Chapter 6

Broadening the Policy Scope:
Cross-cutting Issues∗

The policy scope of Ethiopia is expanding.

In the last few years the government ofEthiopia has studied the possibility and desirability of broadening the policy scopefor industrialization, and it is now ready to put this idea into practice.

The policychange will be incorporated in A Plan for Accelerated and Sustained Development
to End Poverty (PASDEP) II (2011–2015), which is the national five-year
development plan currently under preparation.

The broadening of policy scope isalso recommended by a number of foreign experts.1
Ethiopia’svisionforindustrialization

Industrialization (ADLI).

is

Agricultural

Development

Led

ADLI has been concretized in a series of documents

such as An Economic Development Strategy for Ethiopia (1994), Rural Development
Policies, Strategies and Instruments (2001), Industrial Development Strategy (2002),
Sustainable

Development

andPoverty

Reduction

2002/03–2004/05, and PASDEP 2005/06–2009/10.

Program(SDPRP)ADLI is an industrialization

strategy in which agriculture plays a key role in preparing various conditions forfull-fledged industrialization through the provision of industrial materials,
consumption goods (mainly food), demand for industrial goods, labor supply, andforeign exchange.

The transformation of small subsistence farming into

commercial agriculture is at the center of this strategy (chapter 5).
∗

1

This chapter was prepared for the bilateral policy dialogue held in Addis Ababa in early September
2009 between Ethiopia and Japan. It is based on the information from official documents, a seriesof discussions and exchange of letters with Ethiopian leaders and high officials, and studies by the
GRIPS Development Forum (GDF). All responsibility for the content shall be borne by the GDF.
Joseph Stiglitz (Columbia University), Dani Rodrik (Harvard University), and Justin Linn (WorldBank chief economist) are said to have advised in this way. Among them, Rodrik’s note for Ethiopia
calls for the following revisions: (i) broadening policy scope to include more sectors for promotion;(ii) supporting “new” activities for Ethiopia rather than exports; (iii) recognition that mistakes areboth unavoidable and necessary; (iv) broadening the list of policy instruments; (v) giving incentives
and subsidies to “pioneers” only and not emulators; and (vi) enhancement of lines of communicationand coordination with the private sector (Rodrik, 2008).

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CHAPTER 6ADLI shifted from the formulation stage to serious implementation around
2002–2003.

In the last several years, the government of Ethiopia has concentrated

limited human and financial resources on a small number of export-oriented priority
industries.

These industries, such as leather and leather products, textile andgarment, food processing, and floriculture, were given generous incentives and highpolicy attention.

Among these, floriculture, which was not included in the originallist of priority industries, has recorded the fastest growth in output and export,
followed by leather and leather products—albeit from very low bases.

Meanwhile,

the results of the other two priority industries were less spectacular.

Thegovernment has also actively mobilized donor assistance for these industries indrafting master plans, strengthening industrial human skills, leveling up technology,
establishing research and training centers, marketing and business matching,enhancing business associations, and so on.

Important tools of industrial policy,

such as benchmarking, business process re-engineering (BPR), pilot projects andsubsequent scaling up, and public private partnership, have been learned andimplemented.

More recently, kaizen has been added to the policy toolkit.

In all fairness, it can be said that Ethiopia in the last several years has made good
progress in early industrialization and can now take up the next round of challenges.
Admittedly, past performance has not been perfect and a number of unresolved
issues remain.

For example, the expected emergence of competitive local firms

has been slow and inter-ministerial coordination is far from effective.

But thegovernment feels that enough has been learned about the tools, roadmaps andpitfalls of industrialization so that policy space can be enlarged as it formulates thedevelopment strategy for the next five years.

More specifically, Ethiopia from now

on will support not just selected export-oriented industries but also other industries
that mainly supply domestic markets such as steel, metal processing, cement,chemicals, and pharmaceuticals.

In other words, parallel promotion of exports andimport substitution is about to begin.
The National Graduate Institute for Policy studies (GRIPS) policy dialogue teamstrongly supports the expansion of policy scope of Ethiopia accompanied byenhanced policy capability.

This is in line with Dynamic Capacity Development,

the idea we put forward in another paper that internal capabilities should be144

Broadening the Policy Scope: Cross-cutting Issues

selectively and strategically built up to attain concrete industrial objectives rather
than generally and randomly (Ohno and Ohno, 2008).

It should be emphasizedthat causality between policy capability and policy scope is mutual.

Ethiopia can

expand its policy space because its policy capability has improved but setting new
policy goals in turn will require a further upgrading of policy capability.
It is in this context that the GRIPS policy dialogue team wishes to raise somecross-cutting issues and discuss organizational arrangements in industrialization for
the review of the Ethiopian authorities.

Broader policy space opens up greater

opportunities but it also increases the risks of miscalculation, political capture,
wasted resources, and macroeconomic instability.

Policy makers should be fully

aware of these risks in advance and take proper precautions in charting the newpolicy course.

We will conduct this policy dialogue primarily from the perspectiveof high performing East Asia where proactive industrial policy is widely acceptedand practiced.

This does not mean, however, that East Asian good practices arealways relevant in Ethiopia.

The validity of each argument from East Asia must be

carefully examined, with modifications if necessary, before applying to Ethiopiansoil.
In the formulation of industrialization strategy, the largest difference between
Ethiopia and high-performing East Asia—especially Southeast Asian economies—isthe existence in the latter of large inflows of manufacturing foreign direct
investment (FDI) which generates strong demand for quality, skills, logistics,
institutions, infrastructure services, and the like in the national economy.

Thisdemand for local capabilities from foreign manufacturers determines the kind ofpolicy needed for further industrialization.
largely absent in Ethiopia.

But such demand by FDI firms is

Export orientation does expose local industries toglobal competition, but export alone does not produce such strong and broadpressure for local excellence.
In this chapter we present a number of cross-cutting issues as a checklist to
stimulate discussion among policy makers.

Additionally, the next chapter deals

with issues related to organizational arrangements for effective policy making.
When concrete ideas and cases are offered, they are meant to be references and145

CHAPTER 6

initial suggestions rather than final recommendations.

Our discussion covers theexisting export-oriented priority industries as well as the proposed importsubstitution industries located in or near the urban center.

Rural industrialization, a

topic of great importance in ADLI, is beyond the scope of the present chapter.
Below, we address six issues that may become important as Ethiopia’s policy
capability is raised and its policy scope is enlarged.

Each issue contains a few

sub-issues, which are summarized in introductory boxes.

6-1. Policy framework and structure
1-1. Ethiopia has an industrial vision but strategy, action plan, and review
remain incomplete.
1-2. The industrial chapter of the next PASDEP, and the five-year industrial
implementation plan to be prepared by the Ministry of Trade and Industry(MOTI), should state clearly the direction of industrialization strategy inthe next five years.
1-3. All three levels of industrial policy (general, responsive, pro-active)
should be strengthened.
Industrialization strategy should have a layered structure that runs from general tospecific and from long-term to short-term.
strategy, and action plan.

These layers are normally called vision,

The vision is a long-term goal often expressed in aslogan such as “becoming an industrialized country by 2020” or “attaining middle
income by 2025.”

The strategy, also called the master plan or the roadmap, is adocument that typically covers the next three to five years and contains policy
principles, priority sectors, time tables, policy instruments, and so on, to give details
on the road to achieve the vision.

The action plan is a list or a matrix of concrete

actions that must be taken typically within one to three years with clear designationof action content, performance criteria, deadlines, and responsible organizations.
In relatively advanced countries where industrial policy is effectively managed byresponsible officials or organizations, an explicit action plan may be replaced by the146

Broadening the Policy Scope: Cross-cutting Issues

continuous process of policy initiatives and adjustments (chapter 9).

Furthermore,a review mechanism (“monitoring and evaluation”) must be installed to ensure
implementation and facilitate necessary adjustments.

Review may take various

forms including commissioned reports by external experts, a high-level government
committee, and formal or informal internal review by the ministry in charge.
In Ethiopia, ADLI sets the fundamental direction and the Industrial Development
Strategy (IDS) (2002) states key principles such as private sector initiative, exportorientation, strong state guidance, and so forth, and specifies priority sectors.
Together, ADLI and IDS stipulate the basics of industrialization strategy that canremain valid for a long time beyond the five-year cycle of PASDEP.

These

correspond to the “vision” and part of the “strategy” mentioned above.

Meanwhile,industrial master plans have been compiled for the priority industries.

Quality andstructure of these master plans differ greatly—partly because they reflect distinct
characteristics of each sector but mostly because they were commissioned todifferent donors with different methodologies.

For action plan and review, themonthly Export Steering Committee and MOTI’s regular contacts with the business
community (business associations and individual enterprises) are the instruments formonitoring implementation, identifying problems and coming up with solutions.
ADLI and IDS are comprehensive and flexible enough to accommodate most policy
shifts and therefore can continue to guide industrialization for a decade or two to
come.

What is required additionally is the statement of policy elaborations andadjustments that become necessary every few to several years, such as the proposed
introduction of import substitution, due to changing circumstances and rising policy
capability.

Instead of drafting an overall industrial master plan separately, wesuggest that the industrial chapter of the next PASDEP and the five-year industrial
implementation plan, which will be prepared by MOTI after the approval of the next
PASDEP, should serve this purpose.

To do this, the content of both documents

must coincide, with the one being the executive summary of the other, and must be
based on the discussion and agreement of all main stakeholders in advance.

Thismeans that such stakeholder meetings should be held frequently between now andthe completion of the five-year implementation plan.

The industrial chapter of thecurrent PASDEP, as it is written, is not strategic enough to set the medium-term
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CHAPTER 6

policy direction.
Over time, the master plans of priority industries should be drafted (if missing) orrevised (if they already exist) by imposing minimum common orientation andminimum common structure that reflect the overall direction of ADLI, IDS and
PASDEP but allowing sufficient room for the unique features of each sector. 2
Given the limited human and financial resource and donor support, the number ofmaster plans should be relatively small and perhaps should not exceed ten.

Theyshould be drafted for the existing export-oriented industries as well as the proposed
import substitution industries.
To strengthen action plans and reviews, the current works by the Export Steering
Committee and MOTI’s regular interaction with priority industries should be
supplemented by the compilation of standard action plan matrices for each priority
industry.

These matrices should contain actions, sub-actions, performance criteria,

deadlines, and designations of responsible organizations. They may be attached tothe sectoral master plan or produced separately from it.3 Moreover, there should bea formal mechanism to regularly review and adjust the implementation of theseaction plan matrices.

For this reason, the action plan and the review mechanism

should be created simultaneously as inseparable and mutually dependent policy
tools.

Possible enhancement of Ethiopian industrial policy structure is summarized

in Figure 6-1.

2

3

The existing master plans for leather and leather products (assisted by UNIDO) and textile andgarment (assisted by China), for example, have very different style and structure. It is suggested
that the government should be involved more deeply in the initial design of industrial master plans so
the minimum level of conformity is ensured. At the same time, requiring all master plans to havethe same chapter structure, as practiced in Vietnam, is going too far in imposing uniformity.
The standard action matrix format can be seen in the first automotive industry action matrices ofThailand and the Triangle of Hope action plan matrices of Zambia (for improving investment
climate). The former are incorporated in the automotive master plan while the latter are produced
as a separate document submitted to the Government at regular intervals.

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Broadening the Policy Scope: Cross-cutting Issues

Figure 6-1. Possible Enhancement of Industrial Policy Structure
Vision can remain intact

ADLI & IDS

VisionPASDEP & MOTI 5-year
implementation plan should
specify evolving direction

IDS
Strategy
M/Ps

Sectoral master plans must
be completed and upgraded

Action Plan

Standard action plan matrices
should be createdExportSteer.Com.
Review

Additional review mechanism
should be installed

MoTI
dialogue

Industrialization strategy should properly address three aspects.

The first is theestablishment of a stable, transparent and business-friendly environment fordomestic and foreign investors (i.e., cutting red tapes and leveling the playing field).
The second is ensuring quick response to the requirements of the business
community.

Whenever there is a need or a problem, the government should act

promptly to supply what is needed or remove what is impeding business activities.
Ethiopia has already made significant progress in these two areas by implementing
BPR aggressively in every ministry and agency.

However, these aspects are stillbasic and passive.
The third aspect of industrialization strategy is the creation of dynamic comparativeadvantage in which proactive policy makers generate new industrial strengths andguide investors towards new activities under close coordination with private
partners (“public private partnership”) but without necessarily waiting for theirmove (chapter 1). Such proactive industrial policy, which anticipates and creates
dynamic comparative advantage, is commonly practiced in East Asia but still remain
controversial among Western donors.

The disagreement arises from thefundamentally different views about the role of government vis-à-vis the market ineconomic development.

We believe that pro-activeness is essential for theeffectiveness of industrialization strategy, but it requires deeper knowledge andhigher policy capability than the other two.

The industrialization strategy of

Ethiopia, consisting of the MOTI’s industrial implementation plan and sectoral
master plans, should enhance all these aspects, especially the last.
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CHAPTER 6

6-2. Past review and future evaluation
2-1. There should be an ex post review of export industry promotion.
2-2. There should be ex ante analyses of proposed import substitution
industrialization.
As Ethiopia expands its policy scope from a few export-oriented industries to theinclusion of import substitution industries, there is a need to review the past andevaluate the future as soon as practically possible in formulating industrial policy
orientation for 2011–2015.

Review here is different from the reviewing

mechanism of action plans mentioned above.
In the last several years, Ethiopia targeted its human and financial resources to thepromotion of a few export-oriented priority industries.

Promotion tools included

cheap land, preference in taxes and import duties, bank loans, foreign exchange
allocation, research and testing facilities, training programs, close consultation withbusinesses, quick trouble-shooting, and concentrated use of official development
assistance (ODA) for these purposes.

The result of this generous policy package

should be assessed before Ethiopia takes the next bold step in industrialization
strategy.

It is essential to document what has been offered to promote theseindustries and what progress has been made in industrial performance.

It is also

necessary to numerically compare the explicit and implicit costs of promotion
relative to the direct and indirect benefits that accrued to the national economy.
Although precise determination of these costs and benefits may be difficult, best
estimates should be produced with available information and data.

Studies should

be conducted for leather and leather products, textile and garment, and floriculture.
For food processing, one or two concrete agro products may be selected for thisanalysis.
At the same time, there should be preliminary studies of the import substitution
industries that will be promoted during the next PASDEP cycle.

For each industry,

there should be assessment of the domestic situation, global and regional trends,
Ethiopia’s potential, hurdles and pitfalls to be overcome, and possible strategic

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Broadening the Policy Scope: Cross-cutting Issues

orientation for promoting the industry.
We propose these studies, which should be completed within several months, to help
deepen industrial policy debate in Ethiopia and draft the industrial chapter of thenext PASDEP.

They should also be used as preliminary input to the subsequent

drafting or revision of sectoral master plans and the feasibility studies to be
conducted for import substitution industries (see next section).

Since thepreparation of master plans and feasibility studies will take time, these studies
should be used to start policy debate as soon as possible.
Both of these studies—past review and future evaluation—should ideally becommissioned to independent and neutral Ethiopian researchers outside thegovernment.

For each industry, a medium-sized report should be submitted to thegovernment and should also be circulated openly and widely.
be published in one collected volume.
nor too narrative.

These reports may

The reports should be neither too theoretical

They should be sufficiently analytical and contain concrete

numbers and estimates.
MOTI should cooperate with the drafting process of these studies by supplying dataand information, but it should not take the lead in determining the content.
MOTI is too occupied with its existing workload.

First,

Second, a self-assessment ofindustrial policies by MOTI is not nearly as convincing as an assessment by
respectable outsiders.

Third, evaluation of industrial policies by Ethiopian

researchers at universities and research institutes, rather than government officials
or foreign experts, will contribute to the strengthening of local research capability
and the building of constructive relationships between the government and academia(as we see in Tanzania, for example).

The Ethiopian government needs to foster its

ties with local academics to strengthen its own capacity to design and implement
industrialization strategies in the future.

Assistance by donors and foreign experts

may be sought if necessary, but, again, they should not dominate the outcome of thereport.

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6-3. Time dimension of industrial promotion
3-1. Industrial promotion must always be temporary with a pre-announced
graduation schedule.
3-2. Time-bound support measures should be available to all producers,whether pioneers or copycats.
3-3. A long-term liberalization roadmap should be prepared in anticipation of
the World Trade Organization (WTO) accession.
Industrialization strategy must balance the requirement of international integration
with the requirement of local industry promotion.

Policy makers must give proper

weight to liberalization and integration vis-à-vis the amount and duration of support
to local firms so that the policy package as a whole generates strong incentive for
producers to work hard rather than shut down their factories or resort to politicallobbying. Opening the country without regard to the competitiveness of domestic
private industries is suicidal. Protecting local industries without the prospect ofgraduation is equally disastrous.

Striking a balance between accepting global

integration and promotion of local industry is a delicate matter.

Concrete solutions

must be discovered for each industry in each country.
Another inherent aspect of industrialization strategy is its temporary nature.
Industrial promotion can never be permanent—if it is, the policy has failed.
Priority industries may receive generous assistance for a time but not forever.

The

typical duration of intensive promotion is several years but it may be shorter or
longer depending on the case.

Promotion must end when it becomes clear that theindustry has either succeeded or failed in gaining international competitiveness—ineither case, additional support cannot be justified. Ideally, the duration of industrial
promotion should be pre-announced and strategically linked to the internationallycommitted liberalization schedule of that industry.

Promotion must be terminatedwhen the time comes regardless of success or failure of that industry.

As Prof.

Rodrik remarks, the government must accept the fact that mistakes are unavoidable
in industrial policy and that not all supported industries can be winners (Footnote 1).
Previously, Japan and Korea adopted the infant industry promotion strategy of using

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Broadening the Policy Scope: Cross-cutting Issues

temporary tariff protection to shield domestic firms until they gained international
competitiveness.

In the early 21st century, however, latecomer countries are nolonger allowed to use heavy protection to promote domestic industries.

This does

not mean that industrial promotion is no longer possible, but it does mean that
promotion must take a different form.

There exist a large number of measures forstrengthening

without

industrial

capability

violatinganyinternational

commitments—such as education and training, technology transfer, public private
partnership, promotion of small and medium enterprises, development finance,
efficient logistics and distribution, industrial estates, FDI marketing, and reliable
power and transport.

None of the policy measures we discuss violates WTO or any

other international rules.
In Ethiopia, a few export-oriented industries have enjoyed incentives and subsidies
in the last several years. In addition, MOTI has worked very closely with industry
associations and individual firms in the priority industries to assess businessstrategies,

reportmonthly

exports,

mobilizebenchmarking, trouble-shoot problems, and so on.

donors’ assistance,

conduct

Young officials in the Textile

and Leather Development Center (now upgraded to the Textile and ApparelInstitute) of MOTI, who routinely visit member firms in these sectors, seem to know
the ins and outs of the strategies and problems of individual firms.

In the earlystage of industrialization, such intensive public support and guidance is laudable.
However, at some point, perhaps relatively soon, private firms must graduate fromthis heavy dose of guidance and assistance and make their own business decisions attheir own cost and risk.

Technical and financial aid from the government anddonors should be reduced in appropriate steps.

The (revised) master plan of eachof these industries should have a chapter to discuss such graduation.
One related issue raised by Prof.
measures among producers.

Rodrik is how to allocate industrial support

He argues that incentives and subsidies should begiven only to “pioneers” who start “new activities” (in the context of Ethiopia) but
not to emulators who follow pioneers without taking risks themselves.
The key developmental question that a prospective investor needs to be
asked before granting him incentives is not whether his project is153

CHAPTER 6

export-oriented, but whether it is new to the Ethiopian economy—either aproduct not previously produced in Ethiopia or a significant technologicalupgrading of an existing product...

It is the pioneer firms that bear thecost of discovery—can a particular activity operate profitably in Ethiopian
conditions?—and of putting Ethiopia on the global radar screen ofinvestors.

So it is they who need the subsidy, and not the followers who

simply emulate the success—if success is what they experienced—of thepioneers.

Crudely put, the (rhetorical) question is whether the 91st firm

investing in flowers still needs a tax break.

(Rodrik, 2008, pp.6–7)

While this argument may have some theoretical merit, we do not think it is practicalor fair. In reality, it is administratively impossible to determine who is pioneering
and who is not.

Mere order does not tell us the amount of new value created or

new risks taken, because the tenth investor may well be crucial rather than the first.
If support is given only to the first x investors, this will spawn a distorted incentive
to go first and exclude others regardless of whether the first movers have proper
managerial and technical capability.

Such a race for initial privilege is called

license hunting and encourages rent seeking and cartelization.

The Ethiopian

government does not have the capacity to rank firms according to the amount ofvalue created, and even if it did, it should not waste its precious time and humanresources on such ranking.
Industrial promotion measures must be available to all producers that satisfy theannounced criteria defining eligible activities whether they are the first investor or
the 91st.

As argued above, support measures must be time-bound and phased out

after a number of pre-specified years.

But while these measures last, all eligible

producers should be able to access them.

In fact, this is the only administratively

manageable and politically acceptable way of conducting industrial promotion in a
low-income developing country.

If further selection is desired, support may belinked to some readily recognizable performance criteria (such as output or export
volume) so that competition among producers may be engendered.

However, thistype of industrial policy is a fairly advanced one and should not be attempted by agovernment without high capability, transparency, a sufficient toolkit, and strong
trust and constructive cooperation with the business community.
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Broadening the Policy Scope: Cross-cutting Issues

In the medium to long run, there should be an overall industrial master plan (inaddition to those for individual sectors) with mutually consistent schedules forindustrial promotion and international integration.
also be an integral part of this roadmap.
complex and time consuming.

The timing of WTO entry must

Negotiations for WTO accession are

Moreover, large existing members of WTO tend to

impose unreasonable opening conditions, which they themselves do not abide by, on
small new members.

As a result, most negotiating governments become too

pre-occupied with document preparation, legal adjustments, diplomatic battles, andthe like and forget about building linkage between industrialization strategy andintegration strategy.

This is a big mistake.

Trade liberalization with a deadline isa challenge as well as an opportunity for industrial promotion.

To effectively copewith this challenge and opportunity and make WTO accession meaningful fornational development, there must be a clear roadmap for industrial promotion inadvance.
The literature on the order of economic liberalization informs us that there is aproper liberalization sequence that must be followed to avoid macroeconomic crisis.
Liberalization must start with domestic markets such as local goods, services, andlabor.

Then it must be followed by the liberalization of domestic finance.

Capital-account liberalization must come at the end when all domestic markets areliberated and function reasonably well (McKinnon, 1993).

Another importantlesson from the developing world is that factors that contribute to resilience of thereal-sector economy, such as growth potential, structural diversity, and regional
integration, can greatly enhance the capacity of the national economy to withstandglobal shocks under integration.

Ethiopia’s liberalization schedule must have aproper macroeconomic sequence and must be synchronized with the progress of its
industrialization strategy.

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6-4. Import substitution
4-1. Import substitution must avoid the risks of policy misjudgment andpolitical capture.
4-2. Technical details are key to the success of import substitution. A
high-quality feasibility study (F/S) or master plan should be prepared foreach import substitution industry to be promoted.
As Ethiopia embarks on import substitution, we would like to draw the attention of
Ethiopian authorities to its well known risks.

All arguments in the previous section

regarding the temporary nature of promotion apply to import substitution.

Inaddition, even greater precautions must be taken because import substitution is ariskier policy area than export promotion.
Import substitution is riskier than export promotion because the Ethiopian
government can regulate domestic markets more easily than global markets.

It canrestrict entry, use subsidies and taxes that affect prices and profits, and introduce
standards for quality, safety, the environment, and so on, that also influence businessoutcome.

While exporters can hardly lobby for larger overseas markets or higher

commodity prices, producers that sell domestically can often ask the government todo something about their plight.

To the extent that the government has policy

instruments to directly affect domestic markets, import substitution is more subject
to policy misjudgment and political capture than export promotion.

This isprecisely why neoclassical economists dislike import substitution.

Althoughimport substitution may be a beautiful idea theoretically, they contend that it cannot
be implemented effectively because (i) the government does not know the rightindustries to promote; and (ii) the policy will surely be captured by political interest
groups.

Anne Krueger, the former World Bank chief economist and champion of

trade liberalization, states:
The problem with the [infant industry] argument, as a basis for policy, isthat it fails to provide any guidance as to how to distinguish between an
infant that will grow up and a would-be producer seeking protection

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Broadening the Policy Scope: Cross-cutting Issues

because it is privately profitable… The infant industry argument also is an
excellent example of a theory that is nonoperational because criteria forbureaucrats to identify cases have not been put forward. (Krueger, 1997,
p.12)
No matter how careful economists are, special interests always will seize
their research results in supporting their own objectives.

And, no matter

how sophisticated and careful research findings are, there always will bepoliticians formulating, and non-economists administering, policies. (ibid,
p.19)
Today, the neoclassical ideology is no longer dominant as before and few would
support Krueger’s extreme pessimism over the capacity and intention of thegovernment.

Furthermore, as mentioned above, industrial promotion in our age isconducted with an array of WTO-consistent policy instruments rather than hightariffs and non-tariff barriers.

Even so, the risks highlighted by Krueger are realand should not be ignored.

Where we should differ from Krueger is the policy

conclusion.

We know that both market and government are imperfect. The factthat bureaucrats may not know the selection criteria and policy may be hijacked byrent seekers should not lead us to entirely abandon import substitution.

We should

proceed with utmost care to avoid these obvious risks. Policy capability is not given
but can be improved over time.
Policy misjudgment must be minimized by sufficient learning in advance andreadiness to abandon support of projects that fail in actual implementation.
Ethiopia should study the nitty-gritty of each targeted import substitution industry to
reduce expectable risks and wastes prior to the approval of concrete projects or
promotion measures.

A good F/S should be conducted and a good master planshould be prepared by experienced experts for each targeted import substitution
industry.

Political capture must be prevented by strong leadership that punishes

rent seeking and encourages value creation.

Democratic developmentalism (DD),the political regime adopted by the Ethiopian government for national development,
aims to institutionalize precisely such a policy orientation.

As long as this policy

direction is firmly in place, Ethiopian economic policy is less likely to be captured
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CHAPTER 6

into endless protection of inefficient industries.
Take the steel industry, for example.

It is widely known that promoting the steel

industry in latecomer countries is not an easy task (Kawabata, 2007).

The steelindustry consists of a wide range of activities from the cottage industry of long bar
rolling with primitive technology to integrated steel mills with gigantic scale andfrontline technology.

Production is broadly divided into long steel and flat steel,each with many upstream and downstream processes.

Each process in turn can be

performed by various technologies and types of equipment with certain pros andcons.

The market is subdivided into high, medium, and low quality products, eachrequiring different investments and technologies.

The quality of raw materials(iron ore, cokes, scrap metal, etc.) largely determines the quality of output, whiletransport and logistics determine cost competitiveness.

The demand size relative

to efficient equipment capacity, the state of competition, and world business cycles
are crucial determinants of profitability.

Reduction of operational waste anddowntime also contributes greatly to high yield and low cost. Environmental
concern must be addressed as a matter of high priority.

The role of government

differs from one steel production process to another, and it should diminish overtime as private firms grow and become competitive.
In such a complex industry, financial outcome depends crucially on the right choiceof details—technology, production capacity, equipment type, input procurement,
mill location, forward and backward linkage, factory management, training, targetedmarkets and customers, timing of investment, taxes and tariffs, finance, and so on.
In Vietnam, for example, the nation’s first modern flat cold rolling mill in Phu My
could not supply to FDI customers such as Sanyo, Honda, and Yamaha because it
did not have the right equipment for surface treatment, and its marketing wasinsufficient to meet customer needs.

Hoa Phat, a local private business group,purchased a cheap electrical furnace from China to produce billets (intermediate
input for steel bars and wire rods), but it later found out that the furnace capacity
was too small for efficient operation and cost reduction.

An enormous amount ofmoney can be wasted and bankruptcies can soar if these technical details are not set
right.

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Broadening the Policy Scope: Cross-cutting Issues

Before Ethiopia begins to promote the steel industry, the current status of thedomestic steel market should be grasped with respect to material flows (input-output
relations among processes), quality and technology, market segmentation, transportand logistics, operational efficiency, and so on.

The compilation of a material flow

chart, as shown in Figure 6-2 for Vietnam, is the very first step for this purpose.

Inmany latecomer countries experiencing construction booms, demand forconstruction steel (bars, wire rods, galvanized flat steel) is strong while domestic
supply is limited.

While a few rolling mills may spontaneously emerge, the importbill for billets and finished construction steel surges.

In the early stage, the steel

industry should develop from long steel to flat steel, from downstream to upstream,
and from low quality to medium quality.

Another lesson from East Asia is theimportance of steel market intermediaries, such as “coil centers” for flat steel andsteel bar processors for long steel, in creating an efficient supply chain of theindustry.
The government should not invest directly in production facilities but should
manage markets and private investors, both local and FDI, to minimize
inappropriate investments, cope with external shocks, and stabilize the market asmuch as possible (the global steel market is inherently unstable so it is impossible toeliminate all shocks and fluctuations).

The history of the steel industry shows thatprivate investments cannot always be regarded as efficient or environment-friendly.
Many mistakes can be made in large and indivisible investments in steel.
Oftentimes, too many investments are made in technology that is outdated or too
small for achieving efficiency, which overcrowds the market and damages theenvironment.

The government must acquire sufficient capability to monitor andregulate private investments in the early stage of steel industry development.

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Figure 6-2. Material Flows of the Vietnamese Iron and Steel
Industry, 2005

Unit: 1000 tons. Source: Author compiled from SEAISI (2006a, 2006b)
Source: Kawabata (2007), p.9.

This is just a sketch of some of the problems in promoting the steel industry. Fulldetails must be given in a thick feasibility study report or a master plan prepared byexperienced steel experts.

The same can also be said for any import substitution

industry other than steel.

If a full F/S or a master plan takes too much time, apreliminary study should be organized as a starter as suggested in section 6-2
above.4

4

MOTI created master plans (the “strategic plan” and the “business plan”) for chemicals (mainly soap
and detergent) and pharmaceuticals in 2007. Strategic studies and documents also exist for cement
and paper and pulp. Drafting was done by Ethiopian experts with occasional help from the German
Engineering Capacity Building Program (ECBP).

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6-5. Industrial clusters and corridors
5-1. There are many definitions of industrial clusters and corridors.
Applicability of each to Ethiopia should be carefully examined.
5-2. The idea that related projects and programs should be implemented
collectively in certain geographical areas is useful in building agro foodparks and other industrial zones.
The concept of industrial cluster, as practiced in policy formulation, can beclassified into several different approaches.
(i)

Innovation through interaction between top-level researchers andbusinesses—proximity of high tech firms and top-level research institutes
or universities, under an effective local leader, is expected to generate new
products or even new industries. Michael Porter’s cluster approach andthe industrial cluster initiative of Japan’s Ministry of Economy, Trade andIndustry (METI) belong to this category. Commercialization of advanced
technology is anticipated. Silicon Valley in California and Zhongguancun
in Beijing are typical examples.

(ii) Agglomeration of related firms for effective inter-industry linkage—
producers with input-output relations, such as buyers- sellers and assemblerspart suppliers, gather for efficient trading, information sharing, and sharing
of input and output markets.

Kuchiki’s (2008) “flow chart approach” is

an attempt by policy makers to establish an industrial park, provide local
capability and infrastructure services, and invite an anchor firm and amultitude of suppliers.

To succeed, this approach must be accompanied

by proper incentives, training, FDI marketing, FDI-local firm linkage,technology transfer, and so on.
(iii) Concentration of small producers belonging to the same industry—thiskind of cluster, consisting of small and family enterprises, often emerges
spontaneously in both urban and rural areas.

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Trade villages specializing

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in shoe making, ceramic production, etc. are such examples.

Accordingto Sonobe and Otsuka (2006), these clusters typically evolve in three stages:
initiation, quantitative expansion, and productivity breakthrough.
(iv) A broad definition of industry that includes supporting industries andsupporting services—in the cluster-based industrial development strategy
in Malaysia’s Second Industrial Master Plan 1996–2005 (IMP2), an industrial
cluster is defined as “an agglomeration of inter-linked or related activities
comprising industries, suppliers, critical supporting business services,
requisite infrastructure and institutions” (IMP2, p.23). This is a functional
agglomeration that may not necessarily be located in one small geographicalarea.
(v) An industrial estate—sometimes the term industrial cluster is usedsynonymously with an industrial estate (an industrial park, a special economic
zone, an export processing zone, etc), a delineated area with rental plots
and necessary infrastructure developed and operated by a private or stateowned management company.5
The related concept of industrial corridor also has different meanings:(vi) Building international transport infrastructure—this typically involves
the construction of a road that usually connects hinterland or landlocked
countries with a sea port. Development programs and private investments
may follow the construction of such a road, but not always.
(vii) Asian Industrial Corridor Initiative—the Japanese METI is launching an
initiative to create new cross-border industrial regions in Southeast Asia
and India by consciously combining transport infrastructure with otherpolicy components such as public private partnership, efficient logistics,
human resource development, electronic trading, speedy customs clearance,
5

In Vietnam, the term cum cong nghiep, which translates as “industrial cluster,” means a small
industrial park without boundary fences. This terminology is creating confusion when Vietnamese
officials and researchers discuss industrial cluster-based development strategies.

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etc. in comprehensive regional development planning.
(viii) Food processing industry zones—in Ethiopia, the term growth corridor isused as an idea to link agro-ecological potentials with infrastructure andmarkets, including the building of several industrial zones specializing infood processing in rural areas or near local cities.
(xi) Rural economic areas linked with an urban center—when a city provides
industrial goods and employment opportunities to surrounding rural areas
which in turn supply agro products and labor, the resulting economic zone
with a hub city can be called an industrial corridor.6

In Ethiopia, Addis

Ababa and its vicinity is a naturally arising industrial corridor. The federal
government has a plan to create similar industrial corridors in other partsof the country.
Since industrial clusters and corridors have many definitions, the user of these terms
should be careful not to mix different meanings.

Some of them are useful for

Ethiopia’s industrial development, but others are not. Numbers (i) and (vii) are too
advanced for Ethiopia’s reality.

Number (ii) can serve as a reference in building

industrial zones to attract foreign investment, but perhaps on a smaller scale than in
East Asia.

Number (iii) is useful in formulating small and medium enterprise(SME) policy.

Number (vi) gives another entirely different perspective on

development along a transport corridor such as the Djibouti-Addis Ababa highway.
In Ethiopia, number (xi) is guiding the regional development plan of the federal
government but the plan remains broad and ambiguous.

This idea must be

followed up with regional development plans with concrete projects. Separately, theestablishment of integrated agro food parks, proposed in the food processing masterplan draft, may take advantage of some of these concepts selectively.

The idea that

regional development must integrate all related programs by different ministries anddonors into an organic whole is a sound one.

6

Policy coordination required for thisThis is the definition of industrial corridor which Prime Minister Meles explained to us in our policy
dialogue.

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initiative should be provided jointly by MOTI and the Ministry of Agriculture andRural Development (MOARD).
The concept(s) of industrial clusters and industrial corridors most useful for
Ethiopia’s development strategy should be identified, modified (if necessary), andintegrated into the next PASDEP.

Industrial estates for local investors and those

aimed at inviting FDI generally require different conditions.

While both may

commonly require good administration, land preparation, access road, power, water,
and a reliable labor supply, local investors may need more managerial, technical,
and financial support, while harnessing FDI dynamism may require strategic FDI
marketing, an appropriate incentive package, quick and low-cost access to global
markets, and so on.

Specific requirements also differ from one industry to anotherand even from one FDI firm to another.

A development strategy should be draftedwith these different requirements in mind.

6-6. SME promotion
6-1. SME promotion should clarify targeted firms and activities.
6-2. SME promotion policy with clear targets and based on relevant international
experiences should be created and strengthened as the key component ofindustrialization strategy.
SME promotion is a popular industrial policy tool around the world but its content
and results differ greatly across countries.

Most countries produce few results

because they fail to identify proper goals and lack concrete knowledge of how to
conduct effective promotion.

Ethiopia’s SME policy also remains underdeveloped.

Its goal must be re-defined with clarity and concreteness and its policy instruments
and mechanism must be strengthened by learning selectively from successful
countries.
The objectives of SME policy can be broadly divided into the generation of income
and job opportunities for the general population (poverty reduction) and the164

Broadening the Policy Scope: Cross-cutting Issues

selective support of excellent SMEs to become creators of internal value andcompetitors in global markets (competitiveness).

Both of these objectives areimportant and may be pursued in parallel, but the goals, strategies, and instruments
they require are significantly different and should not be mixed.
In Japan, where both large enterprises and SMEs are historically well developed, thepurpose of SME policy in the post-WW2 period shifted gradually from theprotection of SMEs against exploitation by large parent firms to the encouragementof innovation by SMEs as a source of global competitiveness.

Japanese policy

instruments and mechanisms are highly complex, combining multiple channels for
public private partnership, participatory policy making (“deliberation councils”),
technical assistance, financial support, repeated consultation, and so on.

The

Shindan System (enterprise diagnosis and advisory system), established in 1948 toofficially train and certify SME management consultants, is well developed andeffective in Japan.7 However, the Japanese model is probably too difficult for mostdeveloping countries to adopt initially.
In Malaysia and Thailand, where the economy is highly industrialized but
dominated by FDI firms in electronics, automobile and other machinery industries,
the main policy goal is to increase internal value and replace foreigners with local
managers, engineers, and designers.

SME promotion is at the core of this strategy,

together with R&D, education, technology transfer, national brand creation, etc.
SME Corporation Malaysia, the lead agency for SME promotion in Malaysia, has alarge number of grant and loan programs for SMEs that implement concrete andverifiable activities to improve productivity and expand business.

Althoughdifferent from the Japanese approach and institutionally much simpler, we consider
the Malaysian programs to be one of the best SME policy packages in the world.
They are clearly aimed at boosting international competitiveness and not poverty
reduction.878

For the details of the Japanese Shindan System and efforts to replicate it in Thailand, Malaysia, andVietnam, see Ohno (2010).
For updated accounts of supporting industry promotion, which is an advanced form of SME support,
in Malaysia and Thailand, see Vietnam Development Forum and Goodwill Consultant JSC (2010).

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Table 6-1. Malaysia’s SME Support Programs(Small and Medium Industries Development Corporation)
Enterprises with more than 60% local capital, with annual sales less than
RM25m, and fewer than 150 employees.
Provided for industrial linkage, business planning, product and process
Grantsimprovement, logistic services, overseas marketing, obtaining quality
certification, improved packaging, design, labeling, halal products, etc.
Soft loans Provided for factory relocation, ICT, etc.
“Concept papers” submitted by enterprises are evaluated by SMIDEC
Selection
within 14 days and benefits disbursed within 20 working days.
Proposed actions are monitored after 3, 6, and 12 months, and benefits
Monitoring
may be withdrawn if they are not implemented.
Industrial Database of 18,000 companies; annual matchmaking events with the
Linkageparticipation of over 250 local suppliers and MNCs; pioneer status with
Program 100% tax exemption for five years and other tax privileges.
Eligibility

Source: Ohno, ed. (2006).

Also see www.smidec.gov.my/index.jsp.

In a poor agricultural country where industrial development remains primitive and
FDI absorption is limited, SME promotion covers virtually the entire
industrialization strategy because almost all producers are micro or small.
term SME promotion may be too broad and ambiguous for such a country.

The

Goals,

targeted firms, and policy instruments for such promotion must be realistic andrelevant to the local situation, and must be quite different from those in moreadvanced countries.
Ethiopia’s SME policy needs to target both poverty reduction and international
competitiveness.

These two directions are in principle separable, and should be

drafted and implemented as different strategies.

The first package, which should

be available to all eligible enterprises in urban or rural areas, must provide general
support such as elementary management, technology, accounting, information,marketing, etc.

The second package should be designed more strategically andoffered conditionally only to those enterprises that demonstrate willingness andpotential to excel, with an appropriate monitoring mechanism.

It is necessary to

re-define and re-classify SME promotion into separate policy components whose
responsibilities should be assigned to different organizations (ministries andagencies).

For each, legal and policy frameworks, executing and supportingorganizations, industrial human resource development, management and technology
assistance, finance, and enterprise matching and marketing should be clarified.
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Broadening the Policy Scope: Cross-cutting Issues

At

present,

Federal

Micro

and

Small

Enterprise

Development

Agency(FeMSEDA)’s workshop programs are mainly directed at nationwide poverty
reduction while the work conducted at the Leather and Leather Products Technology
Institute (LLPTI) and the Textile and Apparel Institute, with donor assistance, isdirected at producing excellence.

167