projects increased significantly in six consecutive
years from 2002 to 2008, it seems to be declining monotonically up to 2016 (except
from 2011 to 2012, where it slightly increases). The number of implementation
projects follows largely a similar trend peaking in 2010 and declining thereafter.

61
Figure 8: Annual number of FDI project by investment status

Source: Author’s compilation based on data from Ethiopian Investment Commission (1992-2016).

5.4. Sectoral distribution of FDI

Table 3 presents the sectoral distribution of FDI aggregated over the periods
between 1992 and 2017. As seen in the table, the two most important sectors that
are vastly luring FDI in Ethiopia are the agricultural and manufacturing sectors.
These are also sectors where FDI created the largest number of both temporary and
permanent jobs. There is some level of FDI presence in the construction and
contracting and real estate, machinery and equipment rental and consultancy
sectors, while its presence is negligibly small in the mining, education, health and
hospitality industries as indicated in Table 3. It is important to note that there are
restrictions on sectors that FDI can engage in Ethiopia. According to the “Investment
Incentives and Investment Areas reserved for Domestic Investors…Regulation No.
270/2012”, FDI is not allowed in banking and insurance, packing, forward, and
shipping, broadcasting and mass media, legal and air transport services.

62
Table 3: Sectorial composition of capital invested, levels of temporary and
permanent employment created by FDI projects (1992 up to March, 2017)

Employment (in thousands of

No of Capital in
workers)
Sector
billions of
Projects Permanent Temporary
Birr
Agriculture 288 8.8 122 180
Manufacturing 1,198 69 107 51
Mining 15 0.5 0.62 0.19
Education 59 0.4 1.89 1.15
Health 56 0.5 1.82 0.39
Hotels (Including Resort
Hotels, Motels and 140 1.8 4.4 2.35
Lodges) and Restaurants
Tour Operation,
Transport and 66 0.2 0.76 0.46
Communication
Real estate, Machinery
and Equipment Rental 605 6.4 12.2 12.4
and Consultancy Service
Construction
Contracting Including 173 11.1 19.4 39.4
Water Well Drilling
Electricity (Generation,
Transmission and 1 0.001 0.0001 0.00005
Distribution)
Other 58 0.7 1.58 5.45
Total 2,659 99.401 272 293
Source: Author’s compilation based on data from Ethiopian Investment Commission.

Table 4 compares FDI and domestic private investment across different sectors.
According to Table 4, the largest number of FDI projects (1198 projects) went into
the manufacturing sector, a share that amounts to 45 percent of all FDI projects
committed between 1992 and 2017. There were a total of 605 FDI projects in real
estate, machinery and equipment rental and consultancy services projects, implying
that a little less than a quarter of all FDI projects were in this sector. 10.8% of FDI
projects were in the agriculture sector making the sector a distant third in the sectoral
rankings of FDI investment.

In terms of capital, the manufacturing sector attracted 69% of foreign capital invested
in the country between 1992 and March, 2017. Receiving capital amounting to 11.1
billion birr, the second biggest sector in terms of capital is the construction and
contracting (including water well drilling) sector. Investment in the agriculture sector
is third following the manufacturing and constructions sectors. Agriculture absorbed

63
about 8.8% of total FDI capital invested in Ethiopia between 1992 and March, 2017.
Levels of capital in the agriculture sector, however, is dwarfed by 69 billion birr FDI
investment committed in the manufacturing sector. Capital invested in real estate,
machinery and equipment rental and consultancy services, have received
investments worth 6.4 billion birr between 1992 and 2017.

Contrasting the sectoral rankings on the basis of employment, nearly 45% of FDI’s
permanent employment is created by the agriculture sector followed by the
manufacturing sector with 39%. Construction, contracting (including water well
drilling) and in real estate, machinery and equipment rental and consultancy services
jointly absorbed about 12% of the total permanent jobs created by FDI. The
remaining 4% of permanent jobs are distributed across other sectors.

64
Table 4: Sectorial distribution, capital invested and employment created by operational FDI and domestic private projects from 1992
to March, 2017

FDI Domestic Private

Capital in billions Permanent Capital in billions Permanent
Projects Projects
of birr Employment of birr Employment
Jobs Numb Jobs
Sector Number Percent Amount Percent Percent Percent Amount Percent Percent
created er created
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Agriculture 288 10.8 8.8 8.9 122 44.9 1,786 23.5 28 42.6 47,531 23.3
Manufacturing 1198 45.1 69 69.4 107 39.4 1,896 24.9 14.1 21.2 70,245 34.4
Mining 15 0.6 0.5 0.5 0.62 0.2 45 0.6 0.3 0.5 70,971 34.8
Education 59 2.2 0.4 0.4 1.89 0.7 411 5.4 3 4.5 20,565 10.1
Health 56 2.1 0.5 0.5 1.82 0.7 121 1.6 1.4 2.1 23,821 11.7
Hotels (Including Resort Hotels,
Motels and Lodges) and Restaurants 140 5.3 1.8 1.8 4.4 1.6 431 5.7 2.7 4.1 17,476 8.6
Tour Operation, Transport and
Communication 66 2.5 0.2 0.2 0.76 0.3 329 4.3 2 3 21,591 10.6
Real estate, Machinery and
Equipment Rental and Consultancy
Service 605 22.8 6.4 6.4 12.2 4.5 2,017 26.5 9.9 14.9 27,744 13.6

Construction Contracting Including

Water Well Drilling 173 6.5 11.1 11.2 19.4 7.1 439 5.8 3.8 5.7 36,453 17.8

Electricity (Generation, Transmission

and Distribution) 1 0 0.001 0 0.0001 0 0 0 0 0 17,321 8.5
Wholesale, retail trade & repair
service - - - - - - 102 1.3 0.8 1.2 2,237 1.1
Others* 58 2.2 0.7 0.7 1.58 0.6 33 0.4 0.1 0.2 3,051 1.5
271.67
Grand Total 2659 100 99.401 100 01 100 7,610 100 66.6 100 204,232 100

65
To put the sectoral contribution of FDI in context, Table 4 contrasts it with private
domestic investment in the same period between 1992 and March, 2017. As seen
from columns 7 through 12, domestic private investment is much more widely
distributed across a wide range of sectors compared to FDI, irrespective of whether
sectoral contribution is measured in terms of number of project, capital invested or
the size of permanent jobs created. Real estate, machinery and equipment rental
and consultancy services is the largest sector when measured in terms of projects;
27% of domestic investment projects are in this sector. Projects in the manufacturing
and agriculture sectors account for 23.5% and 25% of total projects by domestic
investments.

In terms of capital, domestic investment in the agricultural sector is double of the

manufacturing and nearly triple of the real estate, machinery and equipment rental
and consultancy services. Both the absolute value and share of capital committed
and employment generated in the manufacturing sector by domestic investors,
however, seems to be much lower than by foreign investments, signifying further the
importance of FDI in the manufacturing sector. In other words, while the number of
domestic projects in the sector is nearly 60% higher than those of FDI firms; each
domestic investment project on average seems to be smaller both in terms of capital
invested and employment created. For example, domestic capital invested in the
manufacturing sector is only 20% of those invested by FDI in the sector.

Consistent with the prevalence of FDI in the agriculture and the manufacturing
sectors, Figure 9 presents a more disaggregated pattern of FDI flow into these two
sectors. As indicated in the figure, FDI to both the agricultural and the manufacturing
sectors started increasing rapidly from 2005. FDI inflow towards the agriculture
sectors, however, peaked in 2009 and started dramatically declining since 2009. As
a result, the stock of FDI in the sector appears to have leveled off at the value
observed more or less in 2010.

66
Figure 9: Annual FDI flow and stock in the agricultural and manufacturing
sector from 1992 to 2014

Source: Author’s compilation based on data from Ethiopian Investment Commission.

While annual FDI inflow into the manufacturing sector exhibits the usual pattern of
volatility, the trend seems to be generally positive since 2005. As indicated in Figure
9, between 2012 and 2013, FDI into the manufacturing sector increased by more
than 50% contributing greatly to the overall expansion of FDI into the country as
presented in Figures 4 and 6 earlier. This massive inflow of FDI is largely driven by
the entry of new investment from China, Turkey and India. In fact, the pattern of FDI
inflow into Ethiopia appears to be a little similar to that of China. The proportion of
FDI capital invested in the manufacturing sector in China, for example, was 69.9
percent between 1997 and 2008 (Liu, Daley and Varua, 2014).

5.5. Regional distribution of FDI

Once it enters the country, FDI’s choice of investment site is affected by several
location specific factors. The availability of resources, including both natural
resources and skilled labour, wage levels, soft and hard infrastructure, proximity to
both air and land ports, ease of business operation, relative absence of corruption,
local officials’ service provisions and contract enforcement capacity are some of the
key factors that make a specific geographical area more or less desirable compared

67
to other potential investment destinations (see for example, Jordaan, 2008, for
discussion on the determinants of regional choice of FDI in Mexico).

Clustering and agglomeration benefits are also vital in inducing FDI to occupy areas
that are already populated by other investors in the same or different sectors.
Beyond the profit motive, foreign investors would also prefer to invest in locations
where they can enjoy proximity to metropolitan areas to easily access essential
services and amenities, such as education, health and entertainment facilities, for
their employees and family members. In some cases, however, the flow and final
destination of FDI in the country is dictated by existing government system of land
allocation and designation; and hence the availability of industrial land or industrial
parks in some areas and not in others will determine locations which receive FDI
within the country.

Not surprisingly, Figure 10 shows that FDI in Ethiopia disproportionally target two
locations, Addis Ababa and Oromia regions. Of the total FDI stock generated from
1992 to 2017, a little more than 37% of it is invested in Addis Ababa and about 40 %
is in Oromia. The two areas jointly account for more than 77% of total FDI stock and
50% of permanent jobs created by FDI in the country in the same period. Amhara
and SNNPR follow with 9 billion birr (9.4 percent) and 4 billion birr (3.8 percent) of
total FDI stock invested and with 19,000 (7.1 percent) and 8,000 (2.9 percent) of
total permanent jobs created in this period.

68
Figure 10: Regional distribution of FDI stock aggregated from 1992 to March,
2017

Source: Author’s compilation based on data from Ethiopian Investment Commission.

Figure 11 presents the evolution of FDI inflow measured in terms of number of

projects from 1992 to 2014 for the four largest FDI recipient regions. According to the
figure, Addis Ababa and Oromia have always been the two most attractive
destinations for FDI in this period. The number of new FDI projects monotonically
increased in Addis Ababa from 2003 to 2007 and reached the highest point in 2008
before starting to decline up to 2011. More or less, a similar trend is observed in
Oromia as well, with the largest number of new FDI projects registered in 2008. On
the other hand, the number of new projects in Amhara has stayed well below its
highest value (9 new projects) observed in 2004. Similarly, SNNPR and Tigray
appear to have attracted fewer number of FDI projects across all periods covered in
Figure 11.

69
Figure 11: Regional distribution of annual FDI flow from 1992 to 2014 in the
four largest FDI attracting regions

5.6. Sources of FDI in Ethiopia

With the onset of the Structural Adjustment Policies (SAP) of the IMF since the early
1990s, Ethiopia has introduced several market friendly reforms with the aim of
inducing greater participation of the private sector in the economy. As indicated in
the earlier figures, FDI inflow to the country was slow to respond to these changes in
the 1990s and meaningful gains in its annual flow was recorded almost after a
decade, starting from the mid-2000s. This was preceded by the introduction of the
country’s first comprehensive industrial strategy document in 2002/03. This strategy
ushered in a new wave of reforms aimed at promoting export and investment in
priority labour intensive sectors. The FDI regulatory framework also became less
restrictive both in terms of licensing and registration processes and in the number of
sectors that sanctions FDI investment. These reforms seem to have significantly
promoted the inflow of FDI from different sources into the country.

Table 5 presents the list of countries with the largest FDI stock in Ethiopia
aggregated over the past 23 years. Operating more than 21% of the total projects in
the country, China appears to lead the pack in terms of the number of FDI project
followed by India, USA, and Turkey. However, when FDI measured in terms of

70
capital stock is considered, China still remains the largest FDI home country with
Saudi Arabia and Turkey taking the second and third rank. China’s investment
account for 17% of total FDI with Saudi Arabia and Turkey each controlling about 5%
of total FDI stock invested in the country between 1992 and 2017, March. Turkey is
followed by India, China/Ethiopia and joint venture investment between Britain and
the Netherlands.

Table 5: Top 21 source countries of inbound FDI to Ethiopia (FDI stock from
1992 to March 2017)

Capital in billions Permanent

Projects
of birr Employment
Jobs
County of origin Number % Amount % %
created
China 566 21 17 17 32 12
Saudi Arabia 44 2 15 15 14 5
Turkey 86 3 8 8 13 5
India 184 7 6 6 11 4
China/Ethiopia 82 3 5 5 10 4
Britain/Netherlands 4 0 4 4 1 0
Channel
Islands/USA/Ethiopia 6 0 3 3 2 1
Saudi Arabia/Ethiopia 46 2 3 3 6 2
Turkey/Ethiopia 29 1 3 3 2 1
Gibraltar/Ethiopia 4 0 2 2 0 0
France 22 1 2 2 0 0
France/Ethiopia 25 1 2 2 2 1
India/Ethiopia 64 2 1 1 2 1
USA 120 5 1 1 3 1
Egypt/Ethiopia 18 1 1 1 2 1
Netherlands/Ethiopia 57 2 1 1 4 1
Britain/Germany/Nigeria 1 0 1 1 0 0
Kuwait 5 0 1 1 0 0
Sudan 98 4 1 1 3 1
USA/Ethiopia 60 1 1 2 1 1,591
Grand total 2,659 100 99 100 272 100
Source: Ethiopian Investment Commission (2015)

Chinese investment has contributed to about 12% of total permanent jobs created by
FDI. Investment by Saudi Arabia, despite being only second to China with 15% of
total FDI investment, contributed about 5% to permanent jobs. By contrast, Turkish
investment which is equivalent to eight percent of the total FDI stock contributed a
similar 5% to permanent jobs in this period suggesting Saudi investment might be

71
less labour intensive. In contrast, the rate of job creation by the Chinese investment
is more or less comparable to the levels of capital ownership stake they have in the
FDI sector (15% capital and 12% employment).

While there are smaller number of joint venture investments compared to wholly
foreign owned investments, joint venture between Ethiopian and Chinese investors
appear to be the most common type followed by India/Ethiopian joint ventures. Ethio-
Chinese interest also appears to contribute the largest towards jobs creation. The
largest FDI stock, however, is registered by two companies owned by Britain and
Netherland investment groups.

Table 6: All licensed projects in five year intervals by country of origin

Year
1997-2001 2002-2006 2007-2011 2012-2015
Country of Origin Number % Number % Number % Number %
China 4 3.2 120 13.2 294 14.2 408 21.8
Sudan 3 2.4 25 2.8 148 7.2 197 10.5
India 2 1.6 54 6 147 7.1 123 6.6
Turkey 0 0 8 0.9 80 3.9 74 3.9
China/Ethiopia 1 0.8 15 1.7 56 2.7 42 2.2
Saudi Arabia 18 14.4 14 1.5 47 2.3 42 2.2
USA 5 4 57 6.3 138 6.7 35 1.9
Britain 7 5.6 31 3.4 66 3.2 33 1.8
India/Ethiopia 3 2.4 24 2.6 35 1.7 33 1.8
Turkey/Ethiopia 0 0 2 0.2 22 1.1 31 1.7
Egypt 0 0 6 0.7 11 0.5 30 1.6
Saudi Arabia/Ethiopia 11 8.8 17 1.9 30 1.5 29 1.5
Netherlands/Ethiopia 1 0.8 20 2.2 41 2 26 1.4
Britain/Ethiopia 5 4 11 1.2 30 1.5 23 1.2
Sudan/Ethiopia 0 0 9 1 16 0.8 23 1.2
USA/Ethiopia 1 0.8 33 3.6 67 3.2 23 1.2
Italy/Ethiopia 8 6.4 31 3.4 28 1.4 22 1.2
Syria 0 0 0 0 8 0.4 35 1.9
Yemen 0 0 10 1.1 25 1.2 22 1.2
Netherlands 0 0 24 2.6 34 1.6 21 1.1
Other countries 56 44.8 396 43.7 745 36 602 32.1
Grand Total 125 100 907 100 2068 100 1874 100

Table 6 disaggregates the source country data in four to five years intervals starting
from 1997 to better observe trend over time. As seen in the table, Chinese
investment has been monotonically increasing from 1997 to 2014; the number
(percentage share) of licensed projects has increased from 4 (3.2 %) in 1997 to 408

72
(21.8 %) in 2015. Similarly, FDI projects from Sudan, India and Turkey has increased
both in number and percentage share. FDI from Western Europe mainly Britain and
Italy and the US, while has increased in number, its percentage share has largely
declined over time.

Table 7 shows that Investment projects originating from China account for the largest
number of FDI projects licensed between 1992 and 2015. China accounted for
16.5% all licensed projects and 18.7 % of operational projects. In the same period,
21.9% and 18.7% of all licensed and operational projects respectively are from four
countries; Sudan, India, USA and Turkey. As illustrated in the last four columns of
Table 7, the level of engagement of Chinese businesses in the manufacturing sector
is very high. Of the 544 licensed projects in the manufacturing sector from China,
250 of them have started operation. In terms of active engagement in the
manufacturing sector, China is followed by India and Turkey accounting for 9.3% and
5.6% of all operational projects in the manufacturing sector respectively.

73
Table 7: FDI projects by country of origin for selected countries

Manufacturing Operational
All FDI Projects Operational Projects Projects Manufacturing Projects
Country of Origin Number Percent Number Percent Number Percent Number Percent

China 827 16.50 411 18.67 544 25.56 250 27.29

Sudan 375 7.49 85 3.86 129 6.06 27 2.95
India 326 6.51 142 6.45 178 8.36 85 9.28
USA 235 4.69 107 4.86 35 1.64 9 0.98
Turkey 162 3.23 78 3.54 101 4.75 51 5.57
Britain 137 2.73 62 2.82 33 1.55 13 1.42
Saudi Arabia 126 2.51 43 1.95 28 1.32 13 1.42
USA/Ethiopia 125 2.5 54 2.45 32 1.5 15 1.64
China/Ethiopia 114 2.28 59 2.68 87 4.09 45 4.91
India/Ethiopia 97 1.94 51 2.32 50 2.35 23 2.51
Saudi Arabia/Ethiopia 94 1.88 43 1.95 55 2.58 30 3.28
Italy/Ethiopia 89 1.78 48 2.18 41 1.93 21 2.29
Netherlands/Ethiopia 88 1.76 44 2 31 1.46 13 1.42
Netherlands 81 1.62 50 2.27 14 0.66 6 0.66
Italy 76 1.52 41 1.86 22 1.03 13 1.42
Britain/Ethiopia 70 1.4 36 1.64 21 0.99 6 0.66
Yemen 59 1.18 21 0.95 23 1.08 10 1.09
Israel 58 1.16 31 1.41 15 0.7 5 0.55
Canada 57 1.14 20 0.91 9 0.42 2 0.22
Germany 57 1.14 30 1.36 15 0.7 6 0.66
Turkey/Ethiopia 55 1.1 20 0.91 34 1.6 17 1.86
Total Projects 5010 100 2202 100 2129 100 916 100
Source: Ethiopian Investment Commission (2015)
Note. The list consists of 21 wholly foreign owned and joint venture investments from 14 different countries that registered the largest number
of projects in the period between 1992 and 2015.

74
Table 8 provides the number of FDI projects and their relative share at sub-sector
level between 1992 and 2015. Appendix 2 shows the trend for operational projects in
the most recent years starting from 2007. Chinese FDI appears to be large in the
Metal and Engineering sector. Of the 25 FDI enterprises licensed in the basic metal
industry, for example, five are from China.12 Chinese FDI also contributed the
largest share in the production of other metal and engineering products ranging from
metal fabrication to the production of machinery and equipment. EIC has granted
license to 20 projects that target motor vehicles, trailer and semi-trailer production.
Of these licensed projects, however, only six have started production to date. Other
three additional Chinese/Ethiopian joint venture firms have also started operation in
the motor vehicles, trailer and semi-trailer production business. This sector has also
attracted two operational projects from Italian/Ethiopian JVs and two projects from
the Netherlands.

As seen in the second panel of Table 8, the Chemical sector in general and the
manufacturing of Rubber and Plastics Products in particular has attracted FDI from a
wide range of countries. When compared by the number of projects, Chinese FDI
followed by Indian FDI, is a place where 64 projects in the Chemical sector seem to
originate from. In fact, the Chemical sector, more than any other sector, appears to
attract Indian investment; more than 35% and nearly one in four Indian FDI is
invested in the Chemical sector and in the Rubber and Plastics subsector
respectively. In terms of number of projects, however, Chinese FDI seems to be the
largest. In the Rubber and Plastics subsector, for example, there are 69 Chinese FDI
projects, of which 43.5 % have started operation. The corresponding figures for the
Indian investors are 43 % and 48.8 %. While there is five and two FDI projects
originating from the US in the Chemical and Chemical products and Rubber and
Plastic products sub-sectors respectively, only two in the former and one in the latter
industries are operational as of 2015. Similarly, of the seven licensed projects by
Turkish investors in the manufacturing of Rubber and Plastics Products, three have
started operations. Likewise, from the 11 Sudanese projects in the same subsector,
only three have gone operational.

12
Upstream production in the Basic Metal industry involves the mining and extraction of iron ore to
produce iron and steel. Downstream, it involves the production of various types of steel, cold and hot
rolling products using casting facilities or foundries.

75
Chinese nationals are also leading sources of FDI in the Electronics and precision
machinery industry. There are, for example, 31 licensed Chinese investment projects
in the electrical machinery and apparatus n.e.c.13 Of these 31 projects, 11 projects
were already operational as of 2015. This amounts to roughly 32% of all operational
projects in this sub sector. Similarly, from the 13 projects that were granted
investment licenses to engage in the production of radio, television, communication
equipment and apparatuses, eight have already started production.

Agro-processing is one of the sectors that witnessed significant FDI engagement.

Between 1992 and 2015, there have been a total of 639 licensed FDI projects in the
agro-processing sector. From these projects, 33.8 % or 216 projects are operational
at present. Most of the investments in this sector seem to be concentrated on the
processing of food products and beverage as well as in the production of furniture.
The largest number of licensed Investment projects in the agro-processing sector
comes from China and Sudan; as indicated in Table 6, 104 and 73 of these projects
originate from China and Sudan respectively. These countries also seem to have the
largest share of operational projects in the sector, they jointly account for 25% of all
operational projects, with Chinese share standing at about 20%.

Two of the priority sectors explicitly indicated in government development plans,

such as PASDEP II and the GTP are the textile and garment, and the leather and
leather goods industries. Ethiopia seems to attract FDI from mainly China, India,
Turkey and Italy into these sectors. From the 170 FDI projects that are licensed
between 1992 and 2015, 80, 13, seven and nine are from China, India, Turkey and
Italy respectively. Additionally, there are six projects licensed under the joint venture
arrangement between Italy and Ethiopia and four projects under Turkey/Ethiopian
JV.
Chinese, Indian and Turkey investments are also prominent in the other sectors,
particularly in the non-metallic mineral products sector. This sector encompasses a
range of non-metallic products including the production of glass, ceramic and
cements products.

13
n.e.c. abbreviates "not elsewhere classified"

76
 Table 8: Number and share of licensed FDI projects in the manufacturing sector by country of Origin from 1992-2015

China India USA Turkey Sudan

Number Percent Number Percent Number Percent Number Percent Number Percent
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Metal and Engineering
Basic Metals 5 0.9 2 1.1 3 3.0 1 0.8
Fabricated Metal Products, Except Machinery
34 6.3 16 9.0 1 2.9 6 5.9 3 2.3
and Equipment
Motor Vehicles, Trailers and Semi-Trailers 20 3.7 2 1.1 2 5.7
Machinery and Equipment 22 4.1 4 2.3 2 5.7 7 6.9
Chemical
Chemicals and Chemical Products 29 5.3 20 11.2 5 14.3 7 6.9 24 18.6
Coke, Refined Petroleum 2 0.4 1 0.6 1 1.0
Rubber and Plastics Products 69 12.7 43 24.2 2 5.7 7 6.9 11 8.5
Electronics and precision machinery
Electrical Machinery and Apparatus N.E.C. 31 5.7 10 5.6 1 2.9 3 3.0
Medical, Precision and Optical Instruments,
1 0.6 1 2.9 1 1.0 4 3.1
Watches and Clocks
Office, Accounting and Computing Machinery 2 0.4 1 2.9
Radio Television and Communication Equipment
13 2.4 1 0.6
and Apparatus
Agro-processing
Paper and Paper Products 13 2.4 11 6.2 1 1.0 3 2.3
Food Products and Beverage 41 7.6 19 10.7 8 22.9 12 11.9 66 51.2
Furniture, Manufacturing 40 7.4 1 0.6 1 2.9 11 10.9 4 3.1
Wood, Products of Wood; except Furniture 10 1.8
Textile, Garment and Leather Products
Textiles 68 12.5 16 9.0 4 11.4 16 15.8 1 0.8
Wearing Apparel, except fur apparel 37 6.8 10 5.6 4 4.0
Tanning, dressing of leather, & footwear 43 7.9 3 1.7 3 3.0 4 3.1
Other sectors
Other Non-Metallic Mineral products 55 10.1 15 8.4 5 14.3 17 16.8 8 6.2
Other Transport Equipment 7 1.3
Recycling 2 0.4 3 1.7 2 2.0
Total 543 100.0 178 100.0 35 100 101 100 129 100
Source: Ethiopian Investment Commission (2015).

77
6. Linkages between FDI and local firms

The most important factor that seems to underlie the special treatments many
governments extend to FDI firms is their potential to generate positive spillover
effects on the local economy (Aitken and Harrison, 1999).14 The presence and depth
of linkages between FDI and local firms and the attendant benefits in the form of
technology transfer and spillover effects is considered to be critical (Amendolagine et
al., 2013; Javorcik 2004a). It is important to note that spillover effects or technology
transfer are potential benefits of FDI, and there is no guarantee that these potentially
would be realized automatically by the very presence of FDI in the host economy
(Lall 2000; Moran et al., 2005). Indeed, the empirical literature is profuse with
conflicting evidences that report largely mixed results on the presence and depth of
such spillover effects (Aitken and Harrison, 1999; Sadik and Bolbol, 2001; Veugelers
and Cassiman 2004; Javorcik and Spatareanu, 2011).

The lack of robust and conclusive evidence on the extent of technology transfer
generated by FDI firms in the host economy suggests that perhaps attracting FDI is
only the first and necessary step and may not be sufficient to secure the benefits
from it. There are a myriad of factors related to host country characteristics, such as
level of industrialization and market size, and to the nature of FDI (resource,
efficiency or market-orientation), which determine the depth of linkages established
and the extent of spillover effects.

In low income economies where markets may not be functioning properly,

understanding how policy can leverage the benefits from technology learning and
spillover effects is vital. A good understanding of sources and nature of productivity
gains in relation to domestic-FDI firm linkages would help quickly redress market
failures or policy barriers that preclude interactions or transactions between FDI and
local firms. This would also aid policy makers identify and target firms with the
largest potential for FDI and domestic linkages on the basis of size, scope of
technology transfer and other spillover effects.

14
We broadly define spillover effects as the transfer of procurement and marketing knowledge,
process and production technology and management practices or any other useful productivity
enhancing knowledge from FDI to domestic firms (Gorodnichenko, Svejnar and Terrell, 2007).

78
As the first attempt in that direction, this section assesses the level of FDI-domestic
firm linkage that exists in Ethiopia. We rely on a unique data set collected by CSA
jointly with IFPRI in 2013/14.15 The data is drawn from the annual survey of Large
and Medium enterprises, which for the first time included a module on FDI. The
module contains a rich set of questions on FDI-domestic firm interactions including
different measures of vertical linkages (backward and forward) as well as horizontal
linkages. The survey generated data from a census of 1708 manufacturing
enterprises that employ more than 10 workers and use electricity driven machineries
in their production processes. Of the surveyed firms, 310 were FDI firms.

This section has two parts. The first part revisits the state of FDI in Ethiopia in
comparison with domestic firms in the manufacturing sector in further detail. The
second part explicitly examines the presence (or lack thereof) linkages between FDI
and domestic firms.

6.1. FDI and Domestic firms: a simple comparison

Table 7 compares FDI and domestic firms by size, performance, technology

indicators and procurement and marketing practices.16 As indicated in the Table,
FDI firms are much larger both in terms of capital and employment. FDI firms, for
example, employ more than twice as many workers as in domestic firms on average
and the difference is statistically significant even at 1 percent level of significance.

Sales, value added and Gross profit are some of the standard performance
indicators that can be used to gauge the performance of domestic firms against
FDI.17 Across all these measures, FDI firms have larger values than domestic firms.
In 2013, FDI firms tended to have about 2.4 fold times higher sales turnover and
more than 3.35 times higher value addition than domestic firms. In the same year,

15
Using this unique data set, there is an on-going empirical work to rigorously evaluate the level of
technology transfer between FDI and local firms. The project is led by Margaret McMillan at IFPRI,
and funded by a Major Research Grant No. 1386 with a Project title: Ref 1386 "The Role of Asian
Investment in Manufacturing in Catalyzing Economic Development in Africa".
16
To improve inference, we lump FDI and Joint Venture firms together and call them FDI. In the
sample, 52 % of the FDI firms were Joint Ventures.
17
Value added is calculated by subtracting raw material, fuel, electricity, water and transport costs
from sales revenue. Gross profit is the difference between value added and the total wage bill of the
enterprise.

79
FDI firms made a gross profit amounting to 42 million birr on average, which is more
than three times higher than the 13 million birr earned by domestic firms.18

Table 9 also shows that FDI firms are more technology intensive than local firms.
More than one-in-ten FDI firms (11%) stated that they have conducted Research and
Development to help improve their production processes. The corresponding figure
for domestic firms was about 6 %. Similarly, while the difference between FDI and
domestic firms is small in the ownership of nationally recognized patent, Table 7
shows that FDI firms are more likely to possess internationally recognized patents
than domestic firms. A larger share of FDI firms also use technology licensed from
other FDI firms than domestic firms.

The last six rows in Table 9 indicate procurement and marketing practices between
FDI and local firms. Domestic and FDI firms sell 5% and 2% of their output
respectively to other FDI firms within Ethiopia suggesting that FDI firms are relatively
more connected with other FDI firms in supply relationships. Inputs procured from
local sources amount to 55 % of the total production cost in the domestic firms on
average and 44 % in the FDI firms. This signifies that FDI firms are more import
dependent than local firms. Similarly, from total raw materials cost, about 79% is
attributed by locally sourced raw materials in domestic firms and about 70 % in FDI
firms.

18
Since we do not have a good measurement of capital cost, our profit measure does not take
account of the capital cost. Also, tax payments and related expenses are not included in the profit
calculation and hence is labelled as Gross Profit

80
Table 9: Enterprise performance, technology and marketing practices by
ownership type in 2013

Domestic FDI All

Enterprise size and performance measures
Number of workers 80 187*** 86
Paid up capital (in millions of birr) 66.8 92.0 71.4
Sales (in millions of birr) 38.7 93.9*** 48.7
value added (in millions of birr) 14.3 46.6*** 20.1
Gross profit (in millions of birr) 12.9 42.6*** 18.3
Technology indicators
Conducted R&D in the last three years 6.29 11.0*** 7.14
Hold nationally recognized patent 6.37 6.77 6.44
Hold internationally recognized patent 1.43 4.19*** 1.93
Use technology licensed from FDI firm 10.2 13.6* 10.8
Procurement and Marketing
Percent of output sold to FDI (% ) 2 5*** 3
Cost share of local inputs19 (%) 55*** 44 53
Percentage of locally sourced raw materials (%) 79*** 70 78
% of enterprises that export 6 16*** 8
% share of export in total sales 11 7 10
Number of observations 1398 310 1708
Source: Author’s compilation based on CSA manufacturing census 2013/14.
Note. ***significant at 1 %, significant at 5 %, and significant at 10%.

Table 9 also indicates that FDI firms are more likely to export than local firms; the
proportion of exporting FDI firms is higher than that of exporting domestic firms by 10
percent. However, among exporting firms, domestic firms appear to export higher
amounts on average than FDI firms; export constitutes 11 % and 7 % of domestic
and FDI firms’ total sales respectively.

Consistent with Table 9, Figure 12 shows that the kernel density distribution of
labour productivity of FDI firms is located to the right of domestic firms suggesting
that FDI firms tend to be more productive than domestic firms. The long left-tail
associated with the productivity distribution of the domestic firms suggests that there
are a large group of domestic firms that are highly unproductive or are poorly
managed. The productivity distribution for FDI firms appears to be tighter and
compressed than domestic firms, which implies relatively small differences in
productivity levels within the FDI group of firms.

19
Measures the local content share of raw materials in total cost of production.

81
Figure 12: Labour productivity dispersion of FDI and local firms (2013)

.3
kdensity estimates
.1 0 .2

-5 0 5 10
Labor productivity (in logs)

FDI domestic

Source: Author’s compilation based on CSA manufacturing census 2013/14.

In short, Table 9, taken together, with Figure 12 points that FDI firms are larger, have
higher sales turnover, add more value, are more profitable and use better production
technologies and are more productive than domestic firms. There are several
possible explanations as to why FDI firms perform better than their domestic
counterparts. First, since FDI firms start larger, they can benefit from scale
economies associated with size.20 Second, as indicated in Table 9, greater adoption
of technology promotes better production processes enabling cost reduction and the
elimination of non-value adding wasteful production practices. Third, FDI firms can
tap into global sources of procurement, management and marketing knowledge,
which enable them to attain greater production capacity. Lastly, it is also possible
that FDI firms may expand at the expense of local firms particularly when the market
is not large enough to accommodate both large FDI and small domestic firms. Due
to differences in level of technology and efficiency and the firm-specific advantages

20
Our data also confirms this where the initial stock of paid capital in FDI firms were found to be about
15 % higher than the initial paid up capital by local firms.

82
that FDI firms enjoy, FDI firms may easily capture local markets by displacing local
firms leading to either their exit or under capacity production in the short-run.

Another important justification forwarded for attracting FDI is that it introduces new
and better paying jobs for the host economy. Empirical studies show that FDI firms
pay higher wages than domestic firms (Heyman et al. 2007; Csengödi et al. 2008).
To explore whether FDI firms pay premium wages, Table 10 presents wage levels by
different category of workers. Since wages could differ by workers characteristics,
Table 8 also includes education attainment and vocational school completion to
improve inference.

According to Table 10, while there appears to be a 240 birr monthly wage difference
between production workers in FDI and domestic firms, which is not a statistically
significant difference. While the education level attained by these workers is not
different between the two types of firms, larger percentage of production workers (20
%) in FDI firms have completed vocational education in comparison with the share of
production workers in domestic firms that attainted the same levels of education (17
%). The difference in wage levels and education attainment between FDI and
domestic firms among supervisors, foremen and quality control personnel is also
small and statistically insignificant.

According to Table 10, the average monthly wage of marketing workers in domestic
firms is about 2075 birr, which is less than the average wage paid for the same
category of workers in FDI firms by more than 300 birr. The difference does not
seem to be driven by differences in educational attainment or vocation school
completion. Similarly, FDI firms pay their administrative workers higher wages, which
is larger than the wage levels in domestic firms by 686 birr on average per month.
Here too the level of education of administrative workers in the two types of firms
does not differ. The last part of the table also indicates that management workers in
FDI firms receive higher wages than in domestic firms. The difference between
wages in FDI and domestic firms is the largest for this group of workers implying FDI
firm tend to reward higher skilled workers more. In fact, the limited wage premium for
production and supervisory level workers and the higher premium for non-production
workers engaged in marketing, administrative and management is consistent with

83
the observation that internal wage dispersion is higher in FDI firms than domestic
firms (Girma and Görg 2007; Huttunen 2007).

Table 10: Employment and wage by ownership type 2013

Domestic FDI All

Number of workers 80 187*** 86
Production workers:
Average monthly wage 1464 1706 1508
Average years of schooling 9 10 10
% with TVET diploma 17 20** 17
Supervisors, foremen and quality control personnel
Average monthly wage 1849 2081 1891
Average years of schooling 11.8 12.0 11.9
Marketing workers:
Average monthly wage 2075 2389*** 2132
Average Years of schooling 12 12 12
Administrative staff
Average monthly wage 1920 2606*** 2045
Average Years of schooling 12 12.3 12.1
Managers, including low-level managers:
Average monthly wage 4840 5674*** 4991
Average Years of schooling 14 14.5 14
Number of observations 1398 310 1708
Source: Author’s compilation based on CSA manufacturing census 2013/14.

We also inquired about the main challenges that prevent both FDI and domestic
firms from operating at full production capacity. Figure 13 indicates that shortage of
raw materials is the major problem that leads to under-capacity production; 25 % and
20 % of domestic and FDI firms respectively identified raw materials shortage as the
number one problem. Although FDI firms rely more on imports than local firms to
source raw materials, they do not seem to be immune from the problem.

84
Figure 13: Major problems that led the firm to produce below capacity

Source: Author’s compilation based on CSA manufacturing census 2013/14.

Problems related with accessing public utility services, such as water and electricity,
is rated as the most important problem by 12.5 % and 10.5 % of domestic and FDI
firms respectively. Power outages and intermittent interruption of electricity supply
can wreak havoc on manufacturing enterprises. In June 2013, for example, the
national power company (then EEPCO) instructed large companies in the
manufacturing sector to “halt production at peak hours” (Capital, 25 June 2013).
There is little doubt that such forms of explicit prohibition coupled with impromptu
power disruptions lead to under capacity production.

Demand-side issues also appear to be important in preventing enterprises from

reaching their full production capacity. About one-in-ten FDI and domestic firms
appear to view marketing problem as one of the important reasons for not producing
more. Surprisingly, a larger percentage of FDI firms report working capital to be a
major concern, while only 3.5 % of domestic firms consider working capital as a
problem in relation to capacity utilization. Few enterprises judge government rules

85
and regulations as impediments to production; 4 % and 3 % of domestic and FDI
firms consider government rules and regulations creating major problems on
production. Lack of foreign exchange, shortage of spare parts and machine
breakage are also important reasons cited for under capacity production by both FDI
and domestic firms.

6.2. Linkages and technology transfer

FDI can potentially benefit the host country in several ways. For example, FDI can
introduce larger capital stock, create employment and stimulate export. In addition to
these direct benefits, FDI can generate spillover effects towards the local economy
that leads to greater technology transfer. For spillover effects to materialize, FDI
firms must be linked with local or domestic enterprises in some meaningful way. In
fact, without domestic-FDI firm linkages, it is not clear how the domestic economy
would benefit from technology spillovers from FDI firms.

Linkage induced technology transfer can arise under different circumstances. First,
FDI firms introduce new products to the domestic market; domestic firms learn about
the product and attempt to imitate or reverse engineer the product thereby acquiring
new knowledge that enhances their level of technology. Second, Competition
upstream in the input market and downstream in the product market can stimulate
productivity gains in the domestic firms. Competition generates both the threat of
elimination from the market and the prize of winning better deals for producers
thereby improving resource allocation in the economy. Third, collabouration with
domestic firms in joint development of technologies leads to the absorption of better
technologies by the local counterpart. This may involve joint venture arrangements
as well as vertical linkages in production or sourcing of materials in supply
relationships.

In this section, we focus on two important channels of linkages and attempt to

explore whether linked domestic firms perform differently from firms that are not
linked with FDI firms in Ethiopia. We consider two important sources of linkages,
supply and labour linkages.

Supply linkages, including sales of inputs, components and delivery of services to

FDI firms, are very important sources of technology and knowledge spillover effects.

86
Stringent quality and delivery requirements imply that the contracted local firm would
be compelled to exert maximum effort in trying to meet these requirements thereby
upgrading its own production and delivery capacity in the process (Javorcik 2004b).

Building efficient local supply chain help FDI firms reduce the cost of non-labour
input and increase the quality of input and hence this motivates FDI firms to transfer
technology to their local suppliers (Blalock and Gertler, 2005). With this objective in
mind, to help local suppliers meet specific order requirements, FDI firms often
provide technical support in the form of sending experts who offer training to
domestic firm workers as well as providing blueprints and drawings that would guide
procurement, production and marketing processes (Long, 2005). FDI companies in
Mexico, Thailand, Brazil and Malaysia, for example, worked closely with their
suppliers providing them with credit and financing, but more importantly, they
extended managerial and technical assistance on input procurement, quality control
and exporting thereby introducing substantial efficiency gains for the local suppliers
(Moran, 2005; javorcik and spatareanu, 2011).21

In this paper, we define supply-linked domestic firms as those that generate at least
10 % of their sales revenue from sales to FDI firms directly.

Another channel of knowledge or technology transfer is labour linkages or labour

mobility from FDI to domestic firms. Labour trained in FDI firms may either start their
own companies or work with domestic capitalists. The remarkable growth of the
garment industry in Bangladesh is, for example, largely attributed to a few young
technicians who started their own factories after receiving an exceptional technical
training by a South Korean garment manufacturer in the 1970s (Rhee, 1990;
Mottaleb and Sonobe, 2011). Similarly, many of the founders of the largest machine
tool producers in Malaysia had previously worked for FDI firms, and one in ten
workers employed by these companies were also poached from FDI firms operating
in the country (Moran, 2005). In a recent survey of FDI and domestic firms in
Ethiopia, 78% of local firms that employ former workers of FDI firms reported to have
experienced a sizable improvement in their production processes and techniques

21
In Malaysia, for example, Moran (XXX Moran, How does FDI affect host country development;)
reports that of the nine largest machine tool producers in the country seven were initially vertically
integrated with FDI firms in supply arrangements.

87
owing to the presence of workers with prior experience in FDI firms (Abebe and
Gebreyessus, 2013).

In this paper, we define labour-linked domestic firms as those that recruited workers
who were previously employed by FDI firms.

Table 11 disaggregates the data on domestic firms into two separate groups.
Columns 1 and 2 disaggregate the total sample of domestic firms into those that are
linked with FDI firms in supply relationships and those that are not linked. Similarly,
Columns 3 and 4 split the sample of domestic firms into those that employed workers
with FDI firm experience and those who do not have such types of workers. The final
column presents the sample average for all domestic firms in the sample.

The first row of Table 11 indicates percentage of enterprises that are linked with FDI
firms either in supply or labour relationships. As shown in the table, 7.5 % and 7.0 %
of domestic firms are supply- and labour-linked respectively. Linked firms are more
likely to be located in Addis Ababa than unlinked firms reflecting the advantage
associated with metropolitan areas.

As stated earlier, competition is an important source of productivity improvement.

Horizontal linkage appears in sectors where FDI and local firms produce same or
similar commodities destined for the local market resulting in competition in the
output market. Table 9 shows that supply linked domestic firms particularly perceive
FDI as a major competitor with more than one in four of supply-linked domestic firms
feeling stiff competition from FDI in the product market. Similarly, nearly 40% of
labour linked domestic firms sense strong competitive pressure from FDI firms in the
product market. As expected, the majority of linked enterprises that stated to have
faced competition from FDI identify competition for the local market as the main
source of competition.

Table 11 also shows that both supply linked (30%) and labour linked (38%) have
experienced adverse effect on their sales turnover due to competition from imports.
Yet the competitive pressure from FDI appears to have helped linked domestic firms
to upgrade their production techniques and processes. To keep up with the FDI
firms’ level of technology in the same sector, 35% and 46% of supply linked and
labour linked domestic enterprises respectively report to have improved their

88
production techniques/processes. In the same manner, 21 % and 38 % of supply-
and labour-linked domestic firms respectively state that they have directly adopted
production techniques/processes by observing or copying from foreign competitors.
This is consistent with the notion that competition can potentially stimulate local firms
to innovate and improve their production practices as their survival would be
increasingly at risk. Blomström and Sjöholm (1999), for example, find that domestic
firms operating in the same industry as FDI benefitted from significant productivity
gains from strong intra-industry spillover effects triggered by FDI presence in
Indonesia.

Table 11: FDI-domestic firm linkages and competition in the product market
2013 (% of enterprises)

Supply Labour All

Linked Not Linked Not
linked linked
% of domestic enterprises 7.5 92.5 7.0 93.0 100
% located in Addis Ababa 53.3 26.96 44.33 27.79 28.94
Faced strong competition in the 26.4 14.6 39.8 13.6 15.5
product market from FDI
Competition in the local market 67.7 77.0 72.0 76.1 75.8
Competition in the export 22.6 8.67 14.0 9.78 10.6
market
Competition in the both 9.68 14.3 14.0 14.0 13.7
markets
Sales suffered because of 30.2 13.9 38.8 13.2 15.0
competition from imports
Changed production techniques 34.9 13.8 45.9 13.1 15.4
due to competitive pressure from
FDI
Adopted production processes by 21.0 11.9 37.8 10.7 12.6
observing FDI firms
Total number of observations 1292 106 1300 98 1398
Source: Author’s compilation based on CSA manufacturing census 2013/14.

We also examine the influence of competition upstream in the input market. Since
labour is a more commonly used input, Table 12 presents the perception of domestic
firms on the intensity of competition for skilled labour and the productivity effect of
employing former workers of FDI firms. Compared to competition in the product
market, fewer domestic firms report to have faced competition in the labour market.
This is true of both linked and un-linked domestic firms in the manufacturing sector.

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By definition, more labour linked domestic firms will sense greater competition
arising from FDI in the local labour market; 9.43 % and 28.6 % supply and labour
linked domestic firms stated that they have faced competition from FDI in the local
labour market in relation to the employment of skilled workers. Interestingly, labour-
linked domestic firms do not only employ former FDI workers, they also tend to lose
their workers to FDI firms; 42 % of these firms said they have lost skilled workers to
FDI firms.

Table 12: FDI-domestic firm linkages and competition in the labour market

Supply Labour
Not Not All
Linked linked Linked linked
Competition in the local labour 9.43 5.57 28.6 4.15 7.01
market
Lost skilled workers to FDI 12.3 7.28 41.8 5.08 7.65
firms
Employed workers from FDI 17.9 6.11 0.00 100.0 7.01
firms
Changed production 73.7 61.7 65.3 - 64.0
technologies
Managerial practices 10.5 6.17 7.14 - 7.0
Organizational structure 0.00 8.64 7.14 - 7.0
Knowledge of how to export 10.5 8.64 9.18 - 9.0
Other benefits 5.26 14.8 11.2 - 13.0
Total number of observations 1292 106 1300 98 1398
Source: Author’s compilation based on CSA manufacturing census 2013/14.

Table 12 also presents the effect of employing workers who had prior experience
with FDI firms. Similar to the effect of product market competition, the employment of
workers with FDI experience is related with positive changes in production
technologies. While more domestic firms linked in supply relationships with FDI
firms (74 %) report to have changed their production technologies, more than 61 %
of domestic firms that are not connected with FDI firms in supply relationships report
to have changed their production technologies as a result of the recruitment of
workers with FDI experience. Smaller effects are also observed in managerial
practices, organizational structure and knowledge of export.

To get a better sense of the impact of supplier-induced technology transfer, we have

also asked domestic firms whether their interactions with their customers (their

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supply relationships) have resulted in a change in production technologies. As
indicated in Table 13, 42.5% of supply-linked and 64.3% of labour-linked domestic
firms stated that their supply relationships with customers required additional or
special investment targeting the improvement of production practices. Of those who
responded in positive to this question, more than 60% and 72% of supply- and
labour-linked domestic enterprises respectively stated that their supply links with
domestic firms resulted in technology transfer from their customers.

Table 13: FDI-domestic firm supply and customer relationships

Supply Labour All

Linked Not Linked Not
linked linked
Domestic firm as a supplier to other firms
(FDI and non-FDI)
Additional investment in production 42.5 26.3 64.3 24.8 27.5
technology or human capital upgrading induced
by customers (%)
Technology transfer from customer 60.7 55.6 72.7 53.5 56.2
% technology transfer from FDI 42.0 12.5 29.1 14.2 16.3
Nature of customer related technology transfer
Changed production technologies 71.2 65.4 75.0 64.5 66.1
Managerial practices 17.3 20.5 11.8 21.6 20.1
Organizational structure 7.69 11.6 11.8 11.1 11.2
Knowledge of how to export 3.85 2.53 1.47 2.89 2.68
Other firms (FDI and non-FDI) as
suppliers to the domestic firm
Additional investment in production 10.4 8.05 16.3 7.62 8.23
technology or human capital upgrading induced
by customers (%)
Technology transfer from suppliers 47.8 44.0 63.2 42.2 44.4
% technology transfer from FDI 64.7 9.74 38.9 12.4 15.2
Total sample size 1292 106 1300 98 1398
Source: Author’s compilation based on CSA manufacturing census 2013/14.

The last column of Table 13 shows that, 56% of domestic firms who required
additional investment because of their supply relationships report to have benefited
from such relationship in the form of technology transfer. The additional investment
appears to have led to technology transfer in 42% of supply linked and 29% of labour
linked domestic enterprises. However, as indicated in the cell designated by the

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interaction of the third row and the last column, only 16% of domestic firms that
experienced additional investment due to their customers state that FDI was the
main source of technology transfer. Consistent with Table 12, Table 13 shows that
the most common effect of technology transfer is observed in the change of
production technologies. More than 71% and about 75% of supply- and labour-
linked firms, and about 65% of unlinked firms report to have experienced a change in
production technologies arising from their supply relationships with their customers.
As indicated in Table 13, linkages do not seem to be leading to sources of changes
in managerial practices, organizational structure and knowledge of export.

We also examined whether domestic firms also benefit from their interaction with
their own suppliers (earlier we looked at domestic firms being suppliers to other
firms; we now look at the flip side of the relationship between domestic firms and
their suppliers). As indicated in Table 11, 10% and 16% of supply- and labour-linked
firms were stimulated to make additional investment in production technology or
human capital as a result of their interaction with suppliers. Given that most of the
domestic firms rely on local raw materials (about 80%, see Table 7 for further detail),
they are likely to deal with small firms that do not have superior production
technology or knowledge to share with their customers unlike FDI firms. Of the very
few who were encouraged to invest in upgrading production technologies or human
capital, however, 44% reported to have experienced technology transfer from their
suppliers. Labour-linked domestic firms particularly seem to benefit more from their
relationships with their suppliers. The source of technology transfer depends on
whether the firm is linked with FDI or not. While the sample average for this group of
enterprises is only 15.2 %., 65% of those that are linked in supply relationships claim
to get the new technology from FDI firms.

Table 14 presents the level of technology intensity for linked and unlinked domestic
firms. As indicated in the table, linked firms are more likely to introduce important
changes in the past three years than unlinked firms. Nearly a third of linked firms
committed resources to buy new machines or upgrade existing ones. Nearly one in
five domestic firms claimed to have come up with better product design in the last
three years irrespective of depth of linkages with FDI firms. About 8% of supply
linked and 15% of labour-linked firms stated that they have expanded the variety of

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products they offer. Slightly more unlinked firms report to have improved the quality
of their product, workers and managerial skills. On the other hand, more linked firms
report to have started using new forms of distribution channels and better supply
chain management.

Table 14: Business changes and technology use

Supply Labour
Not Not
Linked linked Linked linked All
Important changes in the business in the last 68.9 64.4 76.5 63.9 64.5
three years (Yes=1)
The first most important improvement
Machinery investment 37 30 33 31 31
Better design 19 19 19 19 19
Increase variety of products 8 12 15 11 12
Increase quality of products 23 28 21 28 28
Improve working premises 4.3 2.8 2.7 2.9 2.9
Workers skill improvement 0 2.9 2.7 2.7 2.7
Managerial skill improvement 0 0.8 0 0.8 0.8
New forms of distribution 1.4 1.7 2.7 1.5 1.6
Better supply chain 4.3 2.4 2.7 2.5 2.5
Organizational modernization 0 0.8 1.4 0.7 0.8
Others changes 0 0.3 0 0.3 0.3
R&D and Patent
Conducted R&D in the last three years 14.2 5.65 19.4 5.31 6.29
Hold nationally recognized patent 9.43 6.11 14.3 5.77 6.37
Hold internationally recognized patent 2.83 1.32 6.12 1.08 1.43
Use technology licensed from FDI firm 17.9 9.52 31.7 8.54 10.2
Total sample size 1292 106 1300 98 1398
Source: Author’s compilation based on CSA manufacturing census 2013/14.

The last part of Table 14 presents four useful indicators of technology levels. The
table shows that a larger percentage of linked firms (both supply and labour) are
more likely to invest in Research and Development (R & D) than unlinked firms. In
the whole sample of domestic firms, investment in R & D is just a little above 6 %,
while investment in R & D among group of enterprises that are either supply or
labour linked is about 17 % and for both supply and labour linked enterprises is
about 37 % (not shown in the table). Linked firms are also more likely to hold
nationally and internationally recognized patents and are more likely to use
technology licensed from other FDI firms.

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Table 15 presents several performance indicators for both linked and unlinked
domestic firms. As indicated in the tables, both supply- and labour-linked firms enjoy
much larger sales turnover than unlinked enterprises. While supply-linked firms
slightly have lower value addition and gross profit, labour-linked firms have 3.5 and
3.3 times higher value addition and gross profit than unlinked firms. Both supply-
and labour-linked firms tend to sell their output to FDI firms (or are more likely to be
connected with FDI firms in supply relationships). These firms are also less likely to
use local suppliers and seem to be more import-dependent. Table 15 shows that
while comparable percentage of supply-linked and unlinked enterprises are engaged
in export, 13.4 % of labour-linked firms are exporters, a figure which is more than
double of the unlinked enterprises.

Table 15: Performance indicators by linkage type 2013

Supply Labour

Linked Not linked Linked Not linked All

Sales (in millions of birr) 50.1 37.8 86.6 35.2 38.7

value added (in millions of birr) 12.9 14.5 42 12.3 14.3
Gross profit (in millions of birr) 10.7 13.1 37.5 11.1 12.9
Percent of output sold to FDI (% ) 30.6 0.07 5.0 2.17 2.37
Cost share of local inputs (%) 48.1 55 46.4 55.1 54.6
Percentage of locally sourced raw materials (%) 70 80.1 70.6 80 79.4
% of enterprises that export 6.7 6.3 13.4 5.8 6.3
% share of export in total sales 16.9 8.25 6.8 10.7 6.97
Total sample size 105 1291 93 1266 1396
Source: Author’s compilation based on CSA manufacturing census 2013/14.

Figure 14 presents the labour productivity distribution of supply-linked and –unlinked

domestic firms separately along with the productivity distribution of FDI firms. The
kernel density productivity distribution of supply-linked firms is situated well into the
right of unlinked domestic firms. The distribution is also highly compressed with
narrow tails indicating limited productivity variations across supply-linked firms.
Surprisingly, for the most part, the productivity distribution of supply-linked firms is
located to the right of even FDI firms. This suggests that the linked group of firms
constitute few domestic firms that are highly productive even in comparison with FDI

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firms. More or less a similar pattern emerges when one looks at labour-linkages in
Figure 15.

Figure 14: Labour productivity dispersion of supply-linked and un-linked

domestic firms and FDI firms (2013)
.5

Domesitc firms linked with FDI firms

.4
kdensity lnlabor_prod
.3

FDI
.2

Domesitc firm not linked

.1
0

-5 0 5 10
x

Linked Not Linked

FDI

Source: Author’s compilation based on CSA manufacturing census 2013/14.

Figure 15: Labour productivity dispersion of labour-linked and un-linked

domestic firms and FDI firms (2013)
.4

Domestic firms linked with FDI firms

.3
kdensity lnlabor_prod

FDI
.2

Domestic firms not linked

.1 0

-5 0 5 10
x

Linked Not Linked

FDI

Source: Author’s compilation based on CSA manufacturing census 2013/14.

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6.3. Investors’ Perception on FDI and linkages

This section uses evidence from a small survey (containing both quantitative and
qualitative questions) to help us better understand the state and interaction of local
and FDI firms in Ethiopia. Due to the limited number of observations from which data
is collected, we do not intend to draw any statistical inference from the relationships
we observe. Instead, we try to present a succinct summary of perceptions and
suggestions of both local and FDI firms concerning the investment environment and
the interactions between the two groups of firms in the local economy.

The findings from the perception-based analysis are strikingly similar to the
quantitative evidence presented earlier.

The sample used in this section was drawn from a list of firms in CSA’s annual
manufacturing census 2013/14 round. We restricted our relevant population to firms
that employed more than 100 workers and those that are located in Addis Ababa and
in the stretch of land between Addis Ababa and Adama. As shown in the previous
sections, about 60% of firms in the manufacturing sector are located in Addis Ababa
and Oromia regions. Larger firms are more likely to interact with each other and with
FDI firms. Using a sample of larger firms thus offers us a better insight on the
presence (or lack thereof) of linkages in the local economy. In total, we surveyed
about 26 domestic firms and 14 FDI firms. While we do not stratify firms by sector in
drawing our sample, as will be discussed shortly, the sector of operation is balanced
across the two samples.

i. Basic characteristics of firms

A. Domestic firms

The domestic firms in the sample are engaged in different sectors. The majority of
these firms are engaged in labour intensive sectors, such as food processing and
beverages (five firms), textile and garment (three firms), leather, leather producer
and footwear (two firms) and wood and wood products (two firms). The rest of the
domestic firms are engaged in rubber, foam and plastic products (three firms), metal
and metal products (two firms), pharmaceutical, botanical and cosmetics products

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(three firms), packing and printing (four firms), construction materials and cement
(two firms).

Most of the domestic firms are private limited companies (PLCs) and about five are
state-owned enterprises (SOEs). About 58% of these firms started operation after
2000. Nearly half of these firms financed 100% of their initial investment from their
own sources. Four firms reported to have received investment loan from the
Development Bank of Ethiopia averaging about 48 % of their start-up capital (ranging
from 30 % to 70% of start-up capital). Similarly, six companies have financed their
initial investment using loans from commercial banks. The average loan size from
commercial banks amounts to 60.8 % of total start-up capital (ranging from 30% to
100% of start-up capital). Interestingly, none of the domestic firms had taken loan
from both DBE and commercial banks to finance their initial investment.

The survey data also shows that the majority of domestic firms do not export (20 of
them had zero sales revenue from export). Export appears to be common among
enterprises engaged in labour intensive sectors, such as food processing, textile and
garment and leather. Among the exporters, the year of export start and the export
market destination appears to be diverse. Exporting is often carried out through
global buyers, commission agents and using trading companies. The major export
challenges reported by the firms are: 1) lengthy customs clearance procedure, 2)
poor transport logics and, 3) marketing problems.

B. FDI firms

The FDI firms in our sample are from China, India, Turkey, United Kingdom, France
and Maturities. There are also five joint venture companies in the sample. Most of
these firms are private limited companies and three are share companies. Similar to
the domestic firms, about 50% of the FDI firms are engaged in the labour intensive
industries; i.e., food processing and beverages (four firms), textile and garment (one
firm), leather, leather producer and footwear (two firms). The seven remaining FDI
firms are active in chemical and chemical products (two firms), rubber and plastic
products (three firms), metal and metal products (one firm) and cement (one firm).

Using their own sources, 85% of these firms financed 100% of their investment.. One
firm financed 50% of its investment using loan from foreign-based commercial bank.

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In contrast, none of the FDI firms have taken loan from commercial banks in
Ethiopia, while one firm has obtained 70% of its start-up capital from DBE. Similarly,
no single firm in the sample had received grant or assistance from its home country
to invest in Ethiopia. Regarding the mode of entry, eight of the FDI firms entered
Ethiopia through green field investment and six were either through merger or
acquisitions. Except one firm, firms that invested newly in the country (green field)
entered Ethiopia after 1991, while the merged or acquired firms are a little older. In
general, the average year of entry is 1998.

Of the 14 firms, only four had positive export figures in 2015, and three of them
started exporting recently after 2010. Among the exporting firms, two export 100% of
their products. Germany, Somali, South Sudan and USA are main export
destinations for these firms. Similar to the Ethiopian companies, FDI firms mainly
carried out their exporting through global buyers. Shortage and inferior quality of raw
materials and inputs, poor transport logistics and lengthy customs procedures are
main export challenges faced by these companies.

ii. FDI domestic firm linkages

As discussed in length in the previous section of this report, the presence of FDI
firms in the local economy can potentially have both positive spillover and negative
externalities on the local firms. We inquired domestic firms regarding their perception
of FDI companies in stimulating both positive and negative spillover effects in
Ethiopia. We also asked FDI companies their perception of the capability and
prospect of Ethiopian operated businesses. By asking perception questions, we
hoped to gather more diverse responses that reflect the experience, held beliefs and
opinions of respondents that influence actual behavior and decision making patterns
of firms.

A. Domestic Firms

The survey data shows that FDI firms are perceived to contribute positively to the
introduction of new technologies (57.7 % of firms), marketing techniques (61.5 % of
firms) and the employment of FDI-trained workers (30.8 %). On the other hand, 77 %
of the firms consider FDI as an important source of competition that led to loss in
market share (61 %) and skilled workers (50 %). About 42 % of the domestic firms

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also think that the presence of FDI firms has led to credit rationing worsening their
access to finance.

There were 12 domestic firms who believed that FDI firms pose strong competition in
the local market. These firms were asked whether they have experienced any
meaningful benefits from competing with FDI firms. Except three firms that stated
that they did not perceive any benefits from FDI as the result of competitions, the
rest described a wide array of benefits from FDI-related competition. FDI is
perceived to have helped in improving quality and delivery timing of products, in
providing technology and marketing information, increasing capacity of production,
likelihood of technology upgrading and competitiveness of the firm. Of these
perceived benefits, FDI’s role in encouraging the production of quality products and
the adoption of better technology are cited as the two most important benefits arising
from competing with FDI firms.

While competition can generate positive spillover effects, it can also potentially lead
to negative externalities particularly if the market size is small or market power is
asymmetrically distributed between FDI and local firms. The survey asked about the
main challenges domestic firms faced as a result of competitive pressure from FDI
firms. A rapid loss of market share and skilled labour appear to be the two most
important negative effects local firms claim to have experienced because of
competition. Few local firms also claimed that FDI firms charge lower prices with the
malevolent intention of controlling the local market after purging local competitors out
of the market. The difficult to compete with FDI is also presumed to be due to lack of
better technologies, financial capital and skilled labour that can aid in improvement of
existing products or in the introduction of new and more profitable line of products.

We also inquired whether local firms are connected with FDI firms in supply
relationships.22 About 46% of the local firms stated that they have supply linkages
with FDI firm. These firms were asked whether and what forms of benefits they have
experienced from working with FDI firms. The most common benefit resulting from
the supply relationships appears to be improved access to larger quantity and quality
of raw materials to the domestic firms on timely basis. Relatedly, supply relationships
are also claimed to reduce the difficulty associated with accessing foreign exchange
22
Supply relationships involve both buying from and selling to FDI firms.

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to import raw materials which are not produced locally. Supply relationship is also
associated with knowledge transfer, better acquisition of physical capital (machines
and equipment), part and components, better prices, and access to global marketing
information.

Yet, except two firms, most of these firms that are working with FDI firms report to
have experienced some challenges in dealing with FDI firms. Lack of capital and
foreign currency shortage, limited production capacity, low quality production, lack of
skilled labour and higher prices charged by FDI firms are some of the notable
challenges reported by domestic firms.

The other 14 firms that were not connected with FDI firms in supply relationships
were also asked why they were not interacting with FDI firms. Some of the firms
stated that their sector of operation does not allow for the participation of FDI firms
and thus could not work with them. For example, a steel factory claimed that there is
no FDI firm that is active in supplying scraps and other necessary input in the metal
working sector. Similarly, a foam and plastic factory stated that no foreign firms are
engaged in supplying of raw materials and inputs required in their sector and hence
they have to rely on imports. Some of the local firms also do not have interest to
supply FDI firms as they claim to have sufficient and well-established market
supplying domestic customers.

B. FDI firms

Similar to the case of domestic firms, the large majority of FDI firms (79 %) claim to
have faced competition from local firms in the domestic market. FDI firms perceive
that competition has led to significant improvements in the domestic firms’ levels of
production technology, efficiency, product quality, marketing practices, workers’
skills, and imitation of improved practices in many aspects of firm operation. Yet
competition is also perceived to have led to some negative impacts on the
operations of local firms. Since domestic firms have limited capacity a priori, FDI
firms think that some of them have lost significant market shares, some have even
exited the market altogether, due to competition. Domestic firms often operate with
large overhead, transport and marketing costs and have limited financial capital to
withstand shocks, and hence are often vulnerable to price reductions by FDI firms.

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Many of the FDI firms are also linked with domestic firms in supply relationships.
FDI firms believe that such linkages can generate useful advantages to domestic
firms. The most common benefit appears to be the larger profit margin that would
accrue to the domestic firms when they supply to FDI firms. Some FDI firms also
mentioned the prospect of technology upgrading and knowledge transfer through
supply relationships as the main benefits. Some of the challenges of working with
domestic suppliers are lack of flexibility in contracting, higher prices, poor quality of
supply, limited production capacity, volatility of production and inability to deliver on
time. Problems in quality of supply and meeting strict specifications are also
mentioned as the main reasons for not sourcing their supplies from domestic firms
by those who stated that they are not connected with domestic firms in supply
relationships.

Unlike domestic firms where more than three in four expressed willingness to work
with FDI firms, most FDI firms stated that they would not like to work with domestic
firms in joint venture arrangements. The main reasons forwarded by firms that do
not want to work with FDI firms is also similar in spirit to the challenges discussed by
those who would like to work with domestic firms in JV arrangement. The majority of
these firms stated that they do not need to form any sort of partnership as they do
not expect any benefits from joining with domestic firms. There is also a concern that
domestic firms’ inefficiency can contaminate foreign firms. As one of the firm
representatives put it “domestic firms may bring their inefficient work system and kill
the FDI factory”. Consistent with this, the majority of FDI firms deem domestic firms
to have worst levels of technological, managerial and marketing capabilities as well
as inferior levels of workers’ skill and limited export knowledge. They thus do not
value joint ventures as important win-win businesses arrangements.

However, those who are willing to work with domestic firms expect domestic firms to
benefit in the form of larger capital stock, greater availability of working capital, the
transfer of international marketing experience, the recruitment of skilled labour and
technology learning from joint venture arrangements. These FDI firms also expect
some challenges in working with local firms; local firms have limited capital and
inefficient technologies to form joint ventures; the work culture in Ethiopian

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companies is not compatible with the FDI counterparts’ mode of operation; and
setting up JVs may create management difficulties.

iii. Summary

FDI is increasingly viewed as an important vehicle for economic development that

can potentially fill in the resource, technology and productivity gaps between rich and
poor economies. Inspired by the successes of East and South Asian countries, many
developing countries have thus been introducing a myriad of reforms that remove
restriction on capital flows in the hopes of attracting foreign capital. There are,
however, few studies that attempt to look at the nature of FDI inflow and its attendant
benefits to the local economy in the context of Ethiopia. Using different data sources,
this paper presented largely descriptive empirical evidence on the state of FDI in
Ethiopia and its interaction with the local economy. The main objective of this study
is to compare and contrast FDI with local firms and investigate the presence of
linkages and technology transfer benefits to the local economy. We hope this would
lay the groundwork for weighing in possible policy options that can both further boost
FDI inflow and potentially maximize FDI benefits to the local economy.

In order to have a better understanding of FDI flow patterns, sources of FDI, sectoral
contributions, regional distributions, domestic linkages and FDI’s contribution
towards employment, export and technology transfer, we employed: 1) aggregate
level data from EIC and UNCTAD, 2) CSA’s annual Large and Medium
Manufacturing survey, which for the first time contained a module on FDI (collected
with IFPRI), 3) Our own small survey of domestic and FDI firms to understand
investors’ perception on linkages and technology transfer.

Data from EIC and UNCTAD shows that similar to many African countries, Ethiopia
has been striving to attract FDI and maximize the benefits from FDI presence in its
economy. With FDI stock reaching more than 5 billion USD in 2014 from less than
500 million USD in 2000, this effort appears to yield some positive progress in more
recent years. Unlike other African countries (Mozambique, Tanzania and Uganda, for
example) in the region that received large FDI in energy and resource sectors, FDI
projects in Ethiopia increasingly appear to target the manufacturing sectors, where
the sector received about 42% of FDI projects and 72.3% of total FDI investment

102
committed between 1992 and 2014. Yet FDI in Ethiopia appear to be concentrated
in Addis Ababa and Oromia; from all FDI that entered the country between 1992 and
2014, more than 80% of total FDI stock and 50% of permanent jobs created by FDI
is situated in Addis Ababa and Oromia.

Ethiopia particularly seems to be enjoying increasing influx of investment from non-

traditional investment sources, such as China, India and Turkey. Chinese and Indian
investment is predominant in the metal and metal working sector, as well as in the
chemical, rubber and plastic sectors. The agro-processing, textile and garment,
leather and leather goods industries attracted foreign investors from China, Sudan,
India, Turkey and Italy. On the other hand, Investment from Western Europe appears
to be on the decline as share of total FDI. The number of Chinese FDI projects
licensed in the manufacturing sector in contrast grew from 3% in 1997-2001 to 22%
2012-2015. Moreover, 26% of licensed and 28% of operational projects in the
manufacturing sector are from China signifying the growing importance of Chinese
investment in the manufacturing sector in Ethiopia.

Using the CSA/IFPR data set, we compared FDI and local firms across different
dimensions. The comparison produced the following key findings: 1) Across different
size indicators, FDI firms are found to be much larger; tend to own larger capital
stocks, employ twice as many workers, enjoy 2.4, 3.35, 3.1 times larger sales
revenue, value added and gross profit respectively, 2) using a measure of labour
productivity, we find that FDI firms are more productive than local firms, 3) FDI firms
are more likely to export than local firms, 4) FDI firms appear to use better
production technologies and are more technology intensive than local firms, 5) while
the wage paid to production workers is comparable between FDI and domestic firms,
FDI firms tend to pay higher wages for non-production workers engaged in
marketing, administrative and management types of work.

We also disaggregated the CSA data by defining supply and labour relationships
between FDI and domestic firms and attempted to check whether there are
horizontal and vertical linkages due to such relationships. This is aimed at analyzing
the density of linkages between FDI and domestic firms and their implications on
production technology and processes of domestic firms. We find that linkages
between FDI and domestic firms are highly limited. Only 7.5% of domestic firms are

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linked with FDI firms in supply relationships; i.e., from the sample of all domestic
firms, 7.5% of them generate at least 10% of their sales revenue by supplying FDI
firms. In the same way, about 7% of domestic firms have employed workers that
were previously employed by FDI firms.

Despite the small shares of domestic firms that are linked with FDI firms, those that
are linked in some ways with FDI appear to experience positive changes in the way
their businesses are operated. More precisely, both supply and labour linkages are
found to be important sources of investment in upgrading production technologies
and in the transfer of technology from FDI to domestic firms. Supplying relationship,
for example, is found to be one of the channels through which domestic firms acquire
improved technology from FDI, which often leads to improvements in production
technologies. Similarly, horizontal linkages, as manifested by competition from FDI in
the local market, leads to improvements in production processes and techniques.
Linked firms are also more likely to report to have improved their production
processes by imitating or copying the production processes from their foreign
competitors. While there are also some gains in the form of managerial practices,
organizational structure and exporting knowledge, the levels of gains do not seem to
differ between linked and unlinked domestic firms.

We also find that linked firms are more likely to introduce new and important
changes to their business than enterprises that are not connected with FDI in supply
or labour relationships. Linked domestic firms tend to also engage in R &D, possess
both nationally and internationally recognized patents, and procure technology
licenses from FDI firms. Likewise, the employment of former FDI workers is
associated with positive changes in production technologies among the majority of
firms. While competition for labour appears to be less intense than competition in the
product market, the effects of employing former workers of FDI firms is considerable.
The recruitment of these workers is reportedly associated with positive shocks to
production technology of the firm for both supply-linked and -unlinked firms. We also
find that labour productivity differs noticeably between linked and unlinked domestic
firms with the productivity distribution of linked firms displaying higher levels and
limited within group productivity variations. In contrast, the productivity distribution of

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unlinked firms shows that there are many poorly run domestic firms with low levels of
labour productivity.

The EDRI survey on perception of FDI and domestic firms, albeit with smaller
number of observations, yields highly consistent results with the findings from the
quantitative survey. The presence of FDI in the local economy is perceived to result
in product quality improvement, better delivery time, and improved access to
technology and marketing information, greater capacity of production and enhanced
competitiveness of local firms. Supply relationship with FDI firms is particularly
considered to stimulate knowledge transfer, improvements in production processes,
investment in physical capital (machines and equipment) and part and components
and access to global marketing information.

iv. Notes on Methodology

We would like to state that the results discussed thus far are illustrative and we
advise for caution in interpreting the results. We are, for example, careful not to
attribute any of the relationships or differences in outcomes we observe between FDI
and domestic firms to causation or as being the result of linkages. There are some
methodological concerns that preclude sweeping conclusions. The most pressing
concern is called selection problem in the economics literature. On the one hand,
domestic firms that connect themselves with FDI firms might have different sets of
characteristics than those that do not form linkages from the outset. For example,
domestic firms that are highly productive or have higher growth prospect are more
likely to search for good foreign partners that help them realize their potentials and
hence initiate the linkage processes with FDI firms .On the other hand, FDI firms
often select to work with already productive firms and thus linkages and technology
transfer might themselves be determined by the productivity levels of the domestic
firms.

Similarly, domestic firms that employ former workers of FDI firms are able to do so
perhaps because they can pay more or/and offer better working conditions. Higher
wages and better and well-organized working environment are positively correlated
with productivity levels. As such, these firms might be more productive than other
domestic firms that did not employ FDI trained workers from the beginning. Under

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this circumstance, it is difficult to disentangle the effect of linkages from the effect of
embedded productivity levels that exists even without linkages or the employment of
FDI trained workers.

Another important caveat in the interpretation of the results is that they are largely
based on perceptions of firm managers. This approach based on subjective
evaluation can potentially suffer from endogeneity problem as the firm’s subjective
evaluation or perception of FDI may depend on its performance, among others. For
example, highly productive firms might be exposed to more competition with FDI
than less productive ones. More productive firms may thus understate the
productivity enhancing effects of the competition compared to domestic firms who
might target the lower rung of the market in terms of product quality.

In addition to endogeneity, such approach also does not allow us to measure other
strong and indirect effects that may not be easily observable to individual managers
(e.g. positive externalities in the form of improvements in quality of inputs and
negative externalities in the form of higher wages). In addition, the effect of FDI may
be heterogeneous across different firm types and localities, with firms in the same
industry as FDI and those that are located close to FDI potentially enjoying the
greatest benefit. While the consistency of the descriptive results across a battery of
variables do lend them some credence, further empirical work is warranted to
determine the effects of FDI on domestic firm productivity at the local level.23

23
The ongoing research led by Margaret McMillian (Tufts-IFPRI) with Girum Abebe (EDRI), Iñigo
Verduzco-Gallo (Laterite), Deborah Brautigam (SAIS - Johns Hopkins), and Michel Serafinelli
(University of Toronto) is attempting to establish empirical evidences on the existence, strength and
effects of linkages between FDI and domestic firms in more rigorous manner.

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7. Mapping Technological Capabilities of the Priority Sectors

Technological capability is the sum of resources needed to generate and mange

technical changes. These resources include skills, knowledge, experience as well as
particular kinds of institutional structure and linkages necessary to produce inputs for
technical change. Transferring technology from where it originated or matured is one
of the channels for technological capability development. In many developing
countries, Foreign Direct Investment (FDI) has a direct bearing on technology
transfer at sectorial or national levels especially for the manufacturing industries to
build technological capability.

The beginning of the 20th Century marked the genesis of FDI in Ethiopia. It was a
time when the volume of imports increased significantly. Imports directly affected the
trade imbalance at a macro level and resulted in inadequate access to consumable
goods at the micro level. These triggered the establishment of small industries
mostly by foreign investors to get advantage of the market opportunities created.

At the end of the 1940s, efforts were also made to establish meat-processing,
tanning, and cotton and textile industries: industries that could have foreign market to
obtain foreign exchange. The efforts were not effective due to low levels of technical
knowhow and shortage of finance. Hence, the emphasis was on attracting capital
and technology from abroad through direct foreign investment which is the first
attempt to correlate FDI with technology transfer for local capability building.

Technological know-how is still one of the critical challenges to achieve targets set in
the growth and transformation plan to establish and develop the manufacturing
industries base of Ethiopia. For instance, the supplies of low quality raw materials,
the uses of backward technology coupled with low capacity utilization were some of
the stumbling blocks in the first GTP.

Hence, the bottleneck for the modernization of Ethiopia either in the early or modern
times is partly linked with low level of technological capability which is the nation’s
present and future assignment. This demands knowledge of what has been done
and/or achieved up to now.

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Technological capabilities are in general tacit, firm and sector-specific. Its
accumulation is one of the factors that help to explain the success or failure of
countries. Technological capability at national level is measured with generation,
diffusion and human capital. At firm or sector level, technological capability could be
generally measured in investment, production and linkage capabilities (Lall, 1987).
i. Investment capabilities are the skills, knowledge and organization needed to
identify, prepare and obtain technology to design, construct and equip an
expansion or a new facility. They include capital costs of the project, the
selected technology and equipment and the understanding gained by the
operating firm of the basic technology involved.
ii. Production capabilities start from the last step of the first typology: basic
technology skills such as quality control, operation and maintenance, to more
advanced ones such as improvement or adaptation to research, design and
innovation. This implies mastery of technology and, in others, minor or major
innovation.
iii. Linkage capabilities (learning mechanisms) are the skills, knowledge and
organization needed to transmit information, skills and technology to receive
knowledge from component or raw material suppliers, consultants, service
firms and technology institutions. They also include access to external
technical information and support (from foreign technology sources, local
firms and consultants and the technology infrastructure of labouratories,
testing facilities, standards institutions and so on) and access to appropriate
“embodied” technology in the form of capital goods from the best available
sources, domestic or foreign.
Technological capability has been built in the priority sectors. The government of
Ethiopia has established six major priority sectors including agro-processing, textile
and apparel, shoe, leather and leather products, metal and engineering, chemical,
and pharmaceutical industries. It has also identified four other potential areas
including bio-technology, electrical and electronics products, ICT and software parts
and products and packaging manufacturing for GTP II and III.

The aim of this study is to analayze and synthesize technological capabilities of the
Ethiopian manufacturing sector that focus on those priority industries. To address
this aim, the priority sectors’ technological capabilities, technological gaps, and

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policy options to fill the gaps are investigated and defined based on secondary data
and literature review. Interviews were arranged with the leaders of the six industry
development institutes and four corporations, since they are key players in
technology development of the sectors and in expanding the industrial bases of the
priority sectors to support the study with fresh data and validate the results. The
interviews were successfully conducted with the exception of Metal and Engineering
Corporation (METEC) and the Industrial Zones Development Corporation. The
names of the development institutes and corporations are listed below:
i. Chemicals and Construction Materials Development Institute
ii. Chemical Industry Corporation
iii. Leather Industry Development Institute (LIDI)
iv. Metal Industry Development Institute (MIDI)
v. Textile Industry Development Institute (TIDI)
vi. Meat and Dairy Technology Development Institute
vii. Food, Beverage and Pharmaceuticals Industry Development Institute
viii. Sugar Corporation

The interviews were conducted based on ten questions that are instrumental for
measuring technological capabilities of a sector across the value chain. In addition to
these, the interview questions were geared to identify foreign investments’ roles and
gaps for technology development in particular and the industrial development of the
country in general. Summary results of the interviews are given as part of the
summary at the end of this section.

In this section, the technological capabilities of the priority sectors will be analyzed
based on the parameters mentioned above including investment, production and
linkage capabilities. The analysis will be made on the value chain of individual
sectors to identify technological gaps, define investment opportunities that could be
addressed through FDIs to fill the gaps, and finally, interview results of the
development institutes and corporations are given.

7.1. Textile and Apparel Industries

The GTP II has laid out a vision for the textile and garment products sector.
Achieving the GTP II will require a dramatic expansion of existing production and

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export exponentially. This demands the creation or entry of new textile and garment
firms both from local and foreign investors across the value chain.

The textile and apparel vertical value chain falls into five distinct segments: (i) the
production of raw materials including natural fibers (cotton, wool, silk, etc) and
synthetic fibers (petroleum, gas); (ii) the manufacture of yarn through spinning for
natural fibers and petro-chemical processing for synthetic fibers; (iii) the
manufacturing of fabrics including weaving, knitting, dyeing, painting and finishing;
(iv) the making of clothing through designing, cutting, buttonholing, ironing,
packaging, etc.; and (v) the retailing of the finished items including branding,
marketing and servicing.

The textile and apparel value chain of Ethiopia has technological capabilities where
we could build up. However, there are also technological gaps where we need to fill
up to meet the targets set in the GTP II and ensure sustainable growth of the sector.

Figure 16: Textile and Apparel Vertical Value Chain

Raw Materials Yarn Fabrics Clothing Retailing

Technological Capabilities

Years of experience have been accumulated in building technological capabilities on

cotton farming, yarn production from cotton, fabrics manufacturing, garment and
hand-made products. Brief notes on the capabilities of individual components are
given as follows:

Cotton production has long been underway in Ethiopia. Cotton is grown throughout
Ethiopia at elevations above 1000 meters and below 1400 meters. Ethiopia has
about 3 million hectares of suitable land for cotton cultivation. Only 76,000 hectares
has been used so far. There are three types of cotton farms, namely, state farms,
commercial farms, small-holder farms (SHF). Generally, SHFs produce lower grade

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cotton and most high grade cotton is produced by commercial farms with new
technologies. At 100% of suitable land usage, Ethiopia could be the fourth largest
cotton producer in the world. Moreover, Ethiopian cotton can be cultivated at high
standard with staple lengths ranging from 25-31 mm. Ethiopia possesses the most
important resources to be a leading international producer of cotton. However, since
the potential is not sufficiently utilized due to limited capability, it was unable to
supply the input for the few textile industries; in 2013/14 the import reached about
6,000 tons. (International Cotton Advisory Committee, 2014)

Currently, there are 16 companies producing cotton yarn. Ethiopian spinning mills
can currently produce a maximum of 87,100 tons. However, the average capacity of
the plants is only around 60% (52,260 tons) due to old machinery, poor management
and lack of trained labour. This is likely to cause a supply gap which will tend to
increase unless more yarn can be produced. The presence of cheap and locally
abundant cotton and inputs (land, labour, water, electricity) creates a compelling
case for investment on textile production, though it requires a large amount of up-
front capital for investment in machinery.

Approximately one-fourth of major firms registered with Textile Industries

Development Institute (TIDI) are textile-only producers. Indeed, the two largest
factories are both vertically integrated, even though the overall industry development
level suggests that Ethiopia is most competitive in cotton textile manufacturing for
the time being. A barrier worth mentioning is the lack of important complementary
industries; for example, a chemical industry that can produce export-quality dyes.
Having to import accessories and other inputs makes the industry especially
susceptible to the current customs and logistics challenges.

Ethiopia has strong technological capability in the making of clothes. Over 50% of
the registered industries in the sector in Ethiopian Textile and Apparel Development
Institute are garment industries. By their very nature, garment industries are labour-
intensive and have lesser technological complexity. Firms can easily establish a
garment factory as there are trainable cheap labour, and low labour, factors including
land, electricity, and water which are easily available at cheap price though the
factories’ profit margin is limited. Most textile and garment industries in Ethiopia are
operating below their capacity. The problem is due to limited production capabilities

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of the sector. Low productivity also inhibits Ethiopia’s time and price
competitiveness. The Ethiopian garment industry is characterized by small producers
to a greater extent. Shortage of domestic suppliers of accessory and sewing thread,
absence of trusted constant supplier, and delay of raw materials are some additional
challenges of the garment industries.

Ethiopia is one of the few remaining environments in which organic cotton is

authentically grown. Most small-scale cotton farmers still use animal dung as
fertilizer. There is also a strong historical tradition of hand-loomed organic cotton
textile production in Ethiopia, dating back at least 3,500 years. The tradition, artistry,
and skills required for hand-loomed cotton production are intrinsic to Ethiopia,
providing a natural competitive advantage. Organic cotton growing, spinning, and
hand-weaving are labour intensive. It is evident that there are extremely high profit
margins across raw material types, ranging from 45% to 62% for handmade garment
products. It gives a profit and cost breakdown for a simple 100% cotton scarf. Labour
comprises 45% of the total cost of production, an enormous opportunity to capitalize
on Ethiopia’s labour advantage. Sourcing raw materials locally reduces input costs
and creates local value. Finally, the high value of administrative costs illustrates the
necessity of significant investment in marketing. This business model requires strong
expertise in process, branding, marketing, and design. The success of the product
relies on strong global marketing and branding, often through internationally
recognized brand ambassadors and cutting edge design.

With regard to linkage, Ethiopia enjoys a strategic geographic location between

fabric sourcing markets in the East and garment consumption markets in the West,
such as: duty-free and quota-free exports to the US and European markets under
the African Growth and Opportunity Act (AGOA), the Everything but Arms (EBA)
agreement. Moreover, Ethiopia has preferential tariff rates to Eastern and Southern
African markets through the Common Market for Eastern and Southern Africa
(COMESA) agreement.

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Technological gaps

The textile and apparel industries have technological limitations and gaps on raw
materials and accessories processing, capacity utilization, and quality control. More
specific gaps are given below.

 Ethiopia is predominantly using cotton for natural fiber production. The cotton
itself is not fully utilized due to access to quality seed, fertilizer, pesticides and
large scale irrigation investment. In addition to cotton, other potential sources
of fibers including silk, wool, and polyester, viscose, nylon and acrylic, are not
properly explored and exploited.
 Limited access to inputs and accessories in the country like that of chemicals
for textile industries and zippers, sewing thread and button for garment
industries are influencing production capacity and quality of productions.
 Old machines severely limit quality and productivity of local producers.
Besides being slower, these machines limit the ability to produce evenly spun,
woven, and knitted yarn. In addition, it increases cost of maintenance, cost of
production and reduces productivity and convenience of working environment
(KOICA, 2013).
 In general, the production capacity of actors in the entire value chain is found
to be limited to address the local and international demands which have direct
bearing on the firms’ level of technology and economy of scale. For instance
there are very few large foreign industries which have adequate dye facilities.
 Testing and quality assurance facilities to monitor quality of the inputs, work-
in-process and the final products are in short supply in the individual firms as
well as in the sector.

Opportunities for FDIs

Foreign direct investments could be encouraged in the two extremes of the textile
and apparel value chain: expanding raw material supplies and leading garment
industries.

Currently, the raw material in the Ethiopian textile and apparel value chain is mainly
dependent on cotton. Other raw materials like wool and silk from natural fibers and
polyester, nylon, and acrylic from manmade or synthetic fibers in the country are

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either limited or none. Hence, FDIs could be engaged in diversifying the resource
base including cotton which will have a big push effect on the forward value chain
(downstream) of the sector.

The garment subsector could play a leading role in the textile and apparel value
chain. However, most of the local garment industries are operating at low scale and
at the same time, with very few exceptions, they are not operating with full capacity..
Hence, FDIs could scale up current production either through original investment in a
new garment factory, or through a joint venture with or investment in an existing
smaller-scale garment producer. If the garment industries significantly scale up and
take the leading role in the textile and apparel value chain, then it will have a big pull
effect on the backward (upstream) chain of the sector.

7.2. Leather and leather products industries

The critical components of the Ethiopian leather and leather products industries’
value chain constitutes: hide and skin supplies, tanneries, leather goods, footwear
and marketing. The government of Ethiopia, in its GTP II has set targets for
tanneries, leather goods and footwear sub-sectors to significantly increase their
overall production, capacity utilization and export earnings.

Figure 17: Ethiopian Leather and Leather Products Industries’ Value Chain

Leather Goods

Hide and Skin Tanneries Retailing

Footwear

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Technological capability

Ethiopia has a very large livestock population by global standards, which provides
the raw material base for the current leather industry. Ethiopia's livestock population
is estimated at 52 million cattle, 27 million sheep and 23 million goats, totaling 2.8%
of the global population of these animals. Yet this population does not yield an
adequate supply of skins relative to its size. In addition, problems with the quality of
many of the skins supplied limit the price received and market opportunities for the
leather and leather goods industries.

With regard to quality, pre-slaughter issues include ectoparasites and insufficient

care for live animals, while post-slaughter issues are linked to treatment of hides and
skins across the long value chain to the tanneries. Issues restricting quantity include
poor breeding (small size of cattle, sheep and goats) and one of the world’s lowest
off-take ratios. Coupled with these, poor infrastructure regarding all aspects of
markets and marketing networks has further suppressed the development of the
hides and skins sector.

The tanning industry has a very long history and is the leading subsector in exporting
its products from the manufacturing industries. Currently, there are about 31 medium
and large tanneries with a capacity of 187.2 million square feet for sheep and goat
skins and 58.68 million square feet for hides. These tanneries have managed to
produce fully-processed leather (primarily sheepskin) by introducing new
technologies and are exporting almost 80% of their products to the international
market. However, the sector is not well integrated with the Ethiopian shoe and
leather products industries which is theoretically considered as a comparative
advantage in the value chain. Moreover, Ethiopia’s leather tanning industries are
characterized by very low annual capacity utilization, due in part to the highly
seasonal supply of hides and skins, which is linked to key slaughtering periods on
the Ethiopian calendar. As a result, the industry could process over twice as many
hides and skins as it actually does in a given year. With its current installed capacity,
the subsector could meet the GTP’s targets.

Currently, there are 17 medium and large mechanized footwear factories in the
formal sector, of which 2 are foreign (Ara Shoes from Germany and HuaJian from

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China). Nine of them have expansion projects. There are also a footwear cluster and
over 90 cooperatives constituting the small and micro enterprises. The actual current
capacity utilization of these firms is close to 55%. Ethiopian firms have typically
focused on men’s and children’s clothes and casual shoes and boots, but are now
also exporting women’s shoes and reportedly will also export safety shoes. The
focus is on leather shoes, while none-leather shoes are not taking roots in the sector.

There are more than 20 companies operating in the leather goods and garments
sub-sector, including three glove manufacturing companies in the medium and large
scale. There are about 500 cooperatives in the small and micro enterprises group.
Although most of the firms are operating with a small capacity, recently, a long-
standing foreign-owned tannery began successfully producing and exporting leather
gloves to leading markets, and concretely demonstrating the potential in the industry.
Ethiopia has a diverse portfolio of exporting leather gloves to European, American
and Asian countries like Germany, US and Thailand in the last five years. Though in
small volumes, the production of specific niche products like sports and fashion
gloves shows a great potential for Ethiopian products because they are now selling
in very high quality demand countries.

Technological gaps

Technological gaps in the leather and leather products industries are highly related
with quality of inputs, capacity utilization, integration and limited varieties of products.

 Quality of hides and skins are highly correlated with the treatment of live
animals in the pre-slaughter house and handlings of hides and skins in the
post-slaughter house. In addition, low level of technologies in the tanning
industries to upgrade low quality hides and skins.
 Low capacity utilization is common in all the subsectors of the Ethiopian
leather and leather products manufacturing industries.
 The experience thus far illustrates that the expectations for organic growth of
the local industry could not be realized. Tanneries are not in a position to feed
the footwear subsector and the footwear subsector as the tip in the value
addition process is not able to lead the Ethiopian leather sector as a whole.
For instance, Ethiopia currently exports between 80-85% of the finished

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 leather produced, because the shoe industry cannot absorb the supply. But
local shoe factories cite difficulties obtaining a reliable supply of quality
finished leather. The problem is that they are competing with international
finished leather customers, with longer term contracts, higher scale and more
regular orders. However, there are a number of solutions whereby the
Ethiopian shoe industry can provide attractive customers for local tanneries:
outreach to large buyers, joint venture, investing at scale, importing finished
leather
 Up to now, more emphasis is given to leather shoes but rubber, synthetic and
textile shoes are not yet fully used for the sector’s development in general

Investment Opportunities

In the leather and the leather products industries the footwear subsector is assumed
to have a leading roles. However, the current phenomena in the subsector
demonstrated that the footwear industries are not playing their roles. For instance,
local tanneries, rather than supplying finished leather to the local footwear industries,
they are exporting majorities of their outputs. On the other hand, the subsector
mainly concentrates on the leather shoes. Hence, FDIs could be encouraged in
developing the footwear sectors to scale up their production and expand varieties of
products including rubber, plastic, and textile shoes. In effect, the leather value chain
will be organically integrated and technological capability of the sectors in the
upstream will be established.

In addition to footwear, other leather products that are on the tip of the value chain,
like the glove production, could be taken as opportunities for FDIs. It is possible to
replicate the existing successful model of foreign investment in glove production by
attracting new foreign firms to establish production capacity in the country.

7.3. Metals and engineering industries

The metal and engineering industries value chain constitutes mining and refinery,
basic metals and steel, fabricated metal products, machinery and equipment, and
motor vehicles. The basic metals and engineering industries have multiplying effect
on other sectors like agriculture mechanization, infrastructure, textile, garment,

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leather and other priority sectors in the country. Due to this, the sector has been
given special focus in the GTP II plan.

Figure 18: Metal and engineering industries value chain

Machinery and
Equipment

Mining and Basic Metals Fabrication

Refinery and Steel

Motor
Vehicles

Technological capability

Ferrous and non-ferrous metal mining is not yet started in the county. Recycling of
iron/steel, copper, aluminum scraps have been used as basic inputs to the basic
metal industries. There is an established capability to produce billets and cables from
scraps and wastes of metals. However, for many of the high value items, the raw
steel would still need to be imported as there are capable industries that can process
that steel into higher value-added products.

The metals sector, especially fabricated metal products, is not an externally-focused

sector, with relatively fewer links to either international buyers or investors than
leather, textiles, or agro-processing. However, it is a strategically important sector
providing critical inputs whose price and quality impact the competitiveness of other
manufacturing industries. However, for technical applications and galvanized
structures, domestic producers are hampered by high material cost and limited
galvanization capacity. The primary reason for producing under capacity (currently
the industry is at about 50%) is insufficient raw material. As a result, many
galvanized structural components continue to be imported, and potential export
opportunities are lost. For example, EEPCO has been importing electrical tower
structures from abroad for its massive transmission expansion efforts.

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Another important component is production of spare parts for leather industries,
vehicles and other industries. Moreover, spare part production would represent a
move forward into more complex fabricated metal products.

Currently, the involvement of Metal and Engineering Corporation (METEC) in

machineries and equipment manufacturing is the predominant activity in the county
in the subsector. METEC took the responsibility to handle the construction and
erection of the big projects including sugar industries, fertilizer industry, and
electromechanical works of the Ethiopian Great Renaissance Dam Project. METEC
also has numerous initiatives to assemble transformers, agricultural machineries
(assembled about 5000 tractors), construction machineries (assembled about 1000
equipment), and assembled and manufactured about 4000 trailers. Moreover,
METEC is also in a process of manufacturing key engineering products such as
engine, turbines, pumps, bearings, hydraulic machineries, compressors, furnaces,
tankers, etc. It has also a plan to build local capabilities to assemble and
manufacture leather industries, textile and garment industries, food, beverage and
chemical industries following investors’ demands.

There is an established technological capability to assemble and build automobiles

(could assemble up to 400), trucks (up to 1000 per year), trailers, and buses (up to
1000 buses per year). There is also visible attempt to manufacture parts of an
airplane in Ethiopian Airlines and rolling stock for the national railway lines by
METEC.

Technological gaps

The metals and engineering industries are facing technological limitations such as
access to raw materials, low level of capacity utilization with few exceptions,
technical knowhow and others.

 Despite the overall low level of sector development, a number of the

engineering sector firms are looking for ways to expand into new types of
production and new scales of production. But, they are concerned about
maintaining competitiveness when faced with high input costs.
 Some structural steel components can be produced domestically but in
addition to high materials cost, lack of galvanization capacity means that a

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 large number of these products must still be imported. Addressing these
constraints could boost import substitution and possible metal exports.

 The value addition in the sector is minimal which significantly reduces the
competitiveness of the firms.
 Since the design and manufacturing capability is limited, more emphasis is
given to semi knockdown (SKD) than complete knockdown (CKD)

Investment opportunities

One of the basic problems in the metal and engineering industries is access to raw
materials. FDIs which could expand the raw materials base, mining and refinery,
could be in general encouraged. For instance, metal industries which can produce
different sizes of sheet metals, angle iron, hallow sections, other basic inputs to the
metal fabrications, spare parts, machineries, equipment and vehicles production.

In the metal and engineering industries, the automobile (vehicle) industries are the
leading in the global value chain. Currently, there are local and foreign investments
in automobile assemblies with limited size and capacity to tap the domestic market
which is created due to the high import duties and protection. Although the value
addition of the automotive sectors is limited at its current condition, FDIs in the
subsector should be encouraged as they will consider the upstream with time and
should also be export oriented to address the regional auto market. Most machinery
sectors started from simple assemblies and worked their way upstream. These types
of investments should be encouraged for a certain period of time after the operation
started.

Similarly, though the machinery sector is currently tiny in Ethiopia, it represents an

opportunity to add significantly more value and to increase the country’s capacity for
complex and strategic production. Hence, FDIs in this subsector will provide lower
cost inputs for other industries; machinery products can overcome the high cost of
metal inputs by significant value addition which reduces the contribution of raw
material cost to the overall cost structure.

FDIs could also be encouraged in the area of spare parts production to the priority
industries such as textile and garment, leather industries, sugar, cement, chemical,

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beverage, food industries and vehicles to build local capabilities and spare parts
production will by itself trigger machinery and equipment production.

7.4. Agro-processing Industry

Agro processing industries are relatively simple and provide an important opportunity
for Ethiopia to build industrial capabilities and strengthen the linkage between
agriculture and industry. Agro-processing value chain describes the entire range of
activities undertaken to bring a product from the initial input-supply stage, through
various phases of processing, to its final market destination, and it includes its
disposal after use. For instance, agro-food value chains encompass activities that
take place at the farm or rural level, including input supply, and continue through
handling, processing, storage, packaging, and distribution. The agro-processing
industries are predominantly food and beverage industries. Technological
capabilities and gaps in these sectors are briefly described below.

Figure 19: Agro-food Value Chain

Input Supply Handling Processing Storage and Distribution

Packaging

Technological capabilities

The notion of transforming agricultural activities to industrial activities is now

changing. Agriculture itself could be industrialized and at the same time it has strong
linkage with the industry sector. The agro-processing industry is a typical example
which has a linkage with agriculture. Ethiopia has unique climatic advantages and
low factor costs that enable it to produce and process a wide variety of agricultural
outputs.

The food processing sector of Ethiopia is the largest manufacturing industry in the
country. Food industries include grain milling, bakery, macaroni, spaghetti, enriched
foods, edible oils, spices, juices and sugar. By its nature, most food processing
industries use agricultural outputs as inputs and do not require high technology to

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process which helped the sector to catch up and establish local technological
capability in the subsector. This could be illustrated by the development of sugar
industries with local capacity. According to the report, there are over 560 enterprises
in the food manufacturing sector. These manufacturers provide more than 60,000
jobs. Most of the manufacturers are private (536). Grain millers and bakeries
together account for 370 of the total number of industries.

The beverage subsector includes industries producing malt, beer, wine, alcohol and
liquor, soft drinks, mineral waters, roasted and grinded coffee, and processed and
packed tea. There are about 110 medium and large industries in the subsector. The
technological capability in the sector is mixed – some of these industries have well
established technological capabilities and others do not. If we see the brewery
industry, foreign brewers battle for Ethiopia’s beer market. Heineken (HEIN.AS),
Diageo (DGE.L) and Dutch brewer Bavaria, and France's Castel Group have
snapped up state breweries or built new ones in the past few years with state-of the
art technology in the world. They are demonstrating full capacity utilization. Wine and
soft drink producing industries are exhibiting similar performance.

On the contrary, though Ethiopia is the birth place of Coffee Arabica and it is the
major export of Ethiopia, the country has been dependent for decades on raw coffee
export. So far, the processing and value addition have not yet been successful.
Capacity utilization is also limited in this industry.

Ethiopia also has potential in meat and dairy products. Annually the subsector
produces over 90,000 tons of meat from cattle, sheep, goat and chicken; and over
four billion liters of milk. However, the types, quantity, and quality of the products
failed to satisfy even some of the local demands.

Technological Gaps

There are a wide variety of agricultural products that could be used as input to the
agro processing industries. However, the quality and productivity of the agricultural
products limits the food industries’ performance and competitiveness. There are food
industries dependent on imported agricultural products.

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The agro processing industries constitute the largest share of the Ethiopian
manufacturing sector and it has a large market size both in the local and
international markets. At present, however, agro-processed products represent a
very small share of exports. Because processed products generally have a low
value-to-weight ratio, there is some disincentive to trade; however, long product shelf
life as well as variations in production efficiencies and costs counter this to some
extent.

Food product varieties are limited to conventional products. For example Ethiopia
has demonstrated considerable success in cultivation and export of tomatoes, green
beans, papaya, peppers, potatoes, ginger, citrus fruit, peas, and onions, and more
recently, producers have begun to also grow strawberries, passion fruit, avocados,
pomegranates, guava, fresh herbs, and bananas for export. However, the variety
and volume of juices produced are very limited.

Value addition and capacity utilization in some of the subsectors like coffee are
major impediments to earning maximum revenue from its comparative and
competitive advantages.

Unavailability of high quality food packaging materials is also becoming a bottleneck

to the food and beverage industry development.

Opportunities for FDI

In general, in the food industries, the local technological capability is comparatively

good. In addition, Ethiopia has huge potential for further development of emerging
food processing industry sectors such as cereals, pulses, oilseeds, fruits and
vegetables, spices, coffee, tea, potato, livestock and meat, poultry, dairy, and
aquaculture (fish).

Given the technological capability and access to raw materials for processing, the
agro processing sector has a number of opportunities for foreign investors. Hence,
FDIs could be attracted in the processing of agricultural products if they could
produce high quality products which will address the local and international quality
requirements.

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In cases where the raw material supply is limited, FDIs could also be involved in
agricultural products with good varity, high productivity and production.

7.5. Chemical Industries

The chemical industry creates an immense variety of products which impact virtually
every aspect of our lives. While many of the products from the industry, such as
detergents, soaps and perfumes, are purchased directly by the consumer, 70% of
chemicals manufactured are used to make products by other industries including
other branches of the chemical industry itself. The main raw materials of the
chemical industry are fossil fuel, water, air, salt, limestone, sulfur, and other
specialized raw materials. The industry converts these materials into products; a
chief characteristic of the industry is that its products almost always require further
processing before reaching the final users.

Given the complexity of the industry, there are several ways in which the industry is
commonly broken down into sub-sectors and categories. The products of the
chemical industry can be divided into three categories: basic chemicals, specialty
chemicals and consumer chemicals.

Basic chemicals are further divided into chemicals derived from oil, known as
petrochemicals, polymers and basic inorganics. Petrochemicals are chemical
products derived from petroleum. Some chemical compounds made from petroleum
are also obtained from other fossil fuels, such as coal or natural gas, or renewable
sources such as corn or sugar cane.

Polymers are of two types: natural and synthetic polymers; natural polymeric
materials such as wool, silk and natural rubber; the list of synthetic polymers
includes synthetic rubber, phenol formaldehyde resin (or Bakelite), neoprene, nylon,
polyvinyl chloride (PVC or vinyl), polystyrene, polyethylene, polypropylene,
polyacrylonitrile, PVB, silicone, and many more.

Basic inorganic chemicals are used throughout manufacturing and agriculture. They
are produced in very large amounts and include chlorine, sodium hydroxide, sulfuric
and nitric acids and chemicals for fertilizers.

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Specialty chemicals category covers a wide variety of chemicals for crop protection,
paints and inks, colorants (dyes and pigments). It also includes chemicals used by
industries as diverse as textiles, paper and engineering.

Consumer chemicals are sold directly to the public. They include, for example,
detergents, soaps and other toiletries.

Figure 20: Chemical Industries

Specialty
Petrochemicals Chemicals

Raw Martials Basic

Chemicals
Polymers

Consumer
Chemicals
Inorganic
Chemicals

Technological capability

The Chemical Industry Corporation is setup very recently in charge of establishing

factories to produce products from the rubber tree as well as fertilizers, cements and
a range of chemical products for the domestic market and for export. The corporation
will also be responsible for conducting designs and feasibility studies to set up new
factories or to expand those that already exist.

In the chemical and construction inputs industry we have plastic and rubber, pulp
and paper, fertilizer, and cement subindustries. The chemical industries have both
vertical and horizontal linkages with other industries. Due to this, the chemical
industries are cross cutting industries which affect other industries’ performance
positively or negatively.

In Ethiopia, there are over 150 plastic related product manufacturing industries,
though the volume of production and capacity is yet to satisfy the local demand.
These industries mainly produce different plastic materials ranging from common
household equipment to complex industrial products. Most of the plastic factories

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have a limitation in quality of their products, variety of product mix, quality of
expertise and availability of advanced technological equipment.

As far as pulp and paper industries are concerned, there are very few number of
paper industries, not more than four, which are currently functional producing
different variety of paper products. Though there is availability of basic raw materials
for paper and packaging production, pulp factories use imported raw materials for
further processing.

Fertilizer manufacturing from coal is in the project phase. Cement industries on the
other hand are relatively well-established in technological capability in the sector
though most of the cement industries are operating below capacity.

Technological gaps

The chemical industries are facing challenges due to technological capability related
with the supply of quality raw materials, machinery and equipment, capacity
utilization and diversity of products.

 Shortage of raw materials for chemical industries, plastic and rubber, paper
and packaging were among the bottlenecks in the sectors. For plastic
industries, polymers are the basic inputs and the subsector is foreign
dependent. Though there is convenient climatic condition for rubber tree
plantation the sector has not been properly exploited. Similarly, though we
have a resource base for pulp manufacturing, the technological capability to
transform the resources to pulp that would be used in the paper and
packaging factory is not yet developed.
 The factories under the paper sector are using old and outdated machines
that faile to produce products at a required quality and quantity.
 The cement industries have demonstrated a progressive development.
However, they are not able to do so at a full capacity utilization level.
 As described in the introduction, the chemical industries have very wide
variety of products. But in Ethiopia, diversification of the industry both in
product or process is limited.

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Opportunities for FDI

Since the chemical industries have linkages with many industries either directly or
indirectly, the progress registered in Ethiopian economy created huge demand for
chemical products; this implies that there are opportunities for FDIs to get into the
business. In a nutshell, the chemical industries are not yet explored, hence, FDIs
could be engaged in most of the subsectors in the chemical sector including:

 Inorganic chemical industries which have direct bearing on other industries

like textile and leather industries in the country.
 Petrochemical industries
 Plastic and rubber industries
 Specialty chemical industries
 Consumable chemical industries

In the case of rubber industries, some organic and petrochemical industries where
there are potentials to expand the raw material bases, FDIs should concentrate on
the base of the value chain. For example, in the case of rubber industries, expansion
of rubber farms would further expand the subsector’s development. A similar
principle could be applied to the exploration of coal, natural gas, oil and other
important minerals used for inorganic industries.

In cases where there is no potential to expand the raw material bases, then even
simple chemical industries with small value addition should be encouraged as they
will move upstream in the value chain with time.

7.6. Pharmaceutical Industries

Although most people think of pharmaceutical industries as those that produce drugs
(chemicals) used to treat human diseases, these encompass a broad range factories
producing substances, including synthetic/semisynthetic chemical, biological,
recombinant DNA (bioengineered), and radioactive products; drugs for human and
veterinary use; and therapeutic drugs (used to prevent, ameliorate the symptoms of,
or treat diseases) and diagnostic substances (used to diagnose diseases or monitor
health status). Thus, pharmaceutical industries encompass biological products,

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veterinary products, and diagnostic products in addition to chemical dugs used to
treat human disease.

Technological Capabilities

Currently, Ethiopia has 22 pharmaceutical industries. Majority of these factories are

producing drugs for human beings (9) and diagnostic equipment (9). There are also
factories producing drugs for veterinary vaccinations (1), diagnostic reagents (1),
capsules (1) and rat’s serum (1). But since Ethiopia is one of the most populated
countries in Africa, the number of factories is too limited to satisfy the national need.
According to the World Health Organization, the demand for Pharmaceutical
products is expected to increase by 25% annually. In Ethiopia, only 20-25% of the
total demand is covered locally and the remaining 75-80% is imported. According to
GTP II, the annual total cost of pharmaceutical materials reach 10 billion ETB which
shows that there is a very huge demand in this subsector.

Technological gaps

The technological gaps in the Ethiopian pharmaceutical industries are related with
raw materials, skilled manpower, capacity utilization, quality control and diversity of
products.

 Even though there are a lot of resources locally which are used as input for
local pharmaceutical industries, 95% are imported. This is due to
technological limitation to make the raw materials suited to the level of
pharmaceutical grade. For example, we can make bandage and fasha from
textile industry products, chloride from salt factories, glucose syrup, ethanol,
alcohol and sodium from products of sugar factories by investing on some
advanced technology.
 Full capacity utilization of diagnostic equipment manufacturers is yet to be
realized. There is also shortage of skilled engineers in the subsector to
increase the volume of production and diversify products.
 Particularly in human medicine, the products are subjected to very strict
quality control schemes. Due to this, the country is able to produce only basic
drugs.

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Opportunities for FDI

The pharmaceutical industry has wider investment opportunities in the production of

drugs both for human and veterinary uses, essential drugs, cosmetics and diagnostic
equipment. More priority could be given to:

 Pharmaceutical industries which could process abundantly available

resources like herbs and gelatin from abattoirs for industrial uses and
production of drugs and cosmetics.
 Assembling of diagnostic equipment though their value addition is limited as
they will move upstream with time
 Essential drugs like drugs for HIV and Tuberculosis with very high demand in
the country and in the region.

7.7. Electrical and Electronic Industries

Electrical and electronic industries could be categorized into four groups:

consumable electronics, electrical components, industrial electronics and electrical
industries.

The consumer electronics industry manufactures and distributes basically everything

from telephones, stereo components, televisions, alarm clocks, and calculators to
digital cameras, video cameras, VCRs, and DVD and MP3 players,-, etc. Some
industry observers also include desktop and laptop PC manufacturers as part of the
industry.

The Electronic component subsectors are engaged in the production of

semiconductor devices, passive components, printed circuits and other components
such as media, substrates and connectors.

The industrial electronics sub-sector consists of multimedia and information

technology products such as computers, computer peripherals, telecommunication
products and office equipment.

Electrical industries produce products related with lightings, solar related products
and household appliances such as air conditioners, refrigerators, washing machines
and vacuum cleaners.

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Technological capabilities

There are few industries operating in the electrical and electronic industries. About
six mobile phone apparatus assembling companies and wire and cable
manufacturing industries are operating in the country. A major achievement in the
sector is the production of solar panels, and assembling of LCD TV and transformers
by Metal and Engineering Corporation (METEC).

Technological gaps

Even very recently established electrical and electronics industries focus on

assembling of parts and processing with small value addition due to the following
technology related problems:

 Unavailability of component or parts manufacturers and/or suppliers

 Technical knowhow about electrical and electronic industries production
system among local engineers

Opportunities for FDI

Electrical and electronics industries have huge untapped potential for foreign
investors. Although, the technical knowhow is limited in the country, since there is
huge local market, it is possible to start from simple assembly of parts to produce
consumable goods, industrial electronics and electrical products then with time they
will move upstream. In addition, electronics components production with small and
medium scale could also be a potential to invest in. This sector will also provide big
potential not only to domestic market but also chiefly for exports as has been
achieved in East and South East Asia.

7.8. Summary of the Findings

From the study conducted based on secondary data and literature review, cross-
cutting technological gaps identified in the priority sectors are related with quality and
quantity of raw materials, accessory and other input materials, capacity utilization,
variety of products, quality control and assurance, integration and cooperation
among stakeholders, technical knowhow and skilled manpower, outdated
machineries and equipment and low level of value addition. Directly or indirectly,

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these problems surfaced out during the discussions with the interviewees and
proved that they are the real problems of the priority sectors. The discussions have
also revealed issues that had not been raised in the literature review including: 1)
FDIs attraction, evaluation, selection and utilization; 2) the roles of industry
development institutes; 3) technology transfer policy; 4) policy framework for joint
ventures; 5) the role of brokers all the way across the value chain, 6) buyers
influences on the value chain; 7) integration and cooperation of government offices;
8) specialized and generalized firms in the value chain, 9) the role of university-
industry partnership in the technology transfer process; 10) labour policy of the
country; 11) incentives based on value addition, volume of production and location;
and 12) industrial contractors and consultants. The syntheses of these points are
further elabourated in such a way that they will be used as a base for policy
development.

1) FDIs attraction, evaluation, selection and utilization in terms of technology

transfer and industrial development require that much has to be done to get all
the benefits associated with it. There is no systematic way of attracting quality
FDIs. In fact, we have neither the specifications for quality of FDIs nor the
capable people and system to evaluate and select the best FDIs for our
country. Due to this, there are so many cases where foreign investors came
with scraped machineries and equipment, and low level of technology with
inflated prices. Once the FDIs came in, there is no plan for technology transfer
both from the investors and the government’s side which would have been
important for continuous follow up and monitoring the performance. This implies
that the benefits of FDIs are not measured and known exactly. Hence, FDI’s
lifecycle needs to be properly managed from attraction to operation or to the
stage of profit utilization in order for the benefits to further outweigh the losses.

2) The role of the industry development institutes has narrowed down to

facilitation. There are six industry development institutes geared towards the
priority sectors. The aims of these institutes are to become centres of
excellence both for technology and skill related matters. With a minor exception
of the leather, metal, and textile industry development institute, they are

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 immersed in facilitation activities for the investor, activities which are non-
technical in nature. In terms of technology accumulation, while these institutes
are practically responsible for it, there is no way to learn technology from
foreign investments or technologically advanced countries in general and pass
it on to those that have lesser capability. Hence, the institutes should take up
their primary purpose of accumulating technological capability adopt it from
where it is developed and transfer it to where it is most needed.

3) Technology transfer policy is non-existent at institutional and country level. The

issue of technology transfer is prevalent everywhere in the discussions and
findings of the reports. There are also sporadic efforts to transfer technology to
the domestic economy at different levels. However, if those efforts had a
guiding policy, they would have been successful.

4) Joint venture does not have a policy framework. Though some of the
experiences in joint venture are distasteful, most of the development institutes’
leaders believe in the positive contributions of joint ventures for enhancing
technology transfer. The corporations’ leaders also support the idea of joint
ventures to expand the sources of capital in addition to technology transfer for
the big projects that they are planning to implement. From best practices
observed internationally, the Government of the People’s Republic of China
significantly benefited from joint ventures. Hence, the failure of joint ventures in
our country may be because of the absence of a clear policy directive.

5) The role of brokers across the value chain is operating in an invisible way. In
most of our discussion, the contribution of brokers for the performance of the
supply chain has been underlined. In this globalized business environment, the
concept of organizational competitiveness is evolving. That means, the
performance of the supply chain determines the competitiveness of the
business in the chain. The chain’s strength is dependent on the effect of the
weakest link. Hence, the brokers should either be recognized and visibly
contribute to the strength of the supply chain or be trimmed or regulated to
exert only a minimal impact on the chain.

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6) As seen in the textile and apparel industries, buyers’ influence on the value
chain, is of crucial importance. Especially those international buyers who have
the financial power could be said to be leading the value chain in the direction
they want it to go. Buyers, in this context, mean wholesalers and/or retailers
with internationally recognized brands. They are at the tip of the value chain
and, though they do not add functional value on the products, according to the
economic theory, they take the lion’s share of the profit. For example, according
to a study conducted on Ethiopian coffee value chain, since the majority of
coffee is exported in the form of green beans to be roasted outside Ethiopia,
the share for Ethiopia from a cup of coffee sold to the end-user is below 10%.
The same is true for other value chains. However, at this moment in time,
working closely with the global brands is the only option available, as we are
doing with H&M for the textile sector. But, in the future, the local traders
(wholesalers and retailers), key players in the domestic market, should be
trained to follow the paths of global leaders and grow with time to competitors’
position. Hence, a policy which nurtures partnership of local traders with global
brands is most desirable for the competitiveness of the value chain at the global
level. In the local context, the government is the major buyer of industrial
products. Especially in the metal production sector, the government itself is not
favouring domestic producers for one reason or another. This also should be
addressed in the policy.

7) Integration and cooperation of key government offices including Customs

Authority, Ministry of Agriculture, Ministry of Industry, Ministry of Trade, Ministry
of Science and Industry, Ministry of Education, Development Bank of Ethiopia,
Commercial Bank of Ethiopia and Regional Governments leave much to be
desired from the point of view of the satisfaction of the industries. To address
the gaps, steering committees were established for the textile and leather
sectors. However, the roles and duties of the committees have not been
supported by appropriate policies yet.

8) Both specialized and generalized firms are joining the value chain. Specialized
firms are responsible for producing a unique or special kind of product or part of
it in the value chain whereas generalized firms are involved in the entire vertical

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 value chain from raw materials to finished goods production. In the global
context, we have success stories in both cases. China follows the former
approach which triggers cooperation and Brazil follows the latter which triggers
competition among firms. In Ethiopia, both cases are applicable, though it may
have the potential of creating unnecessary competition among firms rather than
a healthy atmosphere of complementing each other. From the FDIs attraction
point of view, following the first approach will be much convenient. Hence, the
government should take a position in this regard and support it with policy
instruments.

9) It is in the universities where knowledge is created and easily disseminated.

The development institutes are using the universities as key players in training
highly skilled personnel in the various sectors. However, the role of the
universities in technology transfer from FDIs has not been defined. Some FDIs
were reluctant to accept interns, one of the simplest forms of university-industry
partnership. Hence, a policy directive may be needed to address the
participation of universities in technology transfer processes including major
project constructions undertaken by foreign contractors and consultants.

10) The labour policy of the country in general favours the employees more than it
does the investors. Yet, the employees are said to be complaining about their
relationship with their employers. Labour and management relations must
always be subject to constant scrutiny and strategy to reconcile the search for
investment benefits and the inalienable rights of workers. According to the best
practices, if the labour policy does not favour the employers, then the labour
unions and the employees will have higher bargaining power than the investors.
This will not be a favourable environment for the investors especially for FDIs.
Hence, the policy may be reconsidered in such a way as to balance the power
among the employees and the employers.

11) Ethiopia has an incentive system for those engaged in the manufacturing
industries. However, there is room for improvement to include value addition,
volume of production and location. Incentives should be regularly re-examined,
especially, the tariffs and tax-base prices designed to take into consideration

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 the challenges and problems of a particular sector as reflected in the present
study.

12) Industrial contractors and consultants need to be established and grow and
expand constantly. There are local firms highly interested in establishing
manufacturing industries. However, there are no companies which carry out
feasibility studies with a follow-up of construction, monitoring, supervision and
commissioning of industrial plants. METEC and Mesfin Industrial Engineering
have demonstrated a commendable performance in the design and
construction of industries including those of sugar and fertilizers though they
have challenges of finishing projects within fixed time schedules. This is also
true even of some international contractors that are believed to have many
years of valuable experience. In general, these types of firms deserve to be
looked after constantly as they are the building blocks for the country’s
economic development.

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Part Four: Review of Ethiopia’s FDI Policy and Regulatory
Framework and Implementations

8. Review of the current FDI policy and regulatory framework

8.1. Policy framework

The broad FDI policy framework can be traced in the Industrial Development
Strategy (IDS), which was formulated in 2002/03. The IDS perceives domestic
investors as having irreplaceable roles in the economy and as being the main bases
for industrial development. On the other hand, it recognizes the fact that the
domestic investors have shortage of capital, technology, and network and knowledge
to penetrate international markets. Hence, FDI is envisaged to play a significant role
in bridging these gaps and enhancing the capacity of domestic investors. The
industrial policy document further states that, in order to attract FDI, the government
should work tirelessly to improve the investment environment including legal
protection of investors, maintaining peace and stability, infrastructure and human
resource development, efficiency in the public service delivery. Even so, FDI entry
into some strategic sectors needs to be carefully evaluated. Moreover, FDI should be
restricted from entering into the micro and small enterprises sector in which most of
domestic investors widely participate and entrepreneurship is nurtured.

This vision has been pronounced in various subsequent five-year development

plans, sector strategies, as well as investment specific and recent industrial park
proclamations and regulations. These documents reiterate the role of FDI as
complementary and supporting but not a substitute to the development of domestic
private investors. FDI is encouraged to participate in the export oriented and labour
intensive sectors as well as in filling the existing gaps in the other agro-industry value
chains. In more recent years, some FDI that are more capital and power intensive
are increasingly being promoted to the import substitution industry. This reflects the
broader choice of priority industries in the industrial policy document.

However, Ethiopia has no comprehensive FDI policy or strategy yet but list of
investment proclamations and regulations concerning both domestic and foreign

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investment. The IDS can neither be considered as FDI strategy, as it contains much
broader industrial development issues but less in terms of the necessary instruments
and directions to attract and maximize from FDI.

The absence of a comprehensive and unified FDI strategy is believed to have led to
divergent understanding among policy makers and practitioners on the importance
and management of FDI. On the one hand, there is an overoptimistic expectation,
which assumes FDI to be eminently advantageous in its own terms; hence, that it is
necessary to attract FDI in whatever form into the economy and offer all sorts of
concessions. This view is further reinforced by the remarkable reluctance observed
among domestic capitalists to venture into the manufacturing sector, instead
disproportionally choosing to invest in the construction, real estate and trading
sectors. The domestic firms are weak, thus, they are not expected to have significant
roles to play at least in the near future. This view is also clearly reflected in the GTP
II plan. See the two quotes below taken from GTP II Plan (English version p. 141 and
p. 142 respectively).

“Quality Foreign Direct Investment: as it is repeatedly noted, the base of the

manufacturing sector is very narrow which in turn needs massive investment
expansion in the sector for transformation. As domestic investors have limited
capacity to meet all the required investment in the next few years, a significant
part of the investment will be covered by foreign direct investment (FDI). Thus,
increasing FDI and attracting foreign investors will play a significant role during the
plan period. In this regard, efforts will be made to attract FDI from every direction
particularly by focusing on capable, quality and reputable companies. …”

“… Domestic Investment: Although priority is given for FDI, adequate

emphasis will also be given to encourage the domestic private sector to invest
in the envisaged export-oriented industrialization drive of the country. By
carefully identifying domestic private investors and providing adequate support, they
will be encouraged to participate in the manufacturing industry including in import
substitution. Arrangements will be made for domestic investors to work in partnership
with foreign investors who are engaged in medium and large scale manufacturing
industries.” pp. 141-142 (FDRE: NPC, 2016 [emphasis own]

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The above quotes explain that domestic investors will have limited capacity at least
in the next few years; thus, priority should be given to FDI attraction. This argument
is rather contrary to the industrial development strategy of the country and is flawed
on the following grounds. First, the lack of capacity of domestic investors cannot
justify exclusion from being given priority and priority cannot be driven by size of
investment but significance of that investment towards the overall development
objective. Unlike domestic investors, foreign investors are more likely to repatriate
profits outside the country and re-invest less in the domestic economy. FDI is also
less ‘sticky’, i.e. more ‘footloose’ and susceptible to short-term political and economic
uncertainties. Hence, despite current size and technology advancement, FDI cannot
serve as an engine of the industrial development.

Secondly, FDI can act as valuable supplement to domestically mobilized fixed capital
rather than be a primary source of finance. Hence, countries incapable of raising
funds for investment locally are unlikely beneficiaries of FDI (OECD, 2002). Thirdly,
the potential positive externalities from FDI can only be materialized when domestic
firms have the capacity to usefully internalize these externalities and if the non-firm
sector supports domestic capacity building (Narula and Dunning 2010). Hence,
enhancing the capacity of domestic investors cannot be postponed; it is an
immediate and urgent task even from the context of maximizing the benefits from
FDI. The implication is that despite their current weaknesses and less capacity, the
domestic investors are the ones that always need to be given priority for any
meaningful industrialization to take place.

The contrasting pessimistic view is that FDI’s motive is to exploit the country’s cheap
factors (labour and natural resources) and cannot contribute towards achieving the
country’s development objectives. Thus, Ethiopia needs to restrict FDI and focus on
the domestic firms. One common danger of these two opposing views is the
undermining of the required efforts and policy framework to maximize the benefits
and reduce the risks from the presence of FDI.

The absence of comprehensive FDI strategy, as will be discussed in the next sub-
sections, has also led to inconsistency between different initiatives, lack of
coordination among different institutions, lack of monitoring and evaluation capacity,
more focus on the process instead of performance and impact.

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8.2. The regulatory framework for FDI in Ethiopia

Proclamation No. 769/2012 enacted on 17th September, 2012 is the recent major
investment revision and currently overriding national investment legislation. This
legislation has set the general regime for domestic as well as foreign direct
investment in Ethiopia. This includes areas of investment reserved for nationals and
or government; forms of investment and capital requirements for foreign investors;
investment permit; technology transfer; investment incentives, guarantees and
protection; investment administration; industrial development zones; and
miscellaneous provisions. The complementing investment regulation that was
introduced in November 2012 (Regulation No. 270/2012) has also listed the
investment areas open to foreign nationals with the respective investment incentive
packages designed to encourage both domestic and foreign nationals intending to
invest in Ethiopia.

8.2.1. Sectors open to foreign nationals

The 2012 legislation classifies investment projects into four categories namely
public, domestic private, foreign and joint-venture investment projects. Joint-venture
investment projects can be formed jointly either between domestic private investors
and foreign nationals or between the government and foreign nationals. This
legislation also allows foreign nationals, but Ethiopians by origin to be considered or
treated as domestic investors. However, the conditions or the criterion through which
this privilege for foreign nationals is given has not been stated both in the legislation
and the complementing regulation to date. Broadly speaking, the FDI-specific
legislation is non-discriminatory and allows foreign investors to access the country’s
resources like labour and land required for their investment projects.24

The 2012 legislation identifies the transmission and distribution of electric energy,
postal service with the exception of courier services, air transport with a seating
capacity of more than fifty passengers be exclusively reserved for government,
whereas the manufacturing of weapons and ammunition and telecom services are
24
The forms of investment capitals are also defined in the 2012 investment legislation. Accordingly,
local or foreign currency, negotiable instruments, machinery or equipment, buildings, working capital,
property rights, patent rights, or other business assets are considered as investment capital in the
legislation. In this definition, negotiable instruments and other business assets as investment capital
may create ambiguity in the implementation process if they are not clearly mentioned in the
implementation directive or operational details of the legislation.

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allowed for joint venture but only with the government. The legislation indicates that
list of areas of investment allowed for domestic investors to be specified by
regulation of the Council of Ministers. Accordingly, the list of investment areas that
are reserved for domestic investors and those allowed for FDI are articulated in
Regulation No. 270/2012 (see the box 1 below).

Box 1: The list of sectors that are reserved for nationals and government in
Ethiopia

1. Banking and insurance

2. Small-scale electricity generation except from hydro-power
3. Small scale air transportation services
4. Radio and television broadcasting
5. Retail trade and product brokerage
6. Wholesale trade and distribution
7. Exports of raw coffee, oil seeds, pulses, hides & skins, live sheep, goats and
cattle
8. Construction companies (excluding grade one contractors) and building
maintenance
9. Tanning hides and skins up to crust level
10. Hotels other than star designated, tearooms, coffee shops, bars, night clubs
and restaurants excluding international and specialized restaurants
11. Tour and travel operators, car-hire, taxis and commercial road and water
transport
12. Grain mills
13. Barber & beauty shops
14. Goldsmiths
15. Non-export tailoring
16. Saw milling and non-export forest products
17. The printing sector
18. Manufacturing of cement, clay and cement products.
19. Finishing of fabrics, yarn, warp and weft, apparel and other textile
products by bleaching, dyeing, shrinking etc.

In general, the long list of sectors excluding FDI participation is intended to

encourage indigenous entrepreneurship and to beef up the capacity of the domestic
private sector as well as reduce the risk of capital repatriation and exposure to
international capital market volatilities (the banking sector is a case in point here).
The Government has indicated that it will continue to review these exclusions, with
the intention of reducing the number of sectors closed to FDI to the minimum level.
In comparison to the service sector, the manufacturing sector is relatively more open
to FDI with the exception of the five sub-sectors in bold above. Although the FDI

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regulatory framework in Ethiopia is increasingly opening through time, it is still
restrictive when compared to many other developing countries, including those in our
region. While many of the sectors currently closed to FDI may not be of high value to
international investors, aside from Multi-National Corporations (MNCs), it is important
to recognize that such restrictions may not give a positive and welcoming image to
potential foreign investors.

More importantly, although the most reserved sectors for domestic investment are in
the service sector (trade, transport and logistics, utilities, and banks) and not the
manufacturing sector, the less competition and inefficiency in these sectors have
substantial negative effects on promotion and benefiting from FDI in the
manufacturing sector. Notwithstanding the inefficiency in the banking and utility
sectors, such as energy and telecom, another major impediment to manufacturing is
the high trading cost caused by high inefficiency in the transport and logistics sector,
which are reserved for domestic investors alone. Moreover, the manufacturing sector
is hampered directly by low quality and insufficient quantity of raw materials. Again,
the wholesale trade, which is reserved to the domestic investors, is not competitive
enough to serve efficiently the manufacturing sector.

8.2.2. Ownership limitations and requirements

Under Proclamation 769/2012, any foreign investor, who is to be allowed to invest

pursuant to this proclamation, shall be required to allocate a minimum capital of USD
200,000 for a single investment project, which is a reduction from the requirement of
minimum USD 500,000 in the previous proclamation. Similarly, the minimum capital
requirement of USD 300, 000 for a joint-venture green-field investment project is also
reduced to USD 150,000. On the other hand, foreign nationals intending to re-invest
their profit generated from existing investment project operating in Ethiopia are not
required to allocate a minimum capital for new investment project. Such reforms
clearly confirm the nation’s strong ambition towards attraction of FDI to the country’s
manufacturing sector.

8.2.3. Investment Incentives

Regulation 789/2012 provides investment incentives that include exemption from

income tax and/or customs duty. The prevailing activity and location specific tax

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regime is non-discriminatory among domestic and foreign investors operating in
areas that are legible for incentives. Appendix 1 provides exhaustive list of income
tax exemption by sector and location. Investment in the manufacturing sector as a
whole and some selected agricultural products are given income tax exemption
between 1-5 years depending on the location and type of activity.

The corporate income tax regime provides a special privilege to investors operating
in some remote and arid parts of the country. For instance, investors operating in
Gambella, Benshangul Gumuz, Somali, Guji, Borena Zone, parts of Afar and some
other remote areas of SNNP are provided with 30% income tax reduction for three
more years after the expiry of the income tax exemption period. Notwithstanding this,
the corporate income tax regime treats investors operating in the country in two
categories i.e., those investors operating in and around Addis Ababa and those
operating in other parts of the country. On average, the income tax exemption
difference between the two categories of investment locations is around 1.2 years.
This slight difference in income tax exemption period between the two cohorts of
investment locations may not be sufficient to attract foreign as well as domestic
investors to invest in locations that are distant from Addis Ababa. It is not clear that
the current tax-related incentive system can more than make up for the
disadvantages of being located in areas that are further away from metropolitan
cities like Addis Ababa. That is partly why we observe high concentration of
manufacturing establishments in Addis Ababa and the surrounding areas. It is
believed that the industrial park initiative across the country might to some extent
improve the geographical distribution of firms.

The investment regime also incorporated other fiscal and non-fiscal incentives for
investments that take place in various sectors of the economy. Particularly, both
foreign and domestic investors operating and intending to operate in the
manufacturing sector are provided with fiscal incentives like:

 100 % exemption from custom duties and other taxes imposed on imports of
capital goods.
 Spare parts that value up-to 15% of the total value of the imported capital
goods are exempted from custom duties.
 Locally produced export items are fully exempted from export tax.

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In addition, firms that export at least 60% of their products are provided with non-
fiscal incentives such as duty drawback, voucher, bonded warehouse, and export
credit guarantee schemes and two years additional income tax exemption.

There are different views on whether tax incentives are effective tools to attract FDI,
and if so, what is the effective level of taxation that can help attract FDI. The
empirical evidence suggests that the tax incentives are not effective tools for
attracting FDI, but instead might promote a race to the bottom in taxation of
corporate profits, harming governments’ ability to provide public services. This does
not imply that tax incentives are not important but there is a limit to competitiveness
in FDI attraction based on tax incentives. Governments are instead advised to focus
on improving the regulatory environment, efficiency of public services including
competitive infrastructure as well as development of human capital.

Another concern regarding the investment incentives in Ethiopia is that they are not
selective and attached to performance. The prevailing incentives introduced to
promote FDI treat all FDIs operating in a given location and engaged in similar
business activities in the same manner. The incentives often are not attached to
meeting specific performance goals, such as, for example, export requirements,
minimum local content, employment of expatriates and foreign exchange restrictions.
In cases where incentives are related with performance, there is a lack of capacity
and system in place to monitor targets agreed and if the incentives provided are
fetching the intended benefits. This has given a loophole for many FDIs to benefit
from the incentive system without meeting the basic conditions that motivated the
introduction of the incentives in the first place. For example, designated exporters,
who were supposed to export 60% to 100% of their products, are found to sell a
large proportion of their products in the domestic market. Similar issues arise with
regard to capital flight through under or over invoicing and foreign loan
arrangements. The incentives also focus on new projects and not on re-investment
and expansion, which are no less important in terms of job creation, export earnings
and technology transfer potentials.

8.2.4. FDI treatment and protection

Investment protections: Any form of manufacturing investment in Ethiopia has an

investment guarantee and protection under the 2012 investment legislation and the
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constitution broadly. For instance, expropriation of investment projects is made only
for public interest by providing the owner with equivalent compensation for the
expropriated investment project. This is completely different from the nationalization
process of private enterprises that had taken place during the military government in
the early 1970s in which no investor had been compensated for his/her expropriated
business enterprise. Moreover, Ethiopia has signed several bilateral agreements
with 30+ countries and multilateral agreement such as Multilateral Investment
Guarantee Agency MIGA in an effort to reduce uncertainty of investors.

Profit remittance and foreign exchange controls: The 2012 investment legislation
granted any foreign investor permission to make full repatriation of profits, dividends,
and principal and interest payments on external loans out of Ethiopia in convertible
currency. Similarly, expatriates working either in domestically or foreign owned firms
can also remit 100% of their salary and other related earnings in a convertible
currency to their home. Although such treatments are among the basic policy
instruments to attract FDI, they might allow massive capital flight from the economy
through remittance of funds by foreign investors in the absence of proper regulations
and monitoring. While the NBE complains of massive illegal foreign exchange
repatriation, particularly among FDI from developing countries, the investors
complain the delay of making available foreign exchange when they want to
repatriate their profits or wages (see the financing section for more on this).

Labour market and employment of foreigners: Regarding labour, as

manufacturing activities are highly skill and technology demanding, the investment
code allows any investor to hire skilled expatriates for the proper execution of
implementation phase investment projects, as well as operational business
enterprises. Moreover, expatriates that work in any type of investment projects shall
be allowed to remit their salaries and other monetary benefits in convertible foreign
currencies out of Ethiopia. However, investors or firms are obliged to replace their
expatriate workers by Ethiopians within a reasonable time period.

Environmental management: Ethiopia enacted the Environmental Impact

Assessment (EIA) proclamation in 2002. According to this proclamation, it is
imperative to conduct environmental impact assessment of investment projects in
order to identify their potential harms to the environment. It also requires monitoring

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of projects to ensure whether the implementation is in accordance with the standards
and conditions. However, the implementations of this regulation have been very lax.

One reason for the poor enforcement of already existing regulations and standards is
the lack of sufficient professionals to review environmental impact studies both at
Federal and local levels. A related cause is the coordination problem among different
agencies both at federal and regional levels. For example, the EIA proclamation
imposes a duty on any licensing agency to ensure that the relevant environmental
agency has authorized implementation of a project before issuing an investment
permit. However, the Ethiopian Investment proclamation does not make EIA a
requirement for obtaining an investment permit and in practice the EIC often grants
investment permits without EIA assessment. The failure to check environmental
compliance can lead to precarious results. A typical example in this regard is the
Ethio-Turkish industrial zone development project near Sendafa, which is suspended
due to potential threats posed at the Legedadi Dam and Water Treatment Plant. The
EIC has also allowed a German company to start a biofuel project on land that was
located inside a wildlife sanctuary (Getu, 2009).

8.3. The institutional framework supporting FDI: promotion and coordination

8.3.1. Organizational transformation of the EIC

Ethiopian Investment Commission (EIC) is the autonomous federal government

institution tasked to implement transparent and efficient investment administration
system and thereby encourage and expand investment in Ethiopia. It was
established in 1992 under the name of Ethiopia Investment Office and since then it
has undergone through various restructuring phase. The recent and major
amendment is Proclamation 849/2014 which was ratified in July 2014 by the
Ethiopian parliament. This proclamation re-established the Ethiopian Investment
Agency as a Commission accountable to the Prime Minister and governed by a
Board of Investment (BOI), which comprises nine members including seven key
ministries, the Mayor of Addis Ababa and the president of Oromia regional
government. The bill has granted the board additional power including granting of
new or additional incentives and writing directives outlining the duties and rights of
investors in the industrial zones without consulting the Council of Ministers.

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EIC used to be under the Ministry of Industry (MoI) with limited mandate and with
tasks mainly restricted to promotion and regulatory services. The new proclamation
and subsequent regulations allow EIC to assume a more active role, including
promotion of investment and exports as well as directly regulating and supporting the
regulation of Industrial Parks. Unlike previous times where minor issues were taken
to the board, now the board only deliberates on major and decisive issues that
cannot be resolved at the EIC level.

Below are some of the present main responsibilities of the EIC.

 Promoting the country’s investment opportunities and conditions to foreign
and domestic investors,
 Issuing investment permits, business licenses and construction permits
 Notarizing memorandum and articles of association and amendment,
 Issuing commercial registration certificates and effecting renewal,
amendment, replacement or cancelation
 Effecting registration of trade or firm name and amendment, replacement or
cancellation,
 Issuing work permit, renewal, replacement, suspension or cancellation
 Grading first grade construction contractors
 Registering technology transfer agreements and export oriented non-equity
based foreign enterprise collaborations with domestic investors,
 Negotiating and upon government approval, signing bilateral investment
promotion and protection treaties with other countries, and
 Advising the government on policy measures needed to create an attractive
investment climate for investors

The EIC also offers additional services on behalf of investors’ request to facilitate the
acquisition of land and utilities (water, electrical power and telecom services), to
process loan and residence permit applications, to get approval of environmental
impact assessment (EIA) studies for the investment projects as well as for the
issuance of tax identification number (TIN).25

Accordingly, the EIC is now in the process of undergoing organizational change to

promote more FDI and render efficient services to investors. The plan includes
25
Source URL: http://www.investethiopia.gov.et/.

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forming three arms; Investment, Industrial Park, and Policy (and research) although
this structure is not yet public. The EIC has also begun a series of reforms to
improve its services. One such initiative was to improve the one-stop-services
(OSS), which brings the documentation requirements ‘in-house’ with 27 of 29 fully
delegated to EIC.

Another related initiative is the aftercare service, which requires the appointment of a
single named contact person for each firm; an initial visit to establish relations and
subsequent regular visits or phone conversations (IGC, 2014). Accordingly, EIC has
developed an investor tracking system where the largest 400 FDI projects are
weekly tracked by seven sectoral teams. The sector teams are organized around the
following seven sectors; leather, textile and garment, chemical, metal, agro-
processing, agriculture and other sectors. There are currently about 25 staff
members each following the maximum of 20 companies. They make calls to the
companies regularly and collect their complaints, of which some are resolved easily
while other serious issues are reported to high level authorities including the Board.
The main obstacles often involve high level intervention and coordination, for
example, as seen in the supply of land and power. The tracking system continues
until the firm is operational and receives business licensing. The perception is that
this has improved the performance and operational rate of the projects.

8.3.2. Changes in the promotional direction

Until recently, the Ethiopian investment promotional activity has been generally
weak, lacking proper strategic direction, generic type and under resourced. In
relation to the restructuring of the EIC and the renewed interest to attract FDI, there
appear to be important directional changes in the promotion activity. This includes
identification of priority sectors and potential country targets, moving from generic
campaign towards attracting anchor investors, and industrial park development. The
discussion below will review each of these.

Sector specific and potential country targeting promotion

One recent development in the strategic direction is the identification of priority

sectors and potential country targets as a primary focus in the promotion to attract
FDI in the manufacturing sector. The priority sectors are the labour intensive and

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export oriented light manufacturing, while the focus countries include the emerging
middle income countries such as China, India and Turkey. China, India and Turkey
are indeed the leading global producers and exporters in the light manufacturing
sector. But at the same time, these countries are facing increasing labour cost, thus,
a deteriorating comparative advantage in these industries providing a big potential
for less developed countries such as Ethiopia to attract FDI.

The figures of FDI sourcing in Ethiopia support this view. See section 5 for further
information on the source of investment and sector distribution in the last 23 years.
When we consider the FDI in the manufacturing sector, China appears to lead with a
contribution of about 26% to the number of projects and 27% to the operational
projects. India, USA, Sudan and Turkey in order are also the major sources in terms
of the number of FDI projects in the manufacturing sector. The recent trends also
show that the bulk of new FDI projects appear to arrive from China suggesting that
the Chinese are keen to relocate from China to Ethiopia. Chinese investment has
been monotonically increasing from 1997 to 2014; the number (percentage share) of
licensed projects has increased from 4 (3.2%) in 1997 to 408 (21.8%) in 2015. The
push factor is that there is excess production capacity in China, overcrowded local
market, rapidly rising labour cost (also in other Asian markets, such as the rise in
wages in Vietnam and labour militancy in Bangladesh) and subsidy by the Chinese
government (the Go Global Policy) are pushing Chinese investors out of China.
Chinese investors are also eyeing Nigeria, Ghana, Tanzania, Kenya, South Africa
and, to some extent, Senegal as possible destinations for relocation. Yet no country
appears to appeal to Chinese investors than Ethiopia. In addition to other host of
attracting factors, the active outreach by the Ethiopian government officials at
various levels (for example, the active involvement of the former Prime Ministry in
introducing Huajian to Ethiopia) is also pulling Chinese investment towards the
country.

Focus on anchor investors

General country image building through media and other outlets is an important
feature of the promotion. But the experiences suggest that general advertisements
on behalf of the host country are less effective in producing results unless
complemented by other modalities. Instead, sector specific and mixed investment

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missions including satisfied private sector representatives might have substantial
impact. Moreover, personal contacts between host country officials and selected
individual companies are believed to be effective. In this regard, Ethiopia has started
to move from the generic type of promotion to sector specific missions and head-
hunting of anchor investors. The justification is that, appealing to Anchor firms and
succeeding in attracting these firms might greatly aid the promotion drive of the
country. Leveraging anchor firms to attract FDI would not only maximize the number
of FDI inflow into the country but also has the potential to improve the quality of FDI
that is attracted to the country.

The majority of anchor investors are most likely to be found in the West countries but
not in the country targets, for example China, Turkey or India. But if convincingly
approached they can help in relocating their suppliers in the East to come and invest
in Ethiopia. A good example is how H & M convinced its suppliers to invest in
Ethiopia. In a trade fair co-organized in Hong Kong by the Ethiopian embassy in
China and H&M, almost all companies (42 textile and garment companies) were
invited by H&M. At the event, H & M told these companies that the next garment hub
is going to be Ethiopia and if they fail to invest now, they are going to miss out on a
big opportunity. Of these companies, 6 have already invested in Ethiopia. This
example clearly illustrates the need to also focus on the USA and Europe but
selectively on the anchor investors linked through the supply chain with producers in
Asia.

In a follow up interview, we asked a sample of FDI firms how they learned about
Ethiopia as a potential investment destination. Nearly 46% of the firms stated that
domestic investors in Ethiopia provided crucial investment information about the
country. Ethiopian diplomatic missions abroad have also been instrumental in
reaching out to potential investors; 30.8% of the FDI firms claimed to have gotten
information about Ethiopia from Ethiopian mission abroad. Foreign investors who
invested in Ethiopia and foreign diplomatic missions in Ethiopia also contributed
positively to passing on investment information to the FDI firms.

The FDI firms were also enquired to describe the changes they observed in the last
few years concerning FDI across three important dimensions; promotion, regulatory
environment and service delivery. Regarding promotion, there is almost a universal

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consensus that marketing of the country by relevant authorities has significantly
increased. On the side of firms, there appears to be improvement towards both the
production of quality products and the aggressive advertisement of these products.
Misinformation or marketing malpractices, such as the advertisement of poor quality
products as high quality, however, seem to still proliferate unabated in the market. All
but one of the FDI firms perceived significant changes in the FDI regulatory
environment in the last few years. Yet unlike changes in the promotion arena, which
are largely positively viewed, the perception towards the change in the regulatory
environment is mixed.

Industrial park as an investment promotion

Ethiopia has recently started to give due emphasis to Industrial Park Development
as one of the major policy tools towards industrialization and as a major instrument
that can be used to significantly boost Ethiopia’s attractiveness for foreign and
domestic investment. Currently there are four operational industrial parks in Ethiopia,
namely – Eastern Zone, Bole Lemi, Hawassa and the information technology (ICT)
park located in Addis Ababa. Two private IPs (Gorge Shoe IP and Huwajan IP) and
other five governments owned IPs (Hawassa No.2, Adama, Kombolca, Arerti and
Mekelle) are also under development.

The Hawassa industrial park is a model for the many other industrial parks that will
be built in other parts of the country. The first phase development covers about 130
hectares of land consisting about 52 sheds dedicated to textiles and apparel sectors,
which are expected to generate one billion USD export revenue. These sheds are
now fully occupied of which about 82% are foreign owned including leading
companies in the sector (for example, PVH, Vanity Fair (USA), H&M (Sweden), Wuxi
Jinmao Foreign Trade Company (China), Arvind and Raymond (India), TAL and
EPIC (Hong Kong), PTU (Indonesia)). Hawassa Industrial Park is providing
integrated public services under one-stop shop service center among others
customs clearance, power, telecom, immigration (visa), commercial banking and
export permits. It has also employed Zero Liquid Discharge (ZLD) that enables to
recycle 85 percent of sewerage disposal water and fulfills international standards.

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8.3.3. Promotion and Coordination

Investment promotion is the primary responsibility of the EIC. But it involves a

number of other government agencies and private sector organizations, including,
the Ministry of State Enterprises, the Ministry of Industry; the Ministry of Foreign
Affairs; other sectoral ministries such as mining, tourism and information; the
National Bank of Ethiopia, Development Bank of Ethiopia; Ethiopian Revenue and
Customs Authority (ERCA), and Regional Investment Bureaus.

Of these, the Ministry of Foreign Affairs (MoFA) and its embassies all over the world
are also crucial in investment promotion. The MoFA was tasked to focus on
economy and business diplomacy consistent with the country’s development
strategy and following the formulation of the Foreign and Security policy document in
2002/03. The Economy and Business Diplomacy department was established
around 2004/05, which was later renamed as business diplomacy. In 2010/11, a high
level Coordinating Committee led by the minister of MoFA and comprising
representative from different federal ministries and agencies was established. This
committee is still functional and its main objective is to exchange information and
coordinate different government organs to provide solutions to emerging problems
related to investment, tourism and trade. Five sub-committees were formed under
this which include, trade promotion, investment promotion, tourism, economic
cooperation and remittance, and technology transfer. The Investment Office is a
member of this coordinating committee and the MoFA works in close coordination
with the Investment Office.

Recent EIC’s targeting strategy involves tasking the embassies to “Identify top 10
companies from the country of their mission; companies that are active in the textile
and leather sector, talk to these companies, get them interested to invest in Ethiopia
and bring them to the country to perform at least preliminary reconnaissance”. The
EIC also provides brochures and leaflets to the embassies about interests and
directions of investment and takes part in the annual ambassadors’ gathering here in
Addis. However, according to the EIC, the majority of embassies do not appear to be
staffed with personnel equipped with the knowledge and capacity to attract
investment towards the country and make sufficient screening of the investors’
backgrounds. To address this, the EIC is planning to dispatch staff members to

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selected target countries from which most FDI comes and work alongside the
commercial attaché in the embassies. On the other hand, the MoFA complains that
the main factor for under performance in investment projects’ conversion to
operational level are the various impediments here at home including poor
infrastructure, public service and bureaucratic obstacles.

The promotion also appears to suffer from coordination problems with other different
government agencies. For example, there has been overlap in responsibilities
between the EIC and the Development Institutes under the Ministry of Industry as to
who should oversee the investment promotion in the manufacturing sector. The
Regional Investment Bureaus also have important contributions to make in
identifying, defining and promoting specific investment project opportunities and in
encouraging FDI inflow into their regions. They are also the ones that should provide
land for the investment. But the lack of coordination between Federal and Regional
entities with regard to making land available including compensation issues has
continued to be among the major reasons for the delay and even cancellation of
projects.

Poor coordination with tax administration and customs office as well as with utility
providers, particularly in the supply of power, is another critical challenge often
raised by investors. Moreover, other organizations, such as Ethiopian Airlines and
tourism agency that should positively support the promotion have not yet formally
and actively been engaged in the effort to attract FDI, despite some recent initiatives
which are at their initial stages.

8.4. National determinants of investment flow and major obstacles

8.4.1. FDI attractive factors

There are known standard factors that attract FDI to host countries. These factors
might differ from country to country. We have enquired the interviewees about what
potentials the FDI considers as attractive to invest in Ethiopia given that identifying
these attractive factors is crucial to further capitalize on them.

According to our interviews with various institutions, there are a number of attributes
that made Ethiopia the preferred destination for FDI. These include:

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  The prevailing political stability in the country.
 Government vision and commitment to development
 the high and continuous growth without oil resources
 The size of the local market.
 Huge investment in social overhead and improvement in the overall
infrastructure.
 The availability of large young trainable and low cost labour force.
 The fact that Ethiopia is among the beneficiaries of African Growth and
Opportunity Act (AGOA) and Everything But Arms (EBA) arrangements.

Some of these factors have been confirmed in our interviews with a random sample
of 14 FDI firms in Ethiopia. They were asked why they decided to invest in Ethiopia
in comparison with other countries. The first primary reason for 57% of the firms (8
companies) appears to be the attractive nature of the domestic market (seeking
markets). The second primary reason appears to be cheap labour and the third,
cheap raw materials and resources. Few companies also mentioned the availability
of cheap electric power, loan provision at DBE and political stability as key
considerations in their decision to invest in Ethiopia. Not surprisingly, FDI firms
believe that Ethiopia has the largest potential to attract FDI firms in traditional labour
intensive sectors, such as food processing and beverages, textile and garment,
leather and leather products.

8.4.2. Major obstacles and bottlenecks

We have asked the FDI firms for their perception on the remaining challenges.
According to their responses, while there are some improvements in the areas of
logistics and customer handling, some major problems appear to linger. The quality
of some services appears to be deteriorating; telecom service, power delivery and
the slow pace of customs clearance process are perceived to have worsened in the
last few years. Consistent with this, when asked how satisfied investors are with their
interaction with different government agencies, except one firm that opted to be
neutral, all the other firms (93%) stated that they are either unsatisfied (78.6%) or
highly unsatisfied (14.4%). Most of the FDI firms think that services related with
power supply, customs procedures, supply of foreign exchange, telecom, water
supply and trade logistics (shipping and maritime) should be improved quickly.

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Moreover, the government bureaucrats need to be more transparent, accountable
and motivated to serve better. Furthermore, policy changes seem to happen
unanticipated without first consulting stakeholders who would be affected by the
policies. Fittingly, many of the FDI firms characterize the FDI regulatory environment
as either excessively overregulated or slightly overregulated.

The main challenges FDI firms currently face in the country are access to power,
limited availability of foreign currency, poor trade logistics related with transportation
of goods and problems in quantity and quality of raw materials (we note that the
major challenges encountered by domestic firms is finance but here, finance does
not feature in prominently). FDI firms would like the government to seek solution to
these problems. More transparency and a consultative policy drafting process,
ensuring adequate and reliable supply of electricity, support for domestic production
of raw materials, parts and components, improving trade logistics by making imports
easier, lowering transportation cost and increasing the speed of exporting process
(reducing complication in customs procedures and clearances) and encouraging
more competition in the telecom sectors are some of the suggestions for the state to
improve the quality of service delivery. Solving all these problems coupled with few
reforms in infrastructure provision, such as reforming the telecom and power sector
as well opening the banking sector for FDI are perceived to be some of the key
reforms Ethiopia can take to attract more FDI.

Most of the government officials we have interviewed tend to agree with most of the
problems identified above. Even though higher officials at different government
institutions have strong commitment towards promotion and attraction of FDI, there
is noticeable policy implementation problem in their respective institutes. The
inefficiency in the existing bureaucracy is one of the major factors that constrained
the domestic investment as well as FDI in the country. One identified by many
respondents as critical is the problem related to tax administration and customs
procedures and practices at the Ethiopian Customs and Revenue Authority (ERCA).
There is often misinterpretation of rules and regulations that are introduced to
promote investment in the country. On the other hand, the introduction of too many
customs and revenue rules and regulations by the government has made
implementing agents risk averse; as a result, essential decisions are delayed for a

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long period of time. Particularly, the tedious export procedures at ERCA seriously
discouraged foreign firms that produce for export market.

In addition, the commitment of civil servants of various institutions is highly eroded

and they are less willing to dispose their responsibilities. As a result, the incentive
packages designed to encourage FDI are not implemented properly. Other critical
problems voiced by many government offices are, the continued power interruption,
higher banking cost or higher service charge, limited access to foreign currency to
remit as well as to import inputs, long delay in project implementation due to
bureaucratic hassles in various government institutions, the lack of coordination
between Federal and Regional entities particularly with regard to making land
available including compensation issues, inefficient and inflexible banking sectors.

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9. To what extent has Ethiopia benefited from the presence of FDI?

9.1. FDI and Financing

One of the major motives of developing host countries to attract FDI is that FDI
brings new resources that address constraints to development such as saving and
foreign exchange gap that set limits to long-term growth. However, in the absence of
proper regulations and monitoring, foreign firms may widen the gap by extracting
rents from the domestic economy instead of filling the gaps in domestic saving. They
are often criticized for ‘financial leakage’ out of the host region through the
remittance of earnings and profits back to the parent company and use of transfer
pricing to reduce taxes paid in the host region.

A closer look at the structure of FDI financing and mechanisms of profit repatriations
out of the country can help us understand the net financial flow into the economy.
According to our interviews with representatives from Development Bank and
National Bank, there are at least two problems with regard to FDI financing in
Ethiopia. The first problem is that a large number of FDIs that come to Ethiopia
register large amount of debt that is obtained from foreign sources and further apply
to get loans from DBE. And the investment legislation allows foreign companies to
repay their debt (i.e., the principal and interest in a convertible foreign currency)
based on the debt repayment schedule they submitted. The motive is that they do
not have to make profits and pay taxes to start repatriating foreign exchange. This
investment legislation has created a loophole that enables investors to exploit the
country’s limited foreign currency reserve. To counter this, NBE proposed a new
policy that obliges foreign nationals to come with at least 50% of the project fund
from own source and a maximum of 50% foreign debt. This draft policy is still under
evaluation and may require further scrutiny to ensure that the policy does not
preclude the entry of highly capable FDI firms with large technology spillover
potentials but limited self-financing capacity.

The second related problem is that instead of bringing their own capital, the FDI
firms in Ethiopia tend to borrow more from domestic banks and particularly the DBE.
Although foreign nationals are expected to show their initial equity in foreign
currency, the DBE credit policy is non-discriminatory between domestic and foreign

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nationals. Until recently both the domestic and foreign investors can equally use the
30:70 credit scheme (i.e., 30% of the investment cost is covered by the investor in
the form of cash or equity and the remaining 70% is financed by DBE). One of the
main reasons for FDIs to claim loan from DBE is risk diversification. Particularly,
Indians and Turkish mostly come to the country without having financial assets and
try to depend fully on local financial sources. In previous years, Chinese investors
did not need loan form DBE, but now, they are also increasingly applying to DBE.

In principle, DBE should know the source of FDIs initial own equity. In reality,
however, DBE has no legal right to request the source of FDI’s own initial capital. As
there is no systematic tracking mechanism whether these new entrants have debt
abroad or not, DBE is facing high loan default rate. Investors mostly do not have
recorded information in the country as well as in their home. And if they leave the
country before completely repaying their debt, it is very hard for DBE to track them
outside the country. DBE believes that the embassies can do more in screening
investors’ backgrounds. We feel that DBE should be continuously building its own
capacity to conduct due diligence on its prospective clients and find a reliable
mechanism of loan repayment that reduces the risk of default and business
foreclosures.

The 30:70 credit scheme has been revised in recent months in a way that foreign
nationals will be treated in 50/50 credit scheme and domestic investors will be
treated in 25/75 arrangement. But one may further argue why a country like Ethiopia,
hungry of foreign currency, need to provide this much loan to foreign investors
instead of pushing them to bring their own. Instead of introducing various incentives
and credit facilities, the government should give much emphasis on improving the
investment climate such as public service and infrastructure. This may also involve a
focus on those investors or companies with the financial capability.

In this regard, there is clear behavioural difference between investors that come from
the West and other emerging countries from the East. For example, the investors
from the West tend to bring their own finance, introduce genuine investment projects,
make more ethical and transparent business, and are intolerant to inefficiencies in
the public services. In contrast, the investors from other emerging countries such as
India, Turkey, and China often seek finance from domestic banks and also involve in

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illegal practices for example corrupting civil servants, over/under invoicing of
transactions, remit foreign exchange illegally, as well as sell in domestic market
while designated as exporters.

Given that the focus countries are the emerging countries with the above unpleasant
characteristics, the country needs to devise proper strategy and instruments to
enhance net positive capital inflow from FDI.

9.2. FDI and exports

One of the strategic directions to finance balance of payment deficit is promoting

inward FDI that can generate foreign currency through export. In this regard, the
Ethiopian government has been keen to attract FDI to stimulate exports and
generate foreign exchange. The incentive structure also favours export sectors and
as a result many of the FDI have entered into the manufacturing export sectors.
However, the export performance of the manufacturing sector at large and FDI is
short of expectations. Based on the 2013/14 CSA survey in section 6, we have
shown that only about 8% of manufacturing firms are involved in export and the
export to sales ratio is only 10%. When breaking these figures, obviously we find that
proportion of FDI firms that export (16%) is higher than the proportion of exporting
domestic firms (6%) by 10 percentage points. However, among exporting firms,
domestic firms appear to export higher amounts on average than FDI firms; export
constitutes 11% and 7% of domestic and FDI firms’ total sales respectively. This
suggests that FDI’s export involvement is marginal as the majority (84%) are fully
domestic market oriented despite the proportion of exporters being higher in FDI
than local firms. This is not consistent with the country’s interest of attracting FDI and
many factors might have contributed towards this export underperformance.

Despite generous incentives to exporters, Ethiopia has no binding legal export

performance requirement. The export requirement is only on voluntary basis for FDI
firms that decide to engage in labour intensive export-oriented sectors. From the
start, EIC pushes FDI firms to export 100% of their products, but will negotiate with
the investors lowering the export requirement to 60% of total sales. There is neither
any requirement towards FDI to at least cover their imports bill in foreign exchange
through exports. Monitoring whether the export requirements are met appears to be

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challenging. There are several incidents where FDI firms blatantly ignore the export
requirements and sell a large proportion of their product locally. Monitoring and
enforcement of the export requirement is the responsibility of the Ministry of Industry.
However, this is not happening in practice partly due to capacity problems.

But the problem of export underperformance is not only caused by the lack of
regulation or monitoring. Gebreeyesus and Kebede (2016) have examined the anti-
export bias generated by the existing policy (import duties, overvalued exchange
rate) and non-policy factors trading costs (time delay in export processing and
freight costs). Anti-export bias basically measures the relative value added
obtainable in the domestic market versus in exporting. If the domestic price effect of
import restrictions and other domestic market protection exceeds the exporter price
effect of export incentives, then there exists anti-export bias. Higher anti-export bias
means firms will have higher incentive to sell their products in domestic market
instead of exporting.

Gebreeyesus and Kebede (2016) find that the overall (tariff & non-tariff) anti-export
bias is very large, in some sectors reaches up to 200-300%. This implies that the
value added obtainable in the domestic market is greater than three times that
obtained in exporting. Among the different sources; trading costs and particularly
time delay caused by logistic inefficiency and customs procedures is the largest
(above two-third) source of anti-export bias. Import duties is also another important
source of the anti-export bias particularly in the export oriented industries (textile and
leather) that face the higher duty rate (35%). The study also show that exporters are
penalized and discouraged by the increasing overvalued exchange rate of the Birr.
These all have made the domestic market very lucrative and as a result the majority
of firms (including those established for exports) have instead become increasingly
interested in the domestic market.

According to NBE, there is also a critical problem with regard to repatriation of

foreign currency that is earned from exports. On the one hand, some of the FDI that
claim to have come with large foreign debt shift a greater proportion of their export
earnings to finance their debt. On the other hand, some FDI also use under invoicing
of export items and/or over invoicing of imported inputs leading to high flight of
capital out of the country. To minimize the problem associated with under invoicing,

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NBE considers the average world market price of specific export items. If the
repatriated amount is below the average market price by more than 15%, the firm will
be penalized.

The cause of underperformance of FDI in exports can be categorized into the

inefficiency of the system itself and problems related to the FDI themselves although
the latter could have been corrected had the system worked properly.

(i) The system level problems are various but below are the major ones:
 High anti-export bias created the inefficiency of the logistics system from
the port of Djibouti to Addis Ababa
 High anti-export bias created the overzealous export procedure (customs
clearance) of ERCA.
 High anti-export bias created by the existing tariff structure and exchange
rate policies.
 Absence of effective monitoring mechanism on FDIs export.

(ii) Some of the problems related to exporting firms include:

 Improper implementation of the voucher system that is introduced to
promote export. For example, in some cases, inputs that have been
imported to produce exclusively exportable items may not be fully utilized
within 11 months. In this case, ERCA staffs push investors to sell the raw
materials in the local market simply to meet the intended government
revenue target.
 Most of the exporting firms do not add significant value in their process.
 Under/over invoicing of exports/imported inputs.

9.3. FDI and technology/knowledge transfer

Often one of the favourable arguments towards FDI is that it can bring new
technology and know-how to the host country. Maximizing the technology and
knowledge transfer is, therefore, one major prominent objective of the Ethiopian
government to attract FDI. The closest and specific policy regarding technology
transfer is the article in the investment proclamation in 2012 which states that EIC
would register patents and technology transfer agreements as physical capital.

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However, the legislation does not show any form of incentive schemes that
encourage foreign firms to exert efforts to transfer knowledge and technology to
domestic entrepreneurs. There is no linkage programme or joint-venture requirement
to link foreign and local firms to encourage learning and technology transfer. This
shows that the investment regulation is passive when it comes to the issue of
technology transfer. There is no specific mechanism in the system to maximize the
benefits of technology and knowledge transfer in Ethiopia making the technology
transfer benefit from FDI more of rhetoric.

One root cause of the absence of specific and efficient policy gearing towards
technology transfer from FDI could be misconception and underestimation of the
importance of FDI in technology transfer. One major government institution expected
to lead and coordinate the technology transfer efforts from all sources including FDI
is MoST. There might be one department working on technology transfer but this
ministry does not look to be actively engaged in the technology transfer at industry
level yet. In fact, from our discussion with the representative of the ministry we have
sensed some misconceptions altogether about the role of FDI in technology transfer.
Although it might not actually represent the organization, we believe it could be a
widely shared view by others including outside this ministry and we have
summarized it as follows.

“Ethiopia’s main target from inward FDI is to generate employment opportunity,

accumulate asset and achieve overall economic growth but not technology transfer
in principle. FDIs functioning in the country simply come with their machineries and
pre-designed production technologies and hire both skilled and unskilled local labour
and run their production process. The local labour does not have a chance to learn
the main production technology; rather, they simply monitor the production flow or
process. Such FDI and local labour relationship does not enable the achievement of
technology transfer. In real terms, technology transfer can only be achieved if local
staff involved in the pre-production product designing process. Moreover, the
existing FDIs that are engaged in automobile and mobile phone assembly import all
parts of the final product including accessories from their parent company operating
abroad. As a result, the final product does not have local content and the workers
also do not gain the key knowledge behind product designing. Technology transfer is

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said to be realized in a given nation if and only if local labour is involved in product
incubation and designing process not in the final production process. Involvement of
local staff in a production shop floor in any capacity does not enable the
achievement of technology transfer. The existing FDIs operating in the country are
not contributing to technology transfer at all. Creating horizontal linkage between FDI
and academia is more beneficial than promoting vertical linkage between FDIs and
domestic large and medium enterprises as well as small entrepreneurs.” Source
interview

There is a critical problem in this argument, a problem that might lead to the old
fashioned policy of self-sufficiency in technology with a focus on research and
development at the universities. One aspect of the misconception is related to the
type of knowledge and technology the country is seeking to acquire from FDI. At this
early stage of development, we do not expect path breaking technology transfer from
FDI given that the priority sectors are labour intensive manufacturing with mature
and standardized technology. As opposed to other mechanisms (for example, buying
capital with embodied technology, export relations, technology licensing
arrangement) FDI tend to provide access to the whole range of technological,
organizational, and knowledge assets as well as to marketing expertise and brand
names within MNCs (Ivarsson and Alvstam, 2005). Technology and knowledge
transfer should, therefore, be defined to include managerial practices, production
methods, and other tacit and codified know-how by which a firm transforms capital,
labour, materials into a product and markets it. This means it includes production,
process, organizational and marketing technologies and knowledge. In this regard,
local firms can improve their efficiency by copying technologies or marketing
techniques of foreign affiliates through observation or by hiring workers trained by
the affiliates. Local firms can also learn from supply linkages with FDI.

In this regard, like in many other countries, the evidence in Ethiopia shows that local
firms to some extent have improved their technologies and meeting techniques in
their relation with FDI through the horizontal linkages (including competition and
labour turnover) and vertical (mostly as supplier) linkages (see Section 6 for further
detail). Many of the domestic firms interviewed perceive FDI to have helped in
improving quality and delivery timing of products, in providing technology and

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marketing information, increasing capacity of production, likelihood of technology
upgrading and competitiveness of the firm. Box 2 below also gives some good
examples of FDI engagement in technology transfer in Ethiopia. This suggests that
the benefits could have been even more substantial had there been institutional and
policy support.

Box 2 Good examples of FDI technology transfer practices in Ethiopia

According to our interviews with EIC, large FDI firms seem to have a desire to both train
workers and work closely with Ethiopian suppliers to improve the quality of their raw
materials and products. FDI firms are increasingly finding the continual employment of
expat workers expensive. Except knowledge concerning markets and branding, many FDI
firms are willing to transfer important knowledge related with production technology to their
local employees. In connection with the growing interest of FDI to set up local supply
networks in Ethiopia, there are several incidences of learning and technology transfer
towards the local counter parts. For example, the relationship between H&M and MA
garment (a local garment factory located in Mekelle) is a case in point. As a condition to
accept supplies from MA garment, H & M requested MA garment to upgrade its machinery
and provided skills training to machine operators and workers. Moreover, H &M imposed
strict environmental and labour practice standards. Sometimes FDI firms even offer credit
(or pay in advance) to help their local suppliers invest in upgrading activities to meet their
standards. But there seems to be shortage of domestic suppliers that fulfill the FDI’s
requirements.

The now defunct PPESA also have similar positive stories. Those foreign companies
engaged in the production of beverages through acquisition of public enterprises have
brought remarkable productivity improvement in the sector. For instance, Diageo Meta Abo
and Heineken Breweries have mobilized small holder farmers to alleviate the supply
shortage of malt in the country. In this regard, they introduced new variety of barley that is
suitable for production of malt. As a result, the yield per hectare increased more than
100%. That is, in previous years, malt yield per hectare was around 16 quintal but now it
reached about 38 quintal. Assela malt factory is the main producer of malt in the country.
They produce malt using their own inputs and/or process inputs supplied by the Breweries.
Even though the supply shortage of raw barley is alleviated, there are only very few malt
processing agro industries in the country. These constrained breweries operating at full
capacity.

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The theory and empirical evidence suggest that the development of local capabilities
is crucial in maximizing the technology learning from the presence of FDI. The
government can play a role in developing local capabilities in a number of ways:
raise the general level of skilled labour and research expertise, encourage local R&D
and improve quality and quantity of infrastructure are only some of the key
intervention areas that are less controversial. But the primary focus of the technology
transfer should be engaging the firm and the industry. Specific policies to encourage
linkages between local suppliers and foreign multinationals for example, through
domestic-content requirements, joint-venture requirements, linkage programmeme,
or a cluster development strategy, are critical in developing local firms’ technological
capabilities. That means, a deliberate, careful and proactive policy is needed to
encourage technology and knowledge transfer.

Another manifestation of the less focus on the technology transfer in Ethiopia is a

coordination problem among different government institutions. The perception from
EIC appears to be that technology transfer is not part of its mandate; instead, it is the
territory of MoI and MoST. The MoI, through its industry development institutes and
notably the Leather Industry Development (LIDI) and Textile Industry Development
Institute (TIDI), seem to engage in some form of technology transfer activities. For
example, the twining arrangement between LIDI and an Indian leather research
institute called Centre for Leather Research Institute (CLRI) is presumed to have led
to substantial learning gains. But these development institutes are not yet involved in
linking the FDI with domestic investors with regard to technology transfer and still
appear to be mainly tied up in mundane service delivery and regulatory tasks.

To examine the efforts made in this regard, we interviewed the leaders of the six
industry development institutes and four corporations. Section 8 gives detail
discussion on the responses. The main message is that there is a capacity and
orientation problem in these institutions that hinder them from actively engaging in
the technology transfer. The institutes have neither the specifications for quality of
FDIs nor capable people and system to evaluate and select the best FDIs for our
country. Their role has narrowed down to facilitation. With a minor exception of the
leather, metal, and textile industry development institute, they are immersed in
facilitation activities for the investor, activities which are non-technical in nature.

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9.4. Joint venture and technology transfer arrangements

Joint venturing of FDI and local firms has been used as an important instrument in
technology transfer in many other countries and notably in China. Unfortunately,
there is no proactive policy in Ethiopia encouraging the formation of joint venture as
well as the maximization of the benefits that can be exerted from it. The experience
in China shows that, the SOE enterprises played a significant role as counterpart to
the FDI and in transferring knowledge through joint venture and other modalities. But
according to our discussion with the PPESA and MoI, the Ethiopian government is
no longer interested to jointly invest with private actors. Commensurate with this, the
Privatization Agency has recently been abolished and its serviced and workers are
incorporated into a new ministry, the Ministry of State Enterprise. Since private
investors can easily manipulate the JV arrangement to their advantage, the
government decided to pull out of the arrangement in many of the cases.

In the case of Ethiopia, the private sector is envisaged to be the main actor in the
foreign technology transfer even if there is still a potential for joint venturing
arrangement with SOEs. In this regard, EIC does some work on matching between
good local business people and interested FDI firms. In most cases, however, they
seek one another, and EIC’s role would be confined to recognizing and licensing the
JV arrangement. There is limited knowledge on the role of JVs in technology transfer
in Ethiopia. According to the interview with EIC, there are some successful JVs
actively operational in Ethiopia; Dashen Beer (Ethiopia/South Africa), Ahadu
(Ethiopia/UK), Yes bottled water (Ethiopia/Kenya/Uk) and Kadisco (Ethiopia/Indian).

We have collected the perception of the joint venture arrangements in a survey

covering about 26 domestic firms and 14 FDI firms. Below is the summary of the
responses, the details of which are discussed in section 7. According to the survey
results, about 77 % of the domestic firms interviewed claimed that they are willing to
partner with FDI firms in Joint venture arrangement. They perceive to get the
following four benefits from working in joint venture arrangements with FDI: (i) larger
capital injection and improved production capacity through acquisition of new
machinery and production devises and the improvement of production processes; (ii)
Increased marketing knowhow and greater market access; (iii) Increased quality of
production and better competitiveness in those markets; and (iv) Transfer of

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managerial and technological skills from FDI to the local counterpart. In this regard,
the domestic firms appear to prefer European firms for the joint venture as compared
to non-European ones. But the domestic firms also pointed out some challenges
they would face when working with FDI firms, among others, complicated share
valuation system, risk of losing managerial autonomy, communication problems (as
the result of language and cultural differences), lack of trust and conflict of interests
are some of the problems local firms foresee stemming from joint venture
arrangements.

Unlike domestic firms where more than three in four expressed willingness to work
with FDI firms, most FDI firms stated that they would not like to work with domestic
firms in joint venture arrangements. The main reasons forwarded for lack of interest
to work with local firms include; they do not expect any benefits from joining with
domestic firms, domestic firms’ inefficiency can contaminate foreign firms, the work
culture in Ethiopian companies is not compatible with the FDI counterparts’ mode of
operation, and setting up JVs may create management difficulties.

FDI firms would like to form JVs with local businesses that are the best
entrepreneurs in the country in their area of specialization; they prefer to work with
people who have a good understanding of the market, production process and
international financial transactions. Most local investors, however, have a wildly
diversified investment with limited exposure and knowledge of each sector; while
they have money, they often lack the knowledge and exposure required by the
foreign counterpart. Trust is also another important issue where some unscrupulous
local business men were found attempting (and succeeding) in fraudulent activities
by cheating their foreign partners. As a result, currently there are a number of court
cases that arose from breaching of trust and agreements.

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10. Summary and overall assessment of FDI in Ethiopia

10.1. Policy framework

This section tries to summarize the situation analysis above regarding the state,
challenges and prospects of FDI in Ethiopia. With the adoption of the Structural
Adjustment Programme in 1992, Ethiopia introduced various reform measures with
the aim of replacing the command economic system by a market oriented one. In the
same year, the government enacted investment proclamation in an effort to create
favourable condition for private investment both domestic and foreign. Since then,
the investment code was revised several times mainly in the direction of further
liberalizing the investment regime and removing remaining restrictions towards
foreign investors.

The proclamations and other initiatives that have been taken so far regarding FDI
appear to be mainly drawn from the broad development vision and particularly the
Industrial Development Strategy of 2002/03. However, Ethiopia has no
comprehensive policy or strategy on FDI yet leading to divergent understanding of
the importance and management of FDI among policy makers and practitioners, lack
of coordination, monitoring and evaluation capacity in the relevant institutions. The
poor performance in terms of exploiting the envisaged benefits from FDI (capital
in(out)flow, exports and technology transfer) another clear evidence for the lack of
coherent and comprehensive FDI strategy.

10.2. Regulatory and institutional framework

Sectors open to FDI

The 2012 proclamation identifies four categories of investment projects namely

public, domestic private, foreign, and joint-venture investment projects. The
proclamation further identifies some sectors that are not allowed for FDI whether
they are exclusively reserved for the government or for private domestic firms.

However, although the most reserved sector for domestic investment are in the
service sector (trade, transport and logistics, utilities, and banks) and not the
manufacturing sector, the less competition and inefficiency in these sectors have

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substantial negative effects on promotion and benefiting from FDI in the
manufacturing sector.

Investment incentives

Ethiopia provides various investment incentives that include fiscal and non-fiscal
ones. There are different concerns regarding these incentives.

 The income tax exemption difference between the two categories of

investment location (Addis Ababa and the surrounding versus other locations)
is very small (only around 1.2 years) and not sufficient to attract foreign as
well as domestic investors to invest in locations that are distant from Addis
Ababa. That is partly why we observe high concentration of manufacturing
establishments in Addis Ababa and the surrounding.
 The prevailing incentives introduced to promote FDI are not selective and
often not attached to meeting specific performance goals
 In cases where incentives are related to performance, there is a lack of
capacity and system in place to enforce them and monitor if the incentives
provided are fetching benefits

Restructuring of the EIC

In a renewed interest to attract FDI, the government introduced new investment

proclamation in 2012 and as a result the EIC has been reorganized and made to
assume more power and active role, including promotion of investment and exports
as well as directly regulating and supporting the regulation of Industrial Parks.

The EIC has also begun a series of reforms to improve its services.

One-stop-shop service (OSS): The one-stop-shop service has been improved, which
currently brings the documentation requirements ‘in-house’ with 27 of 29 fully
delegated to EIC.

Aftercare service: EIC has developed an investor tracking system where the largest
400 FDI projects are weekly tracked by seven sectoral teams.

Investment promotion: three important changes in the investment promotion direction

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The first change in the strategic direction of promotion is the identification of priority
sectors (labour intensive and export oriented light manufacturing) and potential
country targets (notably emerging countries such as China, India, and Turkey) as a
primary focus in the promotion to attract FDI in the manufacturing sector. The focus
on these countries is consistent with actual FDI flow into the manufacturing. There
are both pulling host country factors as well as pushing source country factors for
this to happen.

The second emerging development is the move from the generic type of promotion
to sector specific missions and head-hunting of anchor investors.

Thirdly, Industrial Park Development is seen as a key to boost Ethiopia’s

attractiveness for foreign and domestic investment.

These changes have been considered as positive developments by the FDIs. There
is almost a universal consensus among the FDI we interviewed that marketing of the
country by relevant authorities has significantly increased. There appears to be
improvement towards both the production of quality products and the aggressive
advertisement of these products.

Problems in the promotion coordination

EIC is not the sole responsible organization for investment promotion. A number of
other government agencies also have responsibilities. These institutions include the
Ethiopian Privatization and Public Enterprises Supervisory Agency (PPESA); the
Ministry of Industry; the Ministry of Foreign Affairs; other sectroal ministries such as
mining, tourism and information; the National Bank of Ethiopia, Development Bank of
Ethiopia; Ethiopian Revenue and Customs Authority (ERCA), Regional Investment
Bureaus.

Of these, the Ministry of Foreign Affairs (MoFA) and its embassies all over the world
are crucial and have been widely involved in the investment promotion. However,
there appear to be concerns from the EIC as the majority of embassies do not seem
to be staffed with personnel equipped with the knowledge and capacity to attract
investment towards the country. As a remedy, the EIC is planning to dispatch staff

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members to selected target countries from which most FDI comes and work
alongside the commercial attaché in the embassies.

The investment promotion also appears to suffer from coordination problems with
other different government agencies. For example;

 There seems overlap between EIC and the Ministry of Industry with regard to
investment promotion.
 There is no organization in charge of the issue of technology transfer from
FDI.
 Lack of coordination between Federal and Regional entities with regard to
making land available including compensation.
 Poor coordination with tax administration and customs office as well as with
utility providers particularly power.
 Organizations such as Ethiopian Airlines and tourism agency that should have
positively support the promotion have not yet been formally engaged until
recently.

10.3. Patterns in FDI inflow to Ethiopia

Overall pattern

FDI stock in Ethiopia has been rapidly increasing since the early 2000s, specifically
from 4 billion birr (about 487 million USD) in 2000 to nearly 100 billion birr in 2016 (5
billion USD). Between 2012 and 2013, there also appears to be a big jump in the
level of FDI stock, presumably because of massive inflow of investment from China,
Turkey and India in the manufacturing sector.

In the 17 years between 2000 and 2016, the number of operational investment
projects registered under FDI increased from 103 to 2658.

The total number of people employed by the FDI sector as of 2016 is 566,000, of
which 270,000 are in permanent employment posts.

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Sectoral distribution

The largest number of FDI projects (1198 projects) went into the manufacturing
sector, a share that amounts to 45% of all FDI projects committed between 1992 and
2017. Agriculture accounted about 12% of total projects.

But on the basis of employment, nearly 45% of FDI’s permanent employment was
created by the agriculture sector followed by the manufacturing sector with 39%.

Between 2012 and 2013, FDI into the manufacturing sector increased by more than
50% contributing greatly to the overall expansion of FDI into the country as
presented in Figures 1 and 3 earlier.

Regional distribution

FDI in Ethiopia disproportionally targets two locations, Addis Ababa and Oromia
regions. Of the total FDI stock generated from 1992 to 2017, a little more than 37%
of it is invested in Addis Ababa and about 40% in Oromia. The two areas jointly
account for more than 77% of total FDI stock and 50% of permanent jobs created by
FDI in the country in the same period.

FDI source

Overall investment projects: Operating more than 21% of the total projects in the
country, China appears to lead the pack in terms of the number of FDI project
followed by India, USA, and Turkey. In terms of capital stock (1992-2017), China still
remains the largest FDI source accounting for 17% of total FDI. Suadi Arabia and
Turkey are the next largest source each accounting 5% of total FDI.

Investment in manufacturing: The level of engagement of Chinese businesses in the

manufacturing sector is very high. For example, of the total of 827 projects licensed
for Chinese firms up to the year 2015, 544 (about 65%) were in the manufacturing
sector out of which 250 have started operation. China takes the lead with above a
quarter of all operational FDI manufacturing projects and followed by India and
Turkey respectively accounting for 9.3% and 5.6% of all operational projects in the
manufacturing sector.

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10.4. Characteristics of the manufacturing FDI and their linkage with local
firms

Comparing FDI and local firms

Based on CSA 2013/14 survey report of manufacturing firms with 10 and above
employees, we compared certain attributes of FDI and local firms operating in
Ethiopia.

FDI firms are on average much larger than local firms in terms of capital,
employment, sales and value addition. FDI firms are also more technology intensive
and more productive than local firms.

FDI firms are less likely (44%) to procure inputs from local sources than local firms
(55). This signifies that FDI firms are more import dependent than local firms.

The proportion of FDI firms that export is higher (16%) than local firms (6%).
However, among exporting firms, domestic firms appear to export higher amounts on
average than FDI firms; export constitutes 11 % and 7 % of domestic and FDI firms’
total sales respectively.

In short, FDI firms are larger, have higher sales turnover, add more value, are more
profitable and use better production technologies and are more productive than
domestic firms. There are different explanations to this including economies of scale,
access to better technology and other resource advantages.

Linkages and technology/knowledge transfer

Horizontal linkage

When FDI and local firms produce same or similar commodities destined for the local
market, it results in competition in the product market as well as labour market. Each
of them might have harmful and useful effects.

Competition from FDI seems to be an important source of productivity improvement.

For example, 35% and 46% of supply linked and labour linked domestic enterprises
respectively report to have improved their production techniques/processes to keep
up with the FDI firms’ level of technology in the same sector.

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Labour turnover: the employment of workers with FDI experience is related to
positive changes in production technologies. And more than 61% of domestic firms
that are not connected with FDI firms in supply relationships report to have changed
their production technologies as a result of the recruitment of workers with FDI
experience.

Vertical linkage

Forward linkage: 42.5% of supply-linked and 64.3% of labour-linked domestic firms

stated that their supply relationships with customers required additional or special
investment targeting the improvement of production practices. Fifty six percent of
domestic firms that required additional investment because of their supply
relationships report to have benefited from such relationship in the form of
technology transfer.

Backward linkage: 10% and 16% of supply- and labour-linked firms were stimulated
to make additional investment in production technology or human capital as a result
of their interaction with suppliers, which in most cases led to technology transfer.

The results from the perception survey have also confirmed the existence of
positive spillover from FDI to local firms. For example, the domestic firms perceived
the FDI positively when it comes to technology transfer. The survey shows that FDI
firms contribute positively to the introduction of new technologies (57.7% of firms),
marketing techniques (61.5% of firms) and the employment of FDI-trained workers
(30.8%). Most domestic firms (77%) consider FDI as an important source of
competition that led to loss in market share (61%) and skilled workers (50%). Many
of these also believe that there is a wide array of benefits from FDI-related
competition.

10.5. Technological capabilities of the priority sectors

One part of this report is assessment of the technological capabilities of the priority
sectors with the aim of identifying the gaps and potential policy remedies. The review
includes the following seven sectors; textile and apparel, leather and leather
products, metals and engineering products, agro-processing industries, chemical
industries, pharmaceutical industries, and electric and electronic industries.

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Interviews were arranged with the leaders of the six industry development institutes
and four corporations, to complement the desk review.

10.6. To what extent has Ethiopia benefited from the presence of FDI?

The three most cited benefits of inward FDI for developing countries are; filling
finance gap, increasing exports, and technology transfer. This report assesses to
what extent Ethiopia has benefited in these three dimensions. Below is a summary of
our findings.

10.6.1. Bridging the capital gap: FDI and Financing

According to our interviews with representatives from Development Bank and

National Bank, there are at least two problems with regard to FDI financing in
Ethiopia.

 The first is, a large number of FDIs that come to Ethiopia register large
amount of debt that is obtained from foreign sources and request extra loans
from DBE. The motive is that they do not have to make profits and pay taxes
to start repatriating foreign exchange. This has created a loophole that
enables investors to exploit the country’s limited foreign currency reserve.
 The second related problem is that instead of bringing their own capital, the
FDI tend to borrow more from domestic banks, particularly the DBE. One of
the main reasons for FDIs to claim loan from DBE is risk diversification.
Particularly, Indians and Turkish mostly come to the country without having
financial assets and try to depend fully on local financial sources. In previous
years, Chinese investors did not need loans from DBE, but now, they are also
requesting loans from the bank.

The 30:70 credit scheme has been revised in recent months in a way that foreign
nationals will be treated in 50/50 credit scheme and domestic investors will be
treated in 25/75 arrangement. But one may further argue why a country like Ethiopia,
hungry of foreign currency, needs to provide this much loan to foreign investors
instead of pushing them to bring their own.

Our interviews also show that there is clear behavioural difference between investors
that come from the West and other emerging countries from the East.

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  The investors from the West tend to bring their own finance, introduce
genuine investment projects, make more ethical and transparent businesses,
and are intolerant to inefficiencies in the public services.
 In contrast, the investors from other emerging countries such as India, Turkey,
and China often seek finance from domestic banks and also involve in illegal
practices for example corrupting civil servants, over/under invoicing of
transactions, reminting foreign exchange illegally, as well as selling in
domestic market while designated as exporters.

10.6.2. Bridging the trade balance gap through enhancing exports

The Ethiopian government has been keen to attract FDI to stimulate exports and
generate foreign exchange. The incentive structure also favours export sectors.
However, the export performance of the manufacturing sector at large and FDI is
short of expectations. FDI’s export involvement is marginal as the proportion of FDI
manufacturing firms that export is only 16% and their export sales constitute only 7%
of total sales.

The cause of underperformance of FDI in exports can be categorized into the

inefficiency of the system itself and problems related to the FDI themselves although
the latter could have been corrected had the system been right.

i. The system level problems are various but below are the major ones:

a. High anti-export bias created by the existing tariff structure, exchange

rate overvaluation, the overzealous export procedure of ERCA, and
inefficiency of the logistics system from the port of Djibouti to Addis
Ababa.
b. Absence of effective monitoring mechanisms on FDIs’ exports.

ii. Some of the problems related to exporting firms include:

a. Improper implementation of the voucher system that is introduced to

promote export.
b. Most of the exporting firms do not add significant value in their process.
c. Under/over invoicing of exports/imported inputs.

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10.6.3. Bridging technology/knowledge gap: FDI and technology/knowledge
transfer

Maximizing the technology and knowledge transfer is stated as one major objective
of the Ethiopian government to attract FDI. But the proclamation (for example, 2012)
is very passive and simply states that EIC would register patents and technology
transfer agreements as physical capital. No specific instruments and incentives are
put to encourage technology transfer. There are no specific mechanism in the
system to maximize the benefits of technology and knowledge transfer in Ethiopia
making the technology transfer benefit from FDI more of rhetoric. There is neither
linkage programme or joint-venture requirement to link foreign and local firms to
encourage learning and technology transfer.

One potential root cause of the absence of specific and efficient policy gearing
towards technology transfer from FDI could be misconception and underestimation
of the importance of FDI in technology transfer. For example, one argument we
faced was; “Ethiopia’s main target from inward FDI is to generate employment
opportunity, asset accumulation and achieve overall economic growth but not
technology transfer in principle”.

Another dimension of the misconception is on the type of knowledge and technology

the country is seeking to learn from FDI. At this early stage of development,
technology transfer should not be seen as referring only to hard technology or
research and development but should be broadly defined to include managerial
practices, production methods, and other tacit and codified know-hows by which a
firm transforms capital, labour, materials into a product and marketing them. In that
case, the primary focus of the technology transfer in the mature industries is to
motivate the firms themselves insert into the global value chain and proactively
engage in the technology and knowledge transfer. Technology transfer does not
happen automatically, but requires deliberate and proactive policies to encourage
technology and knowledge transfer.

More importantly, no organization seems to be fully responsible for the technology

transfer issue. The perception from EIC appears that it is not mandated to work on
technology transfer instead technology transfer is the territory of MoI and MoST. The
MoI, through its industry development institutes and notably the Leather Industry
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Development (LIDI) and Textile Industry Development Institute (TIDI), seem to
engage in some form of technology transfer activities. However, there is a capacity
and orientation problem in these institutions that hinder them from actively engaging
in the technology transfer. The institutes have neither the specifications for quality of
FDIs nor capable people and system to evaluate and select the best FDIs for our
country. Their role has narrowed down to facilitation. With a minor exception of the
leather, metal, and textile industry development institutes, they are immersed in the
facilitation activities for the investor, activities which are non-technical in nature.

10.6.4. Joint venture and technology transfer

Joint venturing of FDI and local firms has been used as an important instrument in
technology transfer in many other countries and notably in China. Unfortunately,
there is no proactive policy in Ethiopia encouraging the formation of joint venture as
well as the maximization of the benefits that can be exerted from it.
 SOEs seem to be not interested in joint venturing
 The joint venturing initiative is left for the private sector
 Domestic firms seem to be willing to partner with FDI but foreign firms are not.
The reason is that despite some successful cases, many experiences of joint
venturing are distasteful. Untrustworthiness, capacity and inefficiency problems
from the side of domestic firms are reasons for the reluctance of many FDI firms
for joint venture
 Above all, there is no specific policy to promote joint-venture and maximize the
technology transfer benefits. EIC does some work on matching good local
business people with interested FDI firms. In most cases, however, they seek
one another and EIC’s role would be confined to recognizing and licensing the
JV arrangement.

10.7. Summary: perceptions on the strengths and bottlenecks

Below, we summarize the main FDI related strengths and bottlenecks, which will be
used as bases for the policy recommendations that follow.

There is a growing interest of global investors eying Ethiopia as the best destination
of FDI in manufacturing in Africa. Many factors have contributed toward this positive
attitude among which the main are listed as follows.

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  Government vision and commitment to industrial development and specifically
to attract FDI
 Pro-active approach: incentives, prioritized support, and high policy attention
to target sectors and firms
 A country registering high and continuous growth and growing domestic
market
 Huge investment in social overhead and improvement in the overall
infrastructure
 Availability of large trainable and low cost labour force
 Cheap electricity cost
 Stable and predictable political environment
This study, on the other hand, identified the following major weaknesses and
bottlenecks that require due attention in order to attract more and quality FDI as well
as benefit from their presence.
 Poor infrastructure and services particularly related with power supply and
telecom service
 Poor coordination among various governmental institutions regarding FDI
promotion, implementation, and performance monitoring
 Inefficiency and lack of motivation and commitment in the bureaucracy in
general and the tax and customs administration in particular
 Slow and expensive trade and logistics
 Limited access to foreign currency and high banking cost
 Lack of raw materials in sufficient quality and quantity in the domestic market
 Incentives: – not selective, less focused, not linked with performance, lack of
monitoring
 Reluctance of domestic investors to enter into the manufacturing sector and
engage FDI in the knowledge and technology transfer
 Lack of consultation and predictability of policies
The remaining task is to outline FDI policy alternatives that will reinforce the
strengths, while addressing the weakness and ultimately make FDI to positively and
substantially contribute towards Ethiopia’s industrialization drive. These policy
recommendations are presented in the next sections.

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Part Five: Policy and Strategic Options for Effective Use of
FDI in Ethiopia

11. Overall FDI strategic directions and key principles

11.1. The significance of designing a unified FDI policy and consensus

building

In the mid-1990s, Ethiopia announced Agricultural Development Led Industrialization

(ADLI) as its development vision which look to agriculture growth as an initiator of
structural transformation and a catalyst for full-fledged industrialization. ADLI is a
home-produced development vision and serves as a key guiding principle for a
series of national development plans and sector strategies. Despite possessing such
a grand development vision and various sectoral strategies, including the industrial
development strategy, Ethiopia has no comprehensive FDI policy and strategy yet.

The international literature on the benefits and risks of FDI is fraught with conflicting
views; some based on different interpretations of the evidence while others on
ideological grounds. This divergent view is further aggravated by the fact that the
evidence on the development impact of FDI on the host country is inconclusive.
Some countries have successfully attracted FDI and transformed their economy,
while the majority failed. Alike there appears to be less consensus among Ethiopian
policy makers and practitioners with regard to the benefits and risks of FDI.

The absence of a coherent FDI policy is believed to have contributed to the divergent
understanding on the importance and management of FDI among policy makers and
practitioners, inconsistency between different initiatives and programmes, lack of
coordination among different institutions, inadequate monitoring and evaluation
capacity, and more focus on the process instead of performance and impact. It is
also responsible for not sufficiently exploiting the development impact of FDI in terms
of capital, exports and technology transfer.

The initial task should, therefore, be to have clear understanding and consensus
building on the benefits and risks of FDI to the host developing country as well as on
the management of it.

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Our review of the literature suggests that the successful countries are those that
formulated suitable investment policy frameworks that are driven by and aligned with
the countries’ development objectives. With adequate policies, FDI can provide
significant economic and social benefits to the host country. In other words, the
presence of an appropriate FDI policy plays a critical role in shaping the ultimate
effect of FDI either by maximizing the benefits or minimizing the risks. It is, thus,
crucial for Ethiopia to design a full-fledged policy and strategy guiding FDI.

Designing a coherent FDI policy can help to;

 align FDI with the overall development objectives and strategic directions of
the country
 create clarity and consensus among stakeholders and particularly policy
makers and practitioners about the benefits and cost of FDI as well as
management
 to build the capacity of national institutions administering FDI and strengthen
the required link and coordination among various implementing agencies
 shape the potential cooperation and conflicts of objectives between the
country’s government and the multinationals, thus, maximize the benefit and
minimize the risks
 continuously build local capability (firm, industry and national levels) with long-
term view and requirement for each stages of development

The most important issue is, however, not whether policy is needed but to set what
specific objectives a country can achieve through FDI and how. In lieu of this, we
identify some of the key principles that should guide Ethiopia’s FDI policy and
strategy.

11.2. The FDI policy and objectives need to be based and aligned with the
overall industrial development objectives and strategies

Formulating and implementing an effective FDI strategy requires above all a broader
development vision. As laid out in the GTP I and II, Ethiopia’s economic vision is to
reach the middle-income country status by 2025. Underpinning this vision is,
sustaining industry growth as an impetus for economic structural transformation. A

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clear understanding on what the overall objective of the industrial policy and whether
FDI is an efficient way of achieving this is, thus, needed.

As set in the Industrial Development Strategic Plan (2013 – 2025), Ethiopia’s vision
of the industry sector development is:

“Building an industrial sector with the highest manufacturing capability in Africa

which is diversified, globally competitive, environmentally-friendly, and capable
of significantly improving the living standards of the Ethiopian people by the year
2025”

This implies that the overall objective of Ethiopia’s FDI policy should be to enhance
industrialization and facilitate structural transformation, thus, the manufacturing
sector should be given priority in attracting FDI. The focus on the manufacturing
sector is consistent with the literature and history of FDI based successes. FDI in
manufacturing is supposed to have better development impact in contrast to other
sectors. The countries that have succeeded by extensively relying on FDI (for
example, Singapore, Ireland and China) used selective policies to attract FDI into
manufacturing and specific sectors within the manufacturing that they considered
strategic for the future development of their economies.

Box 3: The role of FDI in Chinese and Irish manufacturing

A majority of FDI in China has gone into manufacturing. For example at the end of
2001, FDI in manufacturing industry constitute 70 percent of total FDI projects, 56
percent of the aggregate amount of FDI, and 60 percent of aggregate amount of
registered capital in FDI in China. And more than 80 percent Chinese FDI in
manufacturing was green-field investment (Long, 2005). Similarly, Ireland has
successfully used FDI to transform its manufacturing. For example in 1995, FDI in
Irish manufacturing were responsible for about 47 percent of total number of
employees, 77 percent of value added, 68 percent of expenditure in R&D and
82percent of exports (OECD, 1999).

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Ethiopia’s target for 2025 is to increase the share of the industry sector as
percentage of GDP from the current 13% to 27% and the manufacturing sector from
current 4% to 17%. Massive expansion of investment in manufacturing is expected
to achieve these targets and drive the development of the manufacturing industry.
Such huge investment cannot, however, be mobilized from the domestic economy
alone. Similar to many other developing countries, Ethiopia faces two types of capital
shortages arising from the investment-saving and export-imports gaps. FDI can,
thus, play an important role in bridging these gaps. FDI can also bring new
knowledge and technology, which is critically needed to make the industry
internationally competitive and transform the economy at large. In fact, some argue
that the impact of FDI on technology accumulation is central and long lasting in
comparison to the impact on capital accumulation.

The Ethiopian industrial development strategy contains some key principles, which
can inform us in determining the objectives and role of FDI. Ethiopia is endowed with
plenty of land suitable for agriculture and large and cheap labour. In recognition of
this comparative advantage, the strategy states that the labour intensive and those
industries with high potential linkage with the agriculture sector (agro-processing)
should be given priority. The focus on labour intensive and agro-processing
industries is not only based on exploiting the country’s endowment but it also reflects
the development orientation of the incumbent government to pull the rural poor out of
poverty and ensure inclusive development. Export orientation is another key principle
of the IDS. This is because a sustainable and fast industrial development can only
be ensured if the sector is competitive in the international market and has the
potential to generate foreign exchange.

The implication is that, within the manufacturing sector, the light industries
characterized by labour intensive, export-oriented, and strong linkage with
agriculture should be given priority in attracting FDI. This is in confirmation with the
current comparative advantage and overall development objectives.

Based on the above synthesis of development strategies we suggest the following

specific objectives for attracting FDI into the Ethiopian manufacturing sector.

 Transfer technology and know-how

 Boost export competitiveness and improve the balance of trade

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  Enhance the country’s net capital inflow
 Raise the quantity and quality of employment and
 Strengthen the industrial base of the country

These objectives might not be always compatible. For example, some sectors might
be strong in terms of employment or export generation but weak when it comes to
technology transfer. Some other sectors might be pivotal in the needed technology
transfer but less important in employment generation. Effective FDI strategy, thus,
requires the ability to decide on trade-offs between different objectives of
development. The priorities need also to be revised in due time to reflect the
changes in the industrial specialization the country desires. But overall we can say
that technology and knowledge transfer and boosting export competitiveness (in
order) need to be given priority among all the above objectives.

11.3. FDI as complementary and a way to develop local capabilities

The IDS document is crystal clear when it comes to the relative role of FDI and
domestic firms. The domestic private sector is considered as the basis of industrial
development. The policy document also recognized the fact that local industrialists
have been weakened by the deliberate policy of the previous regime and are
characterized by shortage of capital, technology, and network and knowledge to
penetrate international markets. Hence, in the IDS, FDI was envisaged to play a
significant role in bridging these gaps and enhance the capacity of domestic
investors. However, FDI should not be seen as a substitution for domestic investors
but as complementary and a way to develop local capabilities.

The literature shows that successful countries are those that are able to transform
the domestic productive sector by increasing participation in global value chains.
Attracting FDI cannot bear the envisaged benefits of building domestic capacity and
transferring knowledge and technology in the absence of sufficient number of
domestic investors in every major manufacturing sub-sector. However, the anecdotal
evidences show that the Ethiopian domestic investors are less willing to enter into
the manufacturing sector. Many factors might have driven the lack of interest among

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domestic firms.26 What is worth noting at this point is not only the lack of proper
instruments to support the domestic private sector, but also the presence of a de
facto preference for foreign investors over domestic ones similar to many other
developing countries. According to World Bank (2015) report, entry constraints
related to business licensing and registration processes are more severe for
domestic firms than FDI. While FDI firms are supported by EIC, domestic investors
have to deal with local investment offices with a lower capacity than the EIC.
Although not in written form, in practice FDI firms enjoy a preferential or swift access
to land. This bias needs to be carefully balanced to ensure a level playing field and
even travel extra miles to build the capacity of the domestic firms. Some other
studies also show that the current incentive structure in the economy favours the
service sector and particularly the importers rather than domestic production and
does not encourage high value added manufacturing activities.

Encouraging domestic investors to massively enter into the manufacturing sector is a

necessary condition for FDI to bring the envisaged benefits

Governments wanting to use FDI as part of achieving development objectives should

put policies into place not only encouraging massive entry of domestic firms but also
linkages between foreign multinationals and local firms. As far as our review is
concerned, Ethiopia has no specific mechanism in the system or any other linkage
programmes in place to maximize the benefits of technology and knowledge transfer.
This has resulted in poor linkages between FDI and domestic firms. Hence, the FDI
strategy needs to incorporate clear mechanisms to revamp the capacity of domestic
firms and enhance the FDI-local firms’ link (for example joint ventures and linkage
programmes). A conscious effort is needed to cluster domestic firms around FDI (in
all sectors and places) and their absorptive capacities enhanced. Section 13.3 gives
further description of potential linkage programmes between FDI and domestic firms
in relation to technology transfer.

26
How to encourage domestic investors to enter into the manufacturing sector is beyond the scope
of this work but is covered in another related study at the Ethiopian Policy Study and Research Centre
(EPSRC).

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11.4. Continuously improving the country’s absorptive capacity and aim to
avoid the middle-income trap

The empirical evidences have unequivocally confirmed that local absorptive capacity
is one of the major factors determining the attraction and maximizing the benefits
from FDI. Improving the absorptive capacity at national, industry and firm levels is
very crucial. If appropriate skills, infrastructure and national innovation system is not
in place there will not be no learning and much accumulation of technology. Export
platforms will simply become low skill and import dependent. Moreover, even though
the FDI strategy should give more emphasis on attracting foreign investment in the
light manufacturing sector in alignment of the broad industrial policy, in the long-
term, these industries cannot continue to be a basis for sustained industrial
development. The comparative advantage based on cheap labour and other natural
resources will be definitely eroded with economic growth and the associated
increase in per capita income. Moreover, given the labour intensive sector is highly
footloose and can relocate with small changes in labour cost, there would be growing
competition from other low income countries that may start to enjoy relative cost
advantages. Productivity improvement and upgrading should, thus, be given due
emphasis from inception to sustain industrial development and avoid the middle-
income trap.

Lagging growth of productivity compared to wage rates is one of the causes of the
slow-down of exports and growth, and hence the middle income-trap. The FDI
strategy should ensure fast and continuous technology development and upgrading.
The primary focus of the technology development at the initial stage would be the
transfer, adaptation and development of available and suitable technologies in the
world. Achieving the middle-income status is not so much difficult particularly in the
presence of resources. The biggest challenge is, however, moving from resource-
driven growth to growth based on high productivity and innovation. This requires
investments in infrastructure and education--building a high-quality education system
which encourages creativity and supports breakthroughs in science and technology
as well as R&D capacity development. It also requires the start of some ground work
for transformation to heavy and chemical industries as well as high tech industries

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such as ICT and bio-technology. FDI can play important role in this path, thus,
conscious effort is required to achieve this.

11.5. Using the industrial parks as a major mechanism to attract and benefit
from FDI

The Ethiopian Government has initiated ambitious industrial park programme with a
view to accelerate manufacturing growth and sustainable industrialization.27 The aim
is to create about two million manufacturing jobs in the next 10 years. The industrial
park programme largely hinges on attracting FDI in export-led and labour-intensive
manufacturing sector. Industrial park development can play a crucial role in attracting
FDI and benefiting from their presence. It can attract more FDI because it enables
addressing key constraints that hinder manufacturing activities such as land access,
infrastructure, logistics and customs processes. It can enhance the beneficial effect
of FDI because of agglomeration effects and strengthening linkages with local firms
and the economy at large. The industrial parks can also be used as experiments to
try out new policies and instruments, which can be scaled up at a later stage if
proven successful.

China can provide excellent lessons on how to successfully use industrial parks to
attract and benefit from FDI. China has achieved unprecedented economic growth
registering about nine percent annual average growth rate for about 30 years
following the Open Door policy in 1978. In this regard, the Special Economic Zones
(SEZs) and other types of industrial parks have made crucial contributions. For
example, it is estimated that as of 2007, SEZs and other types of industrial parks
account for about 22% of national GDP, about 46% of FDI, and about 60% of
exports and generated an excess of 30 million jobs.28

The Ethiopian industrial park programme is already underway. However, as the IP

development is a relatively new phenomenon for Ethiopia, there is a lack of

27
Successful implementation of industrial park development can bring two main types of benefits;
“static” economic benefits such as employment generation, export growth, government revenues, and
foreign exchange earnings; and the “dynamic” economic benefits such as skills upgrading, technology
transfer and innovation, economic diversification, productivity enhancement of local firms (Zeng
2010).
28
Source, URL: ttp://blogs.worldbank.org/developmenttalk/china-s-special-economic-zones-and-
industrial-clusters-success-and-challenges. Last accessed 29/02/2016

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regulatory and institutional capacity and management experience. A proposal
consisting strategy and institutional setup of industrial park in Ethiopia has been
recently prepared by a team of EDRI researchers in which the two authors of this
report have taken part. The report is based on country situation analysis and review
of best international practices and specifically a visit to China. One can, therefore,
refer to this report on the proposed key strategies and institutional arrangements to
make the IP successful and specifically to enhance the role of FDI.

12. FDI promotion and targeting

Improving the general business environment is important but only the first step.
Successful investment promotion requires effective strategic marketing. Strategic
marketing in turn requires clarity of objectives, among others, the main interest of the
government, why it is trying to attract inward investment, sectors of national
priorities, modalities of FDI, and the role and type of incentives. Hence, Ethiopia’s
investment promotion needs to adopt a two-track approach; providing an excellent
investment climate for all investors and targeted FDI promotion strategy. Below, we
discuss each of these approaches.

12.1. Improving the investment climate

Ethiopia can substantially improve the investment climate for investors through
addressing the identified binding constraints and capitalizing on the strengths. See
section 10 for summary analysis of the challenges and opportunities regarding
inward FDI in Ethiopia.

12.1.1. Addressing the binding constraints with appropriate instruments

Our assessment show that the main challenges FDI firms currently facing in the
country are poor infrastructure and services particularly access to power; limited
access to foreign currency and high cost of banking; poor trading logistics related
with transportation of goods; poor coordination among government agencies; lack of
commitment and efficiency in the bureaucracy in general and tax and customs
administration in particular; and shortage of raw materials in quantity and quality.
These problems hold back not only foreign investors but also the domestic ones. The
government is generally aware of most of these problems and is tirelessly working to
address most of them. For example, the development of industrial park and

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associated initiatives are believed to overcome some of these constraints.
Government is also hugely investing in infrastructure including power and transport
(rail and roads). It has also initiated various programmes to modernize the Ethiopian
Revenue and Custom Authority (ERCA) although with less success so far.

Some of the key constraints identified are not, however, well recognized or
sufficiently addressed. More reforms are, thus, needed to address these existing
bottlenecks. The reform directions required to address these problems might be
policy liberalization or/and robust regulations. There are some crucial areas that
need more of opening to competition and liberalization, while others involve more
regulations and capacity building of regulating agencies. While liberalization can
have beneficial effects reducing cumbersome procedures and encouraging
competition, the beneficial impact depends on the presence of competent and well-
organized market supervisions. Hence, liberalization and regulations are not
necessarily contradictory but complementary (UNIDO, 2009).

For the sake of the management of the discussion, we focus on two issues that need
special attention; the lack of implementation and monitoring capacity in the
bureaucracy and insufficient competition in some sectors.

Building the capacity and aligned rewards of the civil servants

Foreign investors in Ethiopia often admire the strong commitment of top policy
makers and higher officials but complain severely about the inefficiency and lack of
commitment at the lower rank of the bureaucracy. Rent seeking behaviour of the
bureaucracy might be one cause for the inefficiency. But largely, the civil servant is
underpaid and the better skilled workers often leave the public sector, while the
remaining ones are less motivated and inefficient. A recent EDRI study (Abebe et al.,
2017) surveyed about 150 mid-level bureaucrats in 9 key government agencies
involved in industry policy making and implementation in Ethiopia. Their findings is
that about 44% consider the public employment the worst possible employment,
52% suggest low pay as the main cause for the high turnover, and most the
available staffs want to leave within short time (for example, 85% would like to quit in
4 years period). This is indeed alarming for a developmental state that set ambitious
growth targets and aspire to deliver. In the face of low level of remunerations and

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skills of the civil servants, the country is paying higher price in terms of massive
inefficiency. The lessons from successful East Asian countries suggest that the
industrialization and particularly managing FDI cannot be successful without the
formation of meritocratic and well-motivated civil servants.

Ethiopia may need to adopt a two-pronged approach to address the problem in the
quality of the institutions and specifically the civil servants dealing with FDI; (i)
capacity development and (ii) proper incentive mechanisms for performance of the
civil servants.

Modernizing and reforming the service sector (utilities, finance, trade and
logistics)

Ethiopia’s manufacturing sector is fairly open for FDI. The most protected and
reserved sector for domestic investment is the service sector including trade,
transport and logistics, utilities (e.g. energy and telecom) and the financial sector.
Our assessment shows that the promotion and expected benefits from FDI are
hampered by the inefficiencies and high trading costs in these sectors. For that
matter, these are also the binding constraints for domestic investors in the
manufacturing sector. The government has been aware of these problems and made
several attempts to solve them to date, but with less success. The reforms so far
have been focused on modernizing the management systems. These sectors are still
reserved to the public sector or domestic investors and remained closed for foreign
investors. The question is then how can these sectors be made competitive and
efficiently serve the manufacturing sector development. How can competition be
instituted in these sectors and what roles can FDI play in this regard. In other words,
to what extent should the service sectors, such as, the finance, trade and logistics be
opened for competition including from foreign and in what sequence.

It is beyond the scope of this study to concretely suggest on the need and extent of
liberalization or opening of the service sectors for foreign firms. Such suggestions
need to consider wider economic, social and political issues, which were not
explored in depth in the current study. But what is crystal clear from our analysis is
that modernizing and increasing the efficiency of the service sectors requires
instituting more competition. Competition will have to be introduced not only in the

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domestic private sector but also into the sectors that are currently under state
monopoly such as power, telecom, and trade and logistics. This does not necessarily
demand allowing foreign firms’ participation although it remains an option to be
evaluated on its own merit depending on the timing and the sector.29 Competition
can also be enhanced through breaking the monopoly of some of the state owned
enterprises into separate and competing entities or/and encouraging partnership with
the domestic private sector at various segments of the value chain.

We, thus, hereby propose steps to be taken to enhance competition in the utilities,
finance, trade and logistics sectors. With a comprehensive FDI strategy that strongly
anchors FDI attraction and promotion to the national development agenda; we
believe that the potential negative consequences of foreign investment can be better
managed in the logistics and wholesale trade sectors. But controversy may still arise
whether FDI should be allowed in the finance and utility sectors currently and what
the outcomes might look like. We further elaborate on these issues as follows.

First, the logistics sector is known to be one of the critical bottlenecks of Ethiopia’s
export competitiveness. The import/export logistics is dominated by the Ethiopian
Shipping and Logistics Enterprise (ESLSE) which is granted monopoly for arranging
ocean and inland transport of goods imported as well as for the operation of the dry
ports where these goods are cleared since the implementation of the multimodal
system. This has further aggravated the already inefficient logistics systems in the
country. The World Bank estimates the cost to export in Ethiopia to have been USD
2380 per container in 2014, which shows a substantial increase from USD 1760 in
2010. The time for processing documents and customs clearance is also estimated
to be about 44 days. See section 13.2 for further discussions on the severity of the
trading logistics problems and potential solutions. As Ethiopia is a land-locked
country and largely dependent on the road and rail transportation system to export
and import commodities, it is crucial to make the logistics system more efficient than
any other country. This will not only help to attract FDI but also to reap the benefits of
international trade for the entire economy. There is a lot of room to improve the

29
For that matter, Ethiopia is required to open these sectors sooner or later in its run-up to the WTO
membership. Thus, it would be better to begin some policy experiments and make preparations ahead
of time emulating the Chinese strategy.

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logistics efficiency by introducing more competition from domestic private enterprises
and also foreign companies.

Second, low quality and insufficient quantity of industrial inputs is another crippling
constraint in the manufacturing sector. Government is trying to partly solve this
problem by establishing a new entity named Ethiopian Industrial Inputs Development
Enterprise (EIIDE). The rationale is that although private domestic investors were
allowed to import the inputs, they failed to do so because of financial and
management problems. On the other hand, the wholesale trade still remained closed
to foreign firms. Foreign investors can help bridge the existing financial and
management gap, hence, government needs to invite foreign companies in the
wholesales sector with a particular focus on industrial inputs.

Third, the continued inefficiency of the utilities and particularly power supply is
making the economy hostage. Manufacturing enterprises are currently complaining
that they are facing about 30-40% of loss of production time due to power
interruptions. Despite improvements, the telecom service is also marked by low
quality. Government has been trying to modernize these sectors by inviting
foreigners on the basis of management contract, i.e. telecom with France and
electric power with India. These efforts have not produced the envisaged benefits
and the delivery of services remained poor. As a first step, proper evaluation needs
to be made as to why the contract managements failed to bring the expected results.
Then proper and bold measures need to be taken to break this deadlock.
Government can enhance competition short of opening to foreign firms, for example.

Our advice in cases of uncertainty in the reform outcomes, the intended reforms can
be first experimented within the industrial parks envisaged to flourish soon. In this
regard, China can provide good lessons to Ethiopia (see the Box 4 below).

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 Box 4: China’s policy experiments through Industrial parks

China has been very successful in attracting and benefiting from FDI through the Special
Economic Zones (SEZs), which were started in 1980 in four coastal cities (Shenzhen,
Zhuhai, Shantou in Guangdong and Xiamen in Fujian) and gradually extended to other
regions. The SEZs not only served as vehicles of attracting foreign investment but also the
whole country benefited from the adoption of diverse successful liberalization policies
tested in these areas. For example, while foreign banks were shutout of the rest of the
economy, they were permitted to operate in the SEZs in the early 1980s in China. The first
foreign owned bank, Nanyang Commercial Bank, started operations in 1982. By 1986, all
domestic banks were allowed to conduct foreign exchange business in order to increase
competition and to revitalize the banking industry. In 1986, swap centres were established
in some cities where Chinese enterprises with retained foreign exchange or retention quota
and FFEs in SEZs were permitted to trade foreign exchange at a rate that is higher than
official rate (Zhao, 2006).

Many other liberalization reforms including logistics, employment, and land issues have
also been first tested in the SEZs. This strategy has also created consensus building on
the need for further liberalization among the leadership and the population at large. The
enormous success of the SEZs has inspired authorities to replicate them in other parts of
the country and particularly the western part of China under the “Go West Strategy”. China
has also used the SEZs as policy experiments in the inevitable liberalization in the run-up
to the WTO accession (Martinek, 2014).

12.1.2. Exploit the overall economic progress to attract more and quality FDI

Sustain the political and macroeconomic stability

A number of empirical studies identify political and macroeconomic stability of the

host countries as vital factors that affect the inflow of FDI. In support of this, a study
on Chinese FDI in Ethiopia by (Geiger & Goh 2012) also confirmed that a
considerable proportion of the Chinese investors operating in Ethiopia are found to
be motivated to invest in the country due to the prevailing stable political
environment. This has also been confirmed by our field survey. Hence, in order to
attract more FDI, Ethiopia needs to work hard to sustain the existing political and
macroeconomic stability.

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Sustain high economic growth

Countries with high growth potential will tend to receive greater FDI inflow than those
nations with a more volatile economy. By sustaining the current rapid economic
growth performance, Ethiopia can further attract more FDIs from the world. However,
such FDI is motivated by domestic market, thus, market seeking. Ethiopia needs to
strategically place the market seeking investors in import substituting sectors where
there is huge domestic investment gap.

Further improving the infrastructure and human capital

It is argued that high overhead investment such as on infrastructure and education

can motivate FDI. Ethiopia can, thus, improve its attractiveness for FDI by
introducing policies that can improve infrastructure (roads and utilities) and scale up
local skills and build up labour force capabilities.

Exploiting regional market opportunities

Regional integration is among the powerful means to attract FDI because one
motivation of FDI is the presence of large and growing markets. These regional
agreements not only facilitate investment among member countries but also promote
FDI from outside the region of agreement and can also diffuse ‘race to the bottom’
incentive based competition and its negative consequences (UNIDO, 2009).

The Ethiopian economy is growing fast and has changed significantly over the past
decade. Notwithstanding peace and security, Ethiopia is also taking a lead in the
regional integration in terms infrastructure development, for example transport and
power, which is believed to strengthen the economic ties among countries in the
region. Ethiopia’s export to neighbouring countries is also on the rise in recent years.
Ethiopia can no longer shun regional economic integrations and instead should use
them as an opportunity to attract FDI. In this regard, the Common Market for Easter
and Southern Africa (COMESA) FTA presents the most immediate challenge and
opportunity for Ethiopia in its economic relations with the region.

12.1.3. Improving the coordination among relevant institutions

Institutions are important factors that influence FDI inflow to host countries. The
primary institution responsible for investment promotion is the Ethiopian Investment

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Commission (EIC). As shown in the review section above, the EIC is undergoing
major organizational reform. Some of the new initiatives include industrial park, one-
stop-service (OSS) and after care service. Until recently, the new structure was not
public and it might be too early to evaluate its effectiveness. Here, we prefer to focus
not on the EIC structure per se but on how to enhance its functions and
effectiveness. This involves coordination with other relevant institutions and internal
institutional capacity building.

Further empowering EIC and strengthening its internal capacity to play a

leading role

This study shows that coordination among different government agencies is a critical
problem in managing FDI in Ethiopia. One manifestation of the lack of coordination is
that the poor performance of the one-stop-service, which was recently set at the EIC
to solve the coordination problems particularly in the first stage investment leading
up to operation and license. Despite the one-stop-service, bureaucratic hurdles still
continue to affect project implementations. Many of the delegates of the different
agencies who took office at the EIC do not have sufficient authority and decisions
are often made in the headquarters leading to long delays. The coordination is
particularly worse with regard to access to power and land. Malaysia (MIDA) and
Thailand (BOI) can provide best practices on what is required to establish genuine
one-stop-service.

There is a widespread coordination problem among relevant government agencies

and responsibilities are not clearly defined and sometimes lead to confrontations. For
example, between EIC and MoI regarding responsibilities on FDI promotion and
export performance, between EIC, MoI and MoST regarding who should be
responsible for technology transfer, and between EIC, MoI and ERCA with regard to
implementation of incentives and tax administration and customs clearance.

The recent proclamation has allowed the EIC to assume more power and
responsibilities including investment promotion, export promotion and regulating the
industrial parks. In this study we are proposing even more responsibilities to be
given, thus, the EIC monitor FDI in its lifetime from entry to disinvestment. That
means, the EIC may need also to handle performance of FDI firms in terms of

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technology transfer, employment, environmental issues and others. One way of
doing so is to introduce and strictly enforce mandatory (or incentive based)
requirements to enhance technology transfer and environmental and social
sustainability of FDI from the outset. EIC can also prepare an IT platform, whereby
performance of FDIs can be tracked real-time and information is shared among the
different relevant agencies. This will not only solve the coordination problem among
various institutions but also help the commission to have complete system to
manage FDIs entering the country, monitor if the envisaged benefits are realized and
harmonize the incentives with performance. Of course, the EIC is not expected to
have all necessary expertise to monitor and enforce the requirements. But it can still
leverage expertise from respective line ministries and agencies. The most important
message here is that EIC should go beyond investment attraction and facilitation
towards ensuring the envisaged benefits are realized. In sections 13.3, we
suggested an alternative institutional arrangement to ensure technology transfer
whereby each of the relevant institutions, the EIC, MoI and MoST, have been given
clear responsibilities. Similar arrangements can be thought of regarding export
performance and meeting social and environmental obligations.

Alike to other government offices, the EIC lacks talented and motivated staff to
efficiently to meet the ambitious targets and carrying out added responsibilities. The
EIC’s institutional capacity, thus, needs to be further strengthened both in terms of
finance and human resources. Special focus should be given to the consolidation of
policy research department to enable EIC monitor and evaluate new developments
and develop forward looking posture with regard to FDI. EIC has to have its own staff
development programme to attract bright and talented officers that work with
knowledge and dedication. EIC has to open overseas offices in selected destinations
to enhance the promotion effort in coordination with the embassies. The capacity
building of the investment agency and promotion activities have clear budgetary
implications.30

Enhancing regional governments’ role in FDI promotion and management

30
For example at the end of the 1990s, Ireland’s and Singapore’s annual budget for FDI promotion were
respectively about USD 41 million and USD 45 million, which are equivalent to USD 11 and USD 14 per capita
promotion budget respectively (te Velde, 2001). This is over and above the forgone income (revenue) and grants
in relation to the incentives provided to FDI.

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Another critical problem that has been identified in the review was the coordination
issue between the Federal and Regional governments. Unlike other coordination
problems discussed above, the coordination issue between federal and regional
governments is not only technical but largely political. FDI is currently administered
by the federal investment agency and the regional investment agencies are often
passive facilitators. This study shows that regional governments are often sluggish to
make land available and clear the compensation issues leading to long delay of
project implementations. In the absence of motivations from regions and insufficient
incentives from the federal government regarding locations, the FDI regional
distribution is highly skewed. Addis Ababa and Oromia regions alone account for
about 80% of total FDI stock and 50% of permanent jobs created by FDI in the
country. How can the existing skewed distribution of foreign investment be
addressed to ensure equitable distribution of investment among regions?

We propose some concrete steps to be taken towards decentralization and

devolvement of power to regions in order to make them proactive in attracting and
benefiting from FDI. The lack of capacity of regions is often cited as a pretext for
concentration of power in federal agencies regarding foreign direct investment.
However, capacities can never be developed without experimentation and learning-
by-doing. Instituting productive competition among regions towards attracting FDI
can help not only in correcting the skewed geographical distribution but also improve
the country’s overall FDI inflow. This might entail some changes in legislations and
also capacity development programmes.

Again, China can provide useful lessons in this regard. In china local authorities
enjoy considerable degree of autonomy and have been able to implement special
and more flexible policies in the reform and opening up process. They also engage
in intensive law-making to attract foreign investments including all administrative
matters such as resource regulation, approval and licensing, as well as business
services and coordination with related government departments or agencies at the
various levels (Zhao and Farole, 2011). This has led to great innovation and
competition among different regions to attract investment. However, care should be
taken to ensure healthy and productive competition among regions. The experience
from Vietnam shows that too much and unmanaged competition among regions can
lead to wastage of resources and hurt the country at large.

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12.2. Targeted FDI promotion strategy

The targeted approach is particularly useful in boosting the country’s industrial

development but at the same time requires detailed knowledge of FDI issues and
implications, hence, institutional capacity building.

12.2.1. Sector targeting

The country should target attracting quality FDI. Quality FDI can generally refer to
high value added FDI and/or to FDI with positive linkages and spillover effects for the
domestic economy (te Velde, 2001). But more importantly quality FDI should be
defined in terms of the development objectives of the host country. Ethiopia’s aim of
attracting FDI is to enhance the industrialization efforts and specifically bridging the
existing capital, technology, and knowledge gap.

Although FDI in the manufacturing is preferred from the perspective of productivity

spillover and learning, the beneficial impact is not certain and depends on a host of
various factors. One has to apply policy frameworks that take into account investor
characteristics and motives in more systematic manner. For example, the typology
developed by Dunning (1993) on the key motivations of FDI in choosing locations
classifies into four categories: seeking natural resources, domestic markets,
efficiency, or strategic assets. In this regard, preference should be given to efficiency
seeking FDI, which have more desirable impacts in comparison to others. The
market orientation of FDI does also have significant differential impact on the host
country. The export oriented FDI that becomes an integrated corporate supplier
network offers the host country clearer advantages over the FDI that serve protected
domestic host-country market. Hence, policy instruments should be designed in
favour of export oriented manufacturing FDI in contrast to domestic oriented ones.

The government has identified the priority manufacturing industries that include the
light and export oriented industries such as the textile, leather, and other agro-
processing as well as import substituting industries such as metal and engineering
and chemical industries. However, subsectors with more spillover effects were not
clearly defined. Hence, the following sub-sectors are areas where government shall
give especial attention in connection with attracting FDIs and realizing technology
transfer from FDIs.

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a. In textile and apparel industries, FDIs could be encouraged in the two
extremes of the textile and apparel value chain. First, expanding raw material
supplies: currently, the raw material in the Ethiopian textile and apparel value
chain is mainly dependent on cotton. Other raw material producers like wool
and silk from natural fibers and polyester, nylon, and acrylic from manmade or
synthetic fibers in the country are either limited or none. Hence, FDIs could be
engaged in diversifying the resource base including cotton which will have a
big push effect on the forward value chain (downstream) of the sector.
Second, the garment subsector could play a leading role in the textile and
apparel value chain. However, most of the local garment industries are
operating at low scale and at the same time they are not operating with full
capacity and very few exceptions. Hence, FDIs could scale up current
production either through original investment in a new garment factory, or
through a joint venture with or investment in an existing smaller-scale garment
producer. If the garment industries significantly scale up and take the leading
role in the textile and apparel value chain, then it will have a big pull effect on
the backward (upstream) chain of the sector.

b. In the leather and leather products, industries the footwear subsector is

assumed to have a leading role. However, the current phenomena in the
subsector demonstrated that the footwear industries are not playing their
roles. For instance, local tanneries, rather than supplying finished leather to
the local footwear industries, are exporting majority of their outputs. On the
other hand, the subsector mainly concentrates on leather shoes. Hence, FDIs
could be encouraged in developing the footwear sectors to scale up their
production and expand varieties of products including rubber, plastic, and
textile shoes. In effect, the leather value chain will be organically integrated
and technological capability of the sectors in the upstream will be established.
In addition to footwear, other leather products which are on the tip of the value
chain like the glove production could be taken as opportunities for FDIs. It is
possible to replicate the existing successful model of foreign investment in
glove production by attracting new foreign firms to establish production
capacity in the country.

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c. Given the technological capability and access to raw materials for processing,
the agro processing sector has a number of opportunities for foreign
investors. Hence, FDIs could be attracted in the processing of agricultural
products if they could produce high quality products, which will address the
local and international quality requirements. In case where the raw material
supply is limited, FDIs could also be involved in agricultural products with
good variety, high productivity and production.

d. In the metal and engineering industries, one of the basic problems is access
to raw materials. FDIs which could expand the raw material base, mining and
refinery, could be in general encouraged. For instance, metal industries which
can produce different sizes of sheet metals, angle iron, hallow sections, other
basic inputs to the metal fabrications, spare parts, machineries, equipment
and vehicle production. FDIs could also be encouraged in the area of spare
parts production to the priority industries such as textile and garment, leather
industries, sugar, cement, chemical, beverage, food industries and vehicles to
build local capabilities and spare parts production will by itself trigger
machinery and equipment production.

e. In the chemical industries, since they have a linkage with many industries
either directly or indirectly, the progress registered in Ethiopian economy
created huge demand for chemical products which implies that there are
opportunities for FDIs to get into the business. In a nutshell, the chemical
industries are not yet explored; hence, FDIs could be engaged in most of the
subsectors in the chemical sector including: inorganic chemical industries
which have direct bearing on other industries like textile and leather industries
in the country, petrochemical industries, plastic and rubber industries,
specialty chemical industries and consumable chemical industries. In the case
of rubber industries, some organic and petrochemical industries, where there
are potentials to expand the raw material bases, FDIs should concentrate on
the base of the value chain. For example, in the case of rubber industries,
expansion of rubber farm would further expand the subsector’s development.
A similar principle could be applied to the exploration of coal, natural gas, oil
and other important minerals used for inorganic industries. In the case where

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 there is no potential to expand the raw material bases, then even simple
chemical industries with small value addition should be encouraged as they
will move upstream in the value chain with time.

f. The pharmaceutical industry has wider investment opportunities in the

production of drugs both for human and veterinary uses, essential drugs,
cosmetics and diagnostic equipment. More priorities could be given to: (i)
pharmaceutical industries which could process abundantly available
resources like herbal plant and gelatin from abattoirs for industrial uses and
production of drugs and cosmetics, (ii) assembling of diagnostic equipment
though their value addition is limited as they will move upstream with time,
and (iii) essential drugs like drugs for HIV and Tuberculosis with very high
demand in the country and in the region.

g. Electrical and electronics industries have huge untapped potential for

foreign investors. Although, the technical knowhow is limited in the country,
since there is huge local market, it is possible to start from simple assembly of
parts to produce consumable goods, industrial electronics and electrical
products then with time they will move upstream. In addition, electronics
component production with small and medium scale could also be a potential
to invest in. This sector will also provide big potential not only for the domestic
market but also chiefly for exports as has been achieved in East and South
East Asia.

12.2.2. Source country targeting

The focus on light manufacturing, which is labour intensive and export oriented, has
important implication on the FDI source country targeting. In the existing global
division of labour, Asian countries such as China, Malaysia, Thailand, Vietnam, India
and Turkey are hubs of the light manufacturing industry. Many of these countries are
facing rise in labour costs, forcing many investors to relocate their labour intensive
production facilities to other countries with low labour cost. Governments in the
source countries for example China and Malaysia are also encouraging outward FDI
of the labour intensive manufacturing.

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Although there still exist a number of countries within Asia (e.g Myanmar, Cambodia,
Nepal, and Vietnam) that may host some of these relocated FDI, many investors are
eying Africa as the next destination of light manufacturing. Targeting light
manufacturing FDI from emerging countries for example, China, India, Turkey and
others, should be one policy direction for Ethiopia. In this regard, a consensus
seems to already existamong the policy makers and high officials. The FDI inflow
data shows that China, India and Turkey are already the leading source countries of
manufacturing FDI in Ethiopia, confirming the above narrative.

But there are at least two important issues worth noting regarding the potential
source from the emerging Asian countries. The first is that Asian investors are also
eyeing other countries in Africa such as Nigeria, Ghana, Tanzania, Kenya, South
Africa and to some extent, Senegal as possible destinations for relocation. Although
there is a generally favourable view about relocating to Ethiopia compared to others,
Ethiopia needs to prepare itself to compete with these countries by capitalizing on its
strengths (for example, vision, political commitment, huge overhead investment,
strong economic growth, cheaper labour force, and political and macro stability) and
correcting the weaknesses (for example, poor public services and logistics, weak tax
and customs administration).

Second, the characteristics and behaviour of FDI may differ by source country or
region. For example, our review shows that in contrast to those that come from the
west, the investors from emerging countries are more likely to seek finance from
domestic banks and in some cases involve in undesirable practices (for example
corrupting civil servants, over/under invoicing of transactions, remitting foreign
exchange illegally, as well as selling in domestic market while designated as
exporters). There is also difference of behaviour among source countries within Asia.
According to Ohno (2013) Chinese firms have strong overseas networks,
commercial and short term profit orientation, quick decision making, and are very
active in all sectors. India’s FDI have strength in some sectors such as leather,
garment, IT and auto parts. Korean investors are known for making huge investment
and risk taking, while Japanese firms are slow in decision making but have long-term
commitment. The investors from these countries also have difference in their attitude
and practices towards fair working conditions and environmental considerations.

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Policy instruments customized to each source country has a paramount importance
not only to effectively attract FDI but also maximize the benefits as well as reducing
the risks.

12.2.3. Targeting anchor investors

Multinational companies are cautious about relocating their investment despite

development of positive information on the long-term profitability of a new host
country. However, the evidence suggests that reluctance could be transformed into
enthusiasm once the first movers shift direction and then comes a remarkable follow-
the-leader response. Often a “flagship” investment by a major company increases
the information and reduces the risk for other TNCs (Loewendahl, 2001). Hunting
anchor investors has been proved effective to trigger-the-follow-the-leader
investment behaviour. The hunting of anchor investors involves negotiating special
incentives with individual companies, large number of visits before producing results.
Good examples often cited in this regard are; the Malaysian Penang Island attracting
semi-conductor giants; Mauritius attracting Hong Kong garment firms; and Singapore
attracting global aeronautic firms.

In recognition of this, Ethiopian authorities have already started to move from the
generic type of promotion to sector specific missions and head-hunting of anchor
investors. But the anchor investors are multinationals largely found in the West
countries but not in the emerging countries identified as targets, for example China,
Turkey or India. Clear strategy is needed to harmonize the need to hunt anchor
investors and the focus on target emerging countries. The anchor investors
(multinational in the West) have established supply chains including manufactures
mostly based in the emerging countries in Asia. If convincingly approached, they can
help relocating their suppliers in East countries to come and invest in Ethiopia. This
suggests that the need to also focus on the USA and Europe but selectively on the
anchor investors linked through the supply chain with producers in Asia.

12.2.4. Investment promotion modalities

FDI promotion is justified on the grounds of market failure related to imperfect and
asymmetrical information. Governments often form investment agencies and make a
promotion targeting multinationals. The promotion can take different forms from

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general campaign of country image building to specific targeted advertisement.
General country image building through media and other outlets is an important
feature of the promotion. The image of Ethiopia has been improved in recent years
and the country is prominently featuring as the next potential hub for manufacturing
FDI in Africa. This is mainly because the country has maintained continuous and
high economic growth and political stability for the last decade or so. The investment
promotion should capitalize on this image building through different media outlets
and forums.

But the experiences elsewhere suggest that general advertisements on behalf of the
host country are less effective in producing results unless complemented by other
modalities. Instead, sector specific and mixed investment missions including satisfied
private sector representatives have substantial impact. Regular arrangement of such
missions should be given due emphasis in the investment promotion. Above all, the
promotion will be successful if the country can make the existing investors on the
ground happy. Otherwise, they could not convey good stories to potential investors
while they are facing various bottlenecks on the ground. In other words, the
promotion should be accompanied by real changes and improved investment
climate. This calls for coordination with other respective government agencies.

12.2.5. The role of incentives

Almost all countries (developed as well as developing) use various fiscal and non-
fiscal incentives to attract inward FDI. Incentives can be fiscal (tax holidays, tax-free
imports, and tax exemption) and non-fiscal incentives constituting financial and non-
financial instruments such as depreciation method, bank loan’s policies, R&D
support, environmental standard support, and labour training support or government
subsidies. One rationale for providing incentives is the need to match and offset the
growing competition of incentives and preferences to attract FDI by other countries.
This has promoted a race-to-the-bottom in taxation of corporate profits, harming
particularly developing country governments’ ability to provide public services.
Moreover, incentives tend to favour large corporate investors to the detriment of
small ones, as well as foreign over domestic firms because of their lower risk profile
and higher bargaining power. Incentives also lead to capacity and transparency
concerns from the administrators’ side. The empirical evidence suggests that the

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incentives are not generally effective tools for attracting FDI due to the above and
other related reasons.

This is also true for the case of Ethiopia. Our study has identified the following
weaknesses with regard to incentive design and administration. The first weakness
identified is that the prevailing incentives introduced to promote FDI are not selective
and treat all FDIs operating in a given location and engaged in similar business
activities in the same manner. Second, the incentives often are not attached to
meeting specific performance criteria. Third, in cases where incentives are related
with performance, there is a lack of capacity and system in place to monitor targets
agreed and whether the incentives provided are fetching the intended benefits.
Fourth, the incentives also focus on new projects and not on re-investment and
expansion, which are no less important in terms of job creation, export earnings and
technology transfer potentials. Lastly, the differential incentives given to different
locations are not sufficient to attract FDI to other locations than Addis Ababa and the
surrounding.

The policy implications are;

(i) The main focus of attracting FDI should instead be on improving the
regulatory environment, efficiency of public services including competitive
infrastructure as well as development of human capital. This should, however, not
imply fiscal incentives are not important but there is a limit to competing for FDI
on the bases of fiscal incentives. Fiscal incentives are in fact important factors in
attracting FDI particularly focusing on labour intensive exports given the intense
competition and low margins in the international markets for these types of
products.
(ii) When fiscal and non-fiscal incentives are necessary, then they should be
selective and attached to performance; for example, export requirement,
minimum local content, employment of expatriates and foreign exchange
restrictions.
(iii) Clear performance criteria should be set and the monitoring capacity of
relevant government institutions be strengthened. In this regard, coordination
among the relevant institutions is also very crucial.

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 (iv) Incentives need to change in duration and be revised to encourage the FDI
and industrial specialization the country desires. And in some cases incentives
might be only given to FDI with pioneer status selectively on strategic importance
industries.
(v) Additional incentives should also be designed to encourage FDI to reinvest
and make expansions.
(vi) The different tax incentives given to remote regions and distant from Addis
Ababa should be revised factoring out the infrastructure and market
disadvantages of these locations. The industrial park initiative might partly
address the imbalance in the location of FDI among regions.

13. Unleashing the benefits of and reducing the risks from FDI

13.1. Bridging the capital gap: FDI financing and capital flight

The motivation to attract FDI towards Ethiopia is also predicated on the notion that
FDI firms bring with them adequate levels of resources that help in financing their
investment thereby contributing towards capital formation in the country. Our
conversation with representatives of the National Bank of Ethiopia (NBE) and
Development Bank of Ethiopia (NBE) as well as the empirical evidence indicated in
the previous section, however, suggest that FDI flowing towards the country may not
be necessarily based on investor’s own equity. Some of the FDI companies appear
to rely on debt financing both from the source country and by tapping resources
within Ethiopia to finance their investment. When the investment is particularly
market-seeking or does not generate sufficient foreign currency through export, it
leads to capital flight substantially attenuating the potential benefits of FDI towards
balancing the country’s current account and balance of payment deficits. Capital
flight constitutes a detrimental loss of foreign currency that would have been used to
pay for imports, service external debt and finance productive national projects, such
as infrastructure, health and education.

By reducing the extent of capital flight arising from FDI, the government can make
the best use of FDI projects to bridge the financing shortage that the country is

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facing. In line with this, we highlight five key concerns related to FDI along with
possible interventions the government can take to alleviate these concerns.

Discourage debt financing

FDI firms can use several sources of financing when committing resources in the
host economy. First, FDI could be based on own equity of the investor or the MNC.
Second, FDI firms could mobilize resources from their home country through short-
or long-term debt. Third, FDI firms could take out a loan from host country financial
institutions. Fourth, FDI projects could use a combination of any of the above three
to generate sufficient funds for the initial fixed investment.

Investment financing using own resources by FDI is the most preferred investment
approach that frees up local resources for other productive purposes. Given that low
income countries like Ethiopia lack adequate levels of financing capacity, the net
inflow of foreign capital has a large potential to complement local resources,
contribute towards fixed capital formation and stabilize the balance of payment. Yet
many FDI firms appear to increasingly rely on debt financing to pay for their
investment. Compared to investment financing through own equity, loan financing
creates high levels of volatility in the flow of capital, involve high degree of
repatriation and expose the country to a potential debt crisis triggered by
international capital markets.

The Ethiopian investment proclamation allows foreign companies to repay their debt
(i.e., in a convertible foreign currency) based on the debt repayment schedule they
submit. Despite its good intention, this provision in the investment legislation leaves
a loophole that allows investors to exploit the country’s limited foreign currency
reserve. For example, by artificially inflating the loan amount and interest payments
that they owe to international creditors (sometimes creditors are their own parent
companies), FDI firms remit large amounts of foreign currency illegally. To counter
this, the NBE has recently proposed a new policy that obliges foreign nationals to
invest at least 50% of the total project fund from own source by way of limiting the
permissible maximum levels of foreign debt to 50 %. This policy can potentially
reduce the likelihood of FDI, under the guise of international loan repayment,
stripping the meager foreign currency that the country generates from its export.
More importantly, however, the investment strategy should be geared towards

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attracting quality investment projects operated by investors or companies who are
capable and willing to invest their own funds. Alternatively, debit-financing might only
be allowed for exporters using their own foreign currency generated from export.

A large number of FDI projects have also been financed using DBE’s 70/30 debt-
equity ratio modality. This loan arrangement provided credit for fixed investment
capital without requiring additional collateral apart from the investment project and
the fixed capital employed therein. The credit policy was largely non-discriminatory
between domestic and foreign nationals implying that as long as both can cover 30%
of their total investment through own equity, they will be eligible for a loan amounting
to 70% of the total project cost. Yet foreign investors appear to have utilized this
scheme more than domestic ones.

Beyond crowding out domestic investment, there were serious issues with some of
the FDI firms that participated in this loan scheme. Some FDI firms, for example,
attempted and succeeded in defrauding DBE by overstating the actual value of their
equity or assets that they presented to obtain loan (the cut flower industry is a case
in point here). Similarly, highly indebted FDI firms apply for DBE loan on top of the
international loan that they already owe creditors. In both of these cases, unless
DBE manages to institute a system whereby it can screen the loan contents of equity
(initial investment) by FDI firms, it exposes itself to high risk of default and capital
flight. DBE thus need to build its capacity and its staff should continually upgrade
their technical skills to international levels matching their clients. This would enable
DBE to assess the veracity of complex credit requests placed by FDI firms and to
assuage the risk of frauds by these firms. It should also encourage and train its staff
to gain sector-specific knowledge to understand the technical nature of investment
projects in priority areas.

DBE also needs to closely work with Ethiopian mission abroad to investigate the
level of loan burden each of its foreign loan applicants shoulder in their home
country. One key potential benefit of FDI is its contribution towards local capital
formation. Yet this benefit presupposes that FDI generates capital from its own
sources and its entry does not lead to crowding out of domestic businesses by
competing for limited local resources. In economies where the critical size of FDI is
small in the economy, countries have limited leverage and often extend generous

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incentives including low-interest credit to attract investors. Such incentives are often
justified on information externalities that pioneering investors generate in the
economy thereby attracting more investment. However, once such information
becomes publicly available, it is not clear why a poor country like Ethiopia extends
attractive loan regime to foreign firms. For example, the earlier equity/loan modality
whereby investors could get 70% loan conditional on covering 30% of the total
project cost could be rationalized from the perspective of too little foreign
investment and entrepreneurship in the country due to the legacy of socialism in the
1970s and 80s. However, in more recent years, the country is increasingly attracting
more FDI and hence has more leverage over the types of investment that it attracts.
We thus believe that the adjustment of the 70/30 loan/equity modality is very
important. But it is also critical to evaluate what kind of investment such modality has
attracted and its impact on the local economy in the lights of capital reparation.

In the same spirit, the new revisions of the equity/loan modality from 30/70 to 50/50
for FDI and 25/75 for local investors require a careful examination. It is not clear how
a system based on subsidizing of capital for rich business people can attract quality
investment that both contributes to capital formation and the upgrading of local
capacity. There is a risk that this system may still end up attracting foreign investors
with limited long term commitment and financial assets. We thus advice the
government to first carefully examine the effectiveness of the previous loan
arrangement (the 30/70 modality) and the lessons learned from this arrangement to
better inform its decision.

Moreover, it is not clear why a poor country like Ethiopia extend attractive loan
regime to foreign firms who are supposed to invest using their own resources. While
we understand and agree with the adjustment of the

Promote more Greenfield Investment

FDI can enter a host country in several ways and its mode of entry can be highly
related to the level of capital flights it induces. Greenfield investment and Merger and
Acquisitions (M & A) are the two important types of FDI. Regarding the latter,
privatization of existing businesses is often a common way of FDI entry in economies
that had a socialist history. Greenfield investments by their very nature require long-

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term planning and commitment and are less likely to leave at the first sign of trouble.
Moreover, studies show that there is a strong link between Greenfield FDI and
capital formation (Krkoska, 2001). In contrast, M & A appears to be mostly seeking
strategic assets and is highly mobile and less bolted down, and hence might lead to
greater outflow of capital. The government should thus pay special attention to
promoting the inflow of Greenfield investment to the country.

Discourage profit repatriation and encourage reinvestment

Understandably, FDI firms would like to repatriate their profits from the host country
to pay for shareholders and company owners the returns to their investment.
Commensurately, the Ethiopian law allows FDI firms to repatriate their business
profit and/or dividends to their home country in foreign currency and in full amounts.
When the amounts of repatriated profits are very large, however, the loss in foreign
currency can potentially create a balance of payment problem, particularly when new
investment inflows are slower than rates of repatriation. While the prevention of FDI
firms from repatriating their profit is neither possible nor desirable, the government
should ensure that the profit is not ill-gotten, such as through monopolistic practices
or by evading or avoiding local taxes. The current policy system must be evaluated
in light of encouraging reinvestment beyond the clear stipulations centreed on
attracting new investment.

Studies show that capital outflow associated with profit repatriation is lower when
investors sense good prospect in the country, and where the political and economic
system is stable. In contrast, political instability and economic mismanagement leads
to faster and higher rates of profit repatriation. In addition to maintaining economic
and political stability, the government should encourage reinvestment of profits by
existing FDI businesses through wisely designed instruments that make the returns
from the local economy more appealing.

Check the legality of foreign workers’ compensation

According to the investment law, expatriate workers employed either in domestically

or foreign owned firms are allowed to remit 100% of their salary and other related

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earnings in a convertible currency to their home country. In an economy where
foreign currency is scarce, repatriation is only a necessary evil, which any
government cannot legally prevent from happening. Yet by screening expatriate
workers properly, governments can reduce the foreign currency loss prompted by
unqualified expatriate workers. Moreover, some FDI firms are said to inflate their
workers’ pay in order to remit the hard currency abroad illegally; there is a risk of
capital repatriation using workers as legal fronts. Without conducting due diligence
and strict follow-up of the expatriate employment procedures, preventing such cases
of illegal capital outflow would be very difficult. Beyond ensuring workers’ welfares,
designing an employment policy for both nationals and foreigners can also aid in the
fight against capital flight. The issue is thus of both policy implementation and gap in
policy (the absence of employment policy).

Lookout for transfer pricing

Transfer pricing refers to prices that a company uses when trading between its
subsidiaries located in different countries. By artificially inflating or deflating prices of
raw materials, parts, components, finished products, trade mark and royalty
payments, transfer pricing moves resources from the FDI host country to its
preferred location to dodge tax payments or to illegally appropriate scarce foreign
currencies. In Ethiopia, there are serious concerns related to over-invoicing of
imports to inflate costs and under-invoicing of exports to illegally retain foreign
currency abroad. In the latter case, the company pays for a spurious higher import
bill and the difference between the true price and the invoice price would constitute a
capital flight out of the country. Similarly, under-invoicing of exports leads to the
retention of the difference between the true earning of the export and the invoice
price in offshore accounts.

To minimize the problem associated with under-invoicing, NBE considers the

average world market price of specific export items. If the repatriated amount is
below the average market price by more than 15%, for example, the firm presenting
the invoice will be penalized. Yet with the existing system of multiple subsidiaries
scattered across the globe, detecting transfer pricing is very difficult. We advise for a
systematic and modern price assessment system to detect transfer-pricing among

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both FDI and domestic firms. To efficiently detect and penalize transfer pricing
practices, the Ethiopian government should collaborate with governments from FDI
source countries more closely. Relatedly, the government should collect more
information on an array of product attributes, such as quality, size, quantity and
gradient among others, to prevent the foreign currency lose due to transfer pricing.

Dealing with overvaluation of machinery and equipment

Overvaluation of imported machinery, equipment and technology is another problem,

whereby foreign investors can repatriate large sum of foreign exchange and avoid
tax obligations. The government needs to formulate a procedure for appraising
foreign invested property and put in place necessary institution to closely monitor the
fulfillment of contractual commitments.

13.2. Bridging trade balance gap: FDI and Export

The importance of export for economic growth and continued productivity

improvement is long recognized in the economics literature. Particularly merchandise
export is considered to provide not only much needed foreign currency but can also
be an impetus for skills formation, technological adoption and the structural
transformation of the economy by diversifying away from agriculture. In recognition
of these potentials, the Ethiopian government has been encouraging the participation
of FDI firms in the export sector. Several incentives were introduced to hone the
export competitiveness of both local and FDI producers. Full tax exemption on locally
produced export goods as well as non-fiscal incentives such as duty drawback,
voucher, bonded warehouse, and export credit guarantee schemes and two years
additional income tax exemption were made available for firms that mainly sell their
products abroad.

While the export earnings from manufacturing sector grew by around 30% annually
in the last decade, the number of firms that export and the export revenue generated
from the manufacturing sector appears to fall short of the government’s
expectations.31 Over the last decade and half, for example, the average share of

31
The export performance can also be assessed in comparison to the targets set under the GTP.
According to the GTP, the target was to increase the export revenue from the manufacturing sector

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manufacturing export remained at less than 10%, and it was 13% in 2013, and
merchandise exports accounted for only 7 percent of GDP.

Despite the expectations, the presence of FDI does not seem to have significantly
contributed to export earnings. As seen in the earlier section, in labour intensive
sectors such textile, apparel and leather products, the percentage of FDI firms that
export is 47%, 50% and 68% respectively. Yet when one considers the ratio of
export to total sales at 25%, 22% and 41% respectively, the export figures are less
impressive. Additionally, while these figures are higher than the percentage of
domestic firms that export in these sectors (about 16 %), it still falls short of
government’s expectations to use FDI firms as vehicle of export market penetration
and foreign currency earnings.

There are several reasons for poor showing of the export sector. While each reason
requires a careful and separate scrutiny on its own, we highlight important factors
that seem to be commonly acknowledged in retarding the growth of export along with
possible recommendations to boost export in

13.2.1. Improving the poor trading logistics

Transporting products quickly and cheaply across borders is an important element of

competitiveness. As indicated in the main document, one of the most important
challenges FDI firms face is poor trade logistics related to transportation of imports
and exports. This significantly increases costs of production undercutting the
international competitiveness of FDI and local firms producing in Ethiopia by
reducing their sales turnover and production. For example, about 20% of FDI firms
stated that the major problems that led them to produce below capacity is shortage
of raw materials. Given that the cost share of imports (the import content share of
raw materials in total cost of production) is about 56% in FDI firms (45% in local
firms), inefficiencies in the trade logistic have significant impacts on both raw
materials import and products export.

from USD 183.7 million in 2010/11 to USD 1.82 billion in 2014/15. Exports have about doubled
reaching USD 398 by the end of the fourth of the planned period. This is, however, far below the
target, which is only 22% of the planned export earnings.

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 BOX 6. Practical example on the importance of trade logistics

One of the FDI firms interviewed for this report told us that most of the raw materials,
inputs and chemicals they use are imported and delays in imports create problems in
dealing with clients. The first instance of delay in export shipment to the client is
penalized with 10% reduction from the agreed price at the time of the order placed by
the client. With longer delays, the penalty grows larger, sometimes causing the firm to
lose massively on delayed shipments. The two key areas where delays often occur are
in transportation and custom clearing processes.

Efficient trade logistics is also important for value addition and the export of agro-
processing goods. According to the WB (2014) report “Coffee exporters in Addis Ababa
say that roasting involves specialized knowledge about demand for specific tastes and
blends by location, which the European importers have mastered; they source a diverse
range of coffee (including robusta) and use their knowledge to blend coffees in profit
maximizing ways. Roasting is also a machine-dominated activity, and low wages alone
would not be sufficient to lure them to locate in Ethiopia. Once roasted, coffees lose
flavor quickly, so efficient trade logistics becomes critical.” (World Bank, Economic
update report, 2013)

It is thus important to reduce shipping costs associated with raw materials import and
product export. Surely, the government is taking important steps to reduce trading
costs. Large scale infrastructure projects linking various parts of the country via road
and rail to the Djibouti port and the expansions of dry ports inland and the attempt to
diversify away from Djibouti port are all moves in the right direction. While these
changes are welcome, they should be complemented with more coordination
between line-ministers and customs officials.

Indeed, our interviews with various government institutions and investors suggest
lack of coordinated policy support and policy implementation among different
government agencies. For example, the manifested objective of the Ministry of
Industry is to promote FDI inflow into the country and the objective of the Ethiopian
Customs and Revenue Authority (ERCA) is to regulate the businesses operations as
stipulated in the law. Sometimes, the Ministry feel that ERCA is too strict,
bureaucratic and overreaches its mandate. ERCA, on the other hand, thinks that
revenue generation is its main objective and it exercises limited discretion in

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implementing the law to favour investment. Simply put, MoI wants to see more
flexibility on the part of ERCA, while ERCA is rarely light-handed in its
implementation of existing rules and regulations.

As a result of this and related implementation impediments, the application of rules

and regulations, even those designed to promote export have been problematic. For
example, the introduction of the Authorized Economic Operator Status to thwart the
lengthy customs clearing process allowing for customs checks inside the factory of
selected firms was a move in the right direction. Its implementation in some cases,
however, was not greeted positively by FDI investors. For example, customs officials
who are supposed to perform the checks in the factory are sometimes not around or
are too busy with other assignments leading to delays in the release of raw materials
for production. Despite its noble intent of encouraging exporters in the manufacturing
sector, even with Authorized Economic Operator Status, customs clearance still
takes some time at the factory’s own facility. The effectiveness of policies does not
only depend on the design or the political endorsement or ratification of policies at
the highest level, it is also a function of buy in by both implementing agencies and
investors who would be affected by such policies. Therefore, in the designing and
implementation of industrial policies, regulatory regime must be transparent,
predictable, coordinated and easy to comply with and most importantly enforceable.

Some simple administrative changes that reduce paper work and number of hours
required to process imports and export documents might also greatly contribute to
accelerate the trading processes. For example, many firms complain that imports
take time and quite a bit of paper work, and there exists no efficient tracking system
to help locate misplaced products on arrival. As a result, documents, parts and
materials sometimes disappear in transit at the Bole international airport because of
the absence of modern and automated systems. Modernizing the warehousing
system at the Bole International Airport and at dry ports should be given due
attention by concerned government agencies.

The government can also increasingly rely on industrial parks to streamline the
customs and logistics services. To improve trade logistics, the government should be
ready to experiment with and in Industrial Parks in at least two ways. First, Chinese
experience with Industrial Parks amply demonstrated the important roles played by

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Bonded Logistics Zones. These zones are often located within or close to Industrial
Parks and serve the logistics sector by providing similar set of incentives to
enterprises engaged in logistics businesses as manufacturing businesses in
Industrial parks (financial, land, tariff and tax incentives, for example). Bonded
Logistic Park has a potential not only to help the logistics sector expand but also to
improve efficiency in operation of Industrial Park enterprises in the manufacturing
sector.

Second, the very nature of Industrial parks allows for experimentation and piecemeal
changes shielding the rest of the economy from unwarranted shocks and snags.
Thus, investigating the impact of some vital economic reforms within the context of
Industrial parks is important. In this context, relaxing the law that prohibits the
participation of foreign firms in logistics sectors within the industrial park should be
contemplated. This would provide useful lessons that would be instrumental in
designing related policies in the future.

13.2.2. Reducing the anti-export bias

Notwithstanding the government’s explicit ambition to enhance export and the

exporting potentials of producers in Ethiopia, some of the existing trade policies
appear to run counter to this objective. Policies, such as exchange rates, tariffs,
quotas and subsidies, significantly affect producers’ decision to export or to sell their
products locally. A major manifestation of a policy tilt that is less conducive for export
in Ethiopia is the growing attractiveness of the local market and the switching of
exporters towards the local market. While the local market could be important as a
learning platform particularly for emerging local producers, the increasing use of the
domestic market is true of even FDI firms established on the promise of 100%
export. We examine two key policy instruments that may have negative impacts on
export: tariff structure on imports and overvalued exchange rate.

The existing tariff structure by protecting the domestic markets makes export
less attractive.

Fiscal considerations dictate that tariffs can be used as major revenue sources to
bolster the state’s coffers. Preliminary evidence from ongoing research in EDRI that
examines the impacts of trade policies, namely tariffs on imports, suggests some

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interesting findings. The protection of the local market through tariff is found to create
a strong bias against export. The study finds that leather, footwear, textile and
apparel are highly protected sectors and hence the export bias induced by the
existing tariff structure in these industries is very high. For example, the profitability
of local sales in the tanning and footwear sector is larger than export by 100%, and
is larger than 50% in the textile and apparel industry. Under this circumstance, firms
that have the potential to export will choose to sell locally. For example, a Turkish
textile company who invested in Ethiopia with the promise to export 100% of its
producers was found selling its products entirely in the local market. This entails that
promoting export while simultaneously protecting the domestic market from imports
entails substantial levels of trade-off that calls for policy correction.

Overvalued exchange rate also encourages selling in the local market than
export as the real price of dollar obtained from export is suppressed.

Many agree that the Ethiopian exchange rate is highly overvalued (the World Bank
estimates that the real effective exchange rate has appreciated considerably and
that lowering the real exchange rate by 10 % has a potential to increase export by
more than 5 percentage points annually). And this is in contrast to many Asian
countries, which kept relatively competitive exchange rates during their take-off
periods. Since the volume of Ethiopian export has been relatively growing and since
price is the main parameter of competition, increasing the prices exporters receive
would encourage more export. Of course, a concomitant macroeconomic adjustment
should accompany any serious changes to the exchange rate levels and regime.

BOX 7. In addition to the tariff structure and the exchange rate, many FDI and local
firms, particularly in the textile, garment and leather goods sector, told us that they prefer
to sell locally due to the following reasons:
 No bureaucratic hustle and hardship when sales are destined locally (no quality
certification requirement, for example).
 Relatively limited competition in the local market
 Prices seem attractive in the local market
 Quality standards are not very high when selling locally. They can be easily met with
locally sourced cotton, for example, in the textile and garment sector.
 Exporting requires intense commitment and follow up of procurement, production and
marketing. “The challenges are more difficult to bear”.

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To reduce the anti-export bias, we suggest the following recommendations:

a) Carefully revisiting the existing tariff structure on the labor-intensive sector to

remove the strong preference they seem to display towards the domestic
market
b) Adjusting the real exchange rate to offset the overvaluation of the birr that
seem to be penalizing exporters. More broadly, policy makers should
continuously re-evaluate their exchange rate management policy in line with
the objective of export promotion. A large devaluation might not desirable at
the moment given other macroeconomic considerations. However, exporters
need to be compensated for the large overvaluation, for example by paying
out certain amount of Birr per one dollar export earnings.
c) Providing conditional incentive schemes that help overcome the price
disadvantages of selling internationally compared to locally when the local
market is heavily protected (this is discussed in detail shortly).
d) Modernizing the current customs clearance procedure and building the
capacity and motivation of the export bureaucracy. Industrial policy in general
and export promotion in particular require skilled, motivated enterprising
bureaucrats who are not afraid to assume greater role and risk in meeting
Grand National Plans, such as the GTP.

13.2.3. Attract adequate mass of efficiency-seeking FDI

As presented in the discussion in the previous section, one of the key attractions of
FDI in Ethiopia appears to be the growing size of its local market. For example, in
the agro-processing industries dominant multinationals, such as Heineken and
Diageo, and in the Chemical industry, heavyweights, such as Unilever and Asian
Paints, almost exclusively target the local market. Nevertheless, Ethiopia is no
exception; according to the Uganda Bureau of Statistics (2012), for example, nearly
two thirds of FDI flowing into the country cited the local market as a major
determining factor for investment and similar pattern is also observed in Kenya.
Attracting market-seeking FDI is not a problem on its own, and in fact it might be
highly beneficial in terms of job creation, introduction of better and newer products
and the upgrading of the local production capacity. Some studies also suggest that

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market-seeking FDI is more likely to be better connected to the domestic economy
as its uses greater levels of local resources and suppliers.

Notwithstanding these benefits, the repatriation of profits and capital by market-

seeking FDI puts an increasing strain on the limited foreign currency that the country
generates. To generate more foreign currency, promoting efficiency seeking (export-
oriented) FDI in the labour-intensive manufacturing sector that is geared more
towards the export market is important. We understand that the existing investment
practice places an export requirement on FDI firms engaged in labour intensive
export-oriented sectors. Yet monitoring whether the export requirements are met
appears to be challenging and many FDI firms that operate on the pretense of export
are sometimes found to sell a large proportion of their products locally. Instituting the
right incentive systems to encourage export and penalizing non-compliance is very
important (more on this in the next subsection).

The government could also do more to attract anchor firms that sell in the global
markets; experience shows that appealing to anchor firms and succeeding in
attracting these firms might greatly aid in attracting their suppliers. Since these firms
are large players in the global market, they would significantly increase the export
revenue generated from the manufacturing sector.

In addition to anchor firms, to attract efficiency-seeking or export-oriented small FDI

projects, the better targeting of investors is important. Along with economic
diplomacy, the hunting for such types of smaller firms and due diligence work on
interested investors by Ethiopian mission abroad should be carried out. In addition to
ensuring a sound business environment, the government should also focus on
designing and implementing specific promotion tools that attract high potential FDI
firms towards the export-sector (the remarkable and personal role the former Prime
Minister played in attracting Huajian to Ethiopia is a case in point here).
Complementing promotion, improving the existing level of workers’ skills and the
quality of the education and training systems is important to attract efficiency-seeking
FDI.

Moreover, the presence of anti-export bias in the policy is likely to attract market-
seeking FDI firms than efficiency-seeking or export-oriented ones as protection
significantly increases the rent that can be obtained from the local market. Correcting

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for anti-export policy bias will be important for two reasons: 1) by adjusting the
protection-induced price distortions that made the local market attractive, it
encourages existing producers to export than sell locally, 2) It helps attract FDI
businesses that are more efficiency-seeking or export-oriented than those seeking to
benefit from protection.

13.2.4. Instituting the right incentive and penalty system

The exporting potential of FDI firms is often considered as one important justification
for the extension of generous investment incentives to these firms. Of course,
incentive packages are expensive to the host economy as it transfers the costs of
businesses from the FDI firms to the host country’s tax payers by way of subsidies or
tax relief. As a result, many people question the effectiveness of investment
incentives in encouraging FDI firms to export and some believe that the benefit is not
large enough to justify expensive incentives for rich foreign business people.
Moreover, the potency of lessons that can be drawn from other countries’ experiment
with such incentives is limited due to country specificity, context and government
capacity differences and the past use of these policies in combination with a mix of
other policies (macro-economic, fiscal and regulatory reforms). This makes
disentangling the effect of incentives on export from other factors related to country
characteristics, institutional setup and other complementary policies difficult. Indeed,
it is evident that a successful policy instrument in one country may result in a
diametrically opposite outcome in another country due to both institutional and policy
complementarity differences between countries.

While this limits the extent to which lessons from other countries will be relevant for
Ethiopia, it also suggests that policy instruments need to be developed in iterative
manner by learning from others as well as from own practical experience. With these
caveats in mind, we highlight some important steps a government can take to
promote export among FDI firms using incentives. Of course, it is obvious that a
careful cost-benefit analysis needs to be conducted before adopting such measures
as policies.

a) Make incentives conditional on performance: By defining clear metrics of

performances, the government can reward exporters with incentives. This can
take several forms. Instead of duty draw back schemes (where duties paid on
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 imports are reimbursed), for example, the government could fully exempt
exporters from paying tariffs on imports in the first place as long as they can
prove that they have exported a legally sanctioned amount of their sales using
the freely imported raw materials.32 Alternatively, under this system, exporters
could be granted a cash subsidy proportional to the export value rather than
the value of imported inputs. This approach frees up resources for working
capital that otherwise would have been deposited with ERCA (under the duty
draw back scheme) until refunded, and more importantly, it reduces the
cumbersome administrative procedures involved in getting the import duty
paid reimbursed later.

b) Provide additional incentives to high performers: By publicly identifying high

performing exporters, the government can both encourage them to sustain
their export and send an important signal to aspiring exporters that they would
be rewarded handsomely if they succeed in joining this elite group. For
example, rather than providing a blanket tax exemption for all exporters, the
exemption could be calibrated on the basis of export levels in the preceding
years where the exemption varies proportionally to the levels of export
registered in the previous year(s). Similarly, firms that exported a pre-defined
percentage of their sales (for example, 60%) would be entitled to an “X”
amount of cash subsidy. Moreover, high performing exporters could benefit
from preferential rates for air flight and rail transport.

c) Simplifying export regulations: While regulation is important to hold

companies to the highest possible standard, too much regulation could be a
serious bottleneck against export. Misalignment in objectives between the
MoI and the Ethiopian Customs and Revenue Authority (ERCA) is currently
one of the difficulties exporters face. The introduction of numerous customs
and revenue rules and regulations by the government has made implementing
agents risk averse; as a result, essential decisions are delayed for a long
period of time. Particularly, the tedious export procedures at ERCA seriously

32
In Mexico, for example, under the ALTEX program, firms that exported more than 40 % of their sales were
exempted from paying import duties on their raw materials. This program is said to be successful; “this is
considered one of the reasons for Mexican export success in the 1990s” (Belloc and Di Maio, 2011).

220
 discourage foreign firms that produce for export market. Simplifying the
export regulations and reducing uncertainties resulting from sudden changes
in regulations is thus vital to promote export.

d) Increasing government efficiency: The effectiveness of export strategies and

incentives rests on the capability and motivation of implementing agents or
the bureaucracy. Training and motivating bureaucrats who implement the
export incentives is crucial. Lessons from many African countries in the 1980s
and 1990s show that incapable and unmotivated people result in procedural
inefficiencies and weak implementation of otherwise excellent export
programmes. Thus, building institutional capacity early and motivating
bureaucrats is as important as designing good policies. The government
should swiftly move to address the now common complaints by investors that
they are unsatisfied with the level of public service delivery and the
commitment and motivation civil servants show towards their work at various
points of service delivery.

e) Increasing enforcement capacity: Incentives without monitoring and

enforcement are recipes for exploitation. The government should conduct
regular monitoring of FDI firms against existing rules and regulations to
preempt abuses of incentives and provisions. Regular channels of information
exchange between the government and FDI firms would help identify the
possible contention issues, legal loopholes and implementation difficulties of
existing and proposed regulatory changes well in advance. While prevention
and consensus building is crucial to create a more conducive investment
environment, when abuses are discovered, the government should hold firms
accountable and take quick measures as clearly stipulated in the law.

f) Using Industrial Parks: We agree with the government on the potential roles of
Industrial Parks in attracting FDI with good prospect to promote export. The
government should be very astute in selecting the location of new parks and
improving conditions, such as trade logistics and customs operations, in the
existing parks. Key considerations for attracting FDI into the parks include
infrastructure, labour availability, and basic amenities and efficient park level

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 governance system. Priority should be granted to investors that commit
themselves to easily measurable export targets and that have strong linkages
with the local economy vertically and/or horizontally. The parks should be
used for experimentation with high-risk and high pay-off policies that may
radically change the way FDI operates in the country. For example, more
opening up of the economy, such as the logistics sector, to FDI should be
seriously considered within the industrial park settings.

BOX 8: Korean experience in export (notes from visits to Korea in 2012)

In the 1960s and 70s, the South Korean political leaders had a strong will and
wielded powerful instruments to promote industries and export. Their first step was,
however, to recognize the importance of improving the business environment so that
the private sector can thrive easily. As a result, packages of incentives for the private
sector were provided. These incentives were not blank checks rather were provided
based on export performance often preset by the government (line ministries). For
example, the condition in which cheap credit is distributed in a given year among
several companies is often based on their export performance in the preceding year.
Banks, which are under the state’s influence, used to offer exporters loans at below
market interest rate without collateral after the latter had presented evidence showing
export orders (letter of credit). Such preferential treatment of exporters had
significantly reduced the time they spent and the paper work they would have to go
through in securing loans without increasing the probability of default.

Korean experience also tells us that export diversification is not necessarily in the
menu of priority policies that help promote export. It is rather advisable ‘to do well
what a country can do well’ and is better to spend more energy and time thinking
about choosing an industry that a country has an edge over its competitors (often
termed as latent comparative advantage in the international trade literature) and
concentrating in doing that well.

13.3. Bridging the technology gap: FDI and technology transfer

Technological know-how is still one of the critical challenges to achieve targets set in
the growth and transformation plan to establish and develop the manufacturing
industries base of Ethiopia. For instance, the supplies of low quality raw materials,
the uses of backward technology coupled with low capacity utilization were some of

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the stumbling blocks in the first GTP. One of the aims of this study was to analyze
and synthesize technological capabilities of the Ethiopian manufacturing sector to
identify gaps and opportunities so that the manufacturing industry takes root in the
economy. According to the Industrial Development Strategy (IDS) of Ethiopia,
manufacturing industries are either domestic or foreign owned firms where the
former has primary roles and the latter supportive roles.

From the study conducted, cross-cutting technological gaps were identified in the
priority sectors that inhibited domestic firms from playing their primary roles. Most of
the challenges are related to quality and quantity of raw materials, accessory and
other input materials, capacity utilization, variety of products, quality control and
assurance, integration and cooperation among stakeholders, technical knowhow and
skilled manpower, outdated machineries and equipment and low level of value
addition. These challenges of the domestic industries shall be addressed through
either technology transfer or domestic research and development or both.

Technology transfer has got more value than research and development, since
Ethiopia is a late comer; it has the privilege to adopt technologies that are already
developed at international level. However, transferring technology from where it is
created and developed to where it is not, by itself, requires well-coordinated actions.
There are successful countries in the technology transfer like South Korea and China
although the approaches they deployed vary and there are also many countries
which are not successful in spite of their efforts. In Ethiopia, though sporadic,
successful attempts were also registered in terms of transferring technology from
foreign direct. This study is intended to address challenges investigated in the
technology transfer processes. The study has concluded that, at national level,
issuing a comprehensive technology transfer policy that guides actions and activities
of the country in the field towards clear and common goal/s is the first thing to do for
effective and efficient technology transfer. The following sections deal with policy
related problems in the Ethiopian context coupled with issues that shall be inputs in
the policy to be developed.

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13.3.1. Appropriate channels of technology transfer should be chosen for
specific type of technology

There are different channels of technology transfer. The main channels are formal or
market-mediated channels and informal or non-market-mediated channels. Formal
or Market-mediated channels include foreign direct investment, technology licensing
agreement, imports of capital goods, joint ventures, turnkey contracts, and cross-
border movement of personnel. Informal or non-market-mediated channels include
imitation, departure of employees, data in patent applications and temporary
migration. Since all these channels shall not be equally effective choosing channel/s
for specific technology transfer will help for effectiveness. With this assumption,
though it is general, preferences of the aforementioned channels are given below.

In general, the former channel shall be best fit for medium and large industries and
the latter for micro and small enterprises fits more but this informal channel will also
be used for medium and large industries. More specifically, foreign direct
investments shall be fit for high value adding, high capacity and new technology;
technology licensing agreement for export production to meet international market
standards; import of capital goods for large scale investment; joint ventures for
expansion of investments and marketing strategies; turnkey contracts for mega
projects; cross-border movement of employees for technical and managerial
problems which may require tacit knowledge or research; imitation, departure of
employees, data in patent applications, temporary migration shall be extensively
applied irrespective of scale and sector, practically in all fields where there is
technological capability is limited in the domestic economy since they are
economical in terms of cost and simple in terms of complexity.

The government should set up a system and procedure to match the technology to
be transferred and the channel/s to be deployed. This system will be important to
make the right decision at the beginning of any attempt towards technology transfer.

13.3.2. FDIs attraction, evaluation, and selection should base on their

contribution to technology transfer to the domestic firms

FDIs are the predominant channels of technology transfer. For this purpose,
developing countries are engaged in attracting and retaining FDIs. In the last

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decade, Ethiopia is becoming one of the destinations for FDIs in Africa. However,
attracting and retaining FDI by itself shall not be a sufficient condition to ensure
technology transfer to the domestic firms, rather, wise decisions at each stage of the
FDI’s life cycle from attraction to profit sharing must be made to ensure the benefits
out of the process.

In Ethiopia, FDIs’ attraction, evaluation, and selection in terms of technology transfer

and industrial development require much to be done to get all the benefits
associated with it. There is no systematic way of attracting quality FDIs. In fact, we
have neither the specifications for quality of FDIs nor the capable people and system
to evaluate and select the best FDIs for our country. Due to this, there are so many
cases where foreign investors came with scraped machineries and equipment, low
level of technology with inflated price and low value addition. Although the
government has set priority sectors, FDIs involvement under each sector has not
been clearly defined for healthy operation of the value chain. For instance both
specialized and modularized firms are joining the value chain. To address these
challenges, FDIs should be classified, targeted and preferential treatment should be
put in place to get the maximum benefits out of the investments.

In terms of technology transfer, FDIs with high tech, high value addition, large scale,
specialized process and efficiency driven shall be encouraged, giving privileges to
establish solely foreign owned enterprises that are eligible for investment incentives.
FDIs with modular process, market and resources driven shall be allowed but shall
not be eligible for incentives. FDIs with low tech, low value addition shall be
restricted. They shall be enforced to establish joint ventures with domestic firms or
shall not be eligible for incentives.

Box 9: Chinese Categories of FDIs

In the 1980s, in China, FDIs inflow was through joint ventures, cooperative enterprises,
and solely foreign owned enterprises. China has aggressively shaped a relatively
complete range of laws and regulations governing those three types of foreign investment.
A preferential treatment granted to enterprises in various industries has mainly been
determined under the Guiding Directory – guidance for foreign investment operations. The
Guiding Directory divided FDI involved projects into four categories: projects that were
encouraged, allowed, restricted and prohibited.

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13.3.3. Pro-active policy to encourage the formation of joint ventures

Though some of the experiences in joint venture are distasteful, the experience
elsewhere shows that it can be used as one of the effective channels for technology
transfer from FDIs. The challenge with joint venture is, the country does not have a
policy framework. Hence, the government shall produce clear directive on
establishing and managing joint ventures for successful operation. The directive may
address joint venture with private firms and with state owned enterprises (SOEs)
including requirements for establishment, dispute resolution and profit sharing. For
the restricted sectors, majority share might be given for domestic firms. Best
international practices, especially, the Government of the People’s Republic of
China, has demonstrated significant benefits from joint ventures both with the private
sectors and state owned enterprises.

Box 10: Chinese Joint-venture

The entry modes of foreign firms have evolved from joint-venture in the 1980s to
whole-foreign owned enterprises in the 1990s which accounted for more than 70% of
all FDI projects in the late 1990s. FDI in China occurred through joint ventures,
cooperative enterprises, and solely foreign owned enterprises. However, solely
foreign enterprises were not permitted unless they either adopted advanced
technology and equipment or exported a majority of their products. In 2001, China
removed these restrictions and encouraged foreign owned enterprises to usher in
advanced technology and increase their export volume. At the end of 2001,
manufacturing industry constituted 70 percent of total FDI projects because China
possesses a competitive edge due to lower costs of production. In contrast, China
has strictly controlled the flow of FDI into the service sector for a long period.

Our review shows that the Ethiopian SOEs seem to have less interest in joint
venturing with FDI. This outlook needs to be reexamined and the SOEs should seek
joint venturing arrangement with FDI as one mechanism of transferring knowledge
and technology, which is particularly important given the flourishing number of
government corporations in recent years.

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13.3.4. FDIs should be continuously measured and monitored in terms of
technology transfer performance

Once the FDIs came in, measuring and monitoring the technology transfer, which
includes planning, is the second important point in relation to technology transfer
from FDIs. However, on the ground, there is no plan for technology transfer both
from the investors and the government’s side which erodes the foundation for
monitoring activities. This implies that the benefits of FDIs are not properly measured
and known. Where measured, it is at rudimentary stage, for instance, the
percentages of domestic enterprises linked with FDI firms either in supply or labour
relationships, basic indicators at macro level, are 7.5% and 7.0 % respectively. This
is a fact explaining the low level of domestic firms’ linkage with FDIs, by implication,
low level of technology transfer.

To curb these phenomena, the policy shall put technology transfer issue as one of
the requirements to get in and start business in Ethiopia. At the stage of issuing
business licenses, FDIs shall produce technology transfer plan in terms of linkage
with domestic industries, product and production process introduction, joint product
development, and partnership with higher institutions.

After the FDIs came in and started the business, reporting technology transfer
achievements against their plan shall be considered as one of the requirements for
renewal of license. Moreover, incentives granted for FDIs shall depend on their
technology transfer performance each year. In case where the FDIs are not effective
in the transfer of technology, the incentives granted shall be revoked.

In fact, from practical point of view, rather than expecting technology transfer from
the FDIs, it will be wise if the government has its own technology transfer plan
associated with every FDI and then enforce those targets to be taken by as one of
the FDIs and the domestic firms business. For this purpose, the government shall
introduce a system and or procedure to plan and monitor technology transfer from
FDIs.

In general, FDI’s lifecycle needs to be properly managed from attraction to operation

or to the stage of profit utilization and disinvestment in order for the benefits to
further outweigh the losses. In order to manage the lifecycle of FDIs, the government

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shall put in place systems with capable people that can measure the level of
technology transfer at organizational, sectorial and national levels to continuously
monitor the progress in terms of technology transfer in the country.

13.3.5. Knowledge and technology transfer should also be in the field of

trading and marketing in addition to production processes and products

As it is seen in the textile and apparel industries, buyers’ influence on the value chain
is of crucial importance. Especially those international buyers who have the financial
power could be said to be leading the value chain in the direction they want it to go.
Buyers, in this context, mean wholesalers and/or retailers with internationally
recognized brands. They are at the tip of the value chain and, though they do not
add functional value on the products, according to the economic theory, they take
the lion’s share of the profit. For example, according to a study conducted on
Ethiopian coffee value chain, since the majority of coffee is exported in the form of
green beans to be roasted outside Ethiopia, the share for Ethiopia from a cup of
coffee sold to the end-user is below 10%. The same is true for other value chains.
However, at this moment in time, working closely with the global brands is the only
option available, as we are doing with M&H for the textile sector.

However, the local traders (wholesalers and retailers), key players in the domestic
market, shall be encouraged to follow the paths of global leaders and grow with time
to a competitor’s position. At a global level, the final decision makers are the
customers. In the Ethiopian context, the government is the major buyer of industrial
products, especially, in the metal production sector. However, the government itself
is not favouring the domestic producers for one reason or another.

Hence, the policy shall in the first place encourage the establishment and progress
of General Trading Houses to have interface with the manufacturers and the end
users in the local, regional and international market. Second, the policy shall
encourage the General Trading Houses to build their capacity through linkage
programme with international trading houses. For this purpose, the policy shall
restrict interface of foreign traders on the one hand and provide incentives on the
other to enhance linkage and marketing knowledge transfer. These will nurture
partnership of local traders with global brands, which is most desirable not only in

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enhancing the capability of trading houses but also the global competitiveness upper
stream value chains.

13.3.6. Domestic firms should be supported to improve their technology

absorptive capacity and links with FDIs

According to the IDS of the country, domestic investments have primary roles and
foreign investments will have supportive roles. In this study, gaps in the domestic
firms are identified and the need to invite FDIs is evident to fill some of those gaps
through technology transfer. However, the primary request for technology transfer
form FDIs is the technological capability of the domestic investors. Improving
technology absorptive capacity will be required to attain the mission set for domestic
firms. The policy shall give special emphases to those domestic companies intended
for industrial design and construction.

Industrial contractors and consultants need to be established and supported to grow

and expand progressively. For instance, there are local firms highly interested in
establishing manufacturing industries. However, there are no companies which carry
out feasibility studies with a follow-up of construction, monitoring, supervision and
commissioning of industrial plants. METEC and Mesfin Industrial Engineering have
demonstrated a commendable performance in the design and construction of
industries including those of sugar and fertilizers though they have challenges of
finishing projects within fixed time schedules. This is also true even for some
international contractors that are believed to have many years of valuable
experience. In general, these types of firms deserve to be looked after constantly as
they are the building blocks for the country’s economic development. The policy shall
restrict the design and construction of industries to have local contents and through
which the domestic firms in this sector will be favoured and capacitated.

As it is already stated above, the linkages among domestic and FDI firms in terms of
supply and labour are very low. Government shall issue programmes to promote
linkage in different facets of the firms, to improve the absorptive capacity of the
domestic firms and, in effect, for their technological capability to be internationally
competent. Some of these programmes shall be Vendor Development Programmes
(VDP), Industrial Linkage Programmeme (ILP), the Global Supplier Programme
(GSP), and Technology Incubators (TI). Successful policies promoting linkages can
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be found in Ireland, Chile, Jordan, Malaysia, Thailand, Singapore and South Africa
(Velde, 2001). The Malaysian and Singaporean experience of linkages programmes
between foreign and domestic firms and particularly in relation to SMEs have been
described in detail in section 3. Box 11 below also highlights some more experiences
of linkage programmes from Ireland and the Czech Republic.

Box 11: Linkage programs in Ireland and Czech republic

The Supply Network Shannon initiative, Ireland

Ireland has been heavily dependent on FDI for its industrialization. Shannon Development is the
economic development agency for an underdeveloped rural area in the west of Ireland. It operates a
major export zone (Shannon Free Zone) and technological park, which have helped attract major foreign
investors. In order to increase linkages between foreign investors and local subcontracting firms,
Shannon Development has sponsored “Supply Network Shannon”. Key components of the Supply
Network Shannon initiative are:
− A supplier directory to encourage local sourcing.
− A Supply Network website with information on network events and member contact details by
company and sector listings.
− Support for business clusters. Companies are encouraged to group together in order to benefit
from consultancy work on group strengths and weaknesses and the development of projects on
common issues such as production, waste, team working, procurement, quality management and
finance

The ‘National Supplier Development Program’, Czech Republic

The Czech Republic investment promotion agency, CzechInvest, introduced its Supplier Development
Program in 1999 to support the country’s supplier base and to link it to foreign affiliates. This program
consists of the following three elements:
− Collection and distribution of information regarding the products and capabilities of potential Czech
component suppliers, so as to enable foreign manufacturers to shortlist and contact potential
suppliers.
− Matchmaking, comprising three elements: (i) “Meet the Buyer” events between foreign investors and
potential Czech suppliers. (ii) Seminars and exhibitions organized with and for Czech suppliers
and foreign affiliates. (iii) Taking forward concrete proposals to potential foreign investors,
indicating potential suppliers in the Czech Republic.
− Upgrading of selected Czech suppliers. Suppliers are selected according to predefined criteria in
high-technology industries, such as electronics, or for selected engineering firms supplying to a
wide range of industries. The selected firms produce an upgrading plan, tailored to their individual
capacities and requirements. The upgrading process usually includes consultancy and training
support in such areas as the utilization of technology, general management operations, quality
control and organizational change.
Source: Jonathan potter (2001) Embedding Foreign Direct Investment
https://www.oecd.org/gov/regional-policy/2489910.pdf

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In addition, the issue of labour, especially, skilled labour creation including
technicians, supervisors and managers shall be given attention in the domestic firms
to catch-up knowledge from foreign firms. Knowledge sharing programmes shall be
put in place and this shall be counted as one technology transfer initiative for FDIs.

Lastly, devising incentive systems for effective technology transfer for the technology
recipient shall encourage firms to take the issue of technology transfer as one line of
their business.

13.3.7. Institutional arrangement and coordination to enhance technology

transfer from FDIs

Institutional arrangement for technology transfer will be required to ensure

technology transfer in particular and technology capability building in general. For the
priority sectors, the mandate of accumulating technology to defuse to the domestic
firms was given to the specialized industry development institutes whereas at
national level, Ministry of Science and Technology are responsible for ensuring
technological development of the country. Partly, it is a matter of implementation.
However, the case of technology transfer from FDIs has not been cleared out.

For instance, the role of the industry development institutes has narrowed down to
facilitation. There are six industry development institutes geared towards the priority
sectors. The aims of these institutes are to become centres of excellence both for
technology and skill related matters. With a minor exception of the leather, metal,
and textile industry development institutes, they are immersed in the investment
facilitation activities for the investor, which are non-technical in nature. In terms of
technology accumulation, while these institutes are practically responsible for it,
there is no way to learn technology from foreign investments or technologically
advanced countries in general and pass it on to those which have lesser capability in
the country.

The policy options proposed for the transfer of technology above require institution/s
to deploy them. This study has proposed that the technology transfer agenda shall
be treated at three different levels including firm, industry/sector, and national levels.
Each level requires its own unique institutional arrangements.

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At firm level, every FDI shall be monitored in its life time from entry to disinvestment.
Firm level follow-up is the most critical stage in the technology transfer process from
FDIs. So far Ethiopian Investment Commission (EIC) was responsible for promotion,
attraction and follow up, and Ministry of Industry (MoI) with its industry development
institutes was responsible for the facilitation and technology transfer issues.
Practically, as it is stated above, a clear gap has been evident in ensuring benefits of
Ethiopia in terms of technology transfer.

One of the problems for this could be division of the activities between EIC and MoI.
While most of the information about FDIs is with EIC, forwarding the follow up and
monitoring to MoI will be unwise decision to collect the fruits of FDIs, especially, in
terms of technology transfer. Hence, at firm level, this study proposed EIC to
establish one more function which shall handle individual investment monitoring in
terms of technology transfer. This shall help the commission to have complete
system to manage FDIs entering the country. International practices also suggest
this type of institution to best handle FDIs.

At the industry/sector level, the impacts and contributions of FDIs should be properly
defined and at the same time monitored in terms of technology transfer. As it is
already stated, the industry development institutes should transform themselves from
investment facilitation to technology transfer and diffusion facilitation which was their
primary mandate. The institutes will closely work with FDIs and domestic
investments which will help the institutes to identify, gaps in the domestic
investments and also bridge the gaps through the FDIs. With this, the industry/sector
level technology transfer agenda shall be taken by the Industry Development
Institutes that means MoI.

At national level, developing technology roadmap, science and engineering

education at tertiary level, intellectual property right, and research and development
shall be under the control of Ministry of Science and Technology (MoST). Attracting
monitoring and incentivizing foreign research and development shall be better
managed by MoST.

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 Box 12: Chinese Policy on Foreign R&D
Since 1999, China’s official FDI policies have encouraged foreign investors to
establish their R&D centres in the country. For example, major polices include:
 Any imported and supporting technology confined to the Foreign Invested
Enterprises (FIE’s) labouratory and used for pilot experiments (not for
production) are exempt from tariff and other import taxes
 Income from the transfer of technology that has been developed solely by an
FIE is exempt from sales tax
 An FIE with technological development expenses of at least 10 percent over its
previous year is entitled to a 50%discount of its total technological
development expenses in the current year’s corporate income tax (subject to
approval by the taxation authority)
 FIEs with R&D centres in China are allowed to import and sell a small quality of
high-tech products on a trial basis in the local market, if they are goods
produced as a result of the R&D by their parent companies.

Transformation in the mindset of all actors including the government, private

sector, and academia

Technology transfer involves different stakeholders: government, private sector,

research/education institutions, and end-users. It also requires complex networks
and institutions through which those involved in technology transfer can interact each
other. The successful technology transfer also needs the private sector to
aggressively invest through formal and informal means. There is, however, little
awareness and motive from the private sector to engage in meaningful transfer of
technology. There is also lack of coordination among the different actors. Another
significant barriers to successful technology transfer is a lack of understanding of the
complexity of the innovation process. Moreover, there is a perception that
‘technology transfer’ as an object and its transfer is one-time transaction that
maintains the dependency of the recipient.

The awareness problem might be addressed through outreach programme using all
means available to reach potential users. Government may also use different
economic incentive mechanisms to motivate the private sector to engage in
technology transfer. The technology transfer and productivity catching-up is,

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however, requires more systematic and broad policy measures beyond providing
economic incentives to the private sector. It also requires transformation in the
mindset of all actors and share a sense of national urgency. Thus, the incentives
need to be accompanied by massive campaign to achieve social cohesion and to
mobilise social energy toward a shared goal.

13.4. Reducing the negative environmental impacts of FDI

The weak environmental regulations that have been adopted in many developing
countries striving to attract FDI have caused severe environmental damages on host
countries. China and the Maquiladora industry zone in the US-Mexico border are
often cited as classic examples in this regard. These experiences show that ‘pollute-
and-clean-later’ option is not only an expensive path but also the environmental
damage can be irreversible.

In recognition of this, Ethiopia enacted the Environmental Impact Assessment (EIA)

proclamation in 2000. According to this proclamation, it is imperative to conduct
environmental impact assessment of investment projects in order to identify their
potential harms to the environment. But in practice, the environmental regulations
have not been adequately implemented. Ethiopia, thus, needs to strictly enforce the
existing environmental regulations in its dealing with FDI before it is too late.

Improving capacity and coordination towards strict environmental assessment

The poor enforcement of already existing regulations and standards is partly caused
by lack of capacity and particularly insufficient number of professionals to review the
environmental impacts. Hence, sufficient attention should be given to strengthening
the capacity both at federal and regional investment offices. Another cause of the
poor enforcement of environmental regulations is the lack of coordination among
different government agencies. Again, the EIC should take a lead in the coordination
function of the different institutions involved in the environmental assessment.

Branding a green manufacturing production

In 2011, Ethiopia adopted the Climate Resilient Green Economy (CRGE) strategy
aiming for a carbon free economic growth. The CRGE strategy identified the

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industrial sector as one of the key targets to mitigate emissions. It recognized the
need for greening the industry by using climate-compatible alternatives and
leapfrogging to modern and energy efficient technologies. In line with this strategy,
Ethiopia can brand a green manufacturing concept as a way of FDI attraction and
competitiveness.33 In other words, stricter environmental regulations and standards
can be used to attract quality investment instead of fearing FDI can retreat.

In this regard, Ethiopia can take advantage of the emerging global consensus that
greening industry is an important pathway to achieving sustainable development to
pursue FDI to comply with the environmental standards. FDI source countries
particularly in the West are pursuing their outward FDI companies to follow better
environmental practices. Even China is now encouraging its companies investing
overseas to comply with local and international environmental standards. As a result,
many multinationals are using the green production and environmental performance
as a source of competitive advantage.

At the international level, the Global Environment Fund (GEF) is available for
developing countries to help them meet environmental targets established in some
international agreements. Ethiopia may also tap into the GEF to mobilize finance and
motivate its enterprises comply with the environmental standards.

Use the industrial parks as key to achieve the green industry vision

Ethiopia is placing an aspiring plan to develop industrial parks with attractive

infrastructure facilities to achieve its vision to be the hub of light manufacturing
industries in Africa. The industrial parks are one of the key instruments to attract
foreign direct investment. Industrial parks have the economies of scale benefits in
shared waste management facilities and the provision of greener energy. Creating
Eco-Industrial Parks has been adopted in a number of countries as a key practical
initiative to encourage the greening of industry. The Eco-Industrial Park can facilitate
networking between firms to reduce their waste, recover value and achieve

33
Green industry can be defined as the industrial production and development that does not come at
the expense of the health of natural systems or lead to adverse human health outcomes. This can
include anything from a recycling programme for employees, energy efficient appliances, supplies,
machinery and other components, cautious resource use such as turning the lights off when not in
use, reusing supplies to eliminate waste and refined manufacturing or production processes.

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economies of scale in the production process. It is also useful to monitor and
evaluate the environmental performance of firms.

Box 13: Tianjin Economic Technological Park in China

Established in December 1984, the Tianjin Economic-Technological Development Area

(TEDA) was one of the first eco-industrial areas approved by the State Council for
development along ecological lines. TEDA has launched a range of environmental
initiatives since its establishment, aiming to create an industrial park with leadership in
green manufacturing and recycling of water and waste. Since the early 2000s the focus
has been on transformation toward an eco-industrial park and the creation of a circular
economy at the industrial park level. As a result of those initiatives, the system of
industrial symbiosis has evolved over time, with a number of wastewater, solid waste, and
energy exchanges being established. For example, a wastewater treatment plant started
operation in 2000, and a water reclamation plant was put into use in 2003, thus
substantially reducing the need for freshwater inputs. A cogeneration power station was
built in 2003 that uses treated wastewater as boiler supply water. A landfill company
started operations in 2002 receiving coal powder, cinder, and alkali slag as input and
converting bio-sludge from an enzyme company into fertilizer, thereby producing a useful
product. In addition, a lead recycling company established in 2005 now provides a large
amount of regenerated lead from used batteries and other lead waste from Tianjin and
Beijing regions to another local battery company. … In recognition of those efforts, TEDA
has been adopted as one of the first three approved eco-industrial parks in China as well
as a member of the first batch of circular economy Pilot Demonstrations.

Source Mathews and Tan 2011

Ethiopia can promote the Eco-Industrial Park concept as a way to greening its
manufacturing enterprises, including the FDI that are expected to constitute quite
large number of enterprises in the industrial parks. It might be costly to transform
existing industrial parks into eco-parks. But Ethiopia has the advantage to introduce
the eco-park concept in the design of its industrial parks given that this is a new
initiative.

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13.5. FDI and employment conditions

Many governments in developing countries are continuously reforming their

economies and liberalizing their investment atmosphere to increase the influx of
foreign capital. Such motives often cast aside important social issues, such as the
protection of fundamental workers’ rights and the environment. As a result,
investment from emerging economies seems to be particularly attracted to
developing countries partly because of relatively lax regulatory conditions on labour
and the environments. Moreover, while many bilateral and multilateral investment
treaties provide investment protection and trade guarantees for FDI, they do not
often include social obligations for investors. It is only with the existing national laws
that countries deal with social issues in relation with international investors. In this
subsection, we examine FDI-labour interactions from both policy and implementation
perspectives.

The Ethiopian labour law (labour Proclamation No.377/2003) is largely viewed

positively by both employers and worker representatives. Ethiopia has also ratified
all relevant ILO conventions, such as Freedom of Association and Protection of the
Right to Organize Convention, 1948 (No.87), the Right to Organize and Bargain
Collectively Convention, 1949 (No.98) and the Tripartite Consultation (International
Labour Standards) Convention, 1976 (No.144). While the major labour related
issues are mostly related with the implementation of the policies rather than what is
in the policy itself, there are also few policy gaps. To promote better industrial
relations and maintain industrial peace, we outline three key areas of intervention
that should be carefully looked at case-by-case from both implementation and policy
perspectives. The first is, the need for introducing new legislation and enforcing the
exiting labour law. Second key area of intervention is, encouraging unionization and
collective bargaining. And the third area is, the need for explicit commitment to fair
labour practices. We expound on each area bit-by-bit below.

Introducing legislations and the enforcement of existing law on working

conditions and wages:

Notwithstanding provisions in the labour law (Proclamation No.377/2003), to our

knowledge, there is no effective policy on wages and working conditions that govern

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the relationships between employers and workers. Moreover, the existing
institutional capacity to monitor the implementation of the law is not sufficient. For
example, there appears to be limited effective support system for dispute prevention
and settlement, and labour standard inspection practices are often rare and weak.
Without ensuring better wages and improved working conditions, it is not clear how
workers could benefit from their labour and the increasing profitability of their
employers, particularly as inflation continuously undercuts their real wage in
Ethiopia. In relation to working conditions and wages, we thus outline two areas that
need due consideration.

a) Ensuring safe working conditions and fair employment practices in

foreign firms: This concerns wages and employment conditions in FDI firms.
Many FDI firms stress cheap labour as one of the main reasons for their
investment decisions and they are attracted by low wages. Beyond
employment, the nature of jobs and the conditions under which work is
performed is becoming more important. The Sustainable Development Goals
(SDG), Goal 8, for example, clearly stipulates that economies should aspire to
create descent work environment for workers and ensure that workers earn a
living wage.

While FDI firms on average tend to pay higher wages as indicated in the main
research document (Table 10), the wage difference with domestic firms
cannot be said to be steep. On the other hand, we learn from several
interviews and anecdotes that working conditions in FDI firms, particularly in
Chinese firms, is much more stricter and unfavourable with longer hours of
work, limited breaks, stringent monitoring, and harsher penalties for minor
infringements. To what extent all this is done within the existing legal
framework is not, however, very clear. While the government does not impose
minimum wage requirements, the labour proclamation number 377/2003
clearly stipulates the rights and obligations of both employers and workers
regarding pay and association; empowering workers to bargain for safer and
fairer working environment. Many workers, however, do not know their rights
and Ethiopian work force is largely pliant and weakly unionized. Thus,
increasing the enforcement capacity to penalize exploitative labour practices

238
 without putting investors off is important. Increasing labour inspection
practices by Ministry of Labour and Social Affairs (MOLSA) and relevant
government agencies, and enhancing social dialogue and strengthening the
dispute arbitration system will positively contribute to ensuring safe working
conditions and fair employment practices.

b) Guarding against displacement of local labour force: The second concern

with respect to FDI is the displacement of the local labour force by FDI’s illegal
use of low-skilled expatriate workers. The Ethiopian investment law allows for
the employment of skilled expatriate professionals by FDI firms provided that
the firm has a succession plan where these workers would be replaced by
Ethiopian workers within reasonable periods of time. EIC would issue work
permit for qualified expatriates working for FDI firms based on these plans.
While the absence of local expertise and the possibility of knowledge transfer
from expatriate to local workers are important justification for the easing of
immigration and work permit for qualified professionals, this is not meant to
encourage the importation of low skilled workers, who do not have the skills
sets that would benefit their fellow Ethiopian workers. There is, for example, a
perception that Chinese FDI firms import workers from China even for menial
low skill tasks. Unless the productivity difference between the Ethiopian and
the Chinese workers are very large to justify the higher wage gaps, the
importation of low skilled workers does not make economic sense unless
workers are used as legal fronts for illicit repatriation of capital (as will be
discussed shortly in the next sub-section). To better benefit from the presence
of expatriate workers and reduce its possible downsides, Ethiopia needs to
have an employment policy that clearly stipulates the nature of employment
allowed for expatriate workers. The policy will have to be legally binding and
strictly implemented with regular follow-ups to further improve it and to reduce
it becoming another bureaucratic nuance that discourages the entry of FDI
firms with large potential benefits.

239
Encouraging unionization and collective bargaining

The Ethiopian Labour Proclamation No.377/2003 permits unionization and provides

legal basis for collective bargaining and the participation of employees
representatives in the labour administration system. However, rates of unionization
and cases of collective bargaining agreements are rare among Ethiopian workers.
According to the decent work programme report prepared by ILO and MOLSA (ILO,
2014), for example, while the number of unions and collective agreements has
recently increased, incidences of both unionization and collective agreements are
very low both in the domestic and FDI firms. For example, the total number of
workers covered by collective agreement was only 19,721 in 2010.

It is evident that promoting social dialogues and conversation between employers

and employees is important to find solutions to common problems. While employers
are prone to resist unionization moves at first, they can be encouraged to accept a
unionized work force not only because it is legally sanctioned but also because they
can potentially pre-empt unpleasant surprises in the form of labour unrest and
strikes. Unions and collective bargaining arrangements are useful to ensure work
place harmony by promoting continuous dialogue between the management and
workers to seek consensual solutions to a wide range of issues that are of common
interest to both parties. This would also allow workers to have a better stake in the
enterprise and benefit from its successes as well.

In contravention to the labour law, however, in many FDI firms, workers are not
allowed to form unions. Although explicit probations are rare, in some instances,
such moves have been met with harsh decisions including dismissal of workers.
There is indeed a strong perception that FDI firms, particularly from non-traditional
investment source countries, seem to have difficulty in their industrial relations and
seem to be fervently against unionization and collective bargaining. This is partly due
to limited understanding of the local context, including cultural and religious values,
and partly due to lack of respect to these values. While creating awareness and
convincing FDI firms to refrain from blatant disregard to the law is important, the use
of the legal recourse should not be abandoned altogether; the government has a
responsibility to take legal action against employers who penalize workers solely
because they attempted to create a platform that would reflect the workers’ collective

240
interest and prevent the formation of unions. Bringing bad publicity, introducing
financial penalties and initiating regulatory-related audits would discipline companies
that continue to ignore workers’ demands for association and collective bargaining.

Consistent with the existing law, while the government should protect workers who
take the initiatives to voluntarily form unions, it should also encourage the formation
of unions by workers who often do not know their rights and obligations. In China, for
example, unionization has been promoted heavily by the All-China Federation of
Trade Unions (ACFTU), the only labour union that is legally recognized by the
government. Through aggressive move of the ACFTU, the unionization rate among
workers of Fortune 500 companies that invested in China has grown to 83% by 2008
and there is an ongoing attempt to get all workers unionized since 2010 (Chinese
Business Review, 2010). We understand that Ethiopia is no China and the stage of
development and level of FDI in Ethiopia will not give the country the same leverage
that China has now with FDI firms. Yet to maximize the benefits from FDI, ensuring
that workers’ rights are not seriously violated and that the labour law is being
properly enforced is important.

Explicit Commitment to fair labour practices

A large size of trainable labour force and low wages are increasingly attracting
labour-intensive FDI to Ethiopia. Like any businesses, FDIs pursue a business model
of lowering costs along the supply chain and increasing production and productivity
upstream in the production phase. Workers are thus often easy targets that could be
increasingly squeezed to produce more for less and under harsh and precarious
conditions. After a much publicized and protracted labour strike by garment workers
in Bangladesh and Cambodia in 2013 and 2014, however, the issue of working
conditions, pay and gross exploitation have emerged at the forefront of global buyers
product sourcing decisions. Consumers in the developed world are increasingly
becoming conscious of the conditions under which labour intensive products are
being produced in developing countries.

While a growing awareness of customers on labour issues will force FDI firms to
voluntarily introduce high levels of standards, the Ethiopian government cannot
exclusively rely on informed buyers and their campaigners to improve the working
conditions of workers. This should be complemented by the government’s display of

241
an explicit and unwavering commitment to fair labour practices. All these are
important not just from an ethical perspective to improve worker’s welfare but also
from economic angle as a good marketing strategy internationally (to attract high-end
global buyers) and for improved aggregate demand and purchasing power of the
workforce internally. The government should thus be committed to not lowering or
relaxing labour standards to attract FDI, which might lead to race to the bottom.

There is no one unique solution to simulate desirable investors’ behaviours towards

workers but turning a blind eye to exploitative practices might in the short-run
increase investment but will backfire in the long run with poor working conditions
leading to low productivity, militant labour unions and continuous strives and labour
unrests. Bad publicity associated with such incidents will no doubt cost the country
dearly as seen from recent experiences in Bangladesh and Cambodia. The good
news is that major global buyers appear to be ready to increasingly source from
countries that explicitly commit themselves to fair labour practices. For example,
after the collapse of the Rana Plaza in Bangladesh in 2013, major global buyers
pushed for both policy and practical reforms with the aim of improving the working
atmospheres and worker’s compensation. Similarly, following several months of
labour unrest in Cambodia, eight major clothing brands expressed their readiness to
accept higher wages, which led to a 28 % increases in the minimum wage (Oxfam,
2014).

242
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Appendix 1 Investment areas open to FDI with the respective income tax
exemption in years.
Sector FDI Income tax exemption
Equit in years
y (%) Addis In other
Ababa & parts of
surrounding the
towns of country
Oromia
1. Food Industry
1.1 All forms of food industries other than 100 3 5
manufacture of sugar, chocolate, candy and
biscuits, macaroni & pasta, and baby foods
1.2 Manufacture of sugar 100 5 6
1.3 Manufacture of chocolate, candy, biscuits 100 1 2
1.4 Manufacture of macaroni & pasta 100 3 5
1.5 Manufacture of baby foods 100 2 4
2. Beverage Industry
2.1 Manufacture of alcoholic beverages 100 1 2
2.2 Manufacture of wine 100 3 4
2.3 Manufacture of beer and beer malts 100 2 3
2.4 Manufacture of soft drink, mineral water, or 100 1 2
other bottled water
3. Textile and textile products industry
3.1 Preparation and spinning of cotton, wool, silk 100 4 5
and similar textile fibers.
3.2 Weaving, finishing and printing of textiles. 100 5 6
3.3 Finishing of fabrics, yarn, warp and weft,
apparel and other textile products by 0 3 4
bleaching, dying, shrinking, sanforizing,
mercerizing or dressing
3.4 Other textile finishing activities 100 2 3
3.5 Manufacture of knitted and crocheted fabrics.
3.6 Manufacture of made-up textile articles, 100 4 5
except apparel.
3.7 Manufacture of carpets
3.8 Manufacture of wearing appeal
100 5 6
3.9 Manufacture of accessories for textile
products
4. Leather and leather products industry
4.1 Tanning of hides and skins up to finished 100 5 6
level
4.2 Tanning of hides and skins below finished 0 Not legible Not

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 level for legible for
exemption exemption
4.3 Manufacture of all forms of leather products
4.4 Manufacture of accessories for leather 100 5 6
products
5. Wood Product Industry
5.1 Manufacture of pulp and paper 100 5 6
5.2 Manufacture of paper packages 100 3 4
5.3 Manufacture of other paper products 100 1 2
5.4 Printing industry Not legible Not
0 for legible for
exemption exemption
6. Chemical and chemical products industry
6.1 Manufacture of basic chemicals (including
ethanol) 100 5 6
6.2 Manufacture of fertilizers &/or nitrogen
compounds
6.3 Manufacture of plastics &/or synthetic rubber
6.4 Manufacture of pesticides, herbicides or 100 3 5
fungicides
6.5 Manufacture of paints, varnishes or similar
coatings 100 2 4
6.6 Manufacture of soap, detergent and other
similar products
6.7 Manufacture of man-made fibers 100 5 6
6.8 Manufacture of other chemical products 100 2 3
7. Basic pharmaceutical products and
pharmaceutical preparation industries
7.1 Manufacture of inputs for basic
pharmaceutical products and pharmaceutical 100 5 6
preparations
7.2 Manufacture or formulation of 100 4 5
pharmaceuticals
8. Rubber and Plastic Products Industry
8.1 Manufacture of rubber products 100 3 5
8.2 Manufacture of plastic products used as an
inputs for construction of buildings, vehicles
or other industrial products; plastic pipes or 100 4 5
tubes and fittings used for irrigation and
drinking water supply as well as for
sewerage system
8.3 Manufacture of other plastic products
excluding plastic shopping bags 100 1 2
9. Other Non-metallic Mineral Products
Industry
9.1 Manufacture of glass and/or glass products

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9.2 Manufacture of ceramic products 100 4 5
9.3 Manufacture of cement Not legible Not
9.4 Manufacture of clay and cement products 0 for legible for
exemption exemption
9.5 Cutting, shaping and finishing of marble and
limestone (excluding quarrying) 100 1 2
9.6 Manufacture of lime, gypsum and/or similar Not legible
coating 100 for 2
exemption
9.7 Manufacture of millstone, glass paper or
sound- absorbing or heat-insulating 100 1 2
materials.
10. Basic Metal Industry (excluding mining of
the mineral)
10.1 Manufacture of basic iron and steel 100 5 6
10.2 Manufacture of basic previous and non- 100 3 4
ferrous metals
10.3 Casing of iron and steel 100 4 5
11. Fabricated metal products industry
(excluding machinery and equipment)
11.1 Manufacture of structural metal products,
tanks, reservoirs and containers or steam 100 3 4
generators.
11.2 Except corrugated metal sheets for
roofing and nails, manufacture of other 100 1 2
fabricated metal products (hand tools,
articles and similar products)
12. Computer, Electronic and Optical
Products Industry.
12.1 Manufacture of electronic components 100 4 5
and boards
12.2 Manufacture of computers and peripheral
equipment
12.3 Manufacture of communication 100 3 4
equipment
12.4 Manufacture of consumer electronic
(television, DVD, radio and similar
equipment)
12.5 Manufacture of measuring, testing,
navigating, control equipment or watches 100 3 4
and clocks
12.6 Manufacture of medical equipment
12.7 Manufacture of optical equipment &
photographic equipment and other similar 100 2 3
products
13. Electrical Products Industry
14. Machinery and equipment industry

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15. Vehicles, Trailers and Semi-trailers industry
16. Manufacture of office and household
furniture (excluding those made of ceramics)
17. Manufacture of other equipment (jewelry and
related articles, musical instruments, sports
equipment, games and toys and similar
products).
18. Integrated manufacture with agriculture

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 Appendix 2: Operational projects in different sectors by country of origin, selected countries (2007-2015)
China India USA Turkey Sudan
Number Percent Number Percent Number Percent Number Percent Number Percent
1 2 3 4 5 6 7 8 9 10
Metal and Engineering
Basic Metals 2 1.1 1 1.8 2 4.3
Fabricated Metal Products, Except Machinery and Equipment 17 9.3 6 10.9 4 8.5
Motor Vehicles, Trailers and Semi-Trailers 5 2.7 1 1.8
Machinery and Equipment 8 4.4 3 6.4
Chemical
Chemicals and Chemical Products 5 2.7 10 18.2 2 33.3 3 6.4 4.0 21
Coke, Refined Petroleum 1 1.8 1 2.1
Rubber and Plastics Products 24 13.1 9 16.4 1 16.7 3 15.8
Electronics and precision machinery
Electrical Machinery and Apparatus N.E.C. 9 4.9 5 9 1 2.1
Medical, Precision and Optical Instruments, Watches and Clocks 1 1.8 1 16.7 1 2.1
Office, Accounting and Computing Machinery
Radio Television and Communication Equipment and Apparatus 8 4.4
Agro-processing
Paper and Paper Products 2 1.1 6 10.9 1 5.26
Food Products and Beverage 8 4.4 2 3.6 1 16.7 6 12.8 7.0 36.9
Furniture, Manufacturing 15 8.2 5 10.6 1 5.26
Wood, Products of Wood; except Furniture 4 2.2
Textile, Garment and Leather Products
Textiles 24 13.1 4 7.3 1 16.7 4 8.5
Wearing Apparel, except fur apparel 12 6.6 4 7.3 2 4.3
Tanning, dressing of leather, & footwear 11 6.0 1 2.1
Other sectors
Other Non-Metallic Mineral products 27 14.8 4 7.3 13 27.7 3 15.8
Other Transport Equipment
Recycling 2 1.1 1 1.8 1 2.1
Total 183 100 55 100 6 100 47 100 19 100

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