2022

Ethiopia FDI Policy Report

Policy Studies InstituteNational Graduate Institute for
Policy Studies

Ethiopia
FDI Policy Report

2022

Policy Studies Institute (PSI)
National Graduate Institute for Policy Studies (GRIPS)

Table of Contents

Table of Contents ·························································································· i
List of Tables ······························································································iv
List of Figures ····························································································· v
Abbreviations and Acronyms ··········································································vi
Foreword and Acknowledgments ··································································· xiii
About the Authors······················································································ xiv
A Compact Summary of Policy Recommendations ··············································· 1
Overview and Summary ················································································ 3
Chapter 1. Ethiopia’s FDI Policy Evolution and Performance································ 17
1-1. Introduction ·················································································· 17
1-2. Evolution of FDI policy and the investment framework ······························· 18
1-3. The industrial park development scheme ················································ 30
1-4. FDI inflow and composition in Ethiopia ················································· 32
1-5. Challenges and a way forward ····························································· 40
Chapter 2. FDI Policy for Industrialization: From Quantitative Accumulation to Value
Creation ····················································································· 45
2-1. Introduction ·················································································· 45
2-2. FDI motive versus policy objective ······················································· 46
2-3. Win-win solutions and failures: automotive cases in Asia····························· 48
2-4. Irresistible attractions versus non-essential conveniences ····························· 51
2-5. Policy instruments and removal impediments ··········································· 56
2-6. Moving from quantitative accumulation to domestic value creation ················ 60
2-7. Strengthening domestic firms and building linkage ···································· 69
2-8. Industrial park management ······························································· 71
Chapter 3. Dynamics of FDI in Ethiopia: Bridging the Balance of Payment Gap ········ 79
3-1. Introduction ·················································································· 79
3-2. Literature review············································································· 80
3-3. FDI policy and the BOP: review of best practices ······································ 85i3-4. FDI and the BOP in Ethiopia: policy and performance ································ 93
3-5. Policy recommendations and the way forward ·········································· 99
Chapter 4. Enhancing the Role of FDI in Technology and Knowledge Transfer ········ 101
4-1. Introduction ················································································ 101
4-2. Literature review··········································································· 103
4-3. Some policy lessons from best global practices ······································· 109
4-4. Policies, instruments and institutions in promoting technology and knowledgetransfer in Ethiopia ··········································································113
4-5. Technology and knowledge transfer from FDI: survey results ······················115
4-6. Summary and policy implications ······················································ 125
Annexes ·························································································· 129
Chapter 5. Foreign Direct Investment in Ethiopia: A Survey Report ······················ 133
5-1. Introduction ················································································ 133
5-2. Overview of survey ······································································· 134
5-3. Major findings of the survey ····························································· 136
5-4. Summary ···················································································· 144
Annexes ·························································································· 146
Chapter 6. Current Status and Challenges of the Garment Sector: A Comparison ofVietnam, Bangladesh and Ethiopia ················································· 151
6-1. Introduction ················································································ 151
6-2. The time factor ············································································· 152
6-3. Key players and business associations ················································· 154
6-4. Securing markets ·········································································· 157
6-5. Vertical integration of the firm ·························································· 158
6-6. Domestic value creation ·································································· 159
6-7. Participation in the global value chain ················································· 163
6-8. Wage, labor, productivity and labor quality ··········································· 165
6-9. Ethical correctness vs. product quality ················································· 168
6-10. Policy support ············································································ 170
6-11. Impact of the COVID pandemic ······················································· 172
6-12. Concluding remarks ····································································· 174
Annex: Profiles of Surveyed Garment Firms ··············································· 176

ii

Chapter 7. Pursuit of Product Quality and Ethical Correctness in Developing theGarment Industry ······································································ 179
7-1. Introduction ················································································ 179
7-2. Economic and social upgrading in the garment GVC ································ 180
7-3. Standards and regulations for quality and sustainable GVC ························ 183
7-4. International development cooperation················································· 188
7-5. Comparison of five garment exporting countries: an overview····················· 190
7-6. Bangladesh ················································································· 192
7-7. Vietnam ····················································································· 196
7-8. Ethiopia ····················································································· 198
7-9. Sri Lanka ···················································································· 200
7-10. Myanmar ·················································································· 201
7-11. Three implications for latecomer garment producers ······························· 202
Chapter 8. FDI Strategy in the Age of Industry 4.0 and Post COVID-19 ················· 207
8-1. Introduction ················································································ 207
8-2. Evolution of Industry 4.0 in the world ················································· 208
8-3. Paradigm change in the post-COVID-19 era ·········································· 212
8-4. Impact of Industry 4.0 and COVID-19 on FDI and possible FDI strategy ········ 214
8-5. Industry 4.0/COVID-19 and FDI in the context of Ethiopia ························ 218
8-6. Conclusions and the way forward ······················································· 220
References······························································································· 223

iii

List of Tables

Table 1-1. FDI Minimum Capital Requirements in Ethiopia ······································· 20
Table 1-2. Sectors Prohibited or Restricted for Foreign Investment in Regulation
No. 474/2020 ················································································· 22
Table 1-3. Summary of the Present Investment Incentives in Ethiopia ··························· 24
Table 1-4. FDI Projects by Sector and Status (1992-2020) ········································· 35
Table 1-5. Top 20 Countries of Origin for Operational FDI Projects (1992-2020) ············· 37
Table 1-6. Public and Private Industrial Parks in Ethiopia ········································· 38
Table 1-7. Investment Cost and Source of Fund of Public Industrial Parks ······················ 39
Table 2-1. Compelling versus Non-essential Advantages for FDI Attraction ···················· 52
Table 2-2. Policy Instruments for FDI Attraction ···················································· 57
Table 4-1. Sector Composition and Export Orientation of Sampled Firms ·····················115
Table 4-2. Import Dependence and Technology Transfer ··········································116
Table 4-3. Perceptions of FDI and Local Firms Regarding Technology Transfer andSpillovers ····················································································118
Table 6-1. Vietnam: Number of Textile and Garment Establishments by Ownership Type · 155
Table 6-2. Vietnam: Participation in Global Value Chains ······································· 164
Table 7-1. Social Standards that Regulate GVCs in Developing Countries ···················· 187
Table 7-2. Key Indicators of Garment Industry in Selected Countries·························· 191
Table 8-1. High-level Classification of New Industrial Revolution Technologies ············ 215

iv

List of Figures

Figure 1-1. Top Destinations of FDI in Eastern Africa ........................................................... 33
Figure 1-2. FDI Stock and Percentage of Gross Fixed Capital Formation ............................. 33
Figure 1-3. Number of Projects by Status and Employment Created by Operational
Projects ................................................................................................................. 34
Figure 1-4. Industrial Park Export Share in 2020/21 .............................................................. 40
Figure 2-1. FDI Inflow versus Doing Business Score ............................................................ 55
Figure 2-2. Stages of Catching-up Industrialization: the East Asian Pattern .......................... 61
Figure 2-3. The Smile Curve and Manufacturing++ ............................................................... 62
Figure 2-4. Thailand: Incentivizing Value-adding Activities and Merits ................................ 68
Figure 2-5. Dual Economic Structure ..................................................................................... 69
Figure 2-6. Three-part Strategy for Ethiopia ........................................................................... 70
Figure 3-1. FDI as a Percentage of GDP in Selected Asian Countries ................................... 86
Figure 3-2. Export as a Percentage of GDP in Selected Asian Countries ............................... 87
Figure 3-3. Ethiopia: Trends in FDI and the Balance of Payments (Million USD) .............. 96
Figure 3-4. Ethiopia: Imports and Exports (Excluding Services) (Million USD) .................. 97
Figure 3-5. Ethiopia: Current and Capital Account Balances (Million USD) ........................ 98
Figure 4-1. FDI inflow in Selected Asian Countries ............................................................. 110
Figure 6-1. Value Chain and Business Models of the Garment Industry .............................. 160
Figure 6-2. The Smile Curve and Manufacturing ++ ............................................................ 161
Figure 6-3. Export Value Structure of Vietnam and Bangladesh (Preliminary) .................... 164
Figure 7-1. The Curve of Value-Added Stages in the Apparel GVC .................................... 182
Figure 8-1. Technology Associated with Industry 4.0........................................................... 209
Figure 8-2. National Industrial Policies Inspired by Industry 4.0 in Southeast Asia
(Thailand, Indonesia and Malaysia) ................................................................... 210
Figure 8-3. Mode of Measures for Targets for Investment Promotion during and after
COVID-19 .......................................................................................................... 217
Figure 8-4. FDI Industrial Sector Identification during and after COVID-19 ...................... 218
Figure 8-5. Manufacturing Sub Sector Prioritization for the Coming 10 years .................... 219v

Abbreviations and Acronyms

4IR
AACCSAAATCC
ADB
AfCFTAAGOA
AIFourth Industrial Revolution
Addis Ababa Chamber of Commerce and Sectoral Association
American Association of Textile Chemists and Colorists
Asian Development Bank
African Continental Free Trade Agreement
African Growth and Opportunity Act
Artificial Intelligence

AIP
AKI

Apparel Industry Partnership
Africa Kaizen Initiative

AOTS

Association for Overseas Technical Cooperation and Sustainable Partnership

APO
AQL
AR
ASEAN
ASTM
AUDANEPAD
BCI
BCP
BDS
BGMEA
BIDS
BKMEA
BKPM
BoI (BOI)
BOP

Asian Productivity Organization
Acceptance Quality Limit
Augmented Reality
Association of Southeast Asian Nations
American Society for Testing and Materials
Africa Union Development Agency of New Partnership for Africa’s
Development
Better Cotton Initiative
Business Continuity Planning
Business Development Services
Bangladesh Garment Manufacturers and Exporters Association
Bangladesh Institute of Development Studies
Bangladesh Knitwear Manufacturers and Exporters Association
Badan Koordinasi Penanaman Modal (Indonesian Investment Coordinating
Board)
Board of Investment
Balance of Payment

BSCI
BUILD
CCC
CEOs
CM
CMP

Business Social Compliance Initiative
BOI Unit for Industrial Linkage Development
Clean Clothes Campaign
Chief Executive Officers
Cut-MakeCut-Make-Pack/Cut-Make-Package (Myanmar)

vi

CMT
COMESA
CPS
CSOs
CSR
DBE
DCED
DFID
DX
E&E
EAC

Cut-Make-Trim
Common Market for Eastern and Southern Africa
Cyber Physical System
Civil Society Organizations
Corporate Social Responsibility
Development Bank of Ethiopia
Donor Committee for Enterprise Development
Department for International Development
Digital Transformation
Electrical and Electronics (Electronics and Electrical)
East African Community

EBA
ECOWAS

Everything but Arms
Economic Community of West African States

EEP
EEU
EIC
EIPP
EIZ
EKI
EPRDF
EPZs

Ethiopian Electric Power
Ethiopian Electric Utility
Ethiopian Investment Commission
Ethiopia Industrial Promotion Project
Eastern Industrial Zone
Ethiopian Kaizen InstituteEthiopian People’s Revolutionary Democratic Front
Export Processing Zones

ESG
ETGAMAETIETIDIETUF/TCL
EU
FDI
FIC
FLA
FOB

Environment, Social, GovernanceEthiopian Textile and Garment Manufacturers’ Association
Ethical Trading Initiative
Ethiopian Textile Industry Development InstituteEuropean Trade Union Federation of Textiles, Clothing and Leather
European Union
Foreign Direct Investment
Foreign Investment Committee
Fair Labor Association
Free on Board

FTA
GATT
GC91
GDF
GDP

Free Trade Agreement
General Agreement on Tariffs and Trade
General Corporation 91
GRIPS Development Forum
Gross Domestic Product

vii

GIZ

German Corporation for International Cooperation(Deutsche Gesellschaft für Internationale Zusammenarbeit)

GM
GNP
GOTS
GRIPS
GSCP
GSO
GSP
GSP

General Motors
Gross National Product
Global Organic Textile Standard
National Graduate Institute for Policy Studies
Global Social Compliance Programme
General Statistics Office
Global Supplier Program (Chapter 4)Generalized System of Preferences (Chapter 6/7)

GTP
GTW
GTZ
GVCs
HGER
ICS
ICT
IDI
IDS
IE

Growth and Transformation Plan
Green to Wear
German Technical Cooperation Agency(Deutsche Gesellschaft für Technische Zusammenarbeit)
Global Value Chains
Homegrown Economic Reform
Initiative for Compliance and Sustainability
Information and Communication Technology
ICT Development Index
Industrial Development Strategy
Industrial Engineering

IFC
IGR
ILO
ILP
IMF
IoT
IPAs
IPDC
IPRs
ISO

International Finance Corporation
Intergovernmental Relations?
International Labour Organization
Industrial Linkage Program
International Monetary FundInternet of Things
Investment Promotion Agencies
Industrial Parks Development Corporation of Ethiopia
Intellectual property rights
International Organization for Standardization

JAAFSL
JETRO
JICA
JIS
JV
KPIs

Joint Apparel Association Forum Sri Lanka
Japan External Trade Organization
Japan International Cooperation Agency
Japanese Industrial Standards
Joint Venture
Key Performance Indicators

viii

LDC
LEED
LEFASO
LIBOR
M&A
M&E
METI
MFA
MGMA
MIDA
MIDROC

Least Development Countries
Leadership in Energy and Environmental Design
Vietnam Leather and Footwear Association
London Interbank Offered Rate
Merger and Acquisition
Monitoring and evaluation
Ministry of Economy, Trade and Industry
Multi Fiber Agreement
Myanmar Garment Manufacturers Association
Malaysian Investment Development Authority
Mohammed International Development Research and Organization

MInT

Companies
Ministry of Innovation and Technology

MJTD
MNC
MOI
MoTI
MRSL
NAP
NBE
NGOs

Myanmar Japan Thilawa Development Limited
Multinational Corporation
Ministry of Industry
Ministry of Trade and Industry
Manufacturing Restricted Substances List
National Action Plans on Business and Human Rights
National Bank of Ethiopia
Non-governmental Organizations

NPOs
OBM
OCS
ODA
ODM
OECD
OEM
OJT
OSS
OSSC

Non-profit Organizations
Original Brand Manufacturing
Organic Content Standard
Official Development AssistanceOriginal Design Manufacturing
Organisation for Economic Co-operation and Development
Original Equipment Manufacturing
On-the-job Training
One-stop Services
One-Stop Service Center

PAPA
PDC
PIC
PIT
POC
PPE

Pan-African Productivity Association
Planning and Development Commission of Ethiopia
Productivity Improvement Cell
Personal Income Tax
Proof of Concept
Personal Protective Equipment

ix

PPPs
PSD
PSI
QCC
QCD
QCs
R&D
RCEP
REACH
REX
RMG

Public-Private Partnerships
Private Sector Development
Policy Studies InstituteQuality Control Circle
Quality, Cost reduction, on-time Delivery
Quality Controllers
Research and Development
Regional Comprehensive Economic Partnership Agreement
Registration, Evaluation, Authorisation and Restriction of Chemicals
Registered Exporter
Ready-made Garment

RSC
RSL

RMG Sustainability Council
Restricted Substances List

RTM
SAAS
SAC
SADC
SAI
SDGs
SEDEX
SEIP

Recyclable Textile Management
Social Accountability Accreditation Services
Sustainable Apparel Coalition
Southern African Development Community
Social Accountability International
Sustainable Development Goals
Supplier Ethical Data Exchange
Skills for Employment Investment Program

SEZ
SLITA
SMEs
SMETA
SNNPR
SOEs
SQC
STEP
TFP
TIN

Special Economic Zone
Sri Lanka Institute of Textile and Apparel
Small- and Medium-Enterprises
SEDEX members Ethical Trade Audit
Southern Nations and Nationalities, and People’s Region
State-owned enterprises
Statistical Quality Control
Skills and Training Enhancement Project
Total Factor Productivity
Tax Identification Number

TPP
TPS
TQM
TVET
UAE
UK

Trans-Pacific Partnership Agreement
Toyota Production System
Total Quality Management
Technical and Vocational Education and Training
United Arab Emirates
United Kingdomx

UN
UNCTAD
UNIDO
US
USGBC
VAT
VDF
VDP
Vinatex
VITAS
VJJI

United Nations
United Nations Conference on Trade and Development
United Nations Industrial Development Organization
United States
US Green Building Council
Value Added Tax
Vietnam Development Forum
Vender Development Program
Vietnam National Textile and Garment Group
Vietnam Textile and Apparel Association
Vietnam-Japan Joint Initiative to Improve Business Environment with aVR

View to Strengthen Vietnam’s Competitiveness
Virtual Reality

WDI
WRAP
WRC
WTO
YPDP
ZDHC
ZLD

World Development Indicators
Worldwide Responsible Accredited Production
Worker Rights Consortium
World Trade Organization
Young Professional Development Programme
Zero Discharge of Hazardous Chemicals
Zero Liquid DischargexiForeword and Acknowledgments

Since 2008, the GRIPS Development Forum (GDF) and the Japan International
Cooperation Agency (JICA) have conducted bilateral industrial policy dialogue
with the Ethiopian government. The present report is one of its research outputs
prepared jointly by the Policy Studies Institute (PSI), the policy research
institute of the Ethiopian government, and GDF. It is the second such joint work
between PSI and GDF following the Ethiopia Productivity Report of 2020. The
two research institutes share the responsibility for analyses and policy proposals
contained in this report as well as its writing, editing, publication and financing.
The authors greatly appreciate the substantive participation and funding of JICA
in producing this report. Dr. Le Ha Thanh of the Vietnam Development Forum,
Dr. Monzur Hossain of the Bangladesh Institute of Development Studies andtheir colleagues conducted valuable surveys in their respective countries thatallowed us to compare garment industry performance across Vietnam,
Bangladesh and Ethiopia. Their findings enriched two chapters of this report for
which we are very grateful. We would also like to thank officials and researchersat the Ethiopian Investment Commission, the Ministry of Trade and Industry, thePlanning and Development Commission (listed by names before October 2021)
and other organizations who were kind enough to hear and comment on our early
results. Ms. Mieko Iizuka provided excellent editorial and administrative
support as always. We also acknowledge with gratitude the excellent literature
review by Dr. Selamawit G/Egziabher and competent support for the Ethiopian
firm survey by Dr. Mebrahtu L. Teklehaimanot and Mr. Yirgalem Nigussie.
There is another shorter paper, FDI Policy for Enhanced Value Creation in
Ethiopia: Situation Analysis and Policy Proposals (GDF, October 2021) as acompanion volume to this report with overlapping contents but also withadditional perspectives. Interested readers are invited to consult it as well. We
hope our research will be useful to the Ethiopian government in upgrading FDI
and other related policies.

xiii

About the Authors

Mulu Gebreeyesus (PhD) is a Lead Researcher at the Policy Studies Institute. He has fifteen
years of international experience in post-doctoral research at the United Nations University(UNU-MERIT), Maastricht, and elsewhere and has published widely in the field ofdevelopment economics and actively engaged in policy-oriented research. Gebreeyesus
holds a PhD in Economics from the Department of Economics, University of Gothenburg,
Sweden in 2006.
Kiflu Gedefe Molla (PhD) is a Lead Researcher at the Policy Studies Institute, Ethiopia. His
main areas of research include international trade, international macroeconomics andtaxation. He is currently the coordinator of the Trade Policy Research Center (TPRC) at PSI.
Kiflu holds a Ph.D. in Economics from Stockholm University in 2017.
Kenichi Ohno is a professor at the National Graduate Institute for Policy Studies. He received
a PhD in Economics from Stanford University, California, in 1987. He was at theInternational Monetary Fund, Tsukuba University and Saitama University before taking up
his current position. He specializes in comparative research on industrial strategies in Asia
and Africa. He conducts policy dialogue with Ethiopia and Vietnam. His recent books
include Learning to Industrialize (2013), The History of Japanese Economic Development(2018) and How Nations Learn (2019, co-edited with Arkebe Oqubay).
Izumi Ohno is a professor at the National Graduate Institute for Policy Studies. She specializes
in international development policy, industrial development cooperation, and business anddevelopment. Prior to joining GRIPS in 2002, she worked at the Japan International
Cooperation Agency (JICA), the World Bank, and the Japan Bank for International
Cooperation (JBIC). She served as Director of the JICA Ogata Sadako Research Institute for
Peace and Development during 2018-2020. She holds an MPA from the Princeton School of
Public and International Affairs (SPIA) of Princeton University.
Sayoko Uesu is a Research Associate of the National Graduate Institute for Policy Studies. She
specializes in the political economy of Suh-Saharan Africa, especially francophone countries
in West Africa. She previously worked at the Japan International Cooperation Agency (JICA)
and Japan’s Ministry of Foreign Affairs (MoFA), and in several postings in France as anadvisor for African issues.

xivToru Homma is a Senior Advisor on Private Sector Development of the Japan International
Cooperation Agency (JICA). He holds an MSc in Industrial Strategy and Trade Policy fromthe University of Manchester. He served as JICA Investment Promotion Advisor in Myanmar(2014-2017), JICA Africa Regional Investment Advisor in Kenya (2009), OECD Investment
Policy Analyst for Africa in Paris (2006-2009), JICA Project Formulation Advisor inIndonesia (2003-2006), JICA SME expert in the Ministry of Industry of Indonesia (19992002), and other assignments on private sector development, particularly industrial
development and investment promotion, mainly in Asia and Africa.

xv

A Compact Summary of Policy Recommendations
For the convenience of those who are very busy, six key policy recommendations in the firsthalf of this book are concisely presented below. The list is neither comprehensive nor detailed.
Readers are encouraged to go to the relevant chapters and sections for more analysis, ideas andinstructions.
1. A comprehensive FDI policy document
A new ground-breaking document should be created for renovating Ethiopia’s FDI
policy. It should clearly state policy philosophy, long-term objectives, issues and areas
to be improved, envisaged stages and concrete action plans. The content and structureof this document need not be bound by those of past national development plans,
sectoral plans or investment proclamations. Additional policy learning and inputs fromexperienced foreign advisors should be useful. [Section 1-5; also 1-2 and 4-6]
2. A shift from administrative to proactive FDI policy
The main weight of FDI policy should shift from administrative provisions such as
definitions, procedures, obligations and permitted sectors to more substantive
promotional issues such as policy goals, targeted sectors, incentives associated withperformance criteria, official support and public-private cooperation. Among these,
policy goals should include not just export and job creation but also domestic value
addition, local procurement, FDI-local firm linkage, the transfer of technology andmanagement know-how and meaningful participation in global value chains. Problems
related to macroeconomic instability and poor investment climate should be rectified
as a precondition for this policy transition. [Sections 2-6, 3-3 and 4-6; also 1-5, 3-4, 42]
3. Inviting high-tech FDI along with large labor-intensive exporters
Ethiopia should invite high-tech FDI along with large labor-intensive lightmanufacturing operations. Both are needed, for boosting the country’s technology
level and creating more industrial jobs. High-tech FDI firms are smaller and morevaried in their human and physical needs than light manufacturing, and policy shouldhear and cater to their diverse requirements. The minimum capital requirement for FDI
should be amended and eased. The transition from light manufacturing to high-tech
FDI should be steady but gradual because Ethiopia still needs many jobs to be created.
[Sections 2-6 and 2-8; also 4-6]

1

4. A three-part strategy to enhance domestic capacity and generate FDI-local linkage
To maximize the benefits of FDI and avoid the creation of foreign enclaves, a threepart strategy is essential: (i) strengthening domestic firms and labor so they are capableof working with and learning from FDI, (ii) proper FDI selection and attraction, and(iii) the creation of FDI-local firm linkage. Each is a formidable policy task demanding
serious learning and extensive preparation. Domestic capacity must be raised first to acertain level before FDI-local linkage occurs, not vice versa. [Section 2-7]
5. Industrial park management reform
Ethiopia’s industrial park management should be reformed and further upgraded in thefollowing six aspects: (i) revenue diversification; (ii) strategic provision of facilities
and services based on cost-benefit analysis; (iii) customer-oriented investor services
and park operation; (iv) protection against expectable negative shocks; (v) invitationof FDI from all sectors; and (vi) diverse land and shed choices including small ones.
[Section 2-8; also 1-3, 1-5 and 3-3]
6. Policy capacity building
To effectively execute the policy agenda above, Ethiopia needs clear performance
criteria and the enhanced capacity of industrial officials to conduct and monitor eachpolicy. Policy capacity building should be a separate policy target in itself. Besides
normal visits, training and consultation, Ethiopia’s policy learning should be
reinforced by more active use of policy benchmarking and mobilization of foreign
experts with deep ground knowledge and excellent achievements, especially in theearly stages of each policy. [Section 1-2]

2

Overview and Summary

Ethiopia’s policy learning and growth records were exemplary in the last two decades withactive industrial promotion measures on the ground, an increased inflow of FDI and continued
high growth. Notwithstanding these achievements, structural transformation fell far short of
expectation or plan targets. The weight of output or export hardly shifted from traditional
agriculture and services to industry. Manufacturing remains stagnant in volume, quality andproductivity despite great policy effort expended. More recently, such unfavorable incidents aspolitical instability and the COVID pandemic reduced Ethiopia’s growth momentum andworsened macroeconomic imbalances. The slowdown is experienced even before the nation
reaches middle income unlike many high-performing latecomer economies in the past where
fast growth did not stop until high income was attained. Ethiopia’s policy regime needs
revamping in light of these circumstances.
The Ethiopian economy is currently facing a difficult time. Despite this—or precisely
because of this—a long-term perspective for future development must be established along withshort-term crisis management. One of the pillars of national development strategy is how FDI
should be attracted and mobilized for the nation’s economic development. This report studies
this aspect of Ethiopia’s development strategy featuring literature review, theoretical analyses,
firm surveys and policy considerations with a strong accent on international comparison andglobal lessons. Many perspectives and arguments in this report are grounded on the pastdevelopmental experiences of Japan and Asia, PSI’s existing studies, the three phases of
Ethiopia-Japan Industrial Policy Dialogue since 2009, and JICA’s industrial cooperation in
Ethiopia.
Readers should be warned in advance that some topics are repeated across chapters. They
include the need for selectivity in FDI attraction and how to guide FDI toward desirable actions
such as export, domestic value addition, local procurement, technology transfer, FDI-local firmlinkage, and so on. These issues reiterate because they are vital in designing FDI policy reforms
regardless of the particular subtopics at hand. Whether these actions should be imposed on FDI
as an entry requirement or encouraged through privileges and incentives while leaving the final
decision to FDI firms is a recurring theme in this report. Chapters sometimes give different
analyses and recommendations depending on the author. This may give the book an impressionof slight inconsistency but it must be noted that the issues are not only crucial but also multifaceted and complex. The authors discussed these issues before finalizing the manuscripts andagreed on many points but different nuances and emphasis remain. We believe it is better to leteach reader arrive at his or her conclusion rather than present a simple unvarying policy solution3

to all problems.
The report consists of eight chapters. Each of the two consecutive chapters roughly forms
an issue group with a total of four groups. Chapters 1 and 2 review Ethiopia’s past and current
policy stance, compare it with international practices and offer general recommendations on
how Ethiopian FDI policy should be upgraded. Chapters 3 and 4 delve into the impact of FDI
on the nation’s balance of payments and the transfer of technology and management know-how.
Chapters 5 and 6 report the findings of our Ethiopian firm survey in four selected manufacturingsub-sectors as well as comparative surveys of garment industry performance in Vietnam,
Bangladesh and Ethiopia. Chapters 7 and 8 explore two additional issues relevant to Ethiopia’s
FDI policy, namely, the dual requirement of high quality and ethical correctness in lightmanufacturing imposed by foreign buyers and the influence of Industry 4.0 and the COVID
pandemic on latecomer economies such as Ethiopia.
The rest of this overview chapter presents the policy highlights extracted from these four
issue groups.
FDI policy: current status and future directions (mainly ch.1&2)
A historical review of Ethiopia’s FDI policy confirms that this policy has steadily improved andbecome more open and favorable to FDI. This was achieved by repeated revisions of Investment
Proclamations and accompanying Regulations that gave details of each Proclamation. In
particular, restrictions on FDI entry have been eased in steps so there remain few significant
barriers for FDI as far as sectors permitted for FDI activities are concerned. However, the same
review also finds some important shortcomings in the current FDI policy.
First, FDI policy goals are not clearly defined. The role FDI firms should play in national
economic development is also not spelled out plainly. This is a consequence of the current
policy process where FDI policy is formed cumulatively and additionally by many adjustments
without a clear statement of where they are leading to. The minor-repair approach is appropriate
if the nation’s FDI policy is already high-quality, mature and stable, as in the case of Taiwan’s
industrial policy which is defined by a law that lasts for a few decades. But in developing
countries in the process of rapid economic changes and intensive policy learning, policies stillcontain many areas that need to be improved. In such a case, an explicit statement of long-term
policy goals is highly desirable and necessary even though the current policy is less perfect andconstantly evolving1. This assures investors who come to Ethiopia for long-term engagement
The Industrial Development Strategy of 2003 was clearer about the role of FDI vis-à-vis domestic investment. It regarded
domestic investors as the main irreplaceable driver of industrialization but also highlighted the critical role of FDI in bridging
the shortage of capital, technology, marketing knowledge and managerial experience that domestic firms severely lacked. Eachsector was thus given a different but equally important function (Chapter 1). Now that the volume of FDI has greatly increased
since then, a more concrete statement on what is expected of FDI is needed.
14

rather than for short-term speculative operations. For this, a new FDI policy document (astrategy, a master plan or others by any name) is needed that clarifies policy goals and explains
how they should be attained in concrete steps and policy actions, rather than another revisionof the present Proclamation and Regulation.
Second, the current FDI policy is more administrative than promotive. It is passive rather
than proactive. The policy is heavy on procedure and approval but quite weak in attracting highquality foreign firms to Ethiopia and incentivizing them to do the right things such as domestic
value addition, exports and technology transfer. Take technology transfer, for example. The
current policy defines how investors should register technology transfer contracts and how
these contracts are officially classified, but says little about the nation’s aspiration to absorb
technology, the type of technology which is most welcome, or how FDI is incentivized and how
domestic firms are encouraged to teach and learn new technology. It is these latter provisions
that are vital in FDI policy rather than the former instructions which are only nominal andadministrative. As noted earlier, sectors in which FDI is permitted either by itself or throughjoint venture have been expanded. But opening up is only the first step in engaging FDI fordevelopmental purposes. India since 1991 has had an FDI policy similar to Ethiopia where theoverarching concern was which sectors should be opened to FDI in what steps while thepromotion part was largely neglected. By contrast, in Southeast Asia where competition for FDI
attraction is intense, policies have moved decisively from mere sector opening to the positive
creation of industrial strength. Malaysia has transparent criteria for value-creating and scopebroadening investment with simple and clear incentives. Thailand renovated its FDI policy in2015 in which the previous general promotion of manufacturing was replaced by far more
specific activity- and merit-based incentives. Ethiopia should also define its national goal for
FDI policy where the strengthening of labor quality and enterprise capacity should be one of
the core objectives.
Third, Ethiopia’s FDI policy favors large labor-intensive operations, such as garment andfootwear production, that employ many unskilled workers. This is appropriate for a latecomer
country like Ethiopia where job creation is a paramount national goal. But it should alsostrongly welcome bringers of high technology and new product categories from advanced
nations. Such investors are usually smaller and more varied in their requirements on location,building design and supporting services than large apparel makers. They are needed for Ethiopia
to move from simple manufacturing to more sophisticated production in the future. For this,
there are two policy areas that require reconsideration. The first is the minimum capitalrequirement imposed on FDI. This is supposed to protect domestic SMEs from the invasion offoreign SMEs in simple production and services. But most high-tech foreign SMEs do notdirectly compete with domestic firms due to differences in technology or market segments. The
red carpet should be rolled out for such FDI firms rather than rejecting them as being too small.

5

The second is the practice of building large, same-size sheds in state-run industrial parks. They
are fit for labor-intensive operations but high-tech FDI needs smaller and more varied rental
offices and workshops. Such space is widely available with excellent support services atindustrial parks in Thailand, Vietnam, Indonesia, etc. Ethiopia should also offer such rental
choices.
With these background observations, the key argument of this report, presented mainly in
Chapters 1 to 4, is that FDI policy should be more selective and encouraging to those foreign
firms that bring new or additional value to the national economy. This can be restated as amovement from quantity-based FDI to quality-based FDI. Here, value or quality refers to suchactions as the generation of gross or net export, the transfer of technology and management
knowledge, the introduction of products or processes new to Ethiopia, upgrading of workers
and engineers, procurement of domestic inputs and services, and assisting domestic firms toactively participate in global value chains.
There are three important caveats in realizing this policy orientation.
The first is that value creation should not be forced but encouraged by privileges, incentives
and other favors with the final decision made voluntarily by each FDI firm. Whether or not toadopt recommended actions and receive favors should be up to each firm with no penalty
imposed on non-takers other than forgone favors. FDI is a game of double maximization where
foreign firms maximize profit under the policy framework defined by the host government.
Knowing this, the host government must set policy parameters in such a way to induce the best
response of foreign firms from the viewpoint of national welfare. Unlike China, Ethiopia is too
small to bargain effectively with powerful multinational corporations. Government should notdictate foreign firms or they will leave Ethiopia for other host countries with fewer constraints.
All this requires high policy knowledge and skills.
The second is the question of speed and overlapping in policy transition. Ethiopia currently
needs to create many jobs so it must not accept “quality” investors only. It should continue towelcome large firms that hire many workers. Thus the transition from quantity to quality should
be a phased one with much overlapping. Both large investors and smaller high-tech investors
need to be promoted for many years until Ethiopian surplus labor is exhausted (i.e., the “turning
point” is reached in the Lewis dual economy model).
The third is the preparation of performance criteria and policy capacity. Simple, transparent,
not-too-many and easily monitorable performance criteria must be created and pre-announcedfor FDI. The policy must be designed to incentivize the right investors and actions withappropriate amounts of favors (not too much or too little) while avoiding misuse and fraud. The
capacity of executing agencies, especially EIC and MoTI but also other related ministries, IPDC,
revenue and customs authorities and technical institutes to implement policy and monitor
performance must be enhanced. Coordination among these organizations should be6

strengthened.
Industrial parks offering good infrastructure and investor support are important policy
instruments for receiving FDI. Ethiopia’s industrial park management should be improved to
speed up the absorption of value-creating and quality-improving FDI. At the same time,industrial parks are a real estate business with inevitable ups and downs. Ethiopian industrial
parks must generate profits, improve competitiveness and prepare against unfavorable times.
For this purpose, six suggestions are offered: (i) diversify revenue sources; (ii) provide facilities
and services strategically based on cost-benefit analysis; (iii) develop customer orientation in
investor services and park operation; (iv) protect against negative shocks by building slowly;(v) accept FDI from all sectors; and (vi) offer diverse land and shed choices including small
ones (Chapter 2).
The Balance of payments and the transfer of technology and managerial know-how(mainly ch.3&4, also ch.2)
The two positive impacts expected of FDI are an improved balance of payments and accelerated
transfer of technology and advanced management practices to domestic enterprises. However,these favorable effects are neither automatic nor easy to obtain.
A review of existing literature and international experiences indicates that the impact of FDI
on the balance of payments is ambiguous theoretically and empirically, and much depends onthe country and the specific sector under study. Ethiopia’s balance-of-payments and current
account data in recent years exhibit no apparent correlation with FDI inflow, which corroborates
this ambiguity.
FDI inflow to Ethiopia increased strongly during 2013-2017, peaking at $4.17 billion or
5.8% of GDP in 2016/2017, followed by a decline. FDI was expected to ease the balance-ofpayments pressure by initially injecting additional capital and generating net export thereafter.
During the same period, however, the balance of payments fluctuated between -$1 billion to+$1 billion, or slightly over this range, accompanied by weak export and mounting debt stock.
In any year, the import was several times larger than export. Import rose dramatically while
export remained stagnant during 2015-2017 when FDI inflow was at its peak.
It is evident that FDI inflow does not improve the balance of payments at least in the shortrun. Possible reasons for this are the initial need to import construction materials and equipment
and a lead time before operation reaches full capacity. But time and full operation may not solve
the problem if FDI projects are heavily dependent on imported inputs with little generation ofdomestic value-added. The net impact on the trade balance is the difference between the
project’s export and import, which may be small in the early development stage when domestic
inputs with acceptable quality and prices are hard to find. However, small domestic value

7

creation should not be used to criticize or degrade foreign investors. It is the responsibility of
the home government and entrepreneurs to strengthen domestic human capital and management
capacity for FDI to build backward linkage. It usually takes decades rather than years before avisible result is obtained. Vietnam began to receive FDI in the early 1990s but the country
continued to register trade deficits until the balance finally turned to a persistent surplus in 2012.
It should be stressed that the preceding argument applies equally to exporters and importsubstitutors (firms selling in the domestic market). Exporters contribute little to the net foreignexchange earning if they do not make effort to reduce imported inputs. Meanwhile, importsubstituting firms generate net foreign currency if their activities diminish the need to importsimilar products. The net balance, which is usually small initially, should be examined for any
industry or firm. The Ethiopian government has strongly incentivized exporters but paid lessattention to import substitutors, but such a policy is difficult to sustain as exporters and importsubstitutors are theoretically the same in their contribution to the balance of payments.
Turning to technology transfer, Ethiopia’s past and present investment proclamations andregulations generally lack a clear strategy and effective incentives for promoting technology
transfer unlike such successful countries as China, Singapore and Malaysia. Similarly, Ethiopia
has no distinct policy to stimulate FDI-local firm linkage or joint ventures. Empirical studies
show that, not surprisingly, technology transfer and the learning of global managerial practices
are presently very limited in Ethiopia. Besides the policy problem already mentioned,
challenges include the fact that most FDI firms in Ethiopia are market- and resource-seeking
and need only unskilled cheap labor; limited local capacity; macroeconomic instability; andpolitical instability.
Since many industries currently import almost all materials and components they use, there
is little room for domestic supply linkages. Even in sectors that use domestic raw materials suchas leather and brewery industries, the lack of quality, sufficient and stable supply, reasonable
price and timely delivery are the main constraints for the development of local suppliers.
Among firms competing in the same sectors, our survey finds ambiguity about the learning ofdomestic firms from FDI competitors. FDI firms say locals do not learn but domestic firms
themselves assert to the contrary. About two-thirds of them even complain that foreign firms
prevent technology transfer from occurring. However, one exception is the beer industry where
domestic competition is severe and local firms must upgrade technology in order to survive the
new competition from FDI (Chapter 5).
FDI’s contribution to the transfer of technology and advanced management practice does
not arise naturally. Domestic conditions must first be created by appropriate policy and private
sector readiness before such transfer is effectively realized. Technology transfer occurs throughsuch channels as the demonstration effect, labor migration, increased competition within thesame sector (horizontal linkages), and backward and forward purchase linkages among different8processes (vertical linkages). Joint ventures between foreign and domestic partners also provide
a potential means for technology transfer. To promote these, there are many required domestic
conditions. They include a coherent and predictable policy framework, the capacity building of
local firms, effective export promotion, an ample supply of competent workers and engineers,
basic infrastructure services, a favorable business climate and political stability, among otherthings. The list varies depending on the country, sector and even researcher.
Among these, the existence of domestic labor and enterprises with sufficient capacity isparticularly crucial. Without this, there will be no absorber of advanced technology even if FDI
is willing to teach. A three-part strategy is proposed for countries receiving a large inflow of
FDI in general and for Ethiopia in particular (Chapter 2). The first part consists of domestic
capacity building by applying many policy instruments practiced in successful latecomer
countries. The second part is a selective attraction of value-creating and technology-bringing
FDI by proper policy design and incentive schemes. The third part is linkage formation between
the two which can be promoted by either direct official support or indirect subsidization ofeligible activities conducted by FDI or domestic firms. The content of the three-part strategy is
wide-ranging, complex and demanding. Details of each part must also be tuned to fit the uniquereality of Ethiopia.
The recurrent question of whether technology transfer should be mandatory or voluntary
for FDI comes up again, and our stance is that it should basically be up to each FDI firm to
conduct technology transfer or improvement of local partners under the given policy framework.
For this to work, the policy framework must be attractive enough for profit-driven FDI towillingly engage in such transfer. Ethiopia’s FDI policy does not yet address this issue properly,
let alone successfully induce technology transfer from FDI. Policy improvement in this area isurgently required instead of forcing FDI to transfer technology as a condition of entry into the
Ethiopian market. Similar principles apply to other “desirable” actions by FDI including joint
venture formation with a local partner, procurement of domestic materials and inputs, anddivestiture of foreign control after a certain lapse of time.
It may be added that joint ventures between foreign and domestic firms can acceleratetechnology transfer only if both sides are happy with the marriage. But this is not always thecase due to different business cultures, conflict in interest or non-emergence of expected
benefits. This fact must be taken into account when joint ventures are promoted. Our firm
survey in Ethiopia, reported just below, reveals both similarities and differences between FDI
and domestic firms. Differences may lead to the learning of global management practices bydomestic firms but they may also cause difficulty in cooperation between the two parties. Someforeign firms, especially those designated for export, are interested in joint ventures to accessthe domestic market through local partners, not for mutual upgrading through technology
transfer.

9In sum, Ethiopia needs a comprehensive FDI policy that amends the current shortcomings.
Encouragement should be given conditionally with proper incentives to technology transfer,local procurement, forward and backward linkage, joint ventures and other forms of knowledgetransfer. Domestic firms should be provided with sufficient information about foreign firms andmarkets and available government support programs. A host country must also invest in humancapital so the nation can smoothly learn and utilize foreign technology. In Ethiopia, a goodbusiness environment, basic infrastructures such as power and transport, macroeconomic
stability, policy predictability and political stability must additionally be assured to all investors.
Survey findings from Ethiopia, Vietnam and Bangladesh (ch.5&6)
A firm survey was conducted in Ethiopia to study the management style of FDI and local firms
in the garment, food processing, automotive and leather sectors. Additionally, two firm surveys
focusing on the garment sector were commissioned in Vietnam and Bangladesh, the two leading
apparel exporting countries, for comparison with the Ethiopian garment industry. These surveys
were conducted from November 2020 to January 2021 with a sample size of about 30 firms ineach country. Most questions were related to corporate strategy and management practices but
some were directed to the consequence of the COVID pandemic. Most firms were visited but
some were interviewed online (some results were already reported in the previous section).
Our Ethiopian survey finds both similarities and differences between FDI and local firms.
Incentive structures and promotion criteria for workers—performance, ability, loyalty, family
connection, etc.—are largely the same among all firms regardless of nationality. Basic training
is given to newly hired workers in all establishments. Meanwhile, well-articulated corporate
visions, missions, values and slogans are common among foreign firms but not so among local
ones. In internal communication, local firms mostly rely on formal meetings while foreign firms
use many channels including informal ones. FDI firms inculcate teamwork and organize social
events to motivate workers, but such practices are largely missing in local firms.
A comparison of garment firms in Vietnam, Bangladesh and Ethiopia reveals further
commonalities and differences. It should first be recognized that Vietnam and Bangladesh are
well-established global suppliers of apparel while Ethiopia is a newcomer. The former two boast
an annual apparel export of $30-40 billion each while Ethiopia’s export is still tiny at $143
million (UNCTAD data for 2019). Several thousand garment firms operate in Vietnam and
Bangladesh while Ethiopia has less than 200. But such size differences are natural andexpectable given the different stages of development. For all the three countries, the EU andthe US are the main export markets with Bangladesh and Ethiopia depending heavily on the
EU market while Vietnam leans more toward the US market.
In Bangladesh, garment production is the country’s principal industrial activity accounting

10

for over 80% of total export. Local firms dominate the industry (98% in number). Industry
associations are powerful and play crucial roles in developing the sector and overcoming
challenges. The government also supports garment firms effectively. Meanwhile, in Vietnam,
garment constitutes only 5.4% of total export. Local and FDI firms coexist. Vietnam is amember of many regional and bilateral trade and investment agreements which gives it anenormous advantage in securing overseas markets. In comparison with these two countries,
Ethiopia’s achievements are still limited. Garment export is dominated by FDI firms, industry
associations are relatively weak, and the country does not have WTO membership or effective
trade agreements with its major markets (except trade privileges such as EBA and AGOA).
Labor quality and productivity is not a major problem in Vietnam or Bangladesh. Monthly
wages are $344 in Vietnam and $154 in Bangladesh compared with less than $100 in Ethiopia(2020 data including bonuses, overtime and social security) but high labor productivity in theformer two more than compensates this wage gap. In Vietnam, minimum wages are annually
decided for four different regions according to the distance from major cities while Bangladesh
has minimum wage only for garment workers. Vietnam now faces an acute shortage of unskilledlabor fit for garment production, and job creation is no longer a top national goal.
Regarding domestic value creation, Vietnam and Bangladesh have common features. With
the growth of domestic fabric and accessories suppliers, about 60-70% of garment export value
is created domestically in both countries. Despite this, both face similar challenges in securing
meaningful positions in the global value chain. Garment manufacturing is at the bottom of the
Smile Curve, a diagram that shows the amount of value creation along different production
stages. To expand value, they want to expand to upstream processes such as fabric production,
design and R&D. For this, they are moving from CMT (manufacturing using materials provided
by buyers) to OEM (manufacturing using self-procured materials) with Bangladesh moving
faster than Vietnam. But this is only a small step in the upstream direction. On the downstreamside (global marketing) where H&M, GAP, Tommy Hilfiger and others dominate, businessexpansion is almost impossible for Vietnamese and Bangladesh manufacturers. Even for top
garment manufacturers, invasion into advanced retail markets where two-thirds of total apparelvalue is created is difficult.
Both Vietnam and Bangladesh must comply with buyers’ demands as a precondition for theexport contract. Demands are related to quality, price and on-time delivery (product features)
as well as labor rights and welfare and environment-friendliness (ethical compliance). Garment
firms in both countries consider themselves technically competent but often feel burdened withmultiple and often costly demands of this sort (see next section).
In Ethiopia, garment firms also face constraints in value creation, global value chain
participation and buyers’ demands. These are universal challenges in garment production
regardless of nationality or location. But these problems largely belong to FDI firms in Ethiopia

11

as few local firms export regularly to the European or American market.
Our surveys found different impacts of the COVID pandemic across three countries. As oflate 2020 to early 2021, few Vietnamese garment firms suffered damage and some even enjoyedsales growth due to an increased global demand for casual clothing. This may be thanks to thesteady growth of export markets secured by many regional and trade agreements Vietnam has
concluded. In contrast, negative effects were reported by a broad segment of this industry in theother two countries. In Bangladesh, one-third of the respondents saw the export decline by 4080% and most others reported a decline of up to 30%. Half of the firms undertook the productionof face masks and PPE to partly cover the lost sale. In Ethiopia, four FDI firms reported nonegative effect due to long-term export contracts but two faced difficulties leading to labor
discharge and even the risk of bankruptcy. Monthly export from Hawassa Industrial Park, where
FDI garment firms concentrate, declined from the pre-Corona peak of $8 million to less than
$3 million in April 2020 and only recovered partially thereafter. Prohibition of firing workers
during the state of emergency (April-August 2020) was a serious burden to some garment firms.
No surveyed FDI firms reported any benefits from the postponement of tax and social security
payments offered by the government as a rescue measure. Many respondents said that the
shortage of foreign exchange and political instability were greater impediments to garment
operation than the pandemic.
Coping with global trends and requirements (ch.7&8)
Ethiopia must develop its industries under the circumstances and requirements imposed by the
global economy of the twenty-first century. This report takes up two of such external conditions:the dual demand for product quality and ethical correctness and the rapidly advancing digitalsociety. These add new elements to latecomer industrialization compared with the West or East
Asia whose economies developed before these conditions became apparent and dominant.
Global buyers impose product quality. Various upgrading is called for on manufacturers
along the Smile Curve that shows value creation processes along the value chain. This includes
upgrading in products, processes, functions, chains, channels and supply chains. In morepractical language, foreign buyers demand the absence of defects, observance of physicalspecifications, low cost, prompt delivery, and so on. The quality requirement is particularly
strict in the Japanese market. Any irregular but hardly noticeable stitching causes rejection and
one delivery delay or slightly deviant products may terminate the contract. Consumers in theWest may not be so finicky but they still demand reasonable quality by the standard of advanced
markets. For many export products, safety and quality certifications by globally recognizedorganizations are required. To comply, manufacturing firms and countries must invest in
appropriate production technology and equipment, certifications, inspection systems, and the12training of management, engineers and workers.
Buyers also require social accountability and decent conduct. This is especially evident in
the garment industry though it affects other sectors as well. The largest markets of light industry
consumer products such as apparel, footwear and processed food are the EU and the US where
consumers strongly demand that imported goods must be manufactured by ethically correct
processes. All along the supply chain of any product, labor rights and welfare must be duly
protected and environmentally damaging materials and processes should be avoided. “Decent
Work” or “Better Work” is defined, promoted and monitored by many private, national andinternational organizations including ILO, IFC, OECD and the UN Group. Any indication of aviolation of human rights, forced labor, child labor, lack of safety, underpayment or
mistreatment of workers, environmental irresponsibility, etc. may lead to the termination ofcertification and contracts, and purchasing firms dealing with such establishments will be
penalized.
The requirements of product quality and ethical conduct are not negotiable. They arepreconditions for any order destined to major markets without which no business is possible.
One annoying feature, especially of ethical requirements, is the proliferation of many different
but overlapping standards and certifications that are required of producers. For example,
common ethical standards include IndustriALL, SA 8000, ETI, ICS, SMETA and ISO 26000.
Specifically for textile and garment, there are WRAP, GOTS, BCI and SAC (see Chapter 7 forthese acronyms and their contents). Different buyers and markets demand different actions anddocuments which increases the cost of compliance in terms of time, training, document
preparation and capital investment. Our surveys in Ethiopia, Vietnam and Bangladesh confirm
that this is among the most pestering concerns of garment exporters regardless of nationality or
location. How to cope with these mounting demands of both types is the crucial question forgarment producers in developing countries with limited human and financial resources,
including Ethiopia.
Our surveys also find that some helping hands are available. Foreign buyers sometimes
assist manufacturers to improve quality or social conduct though most of them just explain therequirements without extending any support. Donor nations may dispatch experts or arrange
training courses so manufacturers in developing countries can start exporting to their markets(especially when a new trade agreement is signed or a new trade preference is offered). Host
governments, if they are capable, also provide the necessary support. But most important
assistance is the one organized by industry associations of the exporting country to overcome
difficulties and develop overseas markets. This is the case in Bangladesh where the two large
textile and garment industry associations, BGMEA and BKMEA, actively support their member
firms and entice government incentives and programs for this purpose. In Vietnam and Ethiopia,
the assistance offered by industry associations is less extensive and effective.

13

Industry 4.0 is spreading, and Ethiopia will be part of this global trend. It encompasses
many elements such as IoT, AI, VR, AR, big data, robotics, 3D printer, cloud computing,blockchain and nanotechnology. How these will affect Ethiopia’s development path is difficult
to ascertain because this is a quickly evolving phenomenon and because effective use of thistechnology requires sufficient knowledge backed by advanced human capital and ample
financial resource. Ethiopia is not equipped with either. Nonetheless, the existence of FDI may
help Ethiopia to benefit from this new trend. The last chapter explores this unknown territory.
Many developing countries incorporate Industrial 4.0 in national development strategies. In
Southeast Asia, there are Thailand 4.0 (announced in 2015), Making Indonesia 4.0 (2018) and
Malaysia’s Industry 4WRD (2018). While these countries clearly recognize the potential
benefits of new technology, these documents are similar to past policies with added reference
to Industry 4.0. It is not clear whether and how the country can accelerate economic
development with such technology or what concrete national conditions are currently available
or required for that purpose. Human resources equipped with the latest digital technology arekeenly wanted but its supply is very limited in many developing countries.
There are also negative concerns such as job loss due to AI and automation and data security
issues. For developing countries, there is a fear of losing job opportunities en masse despite
new developmental possibilities and the rise of startups armed with new technology. To
maximize the benefits and minimize the cost, developing countries must strengthen theirdomestic capacity. Proper education and training for digital skills are indispensable. Japan’s
traditional industrial methods, including kaizen, will not become obsolete by Industry 4.0. The
hands-on approach, teamwork, creativity and problem-solving capacity inculcated by kaizen
will become even more essential in the digital age. But adjustments will be necessary to the
new communication and organizational style. Japan must also become a co-creator of newvalues with developing countries on equal footing rather than a teacher of existing technology
in a unilateral direction.
The COVID pandemic of 2020 wreaked havoc on the world economy in the short run, but
its long-term effects may contain some positive elements for the developing world. They
include an accelerated use of Industry 4.0 just mentioned above, new business opportunities
opened by remote contacts, regional economies activated by localized production andconsumption, and new types of international cooperation to cope with the changing world.
The role of FDI in a new world may be positive or negative for development. The world
has changed significantly, and with it the best allocation of production sites across countries.
New FDI flows may occur and existing FDI firms may consider reallocation. FDI will be a
supplier of new technology to developing countries that are ready to receive it, but it will also
shun countries and firms that are not ready. If AI and robots begin to do complicated tasks which
are now done by workers, labor-intensive processes may altogether disappear from the surface

14

of the earth and factories may relocate to countries where advanced technology and global
management can be performed most effectively. The gap between frontrunners and latecomers
may thus widen. This points to the increased importance of learning and capacity building fordeveloping countries wishing to catch up.
In Ethiopia, elements of Industry 4.0 are captured in the Ten Years Development Plan andthe critical importance of digitalization and ICT is officially recognized. However, concrete
strategies are wanting and linkage between Industry 4.0 and the present manufacturing sector
is not spelled out. Another disadvantage for Ethiopia is the low quality and reliability of
infrastructure services in the telecom and internet sector where liberalization is just beginning.
Meanwhile, new technology begins to be used spontaneously by the private sector to create new
products and services, albeit on a small scale. Kaizen, which Ethiopia has adopted with vigor,
will become an even important tool in the new age because it offers complementary ingredientsto Industry 4.0 such as ownership, positive attitude, teamwork, constant alert and improvement,
and so on, provided that kaizen itself is modified and augmented to fit the new world.

15

Chapter 1
Ethiopia’s FDI Policy Evolution and Performance

1-1. Introduction
Inward Foreign Direct Investment (FDI) can serve as an initial driver of industrialization andstructural transformation in developing countries. It can generate multiple benefits to hostdeveloping countries by way of bridging common deficiencies such as capital and technology
in the local economy. Empirical evidence shows that in countries with appropriate policies, forexample in East and Southeast Asia, FDI has contributed significantly to economic and socialtransformation.
In recognition of this, Ethiopia has made FDI attraction an integral part of its development
policy as early as during the Imperial regime. In the industrial policy of the Imperial regime, as
shown in three consecutive development plans covering 1950-74, FDI was envisaged as themain engine of industrial development and given high priority. As a result, FDI presence washigh, and about 65% of the medium and large-scale manufacturing firms were owned or
operated by foreign nationals by the end of the Imperial regime (Chole 1995).
Promotion of the private sector and particularly foreign investment was interrupted in 1975
with the incoming to power of the Dergue regime. It introduced a socialist and command
economic system and nationalized all privately-owned medium and large-scale manufacturing
enterprises, banks and insurance companies. In 1983, the military government reverted to thepromotion of FDI by introducing joint venture legislation packed with various incentives.
However, this limited and belatedly introduced reform failed to attract FDI to the country.
Growing political instability and insecurity, as well as the poor state of the economy, further
discouraged foreign nationals to invest in the country (Gebreeyesus 2016).
The Ethiopian People’s Revolutionary Democratic Front (EPRDF) government that came
to power in 1991 adopted various liberalization measures including privatization, trade opening,market deregulation, and revision of investment and labor laws. Investment Proclamation No.
15/1992, which opened the door for private investment, was one of the earlier reforms of thetransitional government. The Ethiopian Industrial Development Strategy (IDS) formulated in2003 set the vision of the government on the roles of the local and foreign investors towards
industrialization. The IDS perceived domestic investors as having irreplaceable roles in theeconomy and being the main base for industrial development. But it also highlighted the criticalrole FDI could play in bridging the shortage of capital, technology, marketing knowledge and17managerial experience that domestic firms severely lacked.
Attracting FDI is at the core of Ethiopia’s industrialization strategy, which is supported at
the highest level and in particular by the Prime Minister (Ohno 2013). Ethiopia’s investment
laws have been revised several times to expedite FDI inflow to Ethiopia. More recently, thegovernment of Ethiopia started to promote industrial park development as a key policy tool toattract foreign investment in the manufacturing sector. As a result, Ethiopia has seen a rapid
increase in FDI, making the country one of the top FDI destinations in Africa despite aslowdown in the last couple of years. However, comparing the current level of FDI observed in
Ethiopia with those in successful East Asian countries, it is clear that there is an opportunity tofurther increase FDI and widen economic benefits from its presence.
This chapter aims to examine the evolution of FDI policy and performance in Ethiopia.
However, it will not deal deeply with perceived benefits and achievements of FDI as chapters
3 and 4 specifically analyze, among other things, the impact of FDI on the balance of payments
and technology transfer. This chapter is organized as follows. The next section reviews theevolution of FDI policy and the overall investment framework of the country. Section three
examines the industrial parks development scheme, which has been practiced in the last sevento eight years as one of the key policy instruments to attract investment. Section 1-4 presents
the patterns of FDI inflow by sector, regional distribution, and country of origin, and provides
a comparative analysis with selected countries in Africa. This section also discusses theperformance of industrial parks in terms of investment attraction, employment generation andexport earnings. Descriptive analysis is based on secondary data obtained from the Ethiopian
Investment Commission (EIC) and UNCTAD databases. The last section discusses FDI-related
challenges and a way forward for policymakers.
1-2. Evolution of FDI policy and the investment framework
Ethiopia has so far no unified policy or strategy on FDI but there have been a series ofinvestment proclamations and regulations referring to foreign and national investors. Thissection highlights the history of the FDI policy of the country by reviewing different investment
laws, regulations and incentives introduced in the last 30 years to promote investment.
It is worth noting that the existing FDI investment frameworks including regulations,
incentives and support programs appear to be mainly drawn from the Industrial Development
Strategy (IDS) adopted in 2003. This strategy perceives domestic investors as having an
irreplaceable role in the economy and the main basis for industrial development. But FDI wasenvisaged to play a significant role in bridging the deficiencies of domestic investors regarding
the shortage of capital, technology, networks and knowledge, and enhancing their capacity. The
IDS further states that, to attract FDI, the government should work tirelessly to improve the18investment environment including the legal protection of investors, maintaining peace andstability, infrastructure, human resource development and efficiency in public service delivery.
Even so, FDI entry into some strategic sectors needs to be carefully evaluated, and FDI should
also be restricted from entering into the micro and small enterprises sector in which domestic
investors widely participate and entrepreneurship is nurtured. This seems to have been thedriving view of most of the investment law revisions in Ethiopia as they revolved around sectors
to be opened or restricted for FDI. The opening process has generally been gradual and FDI
participation in several areas, particularly the service sector, has been restrictive.
1-2-1. Investment laws and regulations
Investment Proclamation No.15/1992 was the first investment law to be enacted after the
downfall of the Derg regime. The basics of this particular proclamation were limiting the roleof the state, liberalization of private investment, promoting both exports and resource-based
import substitution industries, the lifting of any capital ceiling, and no legal limitation on theshare of foreign equity participation (Abraham 2001, 215-220).
The proclamation designated some sectors as strategic such as large-scale power generation,
postal services and financial services. Many others were reserved for the government while a
few sectors were opened for joint investment with the Ethiopian government. The proclamation
provided some incentives and guarantee against nationalization and expropriation.
Since then, several investment code revisions were made including Proclamation No
37/1996, Proclamation No.116/1998, Proclamation No. 280/2002, Proclamation No. 769/2012,
Regulation No 270/2012 and Proclamation No. 1180/2020. Most of them further relaxed
restrictions on the private sector and particularly foreign investors, and provided more generous
incentives.
One area of amendment in the subsequent investment rules was regarding the required
minimum capital for FDI. The 1992 proclamation put $300,000 and $100,000 as minimum
capital when investing alone and joint venture with locals, respectively. The minimum required
capital has not changed significantly despite repeated revisions. For example, in the recent 2020
revision, required capital by FDI is $200,000 when investing alone and $150,000 when in ajoint venture with locals (Table 1-1).
Another critical element driving the revisions of the investment laws has been thedesignation of sectors allowed or prohibited for FDI. For example, Amendment Proclamation
No.116/1998 and Regulation No. 36/1998 introduced essential changes to the areas FDI could
invest in. The law opened power generation to the private sector but kept the exclusive right ofsupply and transmission to the government. Joint venture with the government intelecommunications and the defense industry, unlike preceding laws, was also allowed.

19

Table 1-1. FDI Minimum Capital Requirements in Ethiopia
Proclamation

Minimum
capital in USD

Criterion

Proclamation
No. 15/1992

300,000

If investment is made on his/her own.

100,000

Foreign investment in joint investment with domestic investor.

Proclamation
No. 1180/2020

200,000

If investment is made on his/her own.

150,000

Foreign investment in joint investment with domestic investor.

100,000

When investing in architectural or engineering works or related
technical consultancy services, technical testing and analysis orin publishing—on his/her own.

50,000

When investing in architectural or engineering works or related
technical consultancy services, technical testing, and analysis
or in publishing—jointly with a domestic investor.

Source: Proclamations No. 15/1992 and No. 1180/2020.

Proclamation No. 116/1998 also offered an option for foreign nationals of Ethiopian origin
to invest either as domestic investors or foreign investors, which was left to their own choice.
Those who choose to be treated as domestic investors have the right to invest in areas
exclusively reserved for domestic investors under Regulation No. 35/1998, but lose the right ofbeing treated as foreign investors. They are not allowed to repatriate their profits and capitaloutside Ethiopia as this is the right to be given only to foreign investors.
Proclamation No. 769/2012 made major revisions in areas of investment reserved fornationals and government. The law indicated that the list of areas of investment allowed fordomestic investors must be specified by a regulation of the Council of Ministers. Accordingly,
Regulation No. 270/2012 identified the transmission and distribution of electric energy, postal
service with the exception of courier services, and air transport with a seating capacity of morethan fifty passengers to be exclusively reserved for the government, whereas manufacturing of
weapons and ammunition and telecom services were allowed for a joint venture but only withthe government. The 2012 regulation carried a long list of sectors restricted for FDI
participation, most of which were in the service sector such as banking and insurance, wholesale
and retail trade, transport and logistics, construction, utilities and small-scale activities. The
manufacturing sector was relatively open except for a few sub-sectors.
According to Gebreeyesus et al. (2017), continued restriction of foreign investment inservice sectors stifled competition and led to inefficiency in these sectors with negative effects
on other sectors including manufacturing. For example, according to the UN International
Telecommunication Union’s 2017 ICT Development Index (IDI), Ethiopia’s telecom service
was ranked 170th out of 176 countries. The logistic performance index also put Ethiopia at
126th out of 166 countries. The present severe inefficiency in the Ethiopian banking, energy,

20telecom and transport sectors, all of which are reserved for domestic investors, has led to hightrading costs and low global competitiveness.
In a stark deviation from its predecessors, Investment Proclamation No. 1180/2020 and
Investment Regulation No. 474/2020 introduced substantial revisions although they did not
negate or reverse the fundamental policy and practice that had been in place for the past two
decades. They were rooted in the wave of economic and legal reforms that have been underway
since 2018.
Regulation No. 474/2020 shifted from the “positive list” approach (listing of areas that areallowed for foreign investors) to the “negative list” approach (listing of areas that are notallowed for foreign investors). This is the most significant aspect of the new investment law
because foreign investors are now allowed to invest in any areas except those that are expressly
reserved for domestic investors. The Regulation provides a list of investment sectors that areprohibited or restricted for foreign investment in three categories: five sectors reserved for joint
investment with the government, 32 sectors exclusively reserved for domestic investors, andseven sectors for joint ventures with domestic investors. All sectors that are not listed in thesecategories are open for foreign investment. See Table 1-2 for the extended list of sectors undereach category.
Transport service is one sector where a notable opening has taken place under this new
regulation. The 2020 regulation allows foreign investors to invest in railway transport, cablecar transport, cold-chain transport and freight transport which were restricted in the previous
laws. The Regulation lists seven sectors where foreign investment is permissible up to 49%
ownership, most of which are related to transport services. These are (i) freight forwarding andshipping agency services, (ii) domestic air transport services, (iii) cross-country public transport
service using buses with a seating capacity of more than 45 passengers, (iv) urban masstransport service with a large carrying capacity, (v) advertisement and promotion services, (vi)audiovisual services, motion picture, and video recording and distribution, and (vii) accounting
and auditing services—see Table 1-2.
Restriction on foreign investment in previous regulations such as cement manufacturing,
health, education, management consultancy, and other services have been removed under the
new regulation. Furthermore, the regulation relaxes rules on wholesale trade, retail trade andelectronic commerce. Under the previous law, foreign investors engaged in the manufacturingsector were permitted only to wholesale their own products. Retail sales of own products were
not permitted and could only be carried out through local intermediaries. The new regulation
allows foreign investors to engage in both wholesale and retail trade provided that they arecarried out via electronic commerce.

21

Table 1-2. Sectors Prohibited or Restricted for Foreign Investment inRegulation No. 474/2020
Areas of investment exclusively reserved for domestic investors:
1. Banking, insurance, and microfinance businesses, excluding capital goods
finance business;
2. Transmission and distribution of electrical power through an integrated
national grid system;
3. Primary and middle-level health services;
4. Wholesale trade, excluding wholesale of petroleum and petroleum products
and wholesale of own products produced in Ethiopia, electronic commerce;
5. Retail trade, excluding retail of and electronic commerce as provided underappropriate law, of own products produced in Ethiopia;
6. Import trade, excluding liquefied petroleum gas and bitumen;
7. export trade of raw coffee, khat, oilseeds, pulses, minerals, hides and skins,
products of natural forest, chicken, and livestock including pack animals
bought on the market;
8. Construction and drilling services below Grade I;
9. Hotel, lodge, resort, motel, guesthouse, and pension services, excluding
those that are star-designated;
10. Restaurant, tearoom, coffee shops, bars, nightclubs, and catering services,
excluding star-designated national cuisine restaurant service;
11. Travel agency, travel ticket sales, and trade auxiliary services;
12. Tour operation;
13. Operating lease of equipment’s, machinery and vehicles, excluding
industry-specific heavy equipment, machinery and specialized vehicles;
14. Making indigenous traditional medicines;
15. Producing bakery products and pastries for domestic market;
16. Grinding mills;
17. Barbershop and beauty salon services, smothery, and tailoring except bygarment factories;
18. Maintenance and repair services, including aircraft maintenance repair andoverhaul (MRO), but excluding repair and maintenance of heavy industry
machinery and medical equipment;
19. Aircraft ground handling and related services.
20. Sawmilling, timber manufacturing, and assembling of semi-finished wood
products;
21. Media services;
22. Customs clearance service;
23. Brick and block manufacturing;
24. Quarrying;
25. Lottery and sports betting;
26. Laundry services, excluding those provided on industrial scale;
27. Translation and secretarial services;
28. Security services;
29. Brokerage services;
30. Attorney and legal consultancy services; and31. Private employment agency services, excluding such services for theemployment of seafarers and other similar professionals that require highexpertise and international experience and network.
32. Transport services, excluding the following areas:(a) Railway transport services;(b) Cable-car transport services;(c) Cold-chain transport services;(d) Freight transport services having a capacity of more than 25 tones;(e) Transport services reserved for joint investment with the Government ordomestic investors.

22

Areas allowed for foreign
investors to jointly invest
with the government:
1. Manufacturing of
weapons, ammunition,and explosives used as
weapons or to makeweapons;
2. Import and export ofelectricity;
3. International airtransport services;
4. Bus rapid transit; and5. Postal services
excluding courier
services

Areas of investment inwhich foreign investor/s
can own up to a
maximum of 49% ofshare capital:
1. Freight forwarding andshipping agency
services;
2. Domestic air transport
service;
3. Cross country passenger
transport service using
buses with a seating
capacity of more than 45
passengers;
4. Urban mass transport
service with large
carrying capacity;
5. Advertisement andpromotion services;
6. Audiovisual services;motion picture and video
recording anddistribution; and7. Accounting and auditing
services.

1-2-2. Privatization
The administration of Prime Minister Abiy Ahmed began economic reforms centered onliberalization, privatization and financial sector reform. In 2019, the Homegrown Economic
Reform (HGER) program was developed to rebalance the sources of growth from pubic
investment-led to private investment-led and from demand-driven to supply-driven. It
envisages boosting the private sector’s contribution to the overall economy through partial
equity sales in four strategic sectors—Ethiopian Airlines, Ethio telecom, Ethiopian ElectricPower Corporation and Ethiopian Shipping and Logistics Services Enterprises—and fullprivatization of several other state-owned enterprises (SOEs) including sugar plants, railways
and industrial parks.
While the privatization of Ethiopian Airlines has been retracted at least for the moment due
to popular discontent, partial privatization of Ethio telecom is underway. This has attracted bids
from several renowned telecom companies. Ethiopia is one of the last countries to have amonopoly national telecommunications operator.
1-2-3. Investment incentives
Ethiopia has provided incentives to encourage both domestic and foreign investment. These
incentives include exemption from corporate income tax for specified years, exemptions onimport duties and non-fiscal incentives. Table 1-3 summarizes the present investment incentives
in Ethiopia. Corporate income tax exemption is activity- and location-specific but nondiscriminatory between domestic and foreign investors operating in areas that are eligible forincentives. Investment in the manufacturing sector as a whole and some selected agricultural
products are given income tax exemption for 1-6 years depending on the location and type ofactivity. In terms of geographical location, income tax exemption makes a distinction between
Addis Ababa and surrounding towns and other parts of the country. Investors receive additional
1-2 years of tax exemption if they invest outside Addis Ababa and its surrounding towns.
Besides this, a special privilege is available for investors operating in some remote and arid
parts of the country such as Gambella, Benshangul Gumuz, Somali, Guji, Borena Zone, partsof Afar, and some remote areas of the Southern Nations and Nationalities, and People’s Region(SNNPR). Income tax exemption also has a provision linked with export performance.
Both foreign and domestic investors are also provided with customs duty exemption or
reduction. These include 100% exemption from customs duties and other taxes imposed on
imports of capital goods and spare parts with a limit of 15% of the total value of imported
capital goods. In addition, firms that export at least 60% of their products are given additional
incentives such as duty drawbacks on imported inputs, vouchers, bonded warehouses, export

23

Table 1-3. Summary of the Present Investment Incentives in Ethiopia
Exemption of duties andother taxes (VAT, surtax,
Non-fiscal incentives
withholding and excise tax)
on imports of Manufacturing sector (up to 6 years)  Capital goods One-stop shop service
 Agriculture sector (up to 10 years)
 Construction materials
 Customs facilitation
 ICT development (up to 5 years)
 Spare parts
 Expedited visa procedure Electricity generation, transmission,  Vehicles
 Guarantee against
and distribution (up to 5 years)
 Raw materials andexpropriation
 Hotel and tour service providers inaccessories including The right to own immovablenon-traditional tourism destinations
packaging materials, used for property(up to 5 years)
export processing Guarantee for remittance of Industrial park development Raw materials needed for
funds/developers (10 to 15 years)
test-run production (sample  The right to open and Additional 2 years for at least 60%
production for issuance of
operate foreign currency
export or supply to exporter (export- business license)
accounts and retention oflinked exemption)
 Personal effects by industrial export earnings Additional 2 to 4 years for industrial park residents
 Export credit guarantee
park enterprises with 100% export
 Raw materials by import Access to foreign loan (withplan and achieving at least 80%
substituting local
debt-equity ratio of 60:40
exportmanufacturers
for foreign investors)
 Pharmaceutical sector in industrial
 Soft/subsidized project loanparks (7 to 14 years)
 Franco valuta import of Loss carry forward for up to 5 years
capital goods, raw materials,
 Personal Income Tax (PIT) exemption
spare parts, and otherfor expatriate employees in industrial
accessories
parks (up to 5 years)
Business income tax exemption(depending on sub-sector andlocation) in

Source: EIC and author’s compilation2.

credit guarantee schemes and additional two-year income tax exemption. Furthermore, thegovernment provides additional incentives to industrial park developers and enterprises locatedin the parks. This is discussed in detail in section 1-3.
Gebreeyesus et al. (2017) argues that investment incentives in Ethiopia are not selective
enough. They do not sufficiently differentiate between FDI and local firms, the scale ofoperation or the country of origin of FDI. Incentives give less attention to re-investment andexpansion. Besides this, incentives are often not conditional on meeting specific performancegoals such as technology transfer, minimum local content of inputs, value addition andemployment. Caution is, however, needed as some of the incentives may not align with theWorld Trade Organization (WTO) rules although the country has not yet joined WTO and there
is some preferential treatment or exemptions for countries whose Gross National Products(GNP) per capita is below $1,000. Even when incentives are associated with performance,2

http://www.investethiopia.gov.et/index.php/investment-process/incentive-package.html accessed 15 May 2021.

24

capacity and systems are lacking to monitor whether agreed targets are achieved. This has given
a way for some firms to exploit the system without meeting the basic conditions that motivatedthe introduction of such incentives. On the other hand, both FDI and local firms often complainthat they are not sufficiently benefiting from the present incentives due to implementation
problems and bureaucratic inefficiency. The effectiveness of incentives relies on the presenceof capable and transparent bureaucracy, which is currently lacking in Ethiopia.
1-2-4. Technology and knowledge transfer
The most plausible argument promoting FDI is that it can bring new technology and knowhow to the host country. However, Ethiopia’s investment framework has been passive withregard to technology transfer. All of the previous investment laws focused on approving
technology transfer agreements between FDI and local enterprises but not actively promoting
them. For example, Proclamation No. 37/1996 stated that whenever the authority received atechnology transfer agreement that went with Sub-Article (1) of the proclamation, it would giveits decision thereon subsequent to the necessary evaluation in accordance with the law. Sections
on technology transfer under Proclamation No. 280/2002 and Proclamation No. 769/2012
remain the same as in Proclamation No. 37/1996. Article 15 of recent Proclamation No.
1180/2020 similarly stipulates an approval process of technology through EIC. None of theprevious investment laws had an explicit mechanism to facilitate and encourage technology
transfer between FDI and local firms, such as a linkage program or promotion of joint venturearrangements.
Technology transfer is one area where coordination among different government agencies
has been precarious. The perception of EIC seems to be that it is not mandated to work ontechnology transfer as it is the territory of the Ministry of Trade and Industry (MoTI) and/or the
Ministry of Innovation and Technology (MInT). MoTI, through its industry development
institutes, seems 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 promoting
technology transfer. Meanwhile, MInT is not closely attached to industrial actors despite its
explicit mandate to work on technology transfer issues (Gebreeyesus et al. 2017).
1-2-5. Investment guarantees, protection and remittance of funds
Proclamation No. 15/1992 guaranteed the absence of nationalization and expropriation.
According to this proclamation, no assets of a domestic or foreign investor might be
expropriated or nationalized wholly or partially except by the due process of law. This was a
critical declaration to attract investment given the damages inflicted on foreign investors by the25

previous regime through nationalization. Articles 2 and 3 of Proclamation No. 37/1996 further
secured the right of foreign investors and granted more protection. According to thisproclamation, adequate compensation corresponding to the prevailing market value would be
paid without delay in case of expropriation or nationalization of an investment for the public
interest. The law also stated that any foreign investor might remit compensation paid to him outof Ethiopia in convertible foreign currency pursuant to the law.
Investment guarantee and protection remained the same under Proclamation No. 280/2002
and No. 769/2012 except for a change in terminology where “nationalization” and“expropriation” were now used interchangeably. Article 19 of the most recent Proclamation No.
1180/2020 came up with a major change by stating “the government may expropriate any
investment undertaken under this Proclamation for a public interest, in conformity withrequirements of the law, and on a non-discriminatory basis”. The proclamation has also added
that, in case of expropriation of an investment effected under Sub-article 1 of Article 19,
adequate compensation corresponding to the existing market value will be paid in advance.
An open foreign exchange regime, with no restriction on converting and transferringcurrency abroad, is an attractive aspect of the foreign investment climate. The Ethiopian
government has been reviewing its investment rules to improve remittance practices.
Proclamation No. 37/1996 stated that any foreign investor had the right, in respect of an
approved investment, to make remittances out of Ethiopia in convertible foreign currency at theprevailing rate of exchange on the date of remittance. Such remittances include profits anddividends accruing from investment, principal and interest payments on external loans,payments related to a technology transfer agreement registered under this proclamation,
proceeds from the sale or liquidation of an enterprise, and proceeds from the transfer of sharesor conferring partial ownership of an enterprise to a domestic investor.
No change was made under the investment laws of Proclamation No. 280/2002 andProclamation No. 769/2012 concerning the remittance of funds. But under Proclamation No.
1180/2020, privileges were added regarding payments related to registered collaborationagreements, proceeds from a transfer of shares or conferral of partial or total ownership of anenterprise to another investor, proceeds from the sale, capital reduction or liquidation of anenterprise, and compensation paid to an investor.
Despite these rules, foreign investors are in practice facing increasingly long delays inremitting funds due to the shortage of foreign currency and inefficient bureaucracy. Several
anecdotal pieces of evidence suggest that foreign exchange shortage and delay in remittances
have become a significant obstacle not only for new investors intending to invest in Ethiopia
but also existing ones who are forced to reconsider their future investment and even survival.

26

1-2-6. Access to foreign loan and foreign exchange
Ethiopia has also gradually relaxed the rules regarding access to external loans and foreignexchange. In 2017, the National Bank of Ethiopia (NBE) issued a new directive, External Loan
and Supplier’s Credit Directives No. FXD/47/2017, which replaced the Registration of External
Loan and Suppliers’ or Foreign Partners’ Credit Directives No. REL/005/2002. The 2002
directive allowed only partners or suppliers credit but procedures for formal loan agreement
were not explicitly stated. The 2017 directive explicitly allows both external loans and suppliers’
credit.
In the old directive, eligible borrowers were only exporters. In the new directive, eligible
borrowers are not only exporters but all foreign investors including non-exporters. When it
comes to domestic investors, eligible borrowers for external loans are only those engaged inprojects that generate foreign currency.
According to the new NBE directive, borrowers have to get approval from NBE before
entering external loans or suppliers’ credit, and guaranteed external loans must be registered at
NBE. The new NBE directive also requires that the debt-to-equity ratio shall not exceed 60:40
in foreign capital (equity from shareholders).
The Directive on Retention and Utilization of Export Earnings and Inward Remittances was
also amended in 2017 by No. FXD/48/2017. Any investor may operate a foreign currency
account in banks in Ethiopia for the purpose of its investment as per an applicable Directive of
NBE. Two types of foreign exchange retention accounts (Account A and Account B) arenormally allowed for this purpose. Account A can be used indefinitely but any balanceremaining in Account B shall be converted to Birr after certain days (usually within one month).
The proportion of money to be put under each account has been a subject of debate and repeatedchanges. For example, the 2017 NBE directive increased the proportion of foreign exchangethat can be retained in Account A from only 10% to 30%. There were some more changes inrecent years.
The 2020 new investment law reiterates the two relaxed rules above: (i) any foreign investor
may incur external indebtedness for their investment, and (ii) any foreign investor may open
and operate a foreign currency account in banks in Ethiopia for the purpose of its investment.
Both are subjected to applicable NBE directives.
1-2-7. Institutional framework
The Ethiopian Investment Office, an autonomous government institution responsible formost aspects of investment including FDI in Ethiopia, was established in 1992. It has since
undergone various restructuring. Under Proclamation No. 37/1996, the investment organ was

27renamed the Ethiopian Investment Authority.
Proclamation No. 769/2012 brought additional structural changes by establishing theFederal Investment Board, which was entrusted with important powers and responsibilities oninvestment matters in Ethiopia, including FDI. This gave the power to the Board in allowing
additional incentives, opening certain hitherto prohibited sectors for foreign investors, anddeciding on appeals against the decision of Investment Authority without forwarding
recommendations to the Council of Ministers as rectified in the law. The proclamation was also
amended to give the Addis Ababa and Dire Dawa Administrative Councils the power similar toother regional states.
The next major institutional amendment was Proclamation No. 849/2014, which reestablished the Ethiopian Investment Agency as a Commission (Ethiopian Investment
Commission: EIC) accountable to the Prime Minister and governed by a Board of Investment(BOI). EIC used to be under the Ministry of Trade and Industry with a limited mandate. But the
new proclamation granted EIC more power and roles including promotion of investment andexports as well as direct support and regulation of industrial parks.
EIC has since then gone through major internal restructuring and reforms to improve its
services and attract more FDI. The reforms included improving one-stop services (OSS) andinitiating aftercare service. According to Gebreeyesus et al. (2017), the OSS reform brought
documentation requirements “in-house” with 27 of 29 requirements fully delegated to EIC. The
aftercare service on the other hand requires the appointment of a single named contact official
for each firm, an initial visit to establish relations, and subsequent regular visits or phone
conversations. Thus, EIC has developed an investor tracking system where the largest 400 FDI
projects are weekly tracked by seven sectoral teams.
According to EIC (2019), EIC in 2016 introduced a donor-supported Young Professional
Development Programme (YPDP) to solve the problem of the lack of qualified personnel. The
program objective was to recruit fresh university graduates for training within the EIC throughmentoring by senior officials, training by instruction, learning by doing and observing, andexposure to the day-to-day investment promotion and facilitation activities that took place atthe EIC. In the short run, the initiative seems to have provided a solution to skill-related constraints
on policy implementation and institutional mandates. However, this donor-funded capacity development
was not sustainable.

Another important change made in the mid-2010s was in investment promotion. The newinvestment promotion direction included identification of priority sectors and potential country
targets, moving from generic campaigns towards attracting anchor investors and using
industrial park development for promotion. The labor-intensive and export-oriented lightmanufacturing was the prioritized sector for promotion, which was in line with the industrial
development strategy. Moreover, emerging middle-income countries such as China, India and28

Turkey were identified as focus countries for investment promotion. The rationale was thatthese countries were facing increasing labor costs and therefore a deteriorating comparativeadvantage in light manufacturing, which provided a big potential for less developed countries
such as Ethiopia to attract FDI from them (Gebreeyesus et al. 2017).
The investment code revision in 2020 (Proclamation No. 1180/2020) re-established EIC as
an autonomous Federal Government Agency having legal personality and being accountable to
the Prime Minister. It further strengthened the role of EIC to lead proactive investment
promotion, aftercare service, investment climate improvement and an investor feedback loop.
Ethiopia’s rank in the World Bank Ease of Doing Business has been lower than many SubSaharan African Countries and deteriorating through time. A special Steering Committee
chaired by the Prime Minister was established in 2018 to improve Ethiopia’s investment anddoing business environment. The Committee vowed to spearhead the reforms in all of the ten
indicators used to measure the ease of doing business. It has been meeting regularly, once amonth and under the chairmanship of the Prime Minister (EIC 2019).
The lack of coordination between federal and regional investment agencies has long been
criticized. To address this concern, the 2020 investment proclamation re-established the Federal
Government and Regional State Administrations Investment Council. The main purpose of thisorgan is to facilitate cooperative and coordinated administration of investment between theFederal Government and Regional State Administrations. An Intergovernmental Relations
Forum (IGR Forum) was established between the central government and sub-regional
governments for joint vision and strategy setting and high-level problem solving (EIC 2019).
The IGR Forum is composed of the Prime Minister and the Presidents of sub-regional
governments including the Addis Ababa and Dire Dawa City Administrations.
Decentralization of FDI management can help ease complicated procedures associated with
FDI projects and improve efficiency. It can also spur creativity and competition among local
governments, which attracts more investment. However, in Ethiopia FDI is still administeredby the federal investment agency. The regional investment agencies are passive facilitators, forexample, making land available for investors although the federal arrangement gives moreautonomy to regions to make decisions on investments in their jurisdiction. The lack of capacityof regions is often cited as a pretext for the concentration of power in federal agencies regarding
foreign direct investment. Gebreeyesus et al. (2017) argues that, in the absence of power,
motivation and competition among the regional governments, project implementation isdelayed and regional distribution of FDI is highly skewed to few areas. For example, Addis
Ababa and Oromia region alone account for about 80% of the total FDI stock and 50% of
permanent jobs created by FDI in the country.

29

1-3. The industrial park development scheme
Ethiopia has significant potential in the light manufacturing sector but faces binding constraints
related to access to land, infrastructure, trade logistics, customs regulations and a skills gap.
Industrial parks are vital in helping easy provision of infrastructure service for industries,
economical use of land, protection of the environment and human wellbeing, and expanding
and establishing new urban centers (World Bank 2012). This section focuses on the industrial
park development scheme which has been emphasized by Ethiopian policymakers since themid-2010s as a major policy instrument to significantly boost Ethiopia’s attractiveness forforeign and domestic investment.
The concept of industrial park (or zone) was introduced earlier in Ethiopia but with a loose
sense. For example, Article 19 of Proclamation No. 769/2012 allowed for the establishment ofIndustrial Development Zones with distinct boundaries designated by an appropriate organ todevelop similar and interrelated industries together. The law also allowed the development ofmulti-faceted industries provided that a plan was drafted to prepare infrastructures such as roads,
electricity and water as well as incentive schemes to contain industrial areas, mitigate
environmental pollution, and administer urban development with proper planning and systems.
But the bold move to promote industrial parks came in 2014 with the establishment of theIndustrial Parks Development Corporation of Ethiopia (IPDC), a publicly owned corporation
with the mandate of developing and operating a wide range of industrial parks in the country,
by Council of Ministers Regulation No. 326/20. Main industrial groups eligible to be hosted inthese industrial parks included textile and apparel, leather and leather products, agro-industries
including food processing, furniture, chemicals, pharmaceuticals, and metals and engineering.
Industrial Parks Proclamation 886/2015 allowed private sector participation in thedevelopment of industrial parks. It stated that industrial parks could be developed by threemechanisms: (a) fully developed by the federal or regional government, (b) developed by
Public-Private Partnerships (PPPs) with the IPDC, and (c) by private developers only.
IPDC was given a wide range of mandates as a regulator, land bank, park developer andoperator. As per Regulation No. 326/2014, the mandates of IPDC are to: Develop and administer Industrial Parks, lease developed land and lease and transfer,through sale, constructions thereon;
Prepare detailed national Industrial Parks Master plan based on the national special Master
plan, and serve as the industrial park landbank per the agreements concluded with regional
governments;
 In collaboration with the concerned bodies, ensure that necessary infrastructure isaccessible to Industrial Park developers;30

Outsource, through management contracts, when it is deemed necessary, the managementof Industrial Parks;
 Promote extensively the benefits of Industrial Parks and thereby attract investors to theparks;
 In line with directives and policy guidelines issued by the Ministry of Finance andEconomic Development, sell and pledge bonds and negotiate and sign loan agreementswith local and international financial sources; and Engage in other related activities necessary for the attainment of its purposes.


The fact that IPDC is given the regulatory role in addition to being a park developer andoperator has become a source of criticism for potential conflict of interest. Besides, the role oflocal governments in managing the parks as well as ensuring the benefits to local people andadministration seems to be blurred again, which may lead to disputes (Woldeselassie et al. 2017).
The Ethiopian investment law provides a wide-ranging special incentive package toindustrial park developers and enterprises in the park. This includes comprehensive financial
incentives and efficiency-enhancing non-financial support measures. See Table 1-3 for thesummary of the incentives.3
The government of Ethiopia offers fiscal incentives along the different stages of investment
within industrial parks from construction to operation and marketing. Industrial park developers
and enterprises benefit from the following corporate income tax exemption incentive package.
 Industrial park developer: 10-15 years income tax exemption depending on the location ofindustrial park; Industrial park enterprise: up to 6 years exemption depending on the sector of engagement
and additional 2-4 years exemption for industrial park enterprises with at least 80% export;
 Expatriate employees of industrial park enterprises: up to five years personal income tax
exemption after issuance of business license for the investment.
Similar to enterprises outside parks, enterprises located in industrial parks and parkdevelopers are provided with various duty-free import incentives. For example, capital goods
and accessories, construction materials, and spare parts up to 15% of the total value of capital
goods can be imported duty-free by manufacturing industries. There are also certain benefits
regarding duty-free importation of motor vehicles related to investment to both industrial parkdevelopers and enterprises located in parks. In addition, all raw materials needed for the
production of export commodities can be imported duty-free.
Industrial park developers enjoy a land sub-lease period of 60-80 years depending on theMore information on the industrial parks and enterprises incentives schemes can be found at:
http://www.investethiopia.gov.et/images/pdf/Industial%20Parks%20Incentives%20FINAL%20VERSION.pdf
331

location. They can import construction materials and equipment necessary for industrial park
construction. Industrial park enterprises have an option to rent or buy factory sheds, or subleasedeveloped land at a promotional rate to construct their production facility.
Investors are also provided with various non-fiscal incentives including simplified
procedures for investment establishment and operation as well as strong property protection
and guarantees. One-stop shop service is being provided by the EIC at the head office that
includes the issuance of investment permits, business licenses, commercial registration
certificates and work permits; notarizing memorandums and articles of association, registrationof trade or firm names and technology transfer agreements as well as the issuance of tax
identification numbers (TIN). One-stop shop service is also provided at industrial park branches
that includes renewal of all licenses issued at the head office; visa and work permit renewal;
duty-free grant for capital goods, construction materials, spare parts, accessories and different
types of vehicles; customs clearance; and banking services.
Post-establishment investment facilitation (aftercare) service is also provided by the EIC.
The government makes available fully developed infrastructure up to the perimeter of the parkand guarantees access to utilities including a dedicated power station. Further, an expedited
procedure for entry, work permit and certificate of residency is provided for expatriate
personnel working in industrial parks and their dependents. Better visa terms are provided forinvestors in industrial parks including multiple-entry visas of up to five years. Concerning
customs facilitation, imported raw materials can be transported straight from a customs post to
the factory through the bonded warehouse or voucher scheme.
The government also offers a guarantee against expropriation or nationalization. Once
expropriation happens, payment of compensation will be made corresponding to the prevailingmarket value of investment property in case of expropriation or nationalization for the public
interest. The right to own immovable property is also available for foreign investors, giving
them the right to own a dwelling house and other immovable property required for theinvestment. Subsidized utility rates are also offered, including electricity which is sold at an
estimated rate of 3 US cents/kWh. The government prepares dedicated power stations for parks
to ensure reliable access to electricity within industrial parks.
Foreign investors can freely repatriate in convertible foreign currency profits and dividends,
principals and interest payments on external loans, proceeds from the sale or liquidation of anenterprise as well as compensation paid. A foreign investor also has the right to open and operate
foreign currency accounts in authorized local banks. The performance achieved so far andchallenges facing the industrial parks will be discussed in the remaining sections.
1-4. FDI inflow and composition in Ethiopia

321-4-1. Trends in FDI inflow
Figure 1-1 presents the FDI inflow of five top East African FDI destination countries
including Ethiopia. Prior to 2010, FDI inflow to Ethiopia showed little progress. However, thecountry saw tremendous growth in FDI inflow in the early 2010s and became the largest
recipient of FDI in Africa. FDI inflow to Ethiopia reached a peak in 2016 with an annual flowof $4.14 billion. The fast growth was driven by sustained high economic growth that the country
achieved and also by the commitment and promotion efforts of the government to attract foreign
investment and develop industrial parks. However, FDI inflow started to decline in 2017 largely
due to domestic political instability and global economic slowdown.
Figure 1-1. Top Destinations of FDI in Eastern Africa

6,000
5,000
4,000
3,000
2,000
1,000

Ethiopia

Mozambique

Kenya

Uganda

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

0

2000

FDI inflow(in USD millions at current prices)

7,000

Tanzania

Source: UNCTAD database.

Figure 1-2. FDI Stock and Percentage of Gross Fixed Capital Formation
30
25
20
15
10
5

Percentage of Gross Fixed Capital Formation
Stock (US dollars at current prices in billion)
Source: UNCTAD database.

33

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

0

According to the UNCTAD database, capital stock from foreign investment in Ethiopia rose
rapidly in the 2010s and reached nearly $25 billion in 2019 (Figure 1-2). Similarly, FDI capital
as a percentage of gross fixed capital formation increased significantly during 2013-16. The
high level of this ratio during this period can be explained by the fact that total fixed capitalformation was low then.
Relying on the EIC database, Figure 1-3 reports the number of foreign investment projects
at different stages. The EIC classifies investment projects into three stages: pre-implementation,
implementation and operational. Pre-implementation refers to licensed investment projects thathave not yet started production of goods or provision of services, i.e., they have only obtained
investment licenses. Implementation refers to investment projects in which practicalundertakings such as the construction of civil works and provision of machinery and equipment
are underway but production of goods or provision of services has not yet started. Operational
projects are investment projects which have either partially or fully begun production of goods
or provision of service.
Overall, during 1992-2019, investment licenses were issued for a total of 5,262 FDI projects
out of which 3,307 have so far become operational. As of 2019, operational FDI projects hadcreated 373,025 permanent jobs.
Starting from 2002, however, a noticeable gap emerged between the three investment stages.
The number of operational projects increased significantly in six consecutive years from 2002
to 2008 while it has been on a declining trend since then. The great rise in operational projects
in the earlier period might have different explanations. One such explanation is that this period

100
90
80
70
60
50
40
30
20
10
0

350

250
200
150
100
50
0

1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019

Number of projects by status

300

Perm empl. Operational firms
No. of proj. Implementation

No. of proj. pre-Implementation
No. of proj. Operation

Source: Ethiopian Investment Commission (1992-2020).

34

Permanent employment ('000s)

Figure 1-3. Number of Projects by Status and Employment Created byOperational Projects

coincided with the increased global interest to grab land and invest in food production in many
developing countries. Ethiopia was one of the developing countries that aroused the attentionof foreign investors as it was richly endowed with fertile land and had a very investor-friendly
environment for that purpose. Especially for the agricultural sector, investment regulations were
relaxed significantly (Weissleder 2009). This was also the period when Ethiopia’s flower sector
attracted huge investment and several Turkish and Indian investors started operations inEthiopia particularly in the manufacturing sector.
1-4-2. The sectoral composition of FDI
FDI in Ethiopia has been concentrated on the manufacturing sector (Table 1-4). The
manufacturing sector accounts for the majority (51.5%) of the total FDI operational investment
projects and about three-quarters (73.3%) of capital invested in the country over the period
1992-2020. The agriculture sector accounts for about 12% of operational projects but a third(33%) of total permanent employment created. This suggests the labor-intensive nature of this
sector. On the other hand, real estate and machinery and equipment rental and consultancy
services, and construction contracting in sum account for 26% of total operational projects, 13%of capital and 26% permanent employment created.
Table 1-4. FDI Projects by Sector and Status (1992-2020)

SectorAgriculture
Manufacturing
MiningElectricity
Education
HealthHotels andrestaurants
Tour operation,transport, andcommunication
Real estate,
Machinery &Equipment rental,
construction
contracting, etc.
OthersGrand Total

Total
number of
Projects
licensedShare
projects Number
(%)
636
333
12.0
2,932
1,676
51.5
22
14
0.2
2
1
0.1
113
63
1.4
111
60
1.1

Operational projects
CapitalPermanent employment
MillionShare
Share
NumberBirr(%)(%)
12,752.2
8.9
53,81933.0
105,219.2
73.3
190,448
37.9
451.4
0.3
591
0.1
1.0
0.0
10
0.0
393.1
0.3
2,121
0.6
795.0
0.6
2,046
0.1

241

149

3.9

1,966.3

1.4

5,475

0.8

130

76

2.0

288.0

0.2

1,005

0.2

1480

881

26.0

19,153.0

13.0

117,105

26.0

116
5,783

70
3,323

1.8
100.0

2597.9143617.5

1.8
100.0

1,755
374,375

1.8
100.0

Source: EIC.

35

A high concentration of foreign investment in the manufacturing sector is uncommon in
Africa where FDI mostly comes to extractive sectors and services. This is partly driven by
Ethiopia’s aggressive manufacturing-focused promotion including the development ofindustrial parks. The sharp rise in manufacturing investment in Ethiopia since 2012 supports
this argument. The fact that a large part of the service and construction sectors is restricted forforeign investors might have additionally contributed to the increasing concentration in the
manufacturing sector.
1-4-3. FDI country of origin
Table 1-5 reports the top 20 countries of origin among operational FDI projects in Ethiopia
in the last three decades. The top 20 countries collectively account for 79% of the total numberof operational projects, 72% of capital and 81% of permanent employment created. China, India,
the US, Turkey and Sudan, in descending order, are the top five investors in terms of the numberof projects. In terms of capital, China, Turkey, India, the Netherlands and the US are the top
five sources. The Netherlands, Italy, Saudi Arabia, France, Egypt and UAE conduct more thanhalf of their investment projects in the form of joint ventures with Ethiopians.
China, India and Turkey not only are the leading investors in Ethiopia but also focus on
manufacturing in their investment projects. These countries are losing comparative advantage
in light manufacturing due to rising labor costs. They are thus significant sources of FDI outflow
in light manufacturing. In recognition of this, Ethiopia has identified them as priority target
countries for attracting FDI in manufacturing.
1-4-4. Performance of industrial parks
This sub-section discusses the performance of industrial parks in terms of investment,
employment and exports. Table 1-6 lists industrial parks in Ethiopia by sector, ownership andstatus. IPDC, which is currently accountable to EIC, has built 13 public industrial parks indifferent parts of the country. In terms of sectors, most of the publicly-owned parks focus on
textile and apparel with a few exceptions such as Kilinto Industrial Park designated forpharmaceuticals and Adama Industrial Park which hosts machinery production as well as textile
and apparel. There are also five foreign-owned private industrial parks. The largest and oldest
private park is the Chinese-owned Eastern Industrial Zone (EIZ), which hosts a mixture ofexport-oriented and import-substituting manufacturing enterprises including textile, leather,agro-processing, metallurgy, building materials, cement, basic iron and steel, and electricalequipment.

36

Table 1-5. Top 20 Countries of Origin for Operational FDI Projects (1992-2020)

China
India
United States
TurkeySudan
Netherlands
Britain
Italy
Saudi Arabia
FranceGermany
IsraelSouth Korea
Canada
Yemen
Egypt
Kenya
Pakistan
UAE
SwedenNo. ofoperational
projects
1005
287
202
133
131
125
114
101
98
60
59
52
45
38
38
35
30
30
30
28

Sum (top 20)
Share of top 20 (%)
Sum (other countries)
Grand Total

2641
79.5
682
3,323

Country of origin
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

% of JV sharewith
Ethiopians
12.2
25.4
35.1
24.8
20.6
52.8
39.5
51.5
51.0
53.3
47.5
36.5
0.0
39.5
26.3
51.4
0.0
0.0
53.3
46.4

Capitalinvestment(million Birr)
45,372.6
6,405.4
2,294.7
12,113.6
1,360.6
3,880.2
1,500.5
1,109.2
19,056.0
3,498.7
950.4
779.9
675.7
320.5
247.4
1,401.3
476.9
1,124.7
761.1
218.2
103,547.6
72.1
40,069.95
143,617.5

Permanent
employment
172,789
27,7505,990
17,442
4,632
8,364
4,938
14,72922,970
2,562
2,697
6,679
3,353
887
1,182
2,166
1,260
2,356
1,084
894
304,724
81.4
69,650.7
374,374.7

Source: EIC.

The establishment of industrial parks has helped to put Ethiopia on the radar screen of
foreign companies, which increased FDI inflow. There are currently nine operational parks—
five public parks: Bole Lemi I, Hawassa I, Mekelle, Kombolcha, Adama, and four privately
owned parks: Eastern Industrial Zone, Vogue, DBL and George Shoe. As of the end of 2018,
the private parks collectively attracted 179 enterprises out of which more than half of them (91)
are located in one private industrial park, the Eastern Industrial Zone. The private parks are
estimated to have generated employment for above 21,500 people as of 2018. The largest publicparks are Hawassa and Bole Lemi, respectively hosting 22 and 11 manufacturing enterprises
most of which are producing apparel as of the end of 2020. The overall occupancy rate of the
public parks in terms of occupied sheds relative to available sheds is as high as above 90%.
However, caution is warranted here. The number of enterprises located in the public industrial

37

Table 1-6. Public and Private Industrial Parks in Ethiopia

1
2

Name

Location

Bole
Lemi I
Bole
Lemi II

Addis
Ababa
Addis
Ababa
Addis
Ababa

Ownership

Eligible
sectors

StatusPublicApparel & textile Operational

PublicApparel & textile

PublicPharmaceutical hub

Ready forsublease
Ready forsublease

AvailOccu- No. of
able
Employpation enterfactorymentrate (%) prises
sheds
21

95

11

18,000

3

100

3

52

100

22

32,000

6

5,000

3

Kilinto4

Hawassa
Phase I,
Cycle I

Hawassa

PublicApparel & textile Operational

5

Hawassa
Phase I,
Cycle II

Hawassa

PublicApparel & textile Operational

6

Adama

Adama

PublicMachinery,
Operational
apparel & garment

15

7

Dire
Dawa

Dire
Dawa

PublicApparel, & textile Operational

15

20

4

8

MekelleMekellePublicApparel & textile Operational

15

93

9

3,000

9

Kombolcha

Kombolcha

PublicApparel & textile Operational

9

100

6

2,000

10

Jimma

Jimma

PublicApparel & textile Operational

9

100

1

11

Bahir
Dar

Bahir Dar

PublicApparel &garment

Operational

9

100

1

12

Debre
BirhanDebre
BerhanPublicApparel &garment

Operational

8

100

2

ICT

Addis
Ababa

PublicDukem,
OromiaPrivate(foreign)

Mix

Operational

Private(foreign)

Leather

Partially
operational

13

Eastern
14 Industrial
Zone
Huajian
15 Industrial
park
16

Vogue

17

George
Shoe

18

DBL

Lebu,
Addis
Ababa
Mekelle,TigrayMojo,
OromiaMekelle,TigrayPrivate(foreign)
Private(foreign)
Private(foreign)

IT manufacturing
and business
Operational
services

Textile andgarment

Partially
operational
Partially
operational
Partially
operational

Leather
Textile andgarment

2

91

14,906

8

5

4,600

2

1

1,700

33

1

353

5

1
Total

179

81,559Source: IPDC, EIC and author’s compilation. Note that figures for the private parks refer to the year 2018
while for the public parks is as recent as the end of 2020.

38

parks is not equal to the number of occupied sheds. This is because some enterprises lease morethan one shed, sometimes even using sheds as storage space. It is estimated that the fiveoperational public industrial parks have created above 60,000 jobs as of 2020.
Table 1-7 reports the investment cost and source of funds of public industrial parks. The
overall investment cost of building 11 industrial parks listed below is estimated to be $819
million. Note that these investment costs are converted from figures in Birr, which are available
to us, to USD on the average exchange rate of the year of each Industrial Park (IP) establishment.
This may cause some discrepancies. Hawassa Industrial Park accounts for above a quarter of
the total sum of investment cost. The main source of investment funds is Eurobond. For the firsttime in 2014, Ethiopia issued Eurobond and raised $1 billion. Part of this Eurobond is used tofinance the construction of public industrial parks as shown in Table 1-7 below.
Although not at the scale expected, the industrial parks have started to generate export
revenue. Export revenue from the parks showed a sudden jump from $50 million in 2017/8 toabove $110 million in 2018/19. The government reported that export revenue for the year
2020/21 from both private and public industrial parks reached about $150 million. Figure 1-4
displays the export share of industrial parks in 2020/21. Hawassa and Bole Lemi, both of which
are public industrial parks, respectively accounted for 44% and 27% of the export revenue
generated from all industrial parks. The ICT Park, another public park, ranks third with 10% of
export. In contrast, the export contribution of private parks is much lower despite generating
significant employment. The private parks collectively account for only 6% of exports in thereference year suggesting their orientation towards the domestic market. This low export
Table 1-7. Investment Cost and Source of Fund of Public Industrial Parks
Industrial park
1
2

Hawassa IP Phase I
Bole Lemi IP Phase I

3
4
5
6
7
8
9
10
11

Kombolcha IP
Mekele IP
Adama IP
Jimma IPICT Park
Dire Dawa IP
Debre Birhan IP
Bahir Dar IP
Kilinto IP
Total

Investment cost
(USD million)
240.92
82.63
62.69
66.80
101.3953.14
29.51
106.44
33.92
41.04
N/A
818.79Source: IPDC.

39

Source of finance
Eurobond
Industry Development Fund
(Ethiopia Ministry of Finance)
Eurobond
Eurobond
Eurobond
Treasury
Data unavailable
Eurobond
Treasury + Eurobond
TreasuryWorld Bank

Figure 1-4. Industrial Park Export Share in 2020/21

Mekelle IP
2%

George shoes IP
1%
DBL IP
Velocity IP
1%0%

Huajian Shoes City IP
2%Dire Dawa IP
2%

Eastern IP
2%
Kombolcha IP
4%Adama IP
5%

Hawassa IP
44%

ICT Park
10%

Bole Lemi IP
27%

performance might be because some of the fully export designated private parks are at theirinitial stage and not fully operational.
1-5. Challenges and a way forward
The above sections reviewed Ethiopia’s history of FDI policy and the present investment
framework and examined the country’s performance in attracting foreign investment andgenerating expected economic and social benefits. The present section highlights the remaining
challenges and a way forward to enhance FDI inflow and maximize the advantages andopportunities from the presence of foreign firms in the economy.
1-5-1. The need for a unified FDI policy
Investment laws have been progressively liberalized, which is expressed in the sectors
opened up for private investment, requirements for admission and other approvals, removal of
limits on foreign shareholding in local companies, and so on. Liberalization accelerated inrecent years which now allowed foreign investors in previously restricted sectors such astransport, logistics, construction, education, health and other services. Besides this, thegovernment started to invite foreigners in partial privatization of large state companies
including Ethio Telecom.

40However, the country has yet to develop a comprehensive and unified FDI policy. The
absence of a unified FDI strategy has led to various problems that include divergent
understanding of the importance and management of FDI, inconsistency between different
initiatives and incentives, lack of coordination among different institutions, lack of monitoringand evaluation (M&E) capacity, and poor performance in terms of exploiting envisaged benefits
from FDI (Gebreeyesus et al. 2017).
1-5-2. Managing investment incentives
Ethiopia provides extensive fiscal and non-fiscal investment incentives to FDI and local
firms. In this chapter, we have shown that incentives are not selective enough and not attached
to meeting specific performance goals. When incentives are associated with performance, there
is a lack of capacity and system to monitor agreed targets and whether provided incentives arefetching the intended benefits. Moreover, both FDI and local firms often complain that they are
not sufficiently benefiting from the incentives provided to them due to implementation
problems and bureaucratic inefficiency. As a result, the incentives are largely ineffective inmeeting their objectives and are sometimes manipulated by various actors involved. Hence, thegovernment has to give high priority to managing incentives properly. Incentives need to be
selective, conditional on the achievement of some performance indicators such as employment,
export or technology, and revised when necessary. Because effective management of incentives
relies on the presence of capable and transparent bureaucracy, there is a need to strengthen thecapacity of civil service for investment policy and management.
EIC needs to take M&E as an integral part of its investment promotion. M&E is essential
for ensuring that objectives are achieved in the most efficient way possible. In this regard, EIC
must introduce key performance indicators (KPIs) into its activities that track outputs andoutcomes through time. Such tracking indicators help assess, for example, whether theinvestment incentives and supports are bringing appropriate results and outcomes.
1-5-3. Improving business environment
It is a widely established notion that, in attracting investors, improving the businessenvironment is more important than offering incentives. Ethiopia’s rank in the World Bank’s
Ease of Doing Business report is still among the lowest (159th in 2020) despite the recent
initiative to improve it through the newly established Steering Committee chaired by the Prime
Minister. Foreign and local investors often complain about, among other things, poor
infrastructure particularly access to power, poor tax administration, the slow pace of customs
clearance and inefficient trading logistics. Foreign investors are also facing increasingly long41

delays to remit their profits and other payments due to the shortage of foreign currency andbureaucratic hurdles.
Providing an excellent investment climate needs to be the priority of the government. Thisrequires addressing the binding constraints identified above and building the capacity andaligned rewards of civil servants. The formation of meritocratic and well-motivated civil service
is critical not only for attracting FDI but also for maximizing benefits that can be gained fromthe presence of FDI.
1-5-4. Enhancing institutional capacity and coordination
EIC is the leading institution with regard to FDI policy in Ethiopia. It has been given
extended responsibilities including promotion of investment and exports, improving theinvestment climate as well as direct support and regulation of industrial parks. EIC has madesignificant achievements to improve its services and investment promotion activities. However,its institutional capacity is still not sufficient to meet the added responsibilities and ambitious
targets. EIC has still limited capacity to design the right regulation, directives, and policy
incentives for effective implementation, monitor the process of implementation, and forecast
current and future developments. Thus, it is essential to further strengthen the capacity of EIC
in terms of the number of qualified people, motivation of staff, organizational structure andfunding.
FDI promotion and implementation suffer from coordination problems among relevant
agencies. For example, there remain areas of overlapping responsibilities and disputes between
EIC, MoTI and MInT. Moreover, there is poor coordination between the tax administration andthe customs office as well as with utility providers, particularly power. Though federal agencies
have opened satellite offices at the EIC, one-stop service is not fully functional due to limited
authority delegation and lack of digital services. There is also a lack of coordination between
federal and local governments as well as regional agencies regarding land administration andother services to investors.
Hence, concrete steps need to be taken to make the responsibilities of different agencies
clearer and strengthen vertical and horizontal coordination. For example, regions need to begiven more autonomy in managing FDI. Instituting productive competition among regions
towards attracting FDI can help not only in correcting the skewed geographical distribution but
also in increasing the country’s overall FDI inflow. In this regard, China can provide useful
lessons. Chinese local authorities enjoy a considerable degree of autonomy; they engage in
intensive law-making to attract foreign investments including all administrative matters suchas resource regulation, approval and licensing, as well as business services and coordination
with related government departments or agencies at various levels (Zhao and Farole 2011).

42However, caution is warranted that too much and unmanaged competition among regions canlead to wastage of resources and hurt the country at large as experienced in Vietnam (Au Thi
Tam Minh 2019).
1-5-5. Improving the effectiveness of industrial parks
Industrial park development is relatively a new concept for Ethiopia. The country lacks
experienced and qualified people in managing and administering industrial parks. IPDC is given
the regulatory role and serves as a land bank for industrial park development in the country.
IPDC is also a developer and operator of industrial parks. As a park developer, it is tasked toprovide serviced industrial land, pre-built sheds equipped with all-encompassing utilities, andinfrastructure facilities. IPDC cannot effectively deliver all its responsibilities given the limited
capacity it has. It often outsources park development to foreign contractors, which makes it
expensive and subject to rent-seeking practices. More importantly, the fact that IPDC is given
the regulatory role in addition to being a park developer and operator may cause a potential
conflict of interest.
It is recommended that IPDC have a “business model” rather than a mix of a business modeland a regulatory role. It has to refrain from the roles of regulator and land bank but focus on therole of industrial park developer and administrator. Moreover, IPDC has to compete with theprivate parks on equal footing. As a business model, it should be market-oriented and able toattract tenant enterprises, provide efficient and effective services to them, and sustain its soundoperation (Woldeselassie et al. 2017).
1-5-6. Enhancing technology transfer and spillover
The development of industrial parks and promotion of foreign investment in Ethiopia has
been perceived as the creator of business linkages and promoter of technology transfer andspillover to the local economy. However, Ethiopia’s investment framework has been passivewith regard to technology transfer. Furthermore, with the limited presence of local enterprises,industrial parks have become enclaves of foreign investors. The prospect for industrial parks tobuild backward linkages (local sourcing) with domestic suppliers is also weak due to the lackof raw materials and intermediates in the local market and poor capacity thereof (Zhang et al.
2018).
Hence, Ethiopia needs to ensure potential benefits of FDI be realized through an innovative
institutional arrangement to create domestic linkages such as co-location, performance-based
and targeted policy incentives, and support programs. The technology transfer issue will be
dealt with in detail in Chapter 4.

43

We end by repeating the recommendations by Gebreeyesus et al. (2017) for maximizing
technology transfer and gains from FDI, which also nicely summarize this chapter. First,
attraction, evaluation and selection of FDI should be based on their contribution to technology
transfer to domestic firms. Second, FDI should be continuously measured and monitored interms of technology transfer performance. Third, a proactive policy to encourage the formationof joint ventures should be designed. Fourth, domestic firms should be supported to improvetheir technology absorptive capacity. Fifth, business linkage programs need to be introduced to
improve technology transfer from FDI to local firms.

44

Chapter 2
FDI Policy for Industrialization:
From Quantitative Accumulation to Value Creation
2-1. Introduction
FDI policy must change with the diverse and evolving circumstances of each economy. There
are many international good practices in FDI attraction and investor support, but not allpractices are appropriate for Ethiopia. There are common success factors as well as different
methods suitable for individual host countries and particular sectors. There is no one-size-fitsall solution for all to follow. In learning global lessons, each government should create the rightmodel that best fits the reality of the home country by combining and adjusting foreign models.
Improper selection of FDI strategy will not work, and may even harm the fiscal anddevelopmental prospects of the nation.
Specifically, FDI policy should be customized in two dimensions. First, it must respond to
the unique conditions each nation possesses such as history, cultural and ethnic factors,
population size and location, resource endowment, developmental stage, the dynamism of theprivate sector or lack thereof, policy capability of the government, and external relations andthe geopolitical situation. Second, over time, the FDI policy of any nation must change as
development proceeds and new challenges emerge, from general attraction to selective
invitation, and from incentivizing all investments to supporting true value creation only.
This chapter discusses six related aspects of FDI policy: (i) FDI policy as a double
maximization problem; (ii) the pursuit of win-win solutions for investors and the host country
with concrete and diverse examples of automotive assembly in Asia; (iii) distinction ofirresistible attractions and non-essential conveniences for FDI; (iv) how to use available policy
instruments and remove impediments; (v) moving from general quantitative accumulation todomestic value creation with selectivity; and (vi) improving industrial park management fromthe Asian perspective. Background information for this chapter was collected from industrial
policy research and dialogue conducted by the National Graduate Institute for Policy Studies(GRIPS) Development Forum and its precursors over the last three decades. Many concrete
cases are drawn from Northeast and Southeast Asia, while some observations come from Africa.
Many countries cited here performed well in FDI policy but some less successful cases are alsopresented. Our method is the extraction of relevant lessons from many case studies. It is hopedthat the discussions below will inform the policymakers of Ethiopia, a country in the early stage

45

of FDI-led industrialization, to identify critical issues and upgrade its FDI policy to the nextstage.
2-2. FDI motive versus policy objective
Firms maximize profits. They also want to expand their businesses. Their primary objective is
not charity or the development of the host country. The global trends of human rights, corporatesocial responsibility (CSR), Sustainable Development Goals (SDGs), and Environment, Social,
Governance (ESG) add responsibility elements to corporate behavior, but they do not dislodge
the original profit motive. This is true across all ages and nationalities, and FDI firms are no
exception. However, firms adopt different strategies to pursue these objectives, which leads todiverse corporate behaviors (Section 2-6).
FDI policy should be regarded as a double maximization problem in which government
promotes national development knowing well that FDI firms pursue their own private purposes
under all circumstances. Technically put, it is the maximization of the objective function of
government subject to the constraint that foreign firms maximize profit. Good FDI policy is theone that entices FDI firms to willingly take actions that are conducive to the development of
the host country, leading to a win-win solution for both sides.
The idea of double maximization makes clear two mistakes often committed by uninformed
governments. The first is to assume that, once FDI firms arrive, they automatically contributeto national development regardless of the type of FDI and without any policy effort to makethis happen. However, such optimism is unwarranted. The second is to regard FDI firms merely
as a policy instrument that government can use to achieve national goals, without recognizing
their private motives (i.e., forcing them to do something against their will). Some governments
are well aware of the nature of this game while others fall into one of these traps. Host
governments should not preach to FDI firms to change their corporate objectives or behavior
against their will. The key question is how to set policy parameters to produce good results forboth the host country and FDI firms, taking the latter’s motives as given.
Regarding the first mistake, Todo (2008), backed by vast theoretical and empirical literature
review, concludes that technology transfer from FDI to local firms does not occur automatically
but accrues only to those countries that (i) select the right types of FDI that contribute todevelopment instead of doing simple production, and (ii) prepare necessary domestic conditionsin terms of policy support, business climate, and sufficient absorptive capacity in technology
and human resource. FDI improves the technology level of a host country through technology
spillover (from FDI to local firms belonging to the same sector) as well as backward linkage(from FDI to local firms that supply materials or components in the upstream of supply chains).
However, there is also the risk of FDI crowding out domestic firms by invading their domestic

46

turfs or export markets as well as by poaching best managers and engineers and increasing theirhiring costs.
Various empirical studies demonstrate that technology transfer from FDI is conditional andcalculated rather than universal and automatic. However, domestic conditions needed tomaximize FDI’s contribution vary among different studies. Using international datasets,
Balasubramanyam et al. (1996) shows that FDI stimulates growth only when export promotion
policy is in place instead of import substitution. Borensztein et al. (1998) finds that FDI
accelerates growth in countries with sufficient human capital but not in others. Alfaro et al.
(2004) and Durham (2004) additionally reveal that the maturity of financial markets and thequality of economic institutions (especially the absence of corruption) also matter in generating
positive FDI impact. Studies on East Asia by Kim and Ma (1997) and Lall (2000) report thatdomestic workers may easily learn factory operation and maintenance, but not fundamental
technology that is the source of global competitiveness.
The model of Glass and Saggi (1998, 1999) suggests that FDI inflow may discourage true
technology learning by domestic firms when they can learn by easy “imitation” (haphazard
copying). Literature is unclear on whether the size of the technology gap between foreign anddomestic firms encourages technology transfer or deters it. When the gap is too wide, local
firms may not be able to digest much from the knowledge offered. This points to the need toacquire minimum technology competency before learning higher technology.
Using firm-level data, Kokko (1994), Chuang and Lin (1999) and Blömstrom and Sjöholm
(1999) find a positive effect of FDI on domestic production in Mexico, Taiwan and Indonesia,
respectively. However, Haddad and Harrison (1993), Kinoshita (2001), Aitken and Harrison(1999) and Le Quoc Hoi (2008) find little or even negative impact in Morocco, the Czech
Republic, Venezuela and Vietnam, respectively. These contradictory results may partly comefrom statistical or data problems, but they may also reflect national differences in readiness tomobilize FDI effectively.
Concerning backward linkage, Rodriguez-Clare (1996) argues that FDI prefers to use
domestic components over imported ones when the logistic cost of imports is high and whenthe quality of domestic components is also high (or at least the same) compared to that ofimports. Empirically, Javorcik (2004), Blalock and Gertler (2008) and Liu (2008) find that thepresence of FDI increases the output of local suppliers (i.e., backward linkage) but does not
improve Total Factor Productivity (TFP) within the same sector (i.e., technology spillover) for
Lithuania, Indonesia and China, respectively4.
Kinoshita (2001) and Todo (2008) additionally argue that R&D activity conducted by FDI firms in host countries
is a significant promoting factor of technology spillover from FDI. Although Todo (2008) insists that this effect ispresent even in low-income countries, it must be admitted that FDI firms usually consider doing serious R&D(beyond adjusting products for local tastes) only after a host economy achieves middle or higher income, with asufficient domestic supply of scientists and engineers.
447

2-3. Win-win solutions and failures: automotive cases in Asia
Regarding the second mistake, attempts to force FDI firms to manufacture advanced products,
transfer high technology or train engineer to high competency usually fail when these demands
are not accompanied by necessary domestic conditions and when the government does not
strive to generate such conditions. Many industrial sectors need large sales volume before they
can invest in the latest equipment and diversify product mixes. Factories using sensitivemachinery require solid ground and absolute stability in power supply. Firms competing
globally in swift customer response cannot operate unless logistics is efficient and free of any
bureaucratic delay or interference. Specific requirements vary from industry to industry, andeven from firm to firm. Nevertheless, one universal demand is the supply of domestic managers,
technicians and workers in sufficient quality and quantity—and at the right price—for the
chosen process. Many governments do not understand these business requirements and force
FDI firms to contribute to national development without trying to supply the required conditions.
This one-sided demand frustrates FDI firms operating in the country and reduces theiroperational efficiency, and keeps others away. There are many examples of such cases in Asia.
Let us take automotive assembly as an example.
Vietnam, after opening its economy to the capitalist world in 1992-93, attracted many
foreign manufacturing firms. Japanese automotive firms began to assemble cars in Vietnam in
1995, spearheaded by Toyota and followed by Honda, Mitsubishi, Mazda and others. Japanesecarmakers insisted that market growth and selection of priority models were key to car industry
development in Vietnam where domestic new car sales were still small. However, theVietnamese government routinely suppressed domestic market growth with high vehicle levies
and registration restrictions for various reasons such as tax collection and traffic control, whileaccusing Japanese carmakers of not transferring technology, not purchasing enough domestic
components and keeping car prices high. The Japanese side complained that necessary policy
measures were not in place, but the Vietnamese side continued to criticize carmakers. This
policy stalemate continues even today. After a quarter-century, Vietnamese car production
remains relatively small at 300,000 vehicles per year for a country of about 100 million people,
with high production costs and little export. Assembly remains inefficient due to the small
volume.
In Thailand, government and Japanese investors maintain a far more constructive
relationship. Japanese carmakers began to arrive in Thailand in the 1960s. Production jumped
in the late 1980s as the Japanese yen appreciated which made Japanese production costs high.
Many Japanese manufacturers left home to build new production bases in Southeast Asia.
Initially, one-ton pickup trucks were the main model in Thailand. The Board of Investment(BOI), the Ministry of Industry (MOI) and the Thailand Automotive Institute all understood48

what foreign automakers needed to compete globally and grow. The automotive policy wasliberalized and localization requirement was eased in the 1990s. Supporting industries(domestic component suppliers), FDI-local firm linkage, automotive engineer training and ecocar production were promoted with a joint effort between Thailand and Japan. Japanesecomponent suppliers came in great numbers to Eastern Seaboard where large industrial parks,
ports and highways were built with Japanese official development assistance (ODA). Car
production traced an upward trend albeit with large fluctuations. Although the population ofThailand is 70 million, which is less than Vietnam, it produces far more automobiles than
Vietnam. It reached one million in 2005, peaked at 2.5 million in 2012-13, and hovered around2 million in 2014-19. Half of the finished vehicles, as well as high-quality automotive
components, are exported. In 2019, Thailand was the eleventh largest car-producing country in
the world. One high official of BOI noted that “investors don’t like being forced.” One Japaneselarge automotive parts maker said it was happy with the Thai business environment and policy
support. Toyota Thailand easily beats Toyota Vietnam in terms of car prices because the former
enjoys much larger domestic and export markets that permit cost reduction.
Malaysia also developed the automotive industry but with a stronger hand of the state thanThailand. Instead of opening and liberalizing, the government established Proton, a state-owned
national car company, in 1983 with heavy support and protection. Technology was initiallyborrowed from Mitsubishi Motors of Japan, but the partnership was later dissolved as Proton
tried to internally develop core capability in design, platform, engine, sales logistics andmarketing. Proton enjoyed many privileges including high import protection, tax and tariff
incentives, and local parts supplier promotion (the Vendor Development Program). By early
2000, Proton had more than 50% of the domestic car market, with 286 local parts suppliers.
However, it got into trouble when global and regional free trade deepened and automotive tariffs
began to be reduced toward zero. Proton’s domestic share plummeted to 27% by 2011 while
those of FDI brands expanded to 44%. Losses were incurred year after year. Several foreign
automotive giants were approached for a new partnership but without success. Finally, Geely
Automobile of China came to the rescue in 2017 by buying up 49.9% of Proton’s shares. After
four decades of operation, the company remains a small player producing 500,000 vehicles per
year mostly for domestic customers. Malaysia’s effort to foster homegrown capacity waslaudable, but the halfway technology it acquired was not good enough to survive in the global
car market where Japanese, European, American and Korean multinationals compete fiercely.
Indonesia, with a population of 271 million and a per capita income of $4,050 (World Bank
data, 2019), has a large and growing domestic automotive market. Attracted by this large market,
many foreign automakers assemble cars in Indonesia even though government offers little49

incentive or support 5 . Both domestic and foreign firms bitterly complain that policies are
unpredictable, ambiguous, arbitrary and uncoordinated, and that ministerial regulations areissued suddenly without stakeholder consultation (GRIPS Development Forum 2016).
Technical training, die-and-mold technology and industrial parks are promoted by private firms
and business NPOs without government support. Indonesia’s manufactured goods are boundmostly for domestic use. Unlike Thailand, multinational corporations do not regard Indonesia
as a global export base. The Indonesian case proves that large domestic demand is a powerfulmagnet for foreign manufacturers even if other business conditions and incentives are missing(Section 2-4). If policies were more proactive and supportive, Indonesia would achieve far morequalitative growth driven by productivity and global competitiveness rather than the current
one driven by volume only.
In a similar vein, but far more drastically, China, boasting 1.4 billion people, is a hugemarket few FDI can resist. When China opened up in the 1990s, its large surplus labor and low
wage were a major attraction, but this supply-side advantage has all but disappeared as income
and wage rose rapidly and labor shortage emerged. But Chinese attraction on the demand side
remains enormous and grows bigger year after year. Chinese leaders are well aware of this anduse it for strategic purposes. They impose additional rules on FDI which are hardly acceptablein other host countries such as disclosure and transfer of frontline technology as well ascompliance with China’s political requirements and sensitivity. Foreign firms are faced withthe tough choice of bowing to these unreasonable rules or quitting this lucrative market. The
issue has caused a head-on collision with the United States over human rights, cybersecurity
and technology theft in competition for world hegemony. It should be stressed that such
coercive actions on FDI are unique to China and not advisable in other developing countries
that are neither a superpower nor with colossal domestic demand. That would only make thehost country less attractive to FDI.
Uzbekistan, a Central Asian republic that attained independence in 1991 after the
dissolution of the Soviet Union, with a population of 33 million, offers an interesting case inautomotive development. It long suffered declining output and high inflation, lingering state
control and doubly landlocked location with long logistic lines (sea access requires passing atleast two countries). The place hardly seems fit for automobile assembly, and it produced nocars before 1992. Yet, with partnership first with Daewoo of Korea, and now with General
Motors (GM) of America, Isuzu of Japan and MAN of Germany, Uzbekistan produces roughly
200,000 vehicles per year some of which are exported to Russia and neighboring Central AsianTax holiday exists on paper, but very few firms receive it due to high hurdles. They include strict sector eligibility,
the requirement of large investment and employment, contribution to socio-economic infrastructure, and buying
local inputs. This virtually shuts out all small firms and even many large ones. When Japanese businesses requested
broader and more meaningful investment incentives, the chairman of the BKPM (a local acronym for theIndonesian Investment Coordinating Board) replied that a large population was Indonesia’s investment incentive.
550

republics. GM built a huge state-of-art engine factory in Tashkent, a feat that no country inSoutheast Asia has achieved. Isuzu has a joint venture for truck and bus assembly in Samarkand
with high quality and efficiency. Both plants are run by local managers and engineers with no
expats directing the daily operation. There are three success factors for Uzbekistan’s automotive
achievement. First, the country had a good supply of well-trained automotive engineers fromthe Soviet era with a university dedicated to this technology. Second, after overcoming
collapsing output, high inflation, foreign currency shortage and dual exchange rates, policy topromote the automotive sector became reasonable with standard tax and tariff incentives andadequate subsidies. Third, given the small domestic and regional market, only one passenger
car maker (GM) and two commercial vehicle makers (Isuzu and MAN) were allowed to enter,
which increased volume per model and realized efficiency and low cost.
2-4. Irresistible attractions versus non-essential conveniences
Almost all nations, both developing and developed, compete for FDI attraction. It is a global
game to bring as many foreign firms as possible, preferably of high quality, to the home country
to accelerate national development6. We therefore need to know what specific national featuresstrongly attract FDI and what policy instruments are available to generate and sustain suchfeatures. These policy instruments must be mobilized to simultaneously support high-quality
FDI and fulfill national purposes, without imposing unilateral demand from one side to theother. This is a task that requires deep industrial knowledge, policy experience and political
judgment.
There are many national features that attract FDI. They can be classified into those that are
irresistible and sufficient and those that are desirable but non-essential (Table 2-1). The first
type is genuine sources of business profit or expansion, and the presence of any one of them issufficient to draw the attention of FDI even in the absence of other conditions. The second type
is those that please FDI firms and facilitate their activities provided that business advantage(s)of the first type is present in the host country and the firms are seriously interested in investment
and operation. The presence of national features of the second type alone, without the first type,does not stimulate FDI very much. In other words, any advantage of the first type constitutes asufficient condition for FDI entry while advantages of the second type are neither necessary nor
sufficient.
There are historical exceptions where development occurred without FDI. Nations with sufficiently high initialcapability did not adopt FDI-led industrialization. Korea borrowed funds actively from international sources but
did not accept FDI. Japan received some foreign firms in the first quarter of the twentieth century but did not
permit them during the rest of its catch-up process. Both preferred domestic firms to build the nation’s industrial
base, and were able to do so. In the 1970s, Southeast Asian countries protested against Japanese FDI as economic
imperialism. But such a hostile attitude is rare today as virtually all developing countries eagerly court FDI.
6

51

Table 2-1. Compelling versus Non-essential Advantages for FDI Attraction

Source: author’s research.

Through extensive interviews and research in 25 economies in Asia and Africa over the last
three decades, the GRIPS Development Forum has identified four compelling reasons for FDI
to rush in (Ohno 2013; GRIPS Development Forum 2016). They are large domestic demand,
natural resources, labor advantage and trade privilege.
Firms go to places where customers are. If demand is large and growing, they are compelled
to enter that market in order to survive and/or prosper. Some special products which are highly
valuable and portable may be exported (think smartphones), but most others that are bulky,
costly to transport and often protected by import barriers must be produced near the market(think automobiles, metal components and processed food). Other reasons to produce at themarket include shorter lead-time and less cost in product delivery and parts procurement, as
well as the need to adjust product design to different national tastes.
The existence or discovery of natural resources—oil, gas, coal, copper, rare metals, diamondand others—is another irrefutable reason for multinational corporations in the extractive sector
to come to particular countries and regions, be it a remote desert or beneath the ocean. There islittle freedom in selecting mining locations even if living and social conditions are harsh. One
thing that the host government should beware of is the fact that the type of ownership,participation or concession provided to extractive foreign firms differs greatly from meager tovery generous, depending on the political and technical capacity of the host country relative tothose of multinationals. In mining, foreign commercial interest and national welfare must be

52balanced properly.
Labor advantage is another powerful lure for FDI firms. This has a great consequence onnational development, and host countries therefore promote it very eagerly. There are two very
different types of labor advantage. The one is the availability of an abundant supply of unskilled
but cheap and trainable workers, which attracts FDI that does large-scale labor-intensive exportoriented production such as garment, footwear, food processing and electronic component
assembly. However, even if the wage is low, productivity must exceed a certain minimum level
for this advantage to work; FDI will incur losses if labor productivity is lower than the wage.
The other is the availability of outstanding professionals in management, engineering,production, research, marketing, procurement, finance, accounting, customer relations andother business functions at prices that may be very high but are justified by their highcapabilities. Again, the balance between productivity and wage is critical. Singapore is an
example of a country with such labor advantage for multinational corporations wanting toestablish a regional hub office. India has a large pool of competent ICT engineers who cancompete with those in advanced countries at a reasonable cost.
Additionally, trade privileges for developing economies such as the African Growth andOpportunity Act (AGOA) of the United States, Everything But Arms (EBA) of the European
Union, regional and bilateral free trade agreements, and global preferential mechanisms under
the World Trade Organization (WTO) are artificially created reasons to relocate factories tocountries enjoying such privileges from places without them. Ethiopia has been a beneficiaryof this advantage, and many garment FDI firms cite this as one of the reasons why Ethiopia waschosen.
These are four irresistible reasons for FDI entry because they directly contribute to thecreation of business profit and/or expansion, and the existence of even one of them makes
foreign firms excited and restless. They often come even if the country is beset with fragile
security, political disorder, natural disasters, chronic recession or a horrible business climate. If
two or more such advantages are offered, attraction is unstoppable. China used to offer a lowwage labor advantage but no more. But its huge domestic demand has made it the most popular
destination for FDI in the world. Thailand and Vietnam followed a similar path where initial
low-wage labor advantage was gradually superseded by domestic demand advantage as
industrialization continued and the middle mass with strong spending appetite emerged. Foreign
firms flock to India and Indonesia for the same reason, drawn by a large population and risingconsumption, even though other advantages are largely missing and the investment climate ispoor. Meanwhile, Nigeria, Zambia, Angola and Mozambique are attractive because of theirunderground resources. Morocco, now economically integrated with the EU, is growing tobecome an automotive hub in North Africa thanks to its double advantages of low wages andtrade privilege.

53

We now turn to the second group of advantages which are useful and even crucial forinvestors for business operation but do not necessarily ensure a large inflow of high-quality
FDI. These are commonly called good business climate or eco-system and include political andsocial stability, clean and accountable government, stable and predictable policies, smoothadministrative procedures (which the World Bank’s Doing Business scores and ranking
capture—see below), ethical and environmental correctness, efficient and reliable infrastructureservices, level playing fields for all enterprises, and so on. There is no denying that suchconditions are desirable and must be pursued as an integral part of the modern businessenvironment. They do accelerate business operation by removing various obstacles if FDI
decides to invest. Yet, they are only auxiliary facilitators of business profit or expansion, andthey alone are incapable of bringing high-quality FDI7. Political stability and reliable power
and logistics are essential for business, but not all countries with these conditions are popularwith FDI. Quick licensing and visa issuance means little when the country does not offer profit
opportunities. Business-friendly procedures do not guarantee commercial success if wages are
too high relative to labor productivity.
Many countries, including Ethiopia, try to improve the World Bank’s Doing Business score
as one of the strategies to activate domestic investors and absorb more FDI. This score is basedon ten areas of business regulation—starting a business, dealing with construction permits,
getting electricity, registering property, getting credit, protecting minority investors, paying
taxes, trading across borders, enforcing contracts and resolving insolvency—where the speed
and simplicity of these business-related procedures are evaluated (World Bank 2020). But they
are not the core FDI motives of the first type. Providing a comfortable business environment isa worthy project that should be implemented with strong resolve. However, that alone may not
greatly increase FDI inflow unless the country already has compelling attractiveness as defined
above.
Figure 2-1 shows the correlation between the World Bank’s Doing Business 2020 score(based on the survey result of 2019) and average annual per capita FDI inflow (in logarithm)
during 2014-2019 for 175 countries and territories. Correlation is 0.561 and statisticallysignificant, confirming that FDI inflow is positively correlated with the Doing Business score8.
After the breakup of the Soviet Union in 1991, Kyrgyzstan became an independent state in Central Asia. It
immediately liberalized and opened up its economy, accepted World Bank advice, implemented IMF
conditionalities and joined WTO which made it the freest economy in the region. It also created a free trade zone
with ample incentives and efficient service for foreign investors. But few foreign firms came because the country,
a tiny republic with nomadic tradition and limited natural resources, did not have any of the irresistible advantages
for FDI attraction. The opposite example is offered by Indonesia (Section 2-3) where a large and growing domestic
demand attracts many automotive assemblers despite a lot of red tapes and little policy support.
8
In this calculation, countries and territories for which data are missing or incomplete as well as tax havens are
excluded. Replacing the UNCTAD data for per capita FDI inflow with similar World Bank data on 167 countries
and territories for 2014-2018 (World Bank data for 2019 is mostly missing as of this writing), we get a correlationof 0.581, which is slightly higher than reported above.
7

54

Figure 2-1. FDI Inflow versus Doing Business Score

Sources: World Bank, Doing Business 2020, October 2019; United Nations
Conference on Trade and Development, FDI Statistics, accessed on October 6,
2020.
Note: for 175 countries and territories for which data is complete in both sources.

However, the R-squared of 0.315 means that more than two-thirds of FDI dynamics remains
unexplained. Scanning Figure 2-1 vertically, we find that countries having the same Doing
Business score may show very different FDI performance from very little to massive. Moreover,a positive correlation does not necessarily imply causality from the Doing Business score to
FDI performance. Both may be the results of a third, more fundamental cause such as income
growth and the government’s general policy capacity.
In Ethiopia at present, low-wage labor advantage is the most compelling FDI attraction, an
advantage that should be further developed in the coming years. Yet this advantage remains
only potential unless the labor productivity-wage nexus is set right, making sure that laborproductivity grows strongly and the fruits of efficiency are equitably distributed to workers (PSI
and GRIPS 2020). This is realized when wages rise at about the same rate as labor productivity
rather than above or below it. This in turn requires a sustained strong national productivity drive
coupled with a (minimum) wage-setting mechanism that is scientific and fair rather thanpolitical and arbitrary.
Another irresistible advantage Ethiopia and many other African countries already enjoy is55various tariff privileges, especially AGOA 9 and EBA but also other bilateral, regional andglobal mechanisms such as the African Continental Free Trade Agreement (AfCFTA), the East
African Community (EAC), the Common Market for Eastern and Southern Africa (COMESA),the Economic Community of West African States (ECOWAS), the Southern African
Development Community (SADC) and the WTO’s Generalized System of Preferences. The
other two irresistible advantages—domestic demand size and natural resource endowment—
are currently modest to insignificant in Ethiopia relative to its population size and in comparison
with other African countries. For a small number of products such as nutrition food supply, beer,
and construction equipment and materials, Ethiopian domestic demand is not so small. But thesame cannot be said for broader categories of goods and services. When Ethiopia reaches lower
middle income and proceeds strongly to upper middle income, and when a middle mass withhigh spending propensity emerges, Ethiopia’s large domestic demand will surely become an
additional magnet for FDI.
2-5. Policy instruments and removal of impediments
The government’s objective in inviting FDI—unless it is a corrupt or incompetent
government—is developmental. This includes job creation, domestic value creation, upgrading
skills and technology, adoption of global practices and standards, expanding export markets,
active and meaningful participation in global value chains, or a combination thereof, for theultimate purpose of raising citizens’ living standards and welfare.
In the early stage when poverty and unemployment are widespread, job creation, especiallyfor the youth, often becomes an overarching national goal as seen in Ethiopia, India and
Myanmar. But not all countries strive for this policy objective. If the country industrializes
vigorously and passes the “turning point,” 10 A massive migration of rural labor to urban
industries eliminates labor surplus and begins to generate labor shortage and upward wage
pressure. For such economies as China, Thailand and the urban areas of Vietnam, improvementof the quality, productivity and innovativeness of labor, rather than the sheer volume of job
creation, is critical for moving up to the next stage. This policy transition is not sudden but anoverlapping one in which job creation and improvement of labor quality must be pursued
simultaneously for a substantial period. Education of good scientists, engineers and workers
The US suspended Ethiopia’s AGOA privilege in January 2022. It is hoped that this situation is only temporary
and Ethiopia’s status will be reinstated in the near future.
10
The dual economy model of Arthur Lewis postulates that industrialization of a labor-abundant traditionalsociety proceeds with an expansion of modern industry which absorbs agricultural surplus labor through ruralurban migration (Lewis 1954). If this process goes successfully and sufficiently, idle or underemployed workers
will eventually be eliminated. This is Lewis’ “turning point” at which labor surplus turns to a labor shortage in thenational economy. Beyond this point, wages start to rise and the total wage bill increases, which tends to generate
income distribution in favor of labor.
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takes a long time for which supporting policies and institutions must be prepared from an earlystage.
Table 2-2 lists standard policy instruments available for inviting FDI to realize the above
aims. These incentives must be given selectively and conditionally based on product, sector,
location, value creation, employment, training, technology transfer, export performance, R&D
expenditure, or any other objective the nation intends to promote. The question is how to use
these policy tools to satisfy the business needs of FDI and pursue national development
simultaneously in the double maximization problem discussed earlier. Moreover, it is important
to avoid being too generous or too mean. Governments sometimes compete too fiercely against
other nations or regions to attract FDI and end up offering excessive incentives. On the other
Table 2-2. Policy Instruments for FDI Attraction
1

Policy instrument
Policy announcement2

Tax incentives

3

Subsidies and loans

4Non-financial privileges

5

Procedural convenience

6

Consultation

7

Participation in policy
design8Foreign currency
allocation (if applicable)

RemarkAn announcement of policy direction as well as prioritized(or permitted) products and activities which receive
official attention and favor, together with incentives.
Time-bound or permanent exemption or reduction of
corporate income tax, import duties, and other taxes andcharges (value-added tax (VAT), sales tax, special
consumption tax, luxury tax, capital allowance to offset
tax liability, etc.)
Subsidies and soft loans given to designated activities suchas export, investment, training, technology transfer,industrial linkage formation, marketing, ICT, etc.
Non-financial privileges concerning land acquisition anduse; preferential access to industrial infrastructure andfacilities; performance-based allocation of export, importor investment quotas (if any); guarantee of stable power,
water supply, security and other services; and access toindustrial information and labor pool.
Exempted, simplified or fast-track administrative
procedure for customs clearance, tax filing, visas,
residence permit and others.
Intensive public-private consultation as well as informal
contacts where government and FDI firms share
information, make requests or solve problems.
Private sector participation in the formulation of a sectoraldevelopment strategy in which firms with serious intentionof investing and value creation are listened to and theirrequests are accepted if reasonable and responsible.
Prioritized allocation of foreign currency when there is anacute foreign currency shortage.

Source: author’s research.

57

hand, incentives are sometimes too restrictive in terms of eligibility, amounts and duration,
which fails to influence the behavior of FDI. Both mistakes must be avoided.
Not all incentives in the above list need to be offered. Many governments provide one or a
few key incentives competently to attract high-quality FDI. Because policy capacity andfinancial resources are limited, each country must prioritize policies where improvement andincentivization are most keenly needed. Copying other countries’ policies with little regard tonational differences hardly works. Let us look at the examples of two Asian governments.
In Malaysia, the Malaysian Investment Development Authority (MIDA) has since 1967
provided highly efficient one-stop FDI marketing, project approval, and facilitating services in
the manufacturing and service sectors. It offers customer-oriented professionalism. Belonging
to the Ministry of International Trade and Industry, MIDA also plays policy functions inrevising and improving the nation’s investment policy. Malaysia’s investment incentives are
simple and transparent (corresponding to item 2 above). For manufacturing, they consist of
Pioneer Status which offers corporate income tax exemption of 100% of the statutory income
for a period of up to ten years, or Investment Tax Allowance of 100% on the qualifying capital
expenditure incurred within five years of initial investment, offset against 100% of the statutory
income for each year of assessment. Firms must choose between Pioneer Status and Investment
Tax Allowance. Some carryovers of unused incentives to other years are permitted.
Manufacturing firms also enjoy import duty and sales tax exemptions for imported materials,
components and equipment. MIDA’s sectoral divisions and weekly Action Committee screen
incentive applicants by using the frequently updated eligibility list supplemented by case-bycase organizational judgment. MIDA prioritizes true manufacturing (not just trading), value
addition, technology transfer and industrial linkage. MIDA works closely with other ministries
and agencies, including the Ministry of Finance. The approval process is quick, taking two
weeks at most. Japanese firms report no trouble in Malaysia’s investment approval procedure.
Compared with Malaysia, Vietnam’s investment policy and procedure are far more complex,
ambiguous and inconsistent. Nevertheless, there is a bilateral official forum to eliminate
concrete problems one by one (item 6 above). In 2003, Japan proposed, and Vietnam agreed to,the establishment of the Vietnam-Japan Joint Initiative to Improve Business Environment witha View to Strengthen Vietnam’s Competitiveness (VJJI for short). Under this initiative,
Japanese FDI firms report problems, then two-year action plans are bilaterally agreed andrigorously implemented and monitored. On the Vietnamese side, the Ministry of Planning andInvestment is the hub organization that invites other ministries to participate in VJJI. On theJapanese side, the Keidanren (Japan Business Federation) and the Ministry of Trade, Economy
and Industry (METI) strongly support this initiative. The Japanese embassy in Hanoi is incharge of operation and logistics. Many Japanese firms in Vietnam, split into several working
teams, actively contribute to VJJI. By the end of 2019, VJJI completed seven phases of VJJI in

58

which 385 concrete issues were selected for correction. Results are classified into four ranks(Done, On track, Delayed, Not implemented). The success rate (Done or On track) ranges from
78% to 94% depending on the phase, which is extremely high for this type of official exercise.
In early phases, business impediments related to taxes, visas, permits, procedures and legal
inconsistencies were mostly dealt with. In later phases, the focus shifted to industrial policy
improvements and the strengthening of Vietnamese partner firms and workers. The benefits of
VJJI are open not only to Japanese FDI but to all firms including domestic firms and nonJapanese foreign firms operating in Vietnam. The latter can enjoy achieved conveniences
without participating in the initiative or incurring any cost.
In Ethiopia, the general business climate is still unfavorable as shown in the World Bank’s
Doing Business ranking (159th among 190 economies, or 16% from the bottom, in the 2020
ranking). Investors encounter numerous problems which are not thinkable in Malaysia or even
Vietnam. To remedy this situation, the Ethiopian government should adopt a two-part strategy
in which broad-based improvements are made steadily and continuously—as the governmentis already doing with the Doing Business score—and, at the same time, improvements are also
made on sharply targeted areas that matter greatly to national development. As one of thecandidates of targeted areas, the GRIPS Development Forum studied the prospects of attracting
automotive assembly to Ethiopia during 2017-19, interviewing Japanese carmakers potentiallyinterested in Ethiopia, in Tokyo as well as at their overseas offices in Kenya and Myanmar—
because these are the two countries at similar automotive development stages as Ethiopia butwhere Japanese firms already assemble cars11.
Interviews with Japanese automotive makers have revealed that four policy areas are criticalin inviting them to Ethiopia (Ohno 2020). First, the foreign currency shortage needs to beameliorated, at least for priority sectors that should include automotive assembly. Second, used
car import should be curbed as a precondition for encouraging domestic car production. Third,
the incentive structure should be simpler and more conducive to domestic assembly. Fourth,long-term automotive demand forecasts, together with car model selection and supporting
policies, should be officially announced. Kenya, where Isuzu and Toyota already assemble
vehicles, satisfies most of these conditions, especially by offering a simple and conducive
incentive structure. Myanmar, whose policies are still primitive and Doing Business ranking(165th in 2020) is lower than Ethiopia, has already attracted assembly plants of Suzuki, Toyota
and others mainly because it succeeded in dramatically reducing used car imports. Ethiopia isalso making effort in these four areas. In 2019, it began to revise the automotive tariff structure
For the countries discussed here, the 2020 World Bank Doing Business rankings are as follows: Malaysia (12th),
Kenya (56th), Vietnam (70th) and Myanmar (165th). It is noteworthy that Myanmar, scoring below Ethiopia in
Doing Business, attracted many foreign automotive assemblers spearheaded by Suzuki with the domestic
production of 15,496 vehicles in 2019. However, Myanmar’s business perspective after the 2021 military coup
remains uncertain.
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and restrain used car imports, and this has already produced a dramatic shift in import demand
from used cars to new cars. When Ethiopia’s automotive policy fully embraces the four criticalissues, it should attract more automotive assembly because domestic vehicle demand ispotentially large and should be growing.
Last but not the least, foreign currency shortage mentioned above is an additional, outdated
and unnecessary business obstacle unique to Ethiopia which discourages not only theautomotive sector but all others. It constitutes the single most serious impediment to investment
in Ethiopia. The Ethiopian government is well aware of this problem and vigorously working
to solve it in cooperation with foreign governments and international organizations. This
enormous disadvantage of Ethiopia, which nullifies all other policy efforts to attract highquality FDI, must be removed as soon as possible.
2-6. Moving from quantitative accumulation to domestic value creation
Because FDI firms are all different, and because the developmental needs of a latecomer
country evolve over time, FDI policy must be adjusted significantly and dynamically, at least
every few decades, to maximize national gains obtained from the presence of foreign investors.
2-6-1. Moving from the initial labor-intensive stage to the next
FDI-led industrialization normally starts with the arrival of large-scale, labor-intensive andexport-oriented manufacturing firms which generate many new jobs for unskilled workers. Hostcountries initially welcome such investors as they help the nation to tackle the problem of
pervasive unemployment and underemployment, even though wages and technology are low
and surging exports are mostly offset by imports of materials and intermediate inputs. That is
the first stage of FDI-led industrialization.
When this process proceeds successfully and sufficiently long, a “turning point” will bereached when surplus labor is eliminated in the national economy, labor shortage emerges andwages begin to rise (Section 2-5). The national economy must now shift from simple processing
to more sophisticated production that requires professional management and engineering.
Policy focus should also shift from creating as many jobs as possible (of whatever kind) to
upgrading industrial human resources for domestic value creation, meaningful participation in
global value chains and competing effectively in the world market. Foreign managers andengineers should be replaced, in proper speed and steps, by domestic ones.
The transition from the first stage of FDI-led industrialization to the next is not sudden but
a gradual, overlapping process. For a considerable time, old-type manufacturers doing simple
production in large standardized sheds co-exist with those engaged in precision, specialized or60

Figure 2-2. Stages of Catching-up Industrialization: the East Asian Pattern

Source: author.
Note: some economies cannot be placed neatly in this diagram. China is a huge country thatencompasses many types of production simultaneously, from simple assembly to frontline
technology. Singapore is a small island state that began with labor-intensive manufacturing in
the 1960s but later deviated from the manufacturing path to develop logistics, finance, high-techservices, and regional business hub functions as its main industries.

otherwise high-tech production in customized, equipment-heavy and usually much smaller
workspaces. Figure 2-2 illustrates a typical pattern in catching-up industrialization as frequently
observed in East Asia. The transition that Ethiopia must make in the future is from Stage One
to Stage Two (and later, Three). This is a process that usually takes many decades to complete.
Furthermore, not all latecomer economies can accomplish this; many slow down halfway andfall into middle income traps. Leapfrogging is theoretically possible and probably feasible inlimited products and services12, but harder to attain in broad sectors for visible growth impact
when the home country is plagued with inactive management, under-skilled workers, and lessthan-reliable power, logistics, and other infrastructure services.
Another way to state the same problem graphically is by way of the famous Smile Curve(Figure 2-3). Plotting the value chain (production stages) on the horizontal axis and value
creation on the vertical axis, the graph shows that the largest value is created in upstream anddownstream processes where foreigners dominate, while latecomer countries are often given
Two types of targeting high-technology, as a user and a creator, should be distinguished. The one is theintroduction of things developed in other countries purchased at commercial costs, such as adopting IoT at factories
and using 5G technology in telecom, which may indirectly support socio-economic development. The other is
R&D and commercialization of such technology and becoming a leading supplier under severe global competition,
which requires high technical competency and large expenditure and risk but may bring huge value and profit if
the project is successful.
1261

Figure 2-3. The Smile Curve and Manufacturing++

Source: author, based on the idea contained in Malaysia’s Second Industrial Master Plan 1996-2005.
Note: Manufacturing++ means two simultaneous efforts to create more value by raising the
productivity of existing processes (moving upward) and capturing additional upstream anddownstream processes (moving horizontally), starting from the bottom of the Smile Curve.

middle-stream activities—simple assembly, sewing, cutting, packing, etc.—where value
creation is small. The idea is not to condemn FDI for imposing this configuration but forlatecomer countries to devise a strategy to move out of this bind. Malaysia’s Second Industrial
Master Plan 1996-2005 proposed the “Manufacturing Plus Plus (Manufacturing++)” strategy
where, starting from low-value processes, domestic industries were required to simultaneously
improve the productivity of existing processes (upward arrows) and take up additional upstream
and downstream processes (horizontal arrows) (Ohno 2006). This two-dimensional (or Plus
Plus) approach should be seriously studied by any latecomer countries in the process of FDIled industrialization.
2-6-2. Selective FDI promotion
Some firms are after short-term gains, and they quickly leave a host country when theobjective is attained or difficulty is encountered. Others aim at long-term business engagementand do not depart even in hard times or with initial losses. Some firms make business decisions
swiftly while others are slow in deciding to invest or expand. Some are willing to take greatrisks while others wait until a favorable business environment is realized. Some are seriously
concerned about the welfare of workers, the local community and the country in which they
operate, while others do not care much about these things. Foreign investors are a mixture ofthese different types, even though they are ultimately after profit and business success.

62To successfully climb the industrial ladder (or embrace Manufacturing++) in the process of
FDI-led industrialization, FDI policy must shift, when the initial phase is over, from “all are
welcome” to selective attraction and incentivization of genuine value creators. For this, adistinction must be made regarding the types of foreign investors. Different FDI firms
contribute differently to the development of a host country in such aspects as training ofmanagers, engineers and workers; capacity building of local partner firms; transfer of skills andtechnology; development of domestic supplier networks; adoption of global standards andbusiness codes; and meaningful participation of local firms in global value chains. Corporate
behavior varies greatly with sectors, firm size, the strategy of each firm and even the idea of
each foreign manager. But one source of difference which is highly noticeable and worthy ofpolicy attention is the nationality of FDI firms. The average behavior of Japanese firms is quite
different from those of Chinese, Korean, Indian, German or American firms which arethemselves mutually dissimilar. Moreover, FDI firms of the same nationality often exchange
information and act together in a host country. National differences provide rough but useful
information on how to mobilize FDI for national development in the most effective way.
For example, Japanese FDI firms anywhere in the world tend to exhibit the following
properties: (i) strong manufacturing orientation (with relatively less weight on mining, property
development and services); (ii) monozukuri spirit (manufacturing as a way to seriously pursue
quality and customer satisfaction); (iii) pursuit of consistent quality, cost reduction and on-time
delivery (QCD) as well as safety; (iv) slow decision making but long-stay orientation once aninvestment is made; 13 (v) willingness to train local workers, engineers and partner firms
beyond simple operation and maintenance, which comes from long-stay orientation; (vi) highlegal compliance 14 ; and (vii) relative lack of foreign language and intercultural skills. This
makes Japanese FDI less visible in short-term presence but more conducive to the long-term
capacity enhancement and network building in host countries, especially in manufacturing.
Meanwhile, Chinese firms offer low cost and high speed in decision making and project
implementation with strong province-based linkage (firms and organizations from the same
Thailand was hit by severe floods which damaged many industrial parks in 2011. Political instability ensued,
and a military coup in 2014 replaced a civilian government with a military regime that stays in power until today.
At the time of the coup, American investors became highly alarmed and jittery. Meanwhile, Japanese firms in
Thailand, numbering over 1,600, did not leave or even think of leaving. New Japanese firms continued to arrive
even after the coup. Natural disasters and political instability are part of the Thai business climate, and Japanese
investors are not deterred by such expectable shocks. As a general rule, Japanese FDI comes slowly but stays
longer.
14
In industrial parks where most tenant firms are Japanese, it is customary to stipulate an internal code of conduct
which includes a strict prohibition of bribe giving and other forms of illegal payment. Thus Japanese firms
collectively resist corruption. In Thilawa SEZ in Myanmar, tenant firms are not permitted to meet local officials
or central ministries individually, and surveillance cameras are installed in rooms where such contact may occur.
In Ha Nam Province of Vietnam, a Korean aid agency asked JICA why Japanese firms could reject bribery
demands of local officials and still operate normally in industrial parks. Korean firms deal with local officials
individually and often succumb to their monetary requests.
13

63

province in China cooperate). Korean firms, especially chaebols (large corporate groups) suchas Samsung and LG, can make huge investments boldly and quickly as they are governed by
top-down decision-making and supported by competent and hardworking staff. European andAmerican investors, besides demanding efficiency and punctuality, are keenly interested in the
ethical correctness of production processes—labor protection and environmental soundness—more than product quality per se15, and impose strict rules of conduct on light manufacturing
establishments such as garment, footwear, processed food and personal accessories as aprecondition for a business transaction (Chapter 6).
In the future, when a sufficient mass of light manufacturing FDI has been accumulated,
Ethiopia should modify FDI policy to give more weight to the quality of FDI in terms of how
much value and skill it brings to the national economy rather than how many (unskilled) jobs it
creates. Eligible firms should be given more policy attention and incentives, and this policy
should be administered clearly and transparently instead of secretly and case-by-case. To dothis in the context of the double maximization problem discussed in Section 2-2, one must fully
understand that not all FDI firms are the same, as they pursue business goals differently andrequire different support and conditions. This policy shift can start even now, in preparation for
upgraded industrial policy in the future.
2-6-3. Four principles for revising FDI policy
Ethiopia is aiming to graduate from low-income to lower middle-income status.
Industrialization is in an early stage with limited technology, worker skills, global
competitiveness and rural-urban labor migration. Economic transformation is not yet visible inmacroeconomic data. There is a large pool of unemployed and underemployed agriculturallabor that needs to be trained and put to more productive tasks. At this stage, job creation
remains the most important national goal. However, Ethiopia will in the future enter a stage
where the quality, not just quantity, of labor and business operation matters most to continue
growing. FDI policy should pursue both goals—quantitative accumulation and quality
upgrading—with the latter’s weight gradually increasing over time. Currently, effective policy
for the latter is largely missing.
How can Ethiopia reform its FDI policy? Four mutually-related principles should guidepolicy re-targeting.
Japanese quality standards are very high, perhaps excessively so, because Japanese consumers demand it.
Japanese industrial experts say that many garment and footwear items exported to the EU and US markets will berejected by Japanese quality inspectors. In Yangon, the Myanmar Garment Manufacturers Association reports thatsome domestic garment firms switch from the Japanese to EU market because complying with European quality
and ethical standards, which are mostly document-based, is easier than producing with Japanese quality (GRIPS
Development Forum 2020).
15

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First, FDI marketing, policy support and investment incentives must be re-directed to valuecreating projects rather than sheer investment size or number of employees. The latter criteria
need not be abandoned but more weight should gradually be given to value creation. For this,
there must be concrete criteria on what constitutes value creation. R&D, the introduction of
new products and methods, high-level staff training, adoption of ICT, linkage creation,
environment-friendly and energy-saving technology and development of remote regions aresome of the globally common eligible actions. However, not all host countries offer incentives
the right way. South Africa incentivized the volume of car production, which attracted global
carmakers to assemble and export cars to advanced markets but with little value addition andwithout developing the quality of domestic workers or component suppliers. Thailand initially
incentivized broad manufacturing but in 2015 switched, when a sufficient industrial base wasformed, to activity- and merit-based incentives with detailed lists of eligible subsectors andactions (see below). Designation of value-creating projects is a delicate task which requires
deep knowledge of global trends in management, technology and value chains of each sector.
Second, foreign investors of all sizes, not just large ones, should be invited. Large standard
rental sheds are useful and even necessary in the early stage when labor-intensive productionof simple consumer goods is dominant. But high-tech firms and firms that bring new technology
and products do not go to such sheds. They hire professional managers and competent engineers
in relatively small numbers, not a large number of unskilled workers. The workshop must havethe right location, size, facilities, support services and amenities to accommodate such staff. In
Malaysia and Thailand, the government discourages labor-intensive processes and asks them toleave the country. They target smaller investors from advanced countries, where manufacturing
small and medium-sized enterprises (SMEs) from Japan are particularly welcome. Many readymade and built-to-order rental factories of small size are available in industrial parks all overSoutheast Asia. At OTA Techno Park in Thailand, the average rental factory size is 327m2. At
Kizuna Ready Service Factory in Vietnam, factory size starts from 240m2. Both are very
popular among Japanese manufacturing SMEs. In Ethiopia, Japanese firms are often told that
their investment is too small. Instead of rejection, a red carpet should be rolled out for foreign
high-tech SMEs.
Third, not only physical facilities but also support services must respond to the needs ofvalue-creating FDI firms. Because FDI needs are highly varied, this requires a mechanism tolisten to their individual needs carefully and implement solutions promptly. One-size-fits-all
services supplied by ill-informed authorities, such as low-quality housing that no one wants torent or expensive waste treatment which tenant firms consider unnecessary, must be avoided.
Besides regular formal meetings, frequent and informal interaction with key investors is65

desirable16. Investors’ concerns may range from safety, security and life amenities to problems
related to workers, logistics, power, ICT and administrative procedure. A telephone hotline
where investors can call at any time to report any problem is useful, which is faster and morecost-effective than a row of one-stop service counters that operate during normal working hours
only17. It is also customary for an investment promotion agency to establish country-specific“desks” for important source countries where a person well-versed in the language and businessculture of each country is assigned. In Southeast Asia, Japan Desk, Korea Desk and China Desk
are common. In Ethiopia, the Ethiopian Investment Commission (EIC) may consider China,
India, EU and Japan Desks18.
Fourth, FDI policy must be not only congenial but also stable and predictable for theforeseeable future. An unstable policy may not be an obstacle for speculators or firms interested
in short-term gains, but it is critical for non-adventurous firms that want to stay longer andinvest in domestic capacity. Even though policy must sometimes be revised, the change should
be announced well in advance, the opinions of stakeholders must be heard, and sufficient leadtime should be given for businesses to adapt to the change. When Thailand’s FDI policy was
drastically revised in 2015, the Thai Board of Investment (BOI) took more than a year to explain
it to investors in advance at home and abroad. By contrast, in Indonesia, domestic and foreign
investors bitterly complain about ministerial regulations that abruptly change rules without
explanation or lead-time. At present, the FDI policy in Ethiopia is highly changeable. Ethiopia
adopts the trial-and-error approach in which policies are drafted relatively quickly and any
problems arising from them are dealt with through subsequent revisions. This speed-first
approach is understandable, but it should be balanced with investors’ need to be assured of astable business environment before making a strategic investment. Many Japanese firms areinterested in Ethiopia and investment seminars in Tokyo are always full. However, very few
actually invest. Foreign currency shortage in Ethiopia and inherently slow decision-making ofJapanese FDI are two likely reasons. But another reason is disenchantment and the lack of trust
In countries where corruption is rampant, government officials may hesitate to contact firms individually forfear of being accused of illegal deals. In Asia’s high-performing economies where such suspicion is largely absent,
officials are positively required to visit and assist individual firms, both large and small, to understand their special
needs and differences in business orientation. Without such ground information, it is difficult to design policies
effectively.
17
In Ha Nam Province of Vietnam, where provincial leaders strongly welcome Japanese SMEs, a 24-hour 365day hotline was created as one of the Ten Commitments. Japanese investors can report any problem in the Japanese
language for the immediate attention of the provincial top leader. Apart from the hotline, the Ten Commitments
include (i) stable power, (ii) rapid procedure, (iii) infrastructure up to park fence, (iv) high-quality labor with asubsidy for labor training, (v) free land for dormitory construction, (vi) same privilege for new FDI and expansion,(vii) quality service for expats, (viii) factory security and worker safety, and (ix) prevention of strikes (Ohno 2017).
18
Another question is whether the government should give extra privileges beyond the investment law to VIP
customers. This may be unfair or legally questionable, but such treatment is normally offered in reality. To invite
Samsung’s smartphone assembly factories, the Vietnamese government provided additional privilege which was
not disclosed, to the chagrin of other FDI firms. As a result, Vietnam became the largest global supplier of Samsung
phones.
1666

caused by many recent incidents of policy instability. Besides Japanese FDI, German firms also
hesitate to invest in Ethiopia for similar reasons.
We always hear in Africa that Japan is too slow to enter this expanding market and thus
losing big opportunities. But we do not hear such admonition in Asia. Policymakers in Asia also
want to attract Japanese FDI, but they understand why Japanese firms do not come to them.
Thailand and the Philippines are alarmed that they are losing FDI to Vietnam. The attraction ofvalue-creating and long-staying FDI requires efforts on the receiving side to provide necessary
conditions for them—right incentives, facilities, support services and policy stability.
2-6-4. The case of Thailand
Thailand rose rapidly, albeit with significant gyration and temporary shocks, from low
income to upper middle income (per capita income of $7,260 in 2019, World Bank data). Its
economic structure diversified from rice monoculture in the 1960s to food processing,automobiles, and electronics and electrical (E&E) appliances. The Thai automotive sector is thelargest in Southeast Asia and ranks eleventh globally, producing roughly 2 million cars per year,
half of which are exported. To climb further to high income, the Thai government launched a
new industrial strategy in 2015 called Thailand 4.0, where the revision of FDI policy was animportant pillar. Other pillars included innovation, productivity, service trade and developmentof the Eastern Economic Corridor.
Prior to 2015, Thai FDI policy prioritized several subsectors including agro-products,
fashion, automotive, E&E, ICT, long-stay tourism, and energy and renewable energy (the list
shifted slightly over time and depending on ministries). Manufacturing was broadly favored,even labor-intensive ones such as garment and toy manufacturing. Incentives consisted of tax
components (exemption or reduction of corporate income tax and import duties on equipment
and inputs) and non-tax components (permission to hire expatriates, own land, and bring or
remit foreign currency). These incentives were administered under the zonal system where
investment projects in Zone 1 (Bangkok and vicinity) received less, Zone 2 (12 provinces)received more and Zone 3 (rural and remote provinces) received the most incentives. The Boardof Investment centrally approved all investment projects and incentives.
In 2015, the FDI policy was upgraded in order “to enhance Thailand’s competitiveness, toovercome the ‘Middle Income Trap’ and to achieve sustainable growth” (BOI 2015). The
following six issues were targeted as goals: (i) national competitiveness—R&D, innovation,
value creation, SMEs, fair competition and inclusive growth; (ii) environment-friendly
activities; (iii) cluster formation; (iv) development of border provinces; (v) special economic
zones (SEZs) in border areas for connectivity with neighboring countries; and (vi) Thai
overseas investment.

67

Figure 2-4. Thailand: Incentivizing Value-adding Activities and Merits

Source: Board of Investment of Thailand (2015).

Instead of promoting many broad sectors generally, the new policy features two new criteria
for offering incentives (Figure 2-4). The first is Activity-based Incentives which are classified
into A1, A2, A3, A4, B1 and B2 with the descending amount of privilege consisting of corporate
income tax, import duties and non-tax incentives. Type A categories are activities that bringhigh technology to Thailand and Type B categories are those that do not use high technology
but strengthen value chains. Each category further specifies eligible actions and subsectors. For
example, A1 includes power generation from waste, creative product design, electronics design,
R&D, and so on. Meanwhile, the second incentive is Merit-based Incentives for any project inany sector that performs recommended deeds (for this, only corporate income tax reduction is
given). Eligible merits are (i) competitiveness enhancement, (ii) decentralization (projects inremote and poor regions), and (iii) industrial park development. Under competitiveenhancement, there are six eligible merits—R&D (Thailand must be the core location),
donation for technology and human resource upgrading, purchase of Thai made intellectual
property, advanced technology training, high-level support for Thai suppliers, and product andpackaging design (prior approval is needed for this). Firms may obtain both incentives if they
qualify.
The 2015 revision of Thai FDI incentives was a natural yet necessary step for a middleincome country graduating from the simple production stage and wishing to climb onto thehigh-tech stage. Such upgrading of FDI strategy, with increased specificity and selectivity, isnecessary for all other economies going through a similar stage shift in the process ofindustrialization.

682-7. Strengthening domestic firms and building linkage
FDI policy should be accompanied by another set of policies to enhance domestic firms sobusiness linkage and technology transfer will occur between FDI and domestic firms (Chapter4). One of the common problems associated with FDI-led industrialization is that domestic
firms generally lack the capacity to capture and internalize foreign technology or management
method. Without solving this problem, economic activities will be split into two segments: theone which is driven by FDI firms integrated with global value chains to produce competitive
products using cheap domestic labor, and the other which is dominated by local firms withinformal management and low technology selling to local markets. With little interaction
between these segments, the FDI sector often becomes an enclave. Establishing various
industrial estates may even encourage this separation. Figure 2-5 illustrates this dual economic
structure observed in many developing countries.
To overcome this duality, policy to strengthen the absorptive capacity of domestic firms
must be executed in parallel with the policy to attract value-creating firms. In addition, thegovernment should facilitate linkage creation between the two parties. These three policy
components—capacity building of domestic firms, FDI attraction, and FDI-local linkage
creation—must be seen as one integrated set. Figure 2-6 shows the typical policy pattern forthis purpose, which is adapted from the author’s lecture to the Vietnamese government officials
in 2013, with adjustments to fit more closely to Ethiopia’s reality.
Figure 2-5. Dual Economic Structure

Source: the author’s lecture series for Vietnam’s Ministry of Industry officials deliveredin 2013, with minor modifications.

69

Figure 2-6. Three-part Strategy for Ethiopia

Source: the author’s lecture series for Vietnam’s Ministry of Industry officials delivered in2013, with deletion of Vietnam-specific comments and adjustments for the reality of
Ethiopia.

SME promotion is a crucial component of industrial policy not only for creating competent
partners for FDI but also for broader welfare purposes such as job and income creation. For theformer purpose (creation of competence), however, targeted firms are narrower and fewer thanthe case of general job and income creation. They must be SMEs that have a high potential toacquire competitiveness and become part of global value chains. Policy measures for them are
more demanding and aim at improving the quality and productivity of domestic firms to a level
required by global markets and standards.
There are two strategies to push domestic firms into the global arena (Figure 2-5). The firstis to work with FDI (or foreign buyers) at home to supply high-quality materials, components
and/or services needed by them. This indirect approach to participate in global value chains, via
FDI, is widely adopted. In Southeast Asia, firms supplying components to large assemblers ofmechanical products such as electronics, machinery and automobiles operating in a host country
are called supporting industries (susono sangyo in Japanese). The promotion of supporting
industries has been a major policy pillar for domestic value creation in Thailand, Indonesia, thePhilippines and Vietnam. The second is to create and foster strong domestic firms that candirectly compete in the global market without FDI’s help. Naturally, this approach is moredifficult than the first, and only a handful of latecomer countries with initially high absorptive
capacity such as Japan, Taiwan, Korea and China have succeeded in this approach. Malaysia,

70which switched from the first approach to the second about two decades ago, is struggling
because indigenous firms in Malaysia can hardly compete with foreign multinationals that
dominate the global market. In any country, a few domestic firms may succeed globally but the
impact is usually too small to visibly transform the economic structure of that country.
If the first approach is taken, the government must facilitate linkage formation between FDI
and domestic SMEs. FDI-local firm linkage can take two forms. The one is for one-time
procurement or service, and the other is for establishing long-term partnerships through a joint
venture, production cooperation, and so on. Needless to say, the second matching is moredifficult and more time-consuming than the first.
Government can promote linkage in three ways. First, it can require FDI firms to find,support and transfer technology to local partners as a condition for granting an investment
license or an incentive. Second, it can directly sponsor official matching services through trade
fairs, reverse trade fairs, matching events and seminars, a domestic supplier database,responding to individual inquiries, and so on. Third, it can indirectly subsidize, reduce tax orotherwise incentivize FDI firms that train and work substantively with local firms. The first
method is sometimes used, for example in China and past Malaysia, but forcing foreign firms
to work with local firms (especially when the latter’s capacity is low) generates discontent andrefusal from FDI, and usually fails. Thus, official matching should be done in the second (direct
support) or third (indirect support) way so linkage occurs willingly rather than coercively.
Thailand offers relatively developed—but not perfect—linkage promotion programs withmany active partners. The Board of Investment (BOI) and the Ministry of Industry (MOI), with
their affiliated agencies, work closely and flexibly with private bodies such as the Alliance for
Supporting Industries Association consisting of 12 industrial associations, as well as foreignbusinesses, NPOs, development partners and Japan Desks. Within BOI, the BOI Unit for
Industrial Linkage Development (BUILD) specializes in matching between FDI and Thai firms.
It operates a matching service for component sourcing, a large annual subcontracting exhibition,a regional supporting industry database, and a subsidy for Thai firms to join international trade
fairs (VESS 2021).
2-8. Industrial park management
Industrial park policy constitutes an important part of FDI policy, and it should evolve as FDI
policy progresses. As discussed above, FDI attraction must shift from large-scale simple
processing to more targeted value-creating activities in proper scope, timing and steps. Thistransition should also change various aspects of industrial park operation such as the park’sbusiness model, facilities and infrastructure provided, one-stop service, FDI marketing, andland and shed rental policy.
Industrial park management is a customer-oriented real estate business whether it is private-71

run or state-run. Host countries and park developers must compete with each other domestically,
regionally and globally to attract good client firms in sufficient numbers. They must offer
conditions FDI firms desire in terms of location; rental, operational and service cost; quality
and availability of labor; infrastructure services; investor support; incentives; business freedom,
etc. This is a broader requirement than just raising the World Bank Ease of Doing Businessranking which concentrates on fast and smooth administrative procedures (Section 2-4).
Ethiopia needs to study, compare and benchmark global practices to introduce the key
ingredients of industrial space competition19.
As with any business, industrial parks must be profitable. Ethiopia is in the early stage ofsetting up industrial parks where the government is currently the main builder and operator.
This is fine until experience is gained and operations become normal and stable. In manylatecomer economies, temporary official guidance and support are provided for industrial parkdevelopment. Ultimately, however, industrial parks must be self-financing and profitable. The
state should not cover their losses forever as this will become a serious burden on the national
budget. Ethiopia’s state-owned industrial parks were partly funded by the proceeds of theEurobond issue, which makes it even more imperative that they generate sufficient earnings to
pay back this foreign currency-denominated debt with high interest rates.
Six ideas are offered below to produce vibrant and profitable industrial parks in Ethiopia.
2-8-1. Diversification of revenue sources
To recover initial investment costs and achieve profitability, it is crucial to have multiple
revenue sources, not just land rent. If land rent (which includes rental shed charges) were theonly revenue, it had to be set sufficiently high to recoup the cost of park development, which
would reduce the price competitiveness of the park. Even if the land rent were initially set low
to attract customers, it must later be raised to recover the cost which would certainly cause
resentment among tenant firms.
There are different ways to generate additional revenues in industrial parks which arewidely practiced in Japanese industrial parks in Asia.
One way is to provide business-related services that tenant firms appreciate. An industrial
park management company can offer a mixture of free and fee-based services. They include
business consultation, investment procedure support, accounting service by certified public
accountants, tax filing and related services, environmental documentation, labor recruitment
and management, finding buyers or supplier companies, ICT installation and maintenance,
rental offices and meeting rooms, equipment and vehicle rental, and incubation space. The park
management can raise additional revenue from these services, which allows reduction of rental

As part of JICA’s support of EIC and IPDC, officials from these organizations were invited in 2018 and 2019
to Thailand, Cambodia, Myanmar and Japan to learn good industrial park management practices. Separately, Dr.
Arkebe Oqubay co-edited a handbook on the theories and practices of industrial parks (Oqubay and Lin 2020).
1972

fees of land and sheds, while offering convenience to tenant firms. BTD Japan, a Japanese
consultant firm that supports several local industrial parks in Northern Vietnam, provides
accounting, tax and labor support for a fee while all other services it provides are free. Kizuna,
a Vietnamese developer of full-service rental factory parks for Japanese SMEs in Southern
Vietnam, also offers fee-based high-quality support in all dimensions by Japanese or Japanesespeaking staff. However, support for doing the initial investment procedure is free.
Another way to raise additional revenue is to provide basic infrastructure services reliably
but with additional charges. Industrial parks may guarantee a stable supply of power, water,
natural gas (where available) or other infrastructure services by investing in additional
equipment such as a substation, generator, power lines, pipelines, etc. when supply from utility
companies is unavailable, unstable or low quality. By doing so, the park can charge higher
tariffs which tenants are usually happy to pay. Meanwhile, park-wide wastewater treatment isa standard facility that must be installed in every industrial park.
Regarding power supply, electricity situations in Ethiopia are currently unstable but should
improve when planned dams, especially the Grand Ethiopian Renaissance Dam, come into fulloperation. However, power distribution networks at the retail level must be upgraded in parallelto the construction of generation capacity and main transmission lines. Until that happens,provisional methods to stabilize the industrial power supply will be required. Japanese expertssuggest three ways to do this20. First, as power transmission and distribution are to be privatizedin Ethiopia, the Industrial Parks Development Corporation (IPDC) may form a joint venturewith a private investor to supply power from the national grid to the industrial parks it manages(and nearby areas) guaranteeing power stability, high-quality maintenance and troubleshooting
services, but charging higher fees for this. This has the additional advantage of broadening
revenue sources for IPDC. Second, even without a joint venture, each industrial park can atleast invest in a substation and a direct line from the national grid to ensure a stable power
supply to the park (power at the national grid is more stable than at the retail distribution level).
Third, the Ethiopian Electric Power (EEP) and the Ethiopian Electric Utility (EEU) should be
obligated to prioritize and safeguard industrial power supply when they invest in, renew ormaintain transmission lines and related equipment.
2-8-2. Strategic provision of facilities and services
State-owned industrial parks should pursue developmental goals within the bounds offinancial soundness. Provision of frontline technology and generous services should not be doneat any cost. In providing on-site facilities and services, an industrial park operator must do a
Interviews with JICA officials and Japanese experts specializing in industrial park management and/or assisting
IPDC during 2018-2019.
20

73

serious cost-benefit analysis to decide which facilities and services are worth offering. The costhere includes not just an initial investment but also future operation, maintenance andreplacement. The state budget and the balance of payments must be protected against a runaway
cost of loss-making projects.
The standard practice at Japanese industrial parks in Southeast Asia is to offer basic
services—safety, security, reliable power, water supply, standard wastewater treatment, internalroads, etc.—with high quality and consistency but not frills and add-ons that tenant firms do
not strongly want or for which they are unwilling to pay extra. Japanese developers do not
usually lay power lines underground because that does not add much value to investors21. They
rarely install sprinklers in factories22. Apartments and dormitories are not built unless they arekeenly wanted by expatriates or workers, and desired location and specs of dwelling are known
precisely so constructed housing will surely be taken rather than remain empty. Similar logic is
applied in providing on-site restaurants, shops, schools, clinics, banks, golf courses, and otheramenities and facilities. Moreover, these services are often outsourced to private firms rather
than provided by park management itself.
The minimum-cost approach is dictated by severe competition industrial parks face inattracting customers. They cannot survive financially unless keenly wanted facilities andservices are supplied at reasonable costs. Beautiful landscaping and high-tech equipment are
nice, but most investors are unwilling to pay extra for such luxuries. If only one customer wants
a specific service such as special water treatment, super solid ground or extremely stable power,park management should persuade the firm to install necessary equipment at its own cost or
choose to invest in another park. An industrial park should not invest in an expensive facility
just for one customer.
Industrial park management buildings should be small and efficient rather than grandiosebecause the size of management buildings does not add much value to investors. At Thang Long
Industrial Park (in Vietnam, by Sumitomo Corporation) and Phnom Penh Special Economic
Zone (in Cambodia, by a local developer) where Japanese multinational corporations such as
Canon, Denso, Panasonic, Yamaha and Minebea operate, park management is housed in a
simple two-story building which is much smaller than the ones in Hawassa, Bole Lemi, Kilinto
or Mekelle.
IPDC should re-examine all facilities and services it offers to tenant firms to see if theirscope, specs and costs are appropriate and contribute to IPDC’s long-term profitability. For
One exception is Phu My 3 Specialized Industrial Park in Southern Vietnam which is located near the sea. To
prevent salt damage, power lines for this park are laid underground. Unless such special reasons exist, power
within parks is normally distributed via open-air transmission.
22
European investors usually require sprinklers in factory sheds. In Asia, a common way to prevent and control
fire consists of a fire station with fire engines and well-trained firefighters on 24-hour duty, fire extinguishers inevery factory, placement of hydrants or ponds throughout the park, annual park-wide fire drills and regularinspection of firefighting equipment.
21

74

instance, the desirability and lifetime cost of the centralized Zero Liquid Discharge (ZLD)
system should be revisited. The Japan International Cooperation Agency (JICA) experts
recommend the standard two-step wastewater treatment plan where heavy water users, such asa dyeing factory or a paint shop, are required to treat (chemical) wastewater inside theirpremises before discharging it to the communal (biological) water treatment plant, as done
widely in Southeast Asia, instead of adopting centralized ZLD for the entire park. Otherwise,
the construction, operation and maintenance costs of wastewater treatment will be enormous(IPDC-EIPP 2018, p.74).
2-8-3. Investor support and park operation
One-stop service should be introduced functionally rather than physically. The existence of
one trusted official at the end of a telephone hotline, who can connect client firms to any offices
and services to solve any problem, is more valuable than installing many desks manned withseconded officials. Dong Van Industrial Park operated by Ha Nam Province, Vietnam, ensuresthat any problem reported by a Japanese tenant firm will be quickly transmitted to the top
provincial leader and industrial park management for immediate attention 24 hours a day, 365
days a year. Japanese investors highly appreciate the speed and quality of provincial response.
At Thilawa SEZ, Myanmar, Mr. Yoichi Matsui, head of the One Stop Service Center, takes careof any issue immediately and professionally, which is greatly appreciated by the tenant firms
and increases the value of the SEZ.
The matter is more of a soft support mechanism than a physical arrangement of desks andcounters. Allocating many officials at each industrial park, who may or may not receive clientson any particular day, will be very costly in terms of both time and budget. Most government
ministries are short of hand, and officials so assigned may become unproductive and dispirited.
Despite great effort so far, investment procedures at EIC and IPDC still lack simplicity andtransparency. Information on investment rules, eligibility, incentives, and so on, should be
easily accessible and understandable to anyone via an official document and the internet.
Standard operation procedures must be established and strictly followed by all EIC and nonEIC officials. Applications of various permits should be standardized and digitized. In Ethiopia,
some investment-related services are slow, irregular or entirely missing such as visa and work
permits, certificate of country origin, residence permit, post-investment services and follow-up,
and claim and complaint procedure by an investing firm.
It is frequently reported in Ethiopia that different officials apply rules differently, approval
processes take long, and investors must visit many offices to obtain any business-related
permission, be it for export, import, hiring or expansion. In Kenya, Japanese firms report nosuch difficulties, customs rules are clear, and all officials say the same thing regardless of75

ministry or position. In Malaysia, the Managing Director of the Japan External Trade
Organization (JETRO) Kuala Lumpur once said he could not think of any problem for Japanese
investors as far as the Malaysian government was concerned.
Another important point is avoidance of micromanagement by the state. Government should
not intervene in industrial park operations excessively. It should not impose rental and service
fees, tenant policies, meticulous operational rules or numerical customer targets. Such
operational parameters should be set by IPDC under the general guidance of the national
development plan. Park operators should have the power to quickly and flexibly cope withshifting customer needs and global situations. At Thilawa SEZ in Myanmar mentioned above,a national committee delegates all operational matters to Myanmar Japan Thilawa Development
Limited (MJTD), a private firm that operates Thilawa SEZ, and the One Stop Service Center
under it. The operational autonomy of MJTD and OSSC is protected by the politicalcommitment of high-level officials of the Myanmar government.
2-8-4. Protection against negative shocks
One important aspect of the industrial park business is coping with inevitable ups and downs.
The speed of tenant firm arrival (and departure) depends on many factors, most of which arebeyond the control of a host country or a park developer. They include global business cycles,
gyration of prices and interest rates, the situation in source countries, financial crises, war andpolitical instability, and the spread of terrorism or infectious diseases. A large negative shock
tends to occur every decade or so. Moreover, not all registered investors actually invest.
Japanese park developers are happy if a newly developed industrial park becomes full in five
years.
Sumitomo Corporation is a Japanese trading house with active industrial park businesses inIndonesia, the Philippines, Vietnam, India, Bangladesh and Myanmar. A Sumitomo park
director states that an industrial park in Asia on average sells (rents out) 20ha per year evenwith high-quality infrastructure and services because there are many industrial parks fiercelycompeting for good tenant firms (GRIPS Development Forum 2020). In Northern Vietnam,
Japanese industrial parks built separately by Sumitomo and Nomura each took more than adecade to be fully occupied because their opening coincided with the outbreak of the Asianfinancial crisis of 1997. By contrast, a Sumitomo-operated SEZ in Myanmar, which began
construction in 2014, became full after six years, a speed which was considered fast. As Zone
A (405 ha) became almost full within six years, the construction of Zone B had begun. Withequally good location and services, the performance of industrial parks diverges due to many
uncontrollable factors. It is customary that Japanese park developers build industrial parks stepby step, starting with the first phase and going to the second and later phases only when theprevious phase becomes 70-80% full. This is to avoid over-investment and the risk of financial
losses.
Property business has both good times and bad times, and good times never last forever.
Host countries should be prepared for this and have a contingency plan for hard times.

76

Ethiopia’s state-owned industrial parks were initially very popular among foreign investors, but
the COVID-19 pandemic, global demand collapse and political instability in Ethiopia are taking
a toll on investor arrival. Future demand for industrial park space is very difficult to forecast.
Construction of the remaining industrial parks must be paced judiciously.
2-8-5. Sector selectivity versus indifference
In Asia, most industrial parks welcome investors of any sector as long as they comply withnational laws and park regulations on environment, labor, intellectual property rights, and soon; pay fees and charges on time; and have a good reputation at home and in other countries.
Sector indifference is a natural consequence of severe competition among industrial parks toattract as many good tenants as possible. If any firm violates a rule, it must be expelled fromthe park regardless of sector.
Some industrial parks do attract investors of the same kind, such as Hsinchu Science Parkin Taiwan (ICT), Vietnam Singapore Industrial Park in Vietnam (electronics) and Amata Nakorn
Industrial Park in Thailand (automotive and electronics components). This is a result of market
forces rather than park policy as these parks in no way preclude firms in other sectors. For
example, Taiwan’s Hsinchu Science Park requires tenant firms to do R&D above certain levels
but welcomes any sector as long as this condition is met. There are parks dedicated to software
firms only, but this is a special case as software programming requires a completely different
work environment—relatively small space, highly educated people, urban amenities and goodinternet connection—instead of large sheds, heavy equipment or wastewater treatment.
Software parks look like modern office complexes rather than normal industrial parks.
The Ethiopian government designates sectors to each industrial park rather than leaving thematter to the spontaneous choice of investors. The wisdom of this approach needs to be
examined. Ethiopia is in an early stage of industrialization with a high concentration on lightmanufacturing and construction materials. Countries having hundreds of industrial parks andreceiving tens of thousands of FDI projects may seek some degree of specialization. Meanwhile,
Ethiopia has less than ten fully operational parks, and a large FDI inflow began only recently.
Some argue that the geographical concentration of firms of the same sector creates synergy andsharing of resources such as skilled engineers and specialized waste treatment. This istheoretically plausible but does not always happen in reality. Firms in the same sector are often
rivals who are wary of labor poaching and information leaks to others. This tendency is stronger
in high-tech industries than in light manufacturing. It is better to let firms decide where to invest,
including whether they prefer concentration or dispersion, rather than the government herding
them to any specific industrial park. Mixed-sector industrial parks are more suitable forcountries on the way to attaining middle income in the near future.

77

2-8-6. Provision of diverse land and rental choices
Ethiopia has built many same-size, large-capacity rental sheds. These standardized sheds
are suitable for labor-intensive export-oriented light manufacturing such as garment, footwear
and food processing in the early stage of FDI-led industrialization. However, most Japaneseand EU firms no longer engage in such production. High-tech firms, skill-intensive processes,
specialized manufacturers and “supporting industries” (component suppliers) need customized
workspace which is often smaller and designed differently for each firm. Some require heavyduty workshop cranes, others need pile work for super solid ground and still others requirecleanrooms for precision equipment. Japanese industrial parks at home and abroad offer rental
land of various sizes for each investor to build any structure it prefers. It also provides small
rental factories of 250-1,000 m2 for high-tech SMEs or firms wanting to test-produce before
building a large plant. Space design and construction work are normally commissioned toconsultants and builders selected by individual tenant firms.
In Que Vo Industrial Park in Vietnam, which houses large Canon and Foxconn (Hong Hai)
plants, the Vietnamese management decided to build 18 ready-made sheds of 5,000m2 to attract
more Japanese firms. A few Taiwanese and Korean firms were interested, but there was no taker
among Japanese FDI. Huge sheds stood empty. The local developer misjudged the spatial needsof Japanese high-tech firms which would not accept standardized large-capacity rental sheds.
Ethiopia currently targets labor-intensive light manufacturing FDI for which large standard
sheds are appropriate. However, to attract more sophisticated manufacturing in the future,
customized industrial space should also be offered. When Japanese manufacturers invest abroad,they typically start with small and made-to-order industrial space of about 250-1,000m2, or evensmaller “incubation” space with only one machine. They want to first check whether local laws,
officials, taxes, customs procedure, market, labor, power, water, logistics and other essentials
are fit for their business model based on quality, cost reduction and on-time delivery (QCD). If
successful, they move to bigger rental space or build their own factories inside or outside anindustrial park. This cautious step-by-step approach is taken because Japanese firms want tostay for a long time, not for short-term profit and a quick leave. They also want to minimize
initial investment costs, unlike Turkish, Chinese and Indian investors who are willing to build
huge factories from the beginning. Many European and American high-tech firms also behave
like Japanese firms even though they tend to be slightly bolder than Japanese.

78Chapter 3
Dynamics of FDI in Ethiopia:
Bridging the Balance of Payments Gap
3-1. Introduction
As in many developing countries, Ethiopia faces two types of gaps arising from the investmentsaving (capital) and export-import (trade or foreign exchange) gaps. There are two potential
mechanisms through which FDI can help in filling these gaps, ease balance of payments (BOP)pressure and fuel economic growth. FDI can bridge the low domestic saving-investment (capitalgap) of host countries by injecting foreign capital (investment) into the economy. It can also
improve the trade imbalance through enhancing exports and substituting imports withdomestically produced goods.
In recognition of this, the Ethiopian government has shown renewed interest to attract FDI
and has, since 2015, built several industrial parks mostly specialized in textile and apparel. As
a result, the country has become one of the top destinations of FDI in Africa despite some
slowdown in the last three years, most likely due to political unrest.
FDI does not, however, necessarily lead to bridging the BOP gap in host countries. Thereare circumstances where FDI may aggravate the BOP deficit of host countries. For example,
this can happen when FDI is engaged in low value-adding activities such as simple assemblythat require large amounts of imported intermediate inputs, or when FDI is oriented towards thedomestic market rather than the export market. Moreover, the effect of initial investment flow
may be counterbalanced by the repatriation of profits and workers’ wages as well as paymentof royalties and interest and principal on a foreign loan. Hence, the net effect of FDI on the
BOP, by and large, depends not only on the type and quality of the attracted FDI but also on therules and regulations governing the operation of multinational corporations (MNCs) in the hostcountry. In a weak policy environment, FDI may aggravate capital leakage and the trade deficit.
The empirical evidence on the impact of FDI on the trade balance is mixed. It can improveor worsen the trade balance and the BOP position of a country. The role of FDI policy istherefore crucial in designing what type of FDI to attract and deciding what kind of conditions
and incentive mechanisms to put in place for foreign investors. Active FDI policy is required
to maximize the benefits of FDI inflows on the BOP and minimize its negative impact.
Ethiopia has designed several incentive schemes and revised proclamations and regulatory
frameworks to encourage FDI inflows and promote exports. Despite these, export remains low

79and the significant shortage of foreign exchange persists with a huge BOP deficit (IMF 2020).
This calls for scrutiny into the laws and policies governing FDI to understand why the existinglaws and policies did not help much in boosting export and easing the BOP pressure despite
these efforts. Overall, stress should be given to refining the FDI policy into a better frameworkthat can help to attract FDI through creating an investment environment suited to the Ethiopian
context and maximize the benefits and minimize the costs associated with inflows of FDI. The
main aim of this chapter is to identify and scrutinize existing FDI-related policy measures withthe aim of identifying the areas that need reforms. The chapter will examine the impact of FDI
on the capital inflow and net export earnings in Ethiopia and propose policy options for
maximizing benefits by drawing on lessons from successful countries.
3-2. Literature review
In this section, we present simplified theoretical predictions on the complex relationshipbetween FDI and the BOP in the context of a developing host country and by looking at boththe current and capital accounts. We also review the existing empirical evidence in the area toassess what the evidence suggests about the relationship between FDI and the BOP. As a prelude,
we present some basic facts about the BOP.
3-2-1. FDI and the balance of payments
The BOP is a statistical record of all transactions of a country’s residents with residents of
the rest of the world for a given period (IMF 2009). It gives a comprehensive assessment of acountry’s economic condition by showing how much a country exports and imports and theamount of foreign exchange a country receives through foreign aid, remittances, foreign loans,foreign direct investment, etc. It is an important indicator of a country’s capacity to pay for its
imports and shows whether a country saves and/or produces enough goods and services to pay
for its economic growth. As we show below, FDI is directly linked to the two main componentsof the BOP: the current account, which includes the trade balance and primary and secondary
income accounts, and the capital and financial account, which contains FDI as one of its
elements.
Using the notations of International Monetary Funds (IMF) (2009) and starting from thenational income accounts identity, we can summarize the different components of the BOP and
how they are related to each other and with the saving and investment gap as follows.
𝑆 – 𝐼 = 𝐶𝐴𝐵
𝑆 – 𝐼 + 𝑁𝐾𝑇 – 𝑁𝑃𝑁𝑁𝐴 = 𝐶𝐴𝐵 + 𝑁𝐾𝑇– 𝑁𝑃𝑁𝑁𝐴 = 𝑁𝐹𝐼

80

where:𝐼 = 𝑔𝑟𝑜𝑠𝑠 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
𝑆 = 𝑔𝑟𝑜𝑠𝑠 𝑠𝑎𝑣𝑖𝑛𝑔
𝐶𝐴𝐵 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
𝑁𝐶𝑇 = 𝑛𝑒𝑡 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑡𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑠
𝑁𝐾𝑇 = 𝑛𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑡𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑠
𝑁𝑃𝑁𝑁𝐴 = 𝑛𝑒𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑜𝑓 𝑛𝑜𝑛 − 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑, 𝑛𝑜𝑛 − 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝑁𝐹𝐼 = 𝑛𝑒𝑡 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑜𝑟 𝑛𝑒𝑡 𝑙𝑒𝑛𝑑𝑖𝑛𝑔/𝑛𝑒𝑡 𝑏𝑜𝑟𝑟𝑜𝑤𝑖𝑛𝑔 𝑣𝑖𝑠 − 𝑎 −𝑣𝑖𝑠 𝑡ℎ𝑒 𝑟𝑒𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑤𝑜𝑟𝑙𝑑
A deficit in the trade balance can be financed through foreign aid and inflows of remittancesand other factor incomes from abroad. If this is still not enough to cover the import needs of thecountry, that is, if the current account is still in deficit, the country will have to rely on foreignloans and other capital inflows like FDI to fill in its current account deficit and/or savinginvestment gap. A deficit in the current account—more imports than what can be financed byexport earnings as well as current transfers and primary and secondary incomes from abroad—indicates that the country does not have enough savings to finance its growth and needs todepend on foreign borrowings and investments. A surplus in the current account, on the other
hand, indicates that the country has enough savings to finance its investment needs and can use
the surplus to acquire foreign assets, invest in other countries (outbound FDI) or use it to reduce
its foreign debt.
As such, a deficit in the current account is accompanied by a surplus in the capital account,which indicates that the country imports more capital (in the forms of FDI, foreign loans, etc.)from abroad than it exports. Developing countries usually have a deficit in their trade balance
and a surplus on their capital account indicating that they are capital importing or, according toSamuelson’s Life Cycle of BOP theory, “young and growing debtor” countries. This is also thecase with Ethiopia where the huge and continuously growing trade deficit is financed by foreignaid, remittances and capital inflows in the form of foreign loans and FDI (Figure 3-5).
The BOP is considered to be in equilibrium when the sum of the current account and thecapital and financial account, including the change in reserves as well as errors and omissions,becomes zero. Running a deficit (or surplus) in both the current and the capital and financial
accounts, called a “twin deficit” or a “twin surplus,” for an extended period is a rare incident.
The only exception in this regard is China which ran a twin surplus from 1994 to 2011 (Zhang,
B. 2017).
3-2-2. Evidence on the relationship between FDI and the BOP

81

FDI is an investment performed by a multinational enterprise (MNC) as part of its strategy
to enlarge profits by incorporating real assets in the host country. In FDI, unlike portfolio
investment, the investing MNC achieves a significant degree of control over the real asset(Johnson 2006). Sen (1995) describes the difference between FDI and portfolio investment ina more informative way. According to this author, FDI involves an equity investment that leads
to the creation or expansion of host country assets and contributes to the creation of new
capacities. Whereas, portfolio investment involves the acquisition of host county non-equity
financial instruments, financial assets or claims of existing real assets in the form of debt orequity. Because of this, FDI is considered a more stable form of investment and less vulnerable
to sudden reversals, bringing with it additional benefits to the host country.
The role of foreign capital inflows in economic growth is debatable. Although FDI isconsidered more favorably in this regard than debt and portfolio investment, there is noconsensus on the impact of FDI on the economies of host countries. For details on this debate,
see Gebreeyesus et al. (2017) and studies cited therein.
Nevertheless, the benefits of FDI to host developing countries in terms of enhanced
productivity and efficiency, improved product quality and use of advanced technologies arenowadays widely accepted. What is more debatable about the role of FDI on host economies is
its potential impact on the BOP—whether or not FDI can be effectively used as a means offinancing gaps in the BOP. The impact of FDI on the BOP can potentially be either positive andnegative, and the overall impact depends on various parameters and elasticities of the economy,
substitutability or complementarity between FDI and local firms (whether they compete orwork together), the time dimension we are looking at (short-, medium-, and long-term), and thetype of FDI (horizontal vs. vertical, market-seeking vs. export-oriented, the degree ofcontribution to domestic capacity building, etc.) On top of these, the role of policy is crucial in
maximizing the gains from FDI and minimizing its negative impacts on the BOP and growth.
Developing host countries can gain a favorable impact of FDI on the BOP through thefollowing three channels: first, when the FDI subsidiary is used to export goods and services toother countries and, second, when FDI serves as a substitute for imports of goods and services.
In either case, FDI can induce positive changes in the current account of the host country(Kurtishi-Kastrati 2013). In addition, for foreign exchange-constrained countries like Ethiopia,
initial capital inflows associated with FDI can also directly improve the BOP.
Theoretically, the positive role of MNCs in promoting exports of host countries is wellestablished. According to Helpman et al. (2004), only the most productive firms choose toinvest in foreign markets, and this implies that MNCs are large, productive, and equipped withappropriate technologies, adequate capital and know-how. FDI thus has the potential to boost
exports of host countries by augmenting domestic capital for exports, making access to foreign
markets relatively easier, raising productivity through the transfer of advanced technologies,

82

upgrading the technical and managerial skills of the labor force, introducing new and modern
ways of doing things, and so forth ( Zhang, K.H. 2005).
Nevertheless, FDI can also have a negative impact on the BOP by inducing capital outflows
in the forms of repatriation of profits, dividends, and repayments of interests and the principal
on debt owed to creditors in the country of origin. FDI can also harm the trade balance by
inducing imports of raw materials and intermediate inputs while neglecting the procurement of
inputs from local firms (Keho 2020; Lam 2014).
When one considers the potential impact of FDI inflows on the BOP, it is important tospecify the time dimension over which these impacts are assessed as the impact of FDI on the
BOP over the short, medium and long run may be different. In the short run, FDI is expected tohave a positive impact on the BOP through the inflows of foreign capital in the form of theinitial investment. This initial inflow of capital can be used to fill the saving-investment gap
and/or a current account deficit. Thus, the role of FDI in easing the BOP pressure is expected
to be positive as long as the equity (as opposed to debt) share of the investment is significantly
higher than the value of the investment that is used to finance imports.
Using parameter estimates for propensities of imports and savings equal to 0.15 and 0.27,
respectively, Sen (1995) shows that unless the equity share of the investment exceeds 36%(assuming zero imports), FDI will have a negative impact on the BOP in the short run. This
underlines the need to focus on FDI projects that have higher equity shares and less importintensity. Gebreeyesus et al. (2017) also indicates that the negative impact of FDI on the BOP
is more pronounced when the foreign investment is focused on low value-adding, importintensive activities such as simple assembly or when part of the investment is financed throughloans provided by the host country.
As FDI firms become profitable, they start repatriating their profits to their source countries.
As a result, the role of FDI as a means of bridging the BOP gaps in the medium to long run
becomes less clear. In general, whether FDI can be used to finance the BOP needs of small
economies will depend on import and export intensities, tendencies to reinvest versus repatriate
profits as well as the extent of outflows of foreign exchange in the forms of payments ofroyalties, foreign debt service and wages of expatriate workers (Gebreeyesus et al. 2017;
Johnson 2006; Keho 2020; Kurtishi-Kastrati 2013; Sen 1995).
The impacts of FDI also depend on the type of FDI. From the perspective of the source
country, FDI can be classified as horizontal FDI, vertical FDI and conglomerate FDI. Each ofthese forms of FDI has different implications for exports and the trade balance. Horizontal FDI
is undertaken to produce similar kinds of goods abroad as in the source country for horizontal
expansion. This is a market-seeking FDI that targets the host economy’s local market and uses
FDI, instead of exporting, to achieve the purpose. This kind of FDI bypasses the host country’s
tariff barriers and becomes closer to their customers.

83

Vertical FDI, on the other hand, sets up part of their production processes in the hosteconomy for the sake of benefiting from resources or other advantages available in the hosteconomy. Vertical FDI can be subdivided into backward vertical FDI and forward vertical FDI.
In the former case, investors exploit labor and other inputs available in the host country at
relatively low costs. The latter, on the other hand, aims to be nearer to consumers by theacquisition of distribution outlets and other means. Conglomerate FDI carries the features ofboth horizontal and vertical FDI (Caves 1971).
Sectors that exhibit many FDI-driven exports can contribute more to the improvement of the
trade balance. If FDI is in the service sector or other less export-intensive sectors, the impact of
FDI on the trade balance is likely to be unfavorable unless this contributes towards substituting
imports. It is therefore important to assess the import content of FDI and encourage FDI that ismore likely to be export intensive, use local goods and services as inputs, and that has arelatively more domestic value addition and/or has better capacity to substitute imports.
The existing empirical evidence is inconclusive about the effect of FDI inflows on theeconomic growth and balance of payments of host countries. Some studies show that FDI boosts
economic growth and helps host countries to ease their BOP problems (Alencar and Strachman
2016; Zhang, K.H. 2005) while others claim that it has a negative impact (Keho 2020; Razmi
2005). For example, Zhang (2005) investigates the impact of FDI on China’s export
performance using industrial data and concludes that China’s export boom over the years is
attributable to the large FDI inflows. Moreover, the author shows that this effect has been muchgreater than that of domestic capital and is more pronounced in labor-intensive industries. On
the other hand, Keho (2020), using time-series analysis for Cote d’Ivoire, shows that inflowsof FDI have led to a deterioration of the trade balance in the long run.
The effect of FDI on the economy and the BOP is thus not uniform across host developing
countries. Some countries have managed to attract large volumes of FDI and benefited the mostout of it, as well as countries that have not been able to do the same. After reviewing thetheoretical and empirical literature, Forte & Moura (2013) conclude that the economic role of
FDI in host countries is inconclusive and depends on domestic conditions. Country case studies
also show that, with the right type of policies and strategies to attract and manage FDI, it ispossible to maximize the benefits and minimize the costs of FDI on the balance of payments ofhost developing countries.
In this regard, Moran (2006) presents Mauritius and the Dominican Republic as two
important success stories showcasing relevant policy reforms in low-income countries that can
exploit the positive role of FDI in spurring growth in exports. These two countries tookstraightforward policy reforms that included setting up export processing zones close to
economic centers; offering foreign investors reliable infrastructure at competitive prices; andensuring a conducive business environment with less corruption, crime, bureaucracy, taxes, etc.

84Apart from this, both Mauritius and the Dominican Republic undertook macroeconomic
reforms to control inflation and end overvalued exchange rates. Madagascar and Lesotho
followed the examples of Mauritius and the Dominican Republic and attracted sizable exportoriented FDI firms.
In general, whether FDI has a positive impact or detrimental effect on the economic growth,
the BOP, and the trade performance of host countries mainly depends on the local conditions
and policies of the host country. This will in turn determine the type and nature of FDI inflows
and thus the role FDI plays in the host country’s economy. Given this, the next section will
review the best practices of selected Asian countries to draw lessons for Ethiopia, on how to
attract and manage FDI from the perspective of improving the BOP position of host developing
countries.
3-3. FDI policy and the BOP: a review of best practices
3-3-1. Trends in FDI and exports for selected Asian countries
In this section, we present a brief overview of the FDI and export performances of selected
Asian countries. Figures 3-1 and 3-2 below present trends of FDI and exports as a share of
Gross Domestic Product (GDP) for selected Asian countries: China, Thailand, Vietnam and
Bangladesh.
Although no foreign-owned firm operated in China before 1979 (Wei 1996), the inflow of
FDI to China has steadily increased since the early 1990s. Through time and the committed
effort of the government, China remains the largest recipient of FDI among developing
countries. After 1992, inflows of FDI into China became the largest among developing
countries and the second largest, next to the United States, globally (Zhang, K.H. 2006). China
has a regulatory framework and policies to boost FDI inflows. The increasing trend in FDI
inflows to China is mainly attributed to its policy and governance structure (Davies 2013).
Among other factors, the investment environment in China remains attractive for FDI in termsof good infrastructure, relatively efficient public services, preferential policies, fast economic
growth, a huge and growing domestic market, macroeconomic and political stability, and theavailability of well-educated human resources (Chen 2011; Li 2013).
Thailand is another developing country that has managed to attract long-term investments
through its investment promotion policies. MNCs have played a crucial role in Thailand’s
industrialization experience over the past five decades (Hahn 2004). FDI inflows into Thailand
have increased since 1986 and this can be attributed mainly to the country’s investment
promotion efforts, low labor cost and devaluation of the local currency. Although the overall
economy and the FDI sector were severely hit and declined during the Asian financial crisis,85

Figure 3-1. FDI as a Percentage of GDP in Selected Asian Countries
14
12
10
8
6
4
2
0

China

Thailand

Vietnam

2018

2016

2014

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

-2

Bangladesh

Source: author’s computation based on data from WDI.

the historical flood and political instability, restoration was made after each incident. This
resilience put Thailand among the eight priority destinations of FDI among emerging
economies and the seventh-largest FDI recipient in East and Southeast Asia in the year 2016
(Maček et al. 2015).
The inflows of FDI to Vietnam were very low until the 1990s. By the mid-1990s, Vietnam
managed to become among the top recipients of FDI, relative to its size, due to its improved
investment regime, outward orientation and macroeconomic stabilization measures. It started
to benefit from FDI, which accounted for 10% of the country’s GDP and 8% of its exports (Junet al. 1997).
Bangladesh was a low-income country until 2015 that needed to overcome its negative
current account balance caused by a huge trade deficit and inappropriate use of foreign direct
investment (Rana 2014). The FDI inflow has been low compared to other Asian countries but
an increase was registered in the recent decade. The share of FDI to GDP in Bangladesh is very
low compared with China, Thailand and Vietnam and this can be attributed to several factors
such as unskilled labor force, the lack of FDI performance requirement provisions,macroeconomic instability, intense external debt and other factors (Muhammad 2020; Salman
2009; Siddikee and Rahman 2020).
Turning to export performance (see Figure 3-2), FDI plays an important role in China’s
trade surplus. The expansion of exports in China has been attributed mainly to FDI and thepolicies associated with it (Davies 2013). For instance, in 2004 China was the third-largest
exporting country in the world, which is a huge improvement compared to its 32nd place in86Figure 3-2. Export as a Percentage of GDP in Selected Asian Countries
120
100
80
60
40
20

1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018

0

China

Thailand

VietnamBangladesh

Source: author’s computation based on data from WDI.

1978 (Zhang K.H. 2005). The export boom and the resulting trade surplus induced a twin
surplus in China. In particular, the period from 1994 to 2011 was a twin surplus period for China
where export-oriented FDI in the processing industry played an important role (Davies 2013;
Zhang, B. 2017).
FDI inflows in Thailand before the 1980s concentrated on import-competing industries,
which later shifted to more export-oriented industries where FDI played a significant role
(Johnson 2006). FDI in Thailand significantly contributes to export performance mainly due towell-defined investment policies that promote free trade and liberalization (Maček et al. 2015).
Exports have doubled as a percentage of GDP since 1982 and the correlation between export
and FDI has been very strong. Like other successful Asian economies, Thailand would notprobably have experienced this rapid acceleration of exports without the presence of FDI.
Exports have been the main engine of Thailand’s economic growth, particularly since the mid1980s, and the shift in export contents reflects the structural transformation of the economy
from agriculture to industry (OECD 1999).
The FDI policy in Thailand was part of both the import-substitution and the exportpromotion strategies. After 1985, foreign affiliates in Thailand became more export-oriented
over time due to export promotion policies and a favorable exchange rate. The potential impactof FDI on the BOP goes beyond their contribution to exports. Foreign affiliates in Thailand do
also import goods and services, bring in capital and repatriate interest, income and royalties.
Moreover, the dependency of exports on imported components to meet the high-quality input
standards partly reduced the benefit to the country’s BOP (OECD 1999).

87

In Vietnam, export promotion has been at the center of government policy which included
the promotion of manufacturing exports through FDI. The contribution of FDI to Vietnam’s
exports developed fast (Schaumburg-Müller 2002), greatly increasing the ratio of export to
GDP since the early 1990s.
The export-to-GDP ratio in Bangladesh is low compared to the other three countries. It has
been relatively stable and has shown an increasing trend since the 1990s.
3-3-2. FDI related policies in selected Asian countries
This subsection draws lessons from best global practices on how FDI policy is used toincrease inflows of foreign capital and improve trade performances and, more generally, theBOP positions of host countries. We review the practices of China, Thailand, Vietnam and
Bangladesh and draw lessons for Ethiopia. In these Asian countries, FDI has had a large impact
on their structural transformation, industrialization pattern and export promotion.
In high-performing Asian countries—not just the selected four but also Indonesia, Taiwan,
Singapore and Malaysia—FDI has played a significant role in transforming their economies.
These countries have pursued different policies based on their respective country conditions
and succeeded in enjoying the benefits of FDI in terms of trade expansion, investment
promotion and improving their BOP (Davies 2013; Gebreeyesus et al. 2017; Johnson 2006).
In what follows, we focus on how these countries maximize the positive impacts of FDI on
their BOP and minimize its potential negative impacts by making use of FDI attraction andmanagement policies. These policies are related to the incentive scheme, profit repatriation,
FDI promotion, performance requirements, institutional reforms as well as export processing
zones (EPZs).
One thing that developing countries like Ethiopia can learn from Asian countries is that they
have clear, coherent and progressive policies to attract and utilize FDI and that the respective
governments have the commitment and capacity to implement these policies effectively. For
example, when China designs its FDI policy, multiple objectives are considered. Among which
the most prominent ones include increasing the value-added of domestic industries, promoting
linkage and export, balancing trade, and promoting technology transfer and regional
development. Among these, a particular focus has been given to two objectives: export
promotion and technological advancement (Gebreeyesus et al. 2017; Long 2005).
To achieve these objectives, China has used several laws and regulations governing FDI in
the country. These include the Law of the People’s Republic of China upon Sino-Foreign Joint
Ventures, the Law of the People’s Republic of China upon Foreign Cooperative Enterprises, theLaw of the People’s Republic of China upon Foreign Wholly Owned Enterprises, the Guidance
for Foreign Investment Orientations, and the Guiding Directory on Industries Open to Foreign

88Investment. China has also laws and regulations governing its preferential policies andstipulations for special economic zones (SEZs) (Long 2005).
Incentives, profit repatriation and FDI promotion in general
Using incentives to attract FDI, guiding it to priority sectors and geographic areas as wellas promoting exports and technology transfer has been a common policy tool used by all of the
Asian countries we have reviewed. The types of incentives and the purpose they are used arealso similar.
Thailand uses both tax and non-tax investment incentive schemes to attract FDI. These
incentives are given under certain conditions. The criteria that must be fulfilled by the investors
include the type of activities they are engaged in evaluated against its economic impact for
Thailand, area development through the investment, and the type of innovations to be
introduced to the country. To promote exports and maximize the benefits from FDI, Thailand
provided tax exemptions or reductions on imported machinery and raw materials, dividend tax
exemption for promoted enterprises and exemption of the corporate income tax for three toeight years. The government also assigned special investment privileges to projects in public
utilities and infrastructure, agricultural products, environmental protection, economic target
industries, and human and technology development (Laoswatchaikul 2011). Moreover, within
the priority sectors, Thailand provides tax exemptions to promote investments in productivityenhancing activities (OECD 2021).
On the other hand, non-tax incentives include land ownership permits, permission to bringskilled workers and experts, easing restrictions on foreign shareholdings and permission toremit money abroad in foreign currency (Cesar and Wahyuni 2020; OECD 2021). With its 201521 investment promotion strategy, it has made its promotion policy more targeted, merit-based,
and reduced the number of activities eligible for incentives. The merit-based incentive system
availed to both foreign and local firms allowed local small and medium-sized enterprises(SMEs) to compete on a more equal basis. It is also worth pointing out that Thailand has a
specific body, the Board of Investment (BOI), which is entrusted with stimulating foreign anddomestic investments as well as leading investment promotion and facilitation activities (OECD2021).
Bangladesh has a favorable geographic location, consumer market, and low labor costadvantages in attracting FDI along with policy incentives such as duty-free imports, tax
exemptions, and full repatriation of profits and invested capital. Bangladesh adopted theForeign Private Investment Act in 1980 to liberalize and encourage FDI to overcome thedeficiency in the domestic financial market, increase employment opportunities and economic
growth, and obtain a new source for much-needed capital. The Act ensured full repatriation of89

profits and capital, protection against expropriation, equal treatment of local and foreign firms,
and 5-7 years corporate income tax holidays for foreign investors (Manzoor and Chowdhury2016).
One major challenge for host countries in maximizing the positive impact of FDI on the BOP
is profit repatriation. This denotes the ability of a firm to send the foreign earned profit or
financial assets back to the firm’s home country in a hard currency such as USD, Euro or British
Pound after meeting the host nation’s tax obligation. The direct effect of FDI on the BOP of ahost country, among other things, thus depends on the difference between net exports and profit
repatriation. If net exports exceed profit repatriation, FDI will positively affect BOPs and if
profit repatriation is higher than net exports, FDI will hurt the country’s BOP position (Zhang,
B. 2017).
Foreign currency repatriation is an area where developing countries need to be extra careful.
While loose profit repatriation rules can be risky in terms of increasing the outflow of foreign
currency, bureaucracy and other difficulties in repatriating profits or repayment of foreign loans
are detrimental to the inflows FDI. In Thailand, authorized financial institutions that approve
the remittance of foreign currency for repatriation of profits or repayment of a foreign loan
make sure that the repatriation is made following terms and conditions of the relevant loan orother agreement, net of all taxes. Moreover, foreign investors in need of repatriating profits are
required to submit certain document evidence such as a relevant invoice, a copy of the relevantloan contract and also must apply for the remittance if the amount exceeds $50,000 (Periera etal. 2016).
Countries also use bold measures, laws, regulations, and incentive mechanisms to guide
FDI to priority sectors, areas, and objectives (export promotion, technology transfer, etc.) For
example, China classifies FDI projects into four categories of encouraged, allowed, restricted
and prohibited. Regulations that prohibit FDI participation in some sectors and industries are
introduced to protect industries that the Chinese government considers strategic, sensitive or
threatening to national economic and spiritual security (Chen 2011; Li 2013).
Under the pressure of BOP difficulty, the Thai government emphasized investment
promotion and liberalization of hitherto restricted sectors. Laws and regulations limiting foreign
ownership in certain activities have been progressively liberalized, especially after the Asianfinancial crisis of 1997-98 (Brimble 2002). In general, Thailand took a favorable policy
approach towards FDI such as amending the alien business law which used to restrict majority
foreign ownership in certain activities, financial sector liberalization, and legal infrastructure
which defined a framework for foreign involvement in industrial restructuring and merger andacquisition (M&A) (Brooker Group plc 2002).
Foreign investment in Thailand is still divided sharply between local market-oriented andexport-oriented production. Recently, however, the import substitution and export promotion90

policies have begun to converge. Firms wishing to export most of their output now face fewer
restrictions in terms of, for example, being able to locate anywhere, holding the entire shares in
the affiliate, and receiving exemptions on duties of imported inputs and tax holidays. On theother hand, firms that wish to sell most of their outputs in the local market are prohibited or
restricted in several ways (OECD 1999).
Vietnam also has a policy that favors foreign investors so that they can contribute to export
promotion and diversification, with strong attention on the exports of the manufacturing sector
and with a more limited concern in opening other potential sectors (UNCTAD 2008). Exportoriented growth strategy and the policy to favor FDI mainly in export-oriented manufacturingsectors are the secrets of success for Vietnam (Andronova et al. 2020).
Performance requirements
Unless incentive schemes are targeted and tied to performances, they can easily be
manipulated or abused and may have unintended consequences. Putting performancerequirements and imposing them in practice requires strong bargaining power and strong
government bureaucracy, capacity and commitment to follow up their implementation.
Before joining the World Trade Organization (WTO) in 2001, China had policies that put
performance requirements on foreign-invested enterprises. They were classified into
compulsory, neutral and voluntary policies. The compulsory requirements included a balancing
of foreign exchanges, procurement of domestically produced inputs above a certain threshold(local content requirement), and the minimum share of total products that must be exported.
China also had requirements for technology transfer and the creation of R&D centers. China
used to allow solely foreign-owned enterprises only under the condition that they either adopted
advanced technology and equipment or exported the majority of their outputs. Otherwise, FDI
had to be in the form of joint ventures and cooperatives. China used its strong bargaining power
to dictate the form of FDI inflows in such a way that it could generate more technology transfer
or export. Most of these requirements were abolished when China joined the WTO (Long 2005).
Meanwhile, China’s neutral policies aimed to create fair conditions for exporters from China
and offer tariff and value-added tax (VAT) exemptions on imports processed for re-exports.
Voluntary requirements were used to promote exports by offering a 50% cut in corporate
income tax to firms exporting 70% or more of their outputs.
Bangladesh as a host country has provisions to promote inflows of FDI but these provisions
are criticized for the lack of performance requirements. Since the country desires to attract more
FDI and the pressure from MNCs is strong, requirements are hardly imposed. Even when they
are imposed, the government is not strongly committed to enforcing them (Hossain et al. 2020).

91

Institutions, infrastructure and FDI-friendly business environment
Having a competitive advantage in certain factors of production and providing fiscal andnon-monetary incentives are not enough to attract FDI. It is important to create and maintain aproactive and FDI-friendly business environment that must go with performance requirement
provisions for foreign firms (Mujeri et al. 2021. In addition to the availability of cheap raw
materials and low-cost labor, foreign investors take into consideration the quality of institutions
and infrastructures of the host country in their investment decisions. If institutions are strong interms of political stability, voice and accountability, control of corruption, government
effectiveness, regulatory quality, and the rule of law, this will induce inflows of FDI and profit
reinvestment instead of profit repatriation to the home country (Siddikee and Rahman 2020).
In Thailand, macroeconomic stability, government effectiveness, regulatory quality, control ofcorruption and political stability are significantly and positively associated with inward foreign
investment (Bunnag 2020).
While China and Thailand have done relatively well in improving institutions, building
quality infrastructure and creating FDI friendly business environment, Vietnam and Bangladesh
are lagging in this regard. In Vietnam, there are several factors identified as major impediments
to FDI. They are related to the lack of adequate infrastructure, the legal environment, treatmentof workers, environmental concerns, property rights, enforcement of contracts, long and nontransparent bureaucratic procedures, red tapes, and so forth (Lam 2014; Schaumburg-Müller
2002; Nguyen Xuan and Dinh Phi 2021). Current FDI laws in Vietnam are, however, quite
liberal compared to other Asian countries for the protection of rights, preferential treatment andpermitted types of investment (Nguyen Hoang Viet et al. 2019). Moreover, macroeconomic
stability, qualified management force and workers’ skills have been important factors that
Vietnam used to realize the full potential of FDI on the balance of payments and the overall
economy (Ngo et al. 2020). Similarly, in Bangladesh, while the low labor cost, natural resources
and a high investment return are key strong features, the country has serious problems in thequality of its institutions. The problems include widespread corruption undermining good
governance and the rule of law, high inflation crippling lives of the poor, shortage of electricity,rising import and a weak currency. These collectively worsen the balance of payments and
impede the overall growth and development (Salman 2009).
Special economic zones
Developing countries may find it difficult to undertake nationwide reforms in institutions
and infrastructures in a short period. It is therefore a practical policy option to develop special
economic zones in limited areas and implement necessary reforms, provide business-friendly

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services and quality infrastructure for FDI as a showcase that can be scaled up progressively
over time. In this regard, China has a rich experience where its open-door policy was
accompanied by the construction of special economic zones (SEZs). China’s SEZs, which wereconcentrated in the Eastern Region, were a major pillar of economic development in the 1990s
that strengthened the country’s export performance and had a positive impact on its BOP(OECD 2000). Enterprises in the SEZs were offered standard policies such as tariff reduction
or exemption and preferential tax treatment, which created a favorable business environment in
geographically confined areas. This encouraged both domestic and foreign investment andpromoted industrial agglomeration. China thus managed to establish SEZs that absorbed FDI
and generated significant national benefits from it (Song et al. 2020).
Similarly, Thailand was able to develop competitive SEZs that attracted large amounts of
FDI and improved the performance of the manufacturing sector. Thanks to these SEZs, thecountry became the center of world-class manufacturing with active participation in global
value chains (Cesar and Wahyuni 2020). SEZs are used as an instrument to experiment in
structural reforms which are difficult to implement at the national level. The zones are deployed
to modernize Thailand’s industrial structure, gain competitiveness and intensify its position in
the value chain. The clustering of economic activities in certain geographical areas facilitated
all this (OECD 2021).
Vietnam’s SEZ policy targets encouraging export, attracting FDI and creating employment
opportunities using different policy tools such as favorable corporate income tax, fees and land
rent. The SEZs are also used as a means to provide better infrastructure and simplification ofadministrative management. The SEZs are built close to expressways, ring roads and national
highways connecting regions in the country. These have been developed in steps. In the
beginning, the focus was given to establishing export processing zones, then to industrial zones
with export orientation. This was followed by the establishment of high-tech and cross-borderzones as well as open and coastal economic zones to promote heavy industries. Finally,
information technology parks and agricultural high technology parks were set up to encourage
new industries in the country (Tien and Huong 2020).
3-4. FDI and the BOP in Ethiopia: policy and performance
In this section, we present Ethiopia’s FDI policy from the perspective of the BOP and discuss
its BOP position vis-à-vis the potential impacts of FDI on the two major components of the
BOP. We look at trends in exports and imports (the trade balance) as well as how the foreignexchange needs of the country are financed, either by debt or FDI, and associated outflows offoreign exchange in the forms of profit repatriation and payments of interest and principal on
the country’s foreign loans.

933-4-1. Overview of Ethiopia’s FDI policy23
When the Derg regime took power in 1974 and instituted a command economic system, it
nationalized major industries owned by Ethiopians and foreigners. This scared off foreign
investors from the country (Gebreeyesus et al. 2017; UNCTAD 2002). After the fall of the Derg
in 1992, the country started to adopt a relatively more liberal policy and took reform measures
as part of the structural adjustment program. It is since then that FDI as a component of capitalformation gained importance in Ethiopia. In the same year, the Ethiopian investment office wasestablished and the first investment proclamation was issued (Proclamation No 15/1992). This
proclamation was the first step towards creating favorable conditions for the private sector, both
domestic and foreign. The proclamation provided incentives to firms participating in the
primary sector and allowed the participation of FDI with a minimum of $125,000 block account(Gebreeyesus et al. 2017; Teka 2013).
Since 1992, the investment proclamation has been revised several times to make the
incentive scheme more generous, especially for those investing in the export sectors, hence
ensuring the participation of more foreign investors in the economy (UNCTAD 2002). In 1994,
the privatization program was started with the main objective of increasing the role of theprivate sector in the economy. To promote the export sector and engagement of the private
sector, several measures were taken towards further liberalizing the investment regime andrelaxing restrictions on the operation of FDI. These reform measures included liberalization of
trade and the foreign exchange rate system, devaluation of the currency, deregulation ofdomestic prices, lowering of import duties, and relieving of export regulations and procedures.
Despite these measures in the past, the Ethiopian economy is still highly regulated. Crossborder trade taxes are still relatively high, reaching as high as 240%, the foreign exchange rateis far from full liberalization with the exchange rate of the birr usually overvalued. The National
Bank of Ethiopia practices foreign exchange rationing and the parallel market flourishes.
Following the introduction of the first comprehensive industrial development strategy in
2002/03, the government of Ethiopia took several reform measures towards promoting export
and investment in selected priority sectors. The regulatory framework broadened economic
sectors open to FDI, made licensing and registration easier, established financial limits for FDI
firms, and stipulated financial incentives as well as monitoring and reporting requirements.
Accordingly, economic sectors open to foreign investors are now all sectors except thosereserved for domestic state and private investment—see UNCTAD (2002) for the list of sectors
reserved for domestic investors only. For both wholly foreign-owned and joint ventures with

23

For a detailed review of Ethiopia’s FDI policy, see Chapter 1 of this report.

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Ethiopians, the minimum required investment is set which can be paid either in cash or in kind.
FDI and domestic investors are also required to provide progress reports on the status of projects
to Ethiopian Investment Commission (EIC) every six months after receiving permission toinvest (Gebreeyesus et al. 2017; UNCTAD 2002). These reforms may have contributed to theincreased FDI inflow since the mid-2000s (Gebreeyesus et al. 2017).
Recently, the Ethiopian government issued Proclamation 1180/2020, a new investment
proclamation that aims at increasing foreign exchange earnings through enhanced global
competitiveness and expansion of exports of goods and services in volume, variety and quality.
The proclamation also promotes the saving of foreign exchange through the local productionof import substitutes. This will augment the BOP by stimulating export and replacement ofhitherto imported goods by domestically produced goods. According to this proclamation, any
investor may engage in any area of investment except in cases where it is contrary to the moral,law, public health or security of the country. Foreign investors are required to allocate aminimum capital of $200,000 for a single investment project or $150,000 if it is a joint venturewith a domestic investor. This restriction remained the same as the provision in the previous
Investment Proclamation No. 769/2012.
Investment Proclamation 1180/2020 also gives foreign investors the right to remit profits,dividends, principal and interest payments on an external loan of their investment out of
Ethiopia in convertible foreign currency at the prevailing exchange rate. To further encourage
foreign investors, the proclamation allows employment of duly qualified foreigners for theoperation of their investment as trainers, high management, supervisors and other professions
if Ethiopians possessing qualifications or experience required by the sector are not available.
The regulations also provide a fiscal incentive scheme for foreign investors including corporate
income tax holidays from one to nine years, additional tax holidays for priority sectors, duty
exemption of raw materials used as inputs for export, provision of land with competitive leaseprices, investment credit support, and duty-free import of capital goods (EIC 2018).
3-4-2. Trends in FDI inflows and the BOP in Ethiopia
FDI inflows to Ethiopia steadily rose since the early 2000s and showed a dramatic increase
between 2012 and 2017. Specifically, net FDI inflows to Ethiopia increased from around $500
million in 2005 and 2006 to a peak of $4.17 billion in 2016/2017 (Figure 3-3). The big jump in
FDI inflows during this period can be explained partly by the reform measures briefly
mentioned in section 3-4-1 and more fully discussed in chapter 1. The observed increase ininvestment is mostly in the manufacturing sector and comes mainly from China, Turkey andIndia (Gebreeyesus et al. 2017). In the years after 2016/17, however, net FDI inflows have been
continuously declining. This can be attributed to the political instability and associated95economic problems within the country during the same period. Despite this fall in the last three
years, the average FDI inflows in the past five years (2015/16-2019/20) is greater than the
average in the previous five-year period (2010/11-2014/15).
FDI as a share of GDP has also grown in the past years. It increased from 0.6% in 2012 toa peak of 5.8% in 2016. After 2016, it declined to reach 2.6% in 2019. Despite this, Ethiopia’s
FDI-to-GDP ratio is higher than the average of Sub-Saharan Africa (less than 2%) and that of
low-income countries (less than 3%) for the period 2016-2018 (IMF 2020). If the current
downward trend in Ethiopia’s FDI inflows continues, the situation may be reversed in the near
future.
With the new administration’s clear move to restrain the use of foreign loans to financepublic investment projects, FDI has become, and is projected to remain, an important source of
external finance to ease the country’s BOP pressure. Although this shift from debt financing to
FDI financing of the BOP is important to reduce Ethiopia’s external vulnerabilities, the current
FDI inflows are not sufficient to cover the country’s external gross financing needs (IMF 2020).
Figure 3-3 also shows trends in Ethiopia’s BOP from 2006 to 2020. It has an alternating
trend over the period. The BOP is mostly in deficit owing to the high import volume thatsignificantly outweighs the volume of exports as well as the increasing need for foreign debt
service. After dipping in 2011/12, Ethiopia’s BOP has remained in deficit except for 2016/17,
a year that saw some pickup in FDI activities.
Given that Ethiopia’s capital account is relatively closed, the external financing needs ofthe country are mainly met by inflows of FDI and external loans taken by the public sector. The
government’s move to slow down external borrowings coupled with the unfortunate decline in
Figure 3-3. Ethiopia: Trends in FDI and the Balance of Payments (Million USD)
5000
4000
3000
2000
1000
0
-1000

Balance of payment

FDI

Source: author’s computation based on data from the National Bank of Ethiopia.

96

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

-2000

FDI inflows has exacerbated the country’s BOP pressure. The International Monetary Fund(IMF) characterizes Ethiopia’s BOP pressure as acute and attributes this low performance tothe “highly overvalued exchange rate, weaker-than-expected export performance in recent
years, and elevated external debt servicing needs. As a result, Ethiopia is experiencing an
intensification of its persistent FX shortages and a large FX backlog, resulting in continued
rationing of hard currency” (IMF 2020).
3-4-3. The trade deficit, current account balance and FDI inflows in Ethiopia
Ethiopia habitually runs a trade deficit, which is growing over the years, due to the stagnant
export performance of the goods sector and an ever-increasing import bill. As depicted in
Figure3-4, Ethiopia has a huge trade gap in the goods sector. After deteriorating for several
years, the country’s trade deficit started to show some improvement from around 2015/16. Oneof the likely explanations for this is import compression. Imports of goods have declined since
2016/17 during which the National Bank of Ethiopia implemented foreign exchange rationing.
Ethiopia’s trade deficit in the goods sector is to some extent compensated by a surplus in service
trade as well as by inward remittances and official transfers. The current account has improved
after reaching the low level in 2014/15 (Figure 3-5). The main reasons for this, apart from theimport compression mentioned above, are reduced imports following a curb in public
investment, an increase in private savings and increased official transfers (IMF 2020).
Figure 3-4. Ethiopia: Imports and Exports (Excluding Services) (Million USD)
18000
16000
14000
12000
10000
8000
6000
4000
2000

Imports

Exports, FOB

Source: author’s computation based on data from the National Bank of Ethiopia.

97

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

0

Figure 3-5. Ethiopia: Current and Capital Account Balances (Million USD)
8000
6000
4000
2000
0
-2000
-4000
-6000
-8000
-10000Current account

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

-12000Capital accountSource: author’s computation based on data from the National Bank of Ethiopia.

Except for the modest improvement in the service trade sector, export earnings do not playa meaningful role in reducing Ethiopia’s current account deficit. Although the government’s
Second Growth and Transformation Plan (GTP II) stipulated an exchange rate policy to promote
exports as well as efficient transport and logistics services, these issues remain majorbottlenecks for the export sector. Similarly, the project for constructing industrial parks, which
is supposed to stimulate exports through an increased supply of industrial land and the benefitsof agglomeration, has not yet brought visible improvements in trade statistics.
FDI is believed to be a strategic tool to finance the BOP deficits through the introduction offoreign capital, export promotion and substitution of imports with locally produced goods.
Cognizant of this, the government of Ethiopia has been working to increase FDI inflows witha focus on export-oriented FDI. The government offers an incentive system that favors theexport sector and established several industrial zones with single window services. Yet, theperformance of the export sector in general and FDI-driven export in particular has beensignificantly below expectations. Firms tend to sell more to the domestic market (Gebreeyesus
et al. 2017; Teka 2013; UNCTAD 2002). Gebreeyesus et al. (2017) finds that only 16% of FDI
firms in the manufacturing sector participate in exports and, on average, only 7% of their sales
is bound for overseas markets. Although a better picture emerges when one focuses on the laborintensive textile, apparel and leather products sectors where 47%, 50% and 68%, respectively,of these FDI firms are exporters. Overall, however, the performance of the FDI-driven export
sector remains below expectations.
Several factors can be listed for this underperformance. First, although the government

98

places export requirements on MNCs, monitoring their fulfillment is challenging. On top ofthis, there is an anti-export bias created by the existing policies such as the overvaluation of thebirr, high import duties and non-policy factors such as inefficient logistics including high freightcosts and delays in customs clearance. Plagued by these factors, manufacturing firms in
Ethiopia tend to be more interested in the domestic market than exporting (Gebreeyesus et al.
2017; Gebreeyesus and Kebede 2017). This accentuates the need for reform in the areas
generating an anti-export bias and to make sure that the incentive system is result-based andeasy to monitor.
Moreover, the high import intensity and the high debt-to-equity ratio of FDI inflows into
Ethiopia may explain why the contribution of FDI to the narrowing of the BOP gap is minimal
and ineffective. As argued in Sen (1995), the debt-equity ratio and direct import component of
the FDI projects should be small for FDI to have a positive effect on the BOP.
In Ethiopia, many foreign investors avail themselves of debt-financed investment obtained
from their source country or locally from the Development Bank of Ethiopia (DBE). When theinvestment is import intensive or does not generate sufficient foreign currency through export,
capital flight may substantially attenuate the potential benefit of FDI as a partial solution to thecountry’s current account and BOP deficits. Repatriation of foreign exchange earned fromexports to finance MNCs foreign debts along with the possibility of inflated debt (usually fromtheir parent companies), under-invoicing of exports, over-invoicing of imported inputs,
defrauding of DBE loans to capital flight are some of the important factors that can explain themarginal contribution of FDI inflows to the BOP needs of the country (Gebreeyesus et al. 2017).
3-5. Policy recommendations and the way forward
In this chapter, we have assessed the BOP effects of FDI inflows from the viewpoint of a hostdeveloping country. As part of this, we have reviewed best practices of selected Asian countries
focusing on policies they have used to attract FDI and maximize its positive impact on the BOP.
Since the aim is to draw lessons for Ethiopia, we have also examined Ethiopia’s FDI policy visà-vis its BOP performance. For foreign exchange-constrained countries like Ethiopia, FDI is an
important source of capital that can be used to ease the BOP pressure. This can, however, beeffective only if the FDI policies, requirements, incentives and monitoring mechanisms are welldesigned and properly implemented.
With its move to join the upcoming African Continental Free Trade Agreement (AfCFTA),
access to the US and European markets via African Growth and Opportunity Act (AGOA) and
Everything but Arms (EBA) tariff exemption arrangements, together with its relatively large
and growing domestic market, Ethiopia is an attractive location for FDI. The government
should therefore exert utmost effort to take bold reform measures and remove the identified

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major bottlenecks in attracting FDI and maximizing its benefits for Ethiopia. Among the areasthat require serious attention are macroeconomic measures towards controlling the highinflation and ending the overvalued exchange rate of the birr; reduction of bureaucratic hurdles
in licensing, registration and customs clearance; and enhancement of infrastructural as well as
logistic services. With these improvements, the government will have stronger bargaining
power when negotiating with foreign investors and can also be more selective in the type of
FDI it wants to attract. Moreover, the overvalued exchange rate of the birr and high trade costs
produce an anti-export bias in Ethiopia. As a result of this, serving the domestic market appears
to be easier and more lucrative than exporting for both FDI and local firms. If Ethiopia wishes
to promote its exports and improve its BOP positions, this issue needs to be carefully addressed.
As Gebreeyesus and Kebede (2017) points out, Ethiopia focuses more on attracting new
FDI, by providing incentives and relaxing restrictions on FDI participation in the economy, thantrying to maximize benefits that can be obtained from FDI that is already in the country. The
incentive scheme available to exporters and foreign investors should be redesigned in such a
way that they become more result-based, easier to monitor, and less costly.

100Chapter 4
Enhancing the Role of FDI in Technology andKnowledge Transfer
4-1. Introduction
Given the gap in technology and know-how between Foreign Direct Investment (FDI) source
countries and their developing host counterparts, FDI can potentially play a crucial role innarrowing this gap. FDI is perceived as one of the key channels for technology and knowledgetransfer across national boundaries and between firms (Torlak 2004). Technology transfer is theprocess of transmitting technical information from one party to another, assuming that thereceiving party can successfully absorb it into its production process (Gheribi and Voytovych
2018). It transfers technology, know-how and expertise, including management practices, from
one individual, enterprise, or organization to its counterpart (Tessema 2016). The benefit ofthese transfers is productivity spillovers, which take place when the entry of foreign affiliates
in a host country leads to an increase in the productivity or efficiency of local firms (Blomström
et al. 2000; Torlak 2004). Technology transfer is critical to the economic growth and welfare of
any country regardless of its level of development. It is also a necessary condition to put
developing economies on a path of sustainable development and poverty reduction (UNCTAD
2010).
The literature recognizes two major channels through which technology and knowledgetransfer from FDI can occur: horizontal and vertical. With respect to the horizontal channel, themain mechanisms of positive technology externalities to local firms are the demonstration effect,
labor turnover and the competition effect. On the other hand, vertical technology transfer occurs
through backward (supplier) and forward (buyer) linkages. The backward linkage is often
regarded as the main channel of FDI technology spillovers. Multinational corporations (MNCs)
have more incentive to facilitate technology diffusion in this direction because they benefit fromthe improved performance of upstream input suppliers. Technology transfer can also occur
directly through joint ventures between MNCs and local firms (Lee and Tan 2006; Fu 2008).
The extent to which new technology, knowledge and management practices are transferred
to host economies varies significantly between regions and countries. These variations canmainly be explained by differences in local conditions, absorptive capabilities of local firms
and government policy. The absorptive capacity of local firms and the existence ofcomplementary assets are crucial to the technology and knowledge spillover from FDI (Fu1012008). The effectiveness of the transfer also heavily depends on the host country’s political,
economic and institutional conditions that allow the leverage of positive effects and reductionof FDI’s adverse effects (Forte and Moura 2013). For an effective transfer of technology andknowledge through FDI, the role of government in supporting the transfer is vital in building
domestic technological capabilities (UNCTAD 2007; UNCTAD 2010).
Among advanced countries, FDI has a significant effect on the local economy in terms ofcapital provision, technology transfer, employment opportunity, knowledge spillover andexport promotion (Holland and Pain 1998; Doeringer and Terkla 2003; Djulius et al. 2018; Te
Velde 2019). However, the empirical evidence on the effect of FDI on technology andknowledge transfer for developing countries is inconclusive. For some developing countries,
FDI has been a significant factor for smooth technology diffusion (Torlak 2004; Lee and Tan
2006; Fu 2008; UNCTAD 2010) while for others it is either neutral or an ineffective device(Javorcik and Spatareanu 2005; Osano and Koine 2016; Gebreeyesus et al. 2017). In many
developing countries, FDI fails to deliver knowledge and technology to local firms due to theirlimited absorptive capacity, weak supply chains, the unskilled labor-intensive nature of the
production process, poor infrastructure, fragile policy coordination and targeting, theunfavorable political and economic environment of host countries, and so on (Acs et al. 2007;
Todo et al. 2009; Djulius et al. 2018).
Ethiopia is keen to attract FDI as a bringer of technology and knowledge. The country has
enjoyed an influx of investment particularly from China, India and Turkey. However, theinvestment proclamations of the country have been passive when it comes to the issue oftechnology and knowledge transfer. There are no specific interventions aimed at forming andstrengthening linkages between FDI and local firms. Moreover, there is no mechanism tomonitor and evaluate the technology and knowledge spillover effect of FDI (Gebreeyesus et al.
2017).
Research on the benefits of FDI concerning technology transfer focuses mainly on products
or processes such as newly introduced machinery and software while the transfer of managerial
know-how and skills is often overlooked. Managerial knowledge transfer from foreign to local
firms through the diffusion of management practices is also a major benefit of FDI to hostcountries. Management practices represent regular routines of management operations of a firm
towards work organization, organizational culture, production management and employee
relationships. Such managerial knowledge is a key determinant factor for the firm’s
competitiveness (Teece and Pisano 1994; Fu 2012).
The purpose of this chapter is to (i) examine the presence and depth of linkages between
FDI and local firms and the attendant benefits in knowledge and technology transfer andspillover in Ethiopia and (ii) propose policy options to strengthen the FDI-local firm linkage
and enhance technology and knowledge spillover in the overall economy. In this spirit, it

102examines both technological transfers by way of introduction of new products, machinery,
software, etc. as well as the transfer of managerial know-how through the adoption of new
managerial practices. These two types of transfer are distinguished in the literature review aswell as our field survey reports.
The rest of the chapter is organized as follows. Section 4-2 reviews the literature on themechanisms through which FDI can generate technology and knowledge transfer in the context
of a developing host economy. Section 4-3 presents global policy practices for effective
technology transfer and diffusion. Section 4-4 reviews the literature and policies regarding FDI
and technology transfer in Ethiopia. Section 4-5, based on a field survey conducted in late 2020,
examines the presence and depth of different mechanisms of technology and knowledge transfer
in Ethiopia as well as the possibility of managerial knowledge spillovers. The last section
concludes with a summary of the main findings and some policy recommendations.
4-2. Literature review
4-2-1. Mechanisms for technology and knowledge transfer through FDI
FDI transfers advanced technology and organizational know-how to domestically owned
enterprises of host economies (Ikiara 2003). The literature distinguishes between knowledgetransfer and knowledge spillovers. The former is an intentional transfer of knowledge fromforeign firms to local ones and can be intra-firm or inter-firm while the latter is an unintentionaltransfer through externality that occurs between different firms (Smeets and Vaal 2006; Te
Velde 2019). Knowledge can be explicit or implicit. Explicit knowledge can easily be
communicated, codified and understood across or within firms. It can be explained in words
and can be spread through written or oral explanations. However, most knowledge from MNCs
is tacit and deeply rooted in the minds and experiences of individuals. It is therefore largely
invisible and hard to codify, articulate or transfer in a systematic fashion (Nelson and Winter
1982; Kogut and Zander 1992; Wang et al. 2009). It cannot be conveyed or disseminated easily
to local firms (Fu 2012). Technology sharing, personnel transfer, strategic interaction between
MNCs and local firms, among others, are critical for knowledge exposure. However, somestrategies are more effective than others for the transfer to take place (Inkpen and Dinur 1998).
Technology and knowledge transfer can be effected through various mechanisms. One
popular mechanism is through supplier (backward and forward) linkages. Local suppliers of
MNCs may generate backward linkage if they receive training, information and technicalassistance to fulfill the required quality standard of inputs. The foreign firms may purposelytransfer knowledge to their suppliers to reduce their production costs and raise efficiency.
MNCs can also supply inputs to local firms and assist the modernization of their production

103

facilities which can induce technology transfer through forward linkage (Tessema 2016).
Another way of technology transfer is through the demonstration effect by which domestic
firms learn and imitate a new product or a new organizational process from MNCs (Wahab etal. 2012). Firms in the same sector may also compete horizontally with MNCs forcing them toreform the management style and update production technology (Sönmez and Pamukçu 2013;
Tessema 2016).
The movement of labor from MNCs to local firms is another mechanism for spillover ofmanagement practices to local firms. Most foreign firms invest in labor through stiff training to
improve productivity using good management practices that can be transferred to local firms
when employees move from foreign to local firms (see also Fu 2012). MNCs are more likely
to manage their labor well towards improving their motivation and competence. They are also
more likely to give due attention to the process of recruitment and training of the labor force.
Local firms can benefit greatly from such labor migration (see also Ito et al. 2010; Franko andKozovska 2010; Djulius et al. 2018).
Expatriates are also an important source of knowledge transfer and learning for local firms(Tsang 1999). MNCs frequently assign expatriate executives at overseas subsidiaries to transfer
knowledge and enhance the subsidiary’s performance through implicit knowledge transfer(Wang et al. 2009). In a joint venture setup, the local partner can acquire knowledge from theforeign partner with different degrees of effectiveness depending on the level of trust between
companies, the depth of business relationship, the degree of engagement of the foreign company,
and the intention of the joint venture to learn together under global competition. The knowledge
absorption capacity of the local firm is a particularly significant factor for effective transfer(Park et al. 2009). Success hinges on the openness and receptiveness of the top management
team of the local firm to embrace and assimilate practices exemplified by the MNC (Fu 2012).
The choice of mechanisms for technology and knowledge transfer depends on thecharacteristics of the host country, labor skills, the education level of the workforce,technological transfer requirements, the complexity and novelty of the technology, and the stateof competition in the host country (Sinani and Meyer 2004; Wahab et.al. 2012). Likewise, theextent to which the mechanism can be effective depends on multiple conditions including theabsorptive capacity of local firms, the extent to which various stakeholders are supportive ofsuch knowledge flows, explicit and implicit policies of the host country, and the degree to which
MNCs are integrated into the national economy (Fu 2008; UNCTAD 2010).
Public policy on inducing linkage and boosting knowledge transfer between FDI and local
firms is also very significant. To promote economic development and to build linkage, politicalincentives are major drivers behind failures through lack of coordination, lack of leadership,
low-quality business and state relations (Te Velde 2019). The technology and knowledgetransfer policy of the host country should focus on boosting the absorptive capacity of domestic

104enterprises, developing innovation systems at various levels, promoting technology
dissemination through linkages, protecting intellectual property rights (IPRs), and targeting
specific technologies and companies (UNCTAD 2010; Forte and Moura 2013).
4-2-2. Global evidence on technology and knowledge transfer through FDI
Though FDI is expected to generate technology transfer and spillover to the domestic
economy and firms, the existing empirical evidence is mixed (Javorcik and Spatareanu 2005;
Johnson 2005). Lee and Tan (2006) examined the intensity of technology transfer through FDI
and the import of machinery in four Asian countries. Their result shows that technology transfer
intensities vary across countries and the intensity of FDI inflow is strongly related to technology
transfer in Singapore, Malaysia, Thailand and Indonesia. This is attributed mainly to local
policies that fostered the absorptive capacity of local firms.
Fu (2008) investigated the impact of FDI on the innovation capabilities of regions in China.
This author finds a favorable effect of FDI on regional innovation capacity and shows that thisheavily depends on the absorptive capacity and the conditions complementary to innovation in
the host region. Reenena and Yuehb (2012) states that the FDI policy in China has been pitchedat developing joint ventures with foreign firms and attracting technology to improve theproductivity of domestic firms. In China, the majority of FDI is in joint venture format which
has a high likelihood to bring technology and knowledge spillover for domestic firms.
On the other edge, Ikiara (2003) notes that few studies address the FDI-local firm link in
Africa and these studies signify the existence of limited technology transfer and spillovers to
the domestic firms in the region. It is indicated that, to reap the benefits from FDI, Africa must
put in place the necessary policies, regulatory frameworks, institutional setups and enforce themaggressively. Similarly, Torlak (2004) tested the intensity of technology and knowledge transfer
through FDI for five transition countries in Eastern Europe including the Czech Republic,
Poland, Hungary, Romania and Bulgaria. Torlak reports the lack of empirical evidence fortechnology diffusion from foreign firms to domestic ones in these transition countries.
The difference in local firms’ capacity to absorb and adopt management practices of MNCs
is a significant factor explaining productivity differences across countries (Bloom and Van
Reenen 2007; Fu 2012). Doeringer and Terkla (2003) explored differences in the production
functions and management practices between manufacturing plants newly opened and owned
by Japanese MNCs in the US in the 1970s and 1980s and new branch plants owned by US
corporations. A large difference was found in the extent to which new Japanese and US plants
invested in management practices and human capital to promote productivity and management
cultures. The management practices of Japanese FDI firms generated faster growth inproductivity and employment. Branstter (2006) examined if FDI was a channel of knowledge105spillovers for Japanese MNCs investing in the US. It was discovered that FDI increased theflow of knowledge spillover in both directions, from and to the Japanese MNCs, because theabsorbing capacity of human capital was high on both sides.
Ferretti and Parmentola (2010) analyzed the influence of host government policies onknowledge spillovers from FDI in Iran. It was shown that government could promote FDI
knowledge spillover only if the absorptive capacity of local firms was improved and a strategic
approach was introduced to create a connection between foreign investors and local firms.
Similarly, Lashaki and Ahmed (2017) examined the influence of FDI on the catching-up process
driven by labor, human capital, physical capital, absorptive capacity and export channel in the
Asia Pacific region. They find a positive link between FDI inflow and absorptive capacity(human capital) which implies that human capital had to be a top priority in effectively
producing spillovers.
Djulius et al. (2018) investigated if FDI could prompt knowledge spillover to textile
companies in Indonesia through labor turnover, the demonstration effect and vertical linkage.
Labor turnover is found to generate knowledge spillover while the demonstration effectpromoted innovation. Nonetheless, the growth of the textile industry driven by foreign
investment is relatively small in Indonesia compared to other developing countries like
Bangladesh, India and Vietnam where initial technology and knowledge levels were higher andthe absorptive capacity of local firms was also high.
Keller (2021) examined knowledge spillovers and positive externalities in the context ofinternational economic transactions. The evidence shows that trade and FDI lead to sizableknowledge spillovers. Monge and Rivera (2021) similarly investigated knowledge spilloverfrom MNCs to local firms in the IT sector of Costa Rica through labor mobility. Foreign anddomestic firms and workers each exhibit salient characteristics and there is low mobility oflabor from MNCs to local firms in the IT sector. IT workers at local firms with previous working
experience in IT MNCs enjoy wage premium which suggests knowledge spillover through labormobility.
The review above generally points to several determinants of effective technology transfer
including the absorptive capacity of local firms, infrastructural development, human capital,
labor mobility, joint venture arrangement, subsidized R&D, licensing, the political environmentof the host country, the level of industrialization, market size, competitive environment, thesystem of proactive governance and fiscal incentives (Holland and Pain 1998; Todo et al. 2009;
Lashaki and Ahmed 2017; Zhang 2017; Djulius et al. 2018; Hauge 2019; Te Velde 2019; Keller2021).
4-2-3. Review of existing studies on FDI’s technology and knowledge transfer in
Ethiopia106

This subsection highlights the existing evidence on the role of FDI on technology andknowledge transfer in Ethiopia. Geda and Meskel (2009) investigated the horizontal andvertical spillovers of Chinese investments in Ethiopia with attention to managerial skill transfer
and technology spillover to Ethiopian firms. Although joint ventures are one means to increase
the spillover, Chinese firms are not enthusiastic and call for appropriate incentives by thegovernment if joint ventures are to be encouraged. The study further shows that, in negotiating
and operating investment projects, the skill and expertise gap between China and Ethiopia
works against the interest of Ethiopia in the short run, and the interests of both parties in thelong run. As a precondition of a successful joint venture, Ethiopia needs to upgrade the skill of
its workforce and the capacities of its officials and experts.
Bekele (2011) assessed the impact of FDI on knowledge and technology transfer in
Ethiopian industrial parks. The results show that knowledge and technology spillover has notbeen achieved and foreign firms request renewal of expat contracts, citing insufficient training
achievements by the locals as a major reason. These firms may even dismiss trained local
workers due to unsatisfactory improvements.
Lemma (2011) examined the impact of FDI on technology transfer in Ethiopia. The study
shows that the horizontal and vertical channels for technology transfer to local firms in themetal and engineering industries in Ethiopia are weak. According to the author, the main
reasons for this are FDI’s engagement in labor-intensive production systems, weak technology
transfer policy, and the frail intention of MNCs to transfer technological know-how to local
firms. Lemma et al. (2014) assessed the effect of FDI on technology transfer in Ethiopian metaland engineering industries. The technological capability of local industries to adopt and modify
technology from foreign affiliates was found to be very weak. This was attributed to theuncooperative environment for foreign and local firms to work together and the technology
policy of the country was too weak to soak up technology benefits.
Ahmad (2016) studied the impact of FDI on the productivity and growth of Ethiopian firms
and found that domestic firms benefited from the presence of foreign firms in their respective
sectors. Domestic firms in sectors with a higher presence of FDI show substantially higher totalfactor productivity (TFP) and output growth, suggesting a horizontal spillover effect. This effectis higher for firms with relatively high productivity and a low technology gap implying that
more advanced domestic firms have a higher absorptive capacity, not those with a large gap tolearn and fill. Begum and Tesfaye (2016) investigated the technology spillover impact offoreign firms on Ethiopian firms using primary data. The presence of foreign firms creates
technology spillover but the magnitude is found to be small. The demonstration is the mosteffective channel for spillover followed by linkages. The study also confirms that changes inorganizational setup and management practices are the most common response of local firms
to the influence of MNCs while changes in products and processes proved to be weak.

107

Gidey (2020) empirically examined the effect of FDI on TFP, export and employment inEthiopia. FDI exerts a significant positive effect on TFP in the long run but has a negative
impact in the short run. The study also urges the government to improve the overall businessclimate to encourage foreign firms to locate and stay in Ethiopia. This should include ensuring
economic and political stability, providing multiple incentives, keeping law and order,developing infrastructures, and minimizing corruption and unnecessary bureaucracies. Negash
et al. (2020) examined the impact of Chinese FDI in Ethiopia on the productivity of domestic
firms through horizontal linkages and absorptive capacities. Chinese ﬁrms are more productive
than local ﬁrms and their existence may produce potentially positive productivity spillover fordomestic ﬁrms. Chinese manufacturing ﬁrms operate more efficiently due to superior
production technology and greater managerial ability. However, local firms gain positive
spillover only when they already have high absorptive capacity while local firms with low
absorptive capacity fail to enjoy the spillover. This echoes the conclusion of Lemma’s researchcited above.
Abebe et al. (2018) did a case study of FDI and knowledge diffusion in Ethiopia. They findthat one-third of Ethiopian plants are linked to FDI through labor sharing, supply chains andcompetition. Exposure to foreign firms induces changes in production processes, managerial
practices, exporting knowledge and logistics of domestic firms. Knowledge transfer is found to
be stronger with labor and firms linked vertically with FDI. Abebe et al. (2018) indicates thatvertical linkage operates primarily between local suppliers of inputs and foreign firms procuringthem. Foreign firms have an incentive to upgrade the quality of domestically purchased inputs
for the sake of their efficiency, and this contributes to technology transfer. The study further
indicates that the low quality of inputs has been a critical factor limiting vertical linkage
between foreign and local firms.
Brautigam et al. (2013) shows that FDI firms engaged in the processing of raw hides andthe production of leather products have limited technology and knowledge transfer to local
firms and workers. It is argued that the Ethiopian investment policy encourages value additionand local processing by large foreign tanneries but fails to encourage smaller Ethiopian
tanneries.
Begum and Tesfaye (2016) examined the existence of knowledge and technology transferfrom foreign to local firms in the Ethiopian manufacturing industry using firm-level survey data.
Evidence indicates weak knowledge and technology spillover mainly in terms of thedemonstration effect and linkages. Changes in organizational setup and management practices
are common adaptation by local firms but reactions in products and processes are low.
Tang (2019b) examined Chinese investments in the leather and leather products sector andthe impact on employment creation, export, productivity increase and knowledge transfer ofEthiopian firms and workers. A positive contribution to employment and export was detected,

108

but problems were found in the interaction of Chinese and Ethiopian stakeholders to facilitate
knowledge transfer which was attributed to the lack of insights on the domestic side into
international business reality which produces numerous inaccuracies.
Vallejo and Mekonnen (2021) asks if current Chinese and Indian FDI in the Ethiopian textile
and garment sector supports knowledge-based economies or shifts growth direction to noninclusive patterns. It was discovered that foreign firms neglect training and technology transfer
beyond what is strictly required for their operations. FDI firms discourage learning by local
firms which makes them turn to the local traditional clothing segment.
In sum, empirical evidence suggests that FDI in Ethiopia has not been successful intransferring managerial know-how to local firms as much as it should or is expected. Forward
and backward linkages between MNCs and domestic firms are very weak which can be
attributed to several factors which require further empirical investigation. Unregulated FDI andthe lack of sound business relationship between foreign and local firms and the passive role ofgovernment in technology and knowledge transfer result in weak local learning andtechnological upgrading.
Although FDI attraction is among the top priorities of the Ethiopian government, theinvestment proclamations and regulations practically fail to provide adequate strategies andincentives to encourage knowledge and technology transfers to domestic firms. They also failto explicitly stipulate R&D and joint venture requirements and incentives needed for sucharrangements (Gebreeyesus et al. 2017; Abebe et al. 2018; Hauge 2019; Tang 2019a; Negash etal. 2020; Vallejo and Mekonnen 2021). There is an urgent need for Ethiopian FDI policy tomore concretely support the capability development and supply chain expansion of thedomestic sector.
4-3. Some policy lessons from best global practices
The benefits of FDI to the economy of the host country do not accrue automatically or evenly
across local firms. National policies matter greatly for attracting FDI and reaping the technology
and knowledge transfer benefits from it. The presence of foreign companies is the mostimportant channel for technology transfer to domestic firms through positive externality(OECD 2002). In this section, FDI policies and regulations for effective transfer of technology
and knowledge by China, Malaysia and Singapore are discussed as the best global practices
from which policy lessons can be drawn. These Asian countries are chosen for our review
because their policies are explicitly or implicitly designed to develop indigenous capabilities.
Figure 4-1 (a to c) presents the FDI inflow of the selected three Asian countries, respectively
China, Singapore and Malaysia. These countries not only have achieved success in attracting

109

Figure 4-1. FDI inflow in Selected Asian Countries
Fig. 4-1a FDI inflow in China

USD billion% of GDP

2019

2017

2015

2013

2011

2009

0.0

2007

0.0

2005

1.0

2003

50.0

2001

2.0

1999

100.0

1997

3.0

1995

150.0

1993

4.0

1991

200.0

1989

5.0

1987

250.0

1985

6.0

1983

300.0

1981

7.0

1979

350.0

Foreign direct investment, net inflows (% of GDP), China
FDI inflow in China USD billion

Fig. 4-1b FDI inflow in Singapore

USD billion% of GDP

120.0

35.0

100.0

30.0
25.0

80.0

20.0

60.0

15.0

40.0

10.0

2019

2017

2015

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

0.0

1983

0.0

1981

5.0

1979

20.0

Foreign direct investment, net inflows (% of GDP), Singapore
FDI Inflow in Singapore USD billion

Fig. 4-1c FDI inflow in Malaysia

USD billion% of GDP

16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0

10.0
8.0
6.0
4.0
2.0

2019

2017

2015

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

0.0

Foreign direct investment, net inflows (% of GDP), Malaysia
FDI inflow in Malaysia USD billion

Source: author’s computation based on data from World Bank, World Development Indicators.

110

FDI but also applied innovative policies to maximize the technology and knowledge transferfrom FDI. This section briefly reviews the key policy lessons from each of these countries.
China
FDI inflow to China was low until the 1980s. After China opened the door for foreign
investors in the 1990s, it experienced a large FDI inflow. It has reached a peak in 2013 with
about $291 billion annual net inflow. The proactive local policy boosted the capacity ofdomestic firms to absorb technology and knowledge from MNCs. China was graduallytransformed from a centrally controlled economy to a market economy with very high Gross
Domestic Product (GDP) growth (Zhang 2011). The following factors made China different
from other countries.
 An emphasis was given on aligning FDI inflow with national priorities such as supporting








innovation, industrial sophistication, developing poorer hinterland regions, and setting up
outsourcing industries (Davies 2013).
There were four specific reasons for China to promote FDI: introduction of advanced
foreign technologies and professional management; making up the capital shortage for
economic construction; reducing unemployment; and FDI as one of the important driversof the market-oriented economic reform (Zhang 2011).
FDI intensity was positively related to the innovation efficiency of different regions in
China, exerting a positive impact on the overall regional innovation capacity. This was
attributed to the proactive policy, the high absorptive capacity by local firms andinnovation- complementary assets in the host regions (Fu 2008).
To encourage technology transfer, China’s FDI policy gave preferential treatment to firms
conducting export and technology transfer.
Transition over time from promoting exports of low-tech and labor-intensive industries tothose of more advanced industries with higher technology requirements (Fung et al. 2004).

Singapore
In Singapore, FDI inflow has been the major cause of rapid economic growth and it became
one of the largest recipients of FDI in the world (Ratiphokhin 2011). Singapore transformed its
economy by enhancing the technological capabilities of its industries through calculated
policies. In the 1960s and 1970s when unemployment was high, attracting foreign companies
was necessary to generate employment. Subsequently, FDI became the major instrument ofdevelopment strategy to make Singapore a business hub of the global market (Koh 2006). As
indicated in Figure 1b, FDI inflow in Singapore was low initially, but through time and thanks111

to the purposeful and committed FDI policy, the country drastically increased its FDI inflows
and reaped its benefits (Koh 2006; Branstetter 2006; Ratiphokhin 2011; Gebreeyesus et al.
2017). FDI net inflow as a percentage of GDP had reached up to 30% in some years.
 In Singapore, FDI remained a significant tool for technology transfer even after the Asianfinancial crisis of 1997-98. It managed to attract more FDI which generated the expected
benefits of technology spillovers (Branstetter 2006).
 Singapore had a proactive and dynamic FDI policy, incentives and institutional setup fortechnology and knowledge transfer. The initial stress on labor-intensive manufacturing waslater replaced by a focus on skill-intensive manufacturing that produced higher valueadded and, more recently, knowledge-based professional services such as Information andCommunication Technology (ICT), finance and offshore services which are now the maindrivers of the Singaporean economy.
The government took measures to improve the technology absorption capacity of SMEs
and create linkage with MNCs (Gebreeyesus et al. 2017). For MNCs, generous tax and
grant incentives were provided by the government along with public investment intechnological infrastructure.
The government has made systematic efforts to re-fashion infrastructure and institutions tobecome an innovative economy.
To upgrade the nation’s technological capabilities, Singapore has an open-door policy to
attract global talents and a policy to strengthen the linkage between research institutions
and the private sector (Koh 2006).

Malaysia
Malaysia is one of the newly industrialized countries and has been among the fastestgrowing economies in the world like China, India and Thailand (Ratiphokhin 2011). FDI inflow
in Malaysia was moderate in earlier periods but an increase was observed starting in the late
1990s (Figure 4-1c). This was attributed to the augmented technology absorptive capacity offirms through various policies and incentives.
 Technology spillover has been supported by many policy instruments and took different
forms including vertical and horizontal linkages (Gebreeyesus et al. 2017). Regarding theintensity of technology transfer, Malaysia was second-highest among Asian economies
after Singapore. After the Asian financial crisis, momentum was gained in attracting
inward FDI, and Malaysia was successful in tapping its benefits and technology transfer.
To this, the local policy combining restrictions and incentives contributed greatly whichstrengthened the absorptive capacity of local manufacturing firms (Lee and Tan 2006). FDI
policy in Malaysia has been selective and based on the motive of investment (introducing

112









new technology, value, etc.) rather than sectors.
Malaysia has a dualistic policy towards incoming FDI. MNCs that contribute to technology
transfer, exports or other national objectives are provided with fiscal and other incentives
with few restrictions. However, if their activities are detrimental to local producers in any
sector, they are prohibited from entering that sector or face many restrictions even if they
are permitted to enter (OECD 1999).
To reduce reliance on imported intermediate inputs of SMEs and induce technology
transfer, the government introduced different programs: the Vendor Development Program(VDP), the Industrial Linkage Program (ILP) and the Global Supplier Program (GSP)
which promoted horizontal and vertical linkages of local firms with MNCs, and Penang
Development Corporation (PDC) as a technology incubator (Gebreeyesus et al. 2017).
The FDI policy in Malaysia has its own requirements and incentives. To obtain amanufacturing license it must be approved by the Malaysian Investment Development
Authority (MIDA) or the Foreign Investment Committee (FIC). Investors must be checked
for technical and marketing agreements, distribution pattern, location, equity structure, useof local professional services, construction date, quality standards, pricing and use of local
raw materials. Investments that conduct more activities in the domestic market naturally
have a greater scope for technology transfer and linkages with the local economy.
Malaysia’s principal investment incentives are the Pioneer status (tax holidays) or aninvestment tax allowance given to companies that bring high-technology products oractivities, strategic products with national importance, support for small-scale industries,
technical or vocational training, and R&D activities. Profits are freely remittable andexchange controls are minimal which makes investments more attractive for foreign
investors (OECD 1999).

4-4. Policies, instruments and institutions in promoting technology and knowledgetransfer in Ethiopia
Ethiopian policies related to foreign investors date back to the Imperial regime when threeconsecutive five-year plans were executed. Though these plans were restrictive for domestic
firms, investment by foreigners in the manufacturing sector was encouraged with various
incentives (Chole 1995; Gebreeyesus et al. 2017; Kebede 2020). During the Derg regime,
companies were nationalized and the private sector was abolished. The joint venture
proclamation of 1983, which was revised in 1989, aimed to attract FDI but failed to do so as
foreigners were uncomfortable with the regime (World Bank 1985; UNIDO 1991; Gebreeyesus
et al. 2017). After the regime change in 1992, a series of reforms including privatization, market
deregulation, trade liberalization, several investment proclamations, and new laws were put in113

place. The 1992 investment proclamation was restrictive in the sense that a huge capitalrequirement was placed on foreign investors without offering sufficient incentives. Since then,the proclamation has been refined repeatedly to overcome its limitations. The most recent
revision as of this writing of the investment proclamation and regulation was done in 2020
whose implications towards technology and knowledge transfer are discussed below.
4-4-1. Proclamations, regulations, incentives, and technological capabilities fortechnology and knowledge transfer in Ethiopia
A full review of the policies and regulations regarding FDI in Ethiopia can be found inchapter 1 of this report. This part tries to briefly highlight the relevant and current legislation
related to FDI technology and knowledge transfer. Ethiopia’s current investment regulatory
framework is defined by Proclamation No.1180/2020 enacted on 2 April 2020 along with
Investment Regulation No. 474/2020 enacted on 2 September 2020. The objectives of the
proclamation are to enhance the competitiveness of the Ethiopian economy; create more andbetter employment opportunities for Ethiopians; increase and save foreign exchange throughpromoting investments in productive and enabling sectors, by advancing the transfer ofknowledge, skills and technology required for national development, encouraging the
expansion of volume, variety and quality of the country’s export products and services; saveforeign exchange through local production of import substitutes; augment the role of the private
sector; create an integrated economy by strengthening inter-sectoral and foreign-domestic
investment linkages; encourage socially and environmentally responsible investments; andexploit and develop natural, cultural, and other resources of the country.
The proclamation requires foreign investors to allocate a minimum capital of $200,000 fora single investment project and $150,000 if the foreign investor invests jointly with a domestic
investor. The investment regulation specifies investment areas reserved for joint investment
with the government, those reserved for domestic firms, those reserved for joint investment ofdomestic investors with foreign companies, and those reserved for foreign investors.
Any investor concluding a technology transfer agreement associated with the investment
must register the agreement with the Ethiopian Investment Commission (EIC). The commission
shall notify registered agreements to relevant federal executive bodies and the National Bankof Ethiopia. Article 19 of Regulation 474/2020 specifies the procedure for knowledge and skill
training and transfer to local employees. An investor employing foreigners in permanent
occupation is obliged to replace the expats with Ethiopians through job training and transfer ofknowledge within a clear time frame.
The proclamation and the investment regulation do not explicitly reveal incentive schemes
to support technology and knowledge transfer to local firms. In either document, there is no114

joint venture requirement to induce technology transfer, linkage creation requirement such as
setting a standard, or local input use requirement. This indicates passivity in the policy
framework for using FDI in transferring technology and knowledge to domestic firms. Thoughrefined repeatedly, the current proclamation and regulation remain general covering all types ofinvestments. They are not sufficiently specific and lacks structured instructions for
implementation. A more concrete FDI policy is required to augment the benefits from FDI andminimize its risks and setbacks.
4-5. Technology and knowledge transfer from FDI: survey results
As explained in the introduction section, technology and knowledge transfer can take placethrough vertical (supply) linkages, horizontal linkages and spillover (which includes thedemonstration effect, competition effect and labor or management turnover) as well as throughjoint ventures.
Using data from a field survey, this section examines the presence and depth of different
mechanisms of technology and knowledge transfer in Ethiopia. The survey was conducted in
the first quarter of 2021. It had a randomly selected sample of 30 firms out of which 16 were
FDI and 14 were local firms. They all belonged to the manufacturing sector covering four
production sub-sectors: textile and garment, leather, brewery and automotive assembly. Table
4-1 gives the sectoral distribution and export participation of the surveyed firms. The textile
and leather sectors each consist of one-third of the overall sample size while automotive andbrewery respectively account for 20% and 13%. The FDI firms are more export-oriented thanthe local firms. On average, about 70% of the FDI firms export 75% or more of their output
while only 14% of the local firms export 75% or more. See chapter 5 for more details on thesurvey and chapter 6 for comparative analysis of garment exports by Ethiopia, Vietnam andTable 4-1. Sector Composition and Export Orientation of Sampled Firms
Ownership composition

SectorAutomotive
Textile & garment
Leather
Brewery
Total% of firmsthat engage
in exports% of firmsthat export
75% or more

Numberof localfirms

Numberof FDI
firms

Total
number

Sector
share
(%)

Local

FDI

Local

FDI

3
4
5
2
14

3
6
5
2
16

6
10
10
4
30

20.0
33.3
33.3
13.3
100

0
50
100
50
57

0
100
100
50
75

0
25
20
0
14.3

0
100
100
0
69

115

Bangladesh.
The four sub-sectors are among those to which Ethiopia is seeking to attract foreign
investors for competitiveness and technology transfer. The textile and garment, leather and foodindustries are designated as export-oriented priority sectors. Categorized within the metal andengineering sub-sector, the automotive industry is among the sub-sectors expected to effectmeaningful technology transfer and facilitate Ethiopia’s industrialization through importsubstitution.
4-5-1. Technology transfer
Vertical linkages
The literature tells us that vertical linkage in general and local backward supply linkage inparticular are the main channels of technology transfer from FDI to local firms. Table 4-2
reports the import intensity of local and FDI firms by sector. The firms in our sample by andlarge depend on imported inputs leaving little room for domestic supply linkage. As a result,the perceived benefit of technology and knowledge transfer cannot be realized. FDI firms are
more import-dependent procuring 78% of their inputs from abroad in comparison with local
firms (65%).
In terms of sectors, the automotive and textile and garment sub-sectors are more dependenton imported inputs. In the automotive sub-sector, one firm entirely imports its input
requirements except for consumable supplies. The other two firms purchase 20% of their inputs
Table 4-2. Import Dependence and Technology Transfer% of imported
Number of local
inputs (rawsuppliers as reported
materials,
by FDI
intermediaries)

Do relations of Have you ever
FDI with local been involved
suppliers
in any capacity- Number
requirebuildingof FDI
technology
activity for your firms
transfer?
supplier?
(yes)
(yes)

Sector

local

FDI

None

2-10

> 10

Automotive

75

86.7

1

0

2

1

1

3

Textile &garment

75

100

5

1

0

0

0

6

Leather

48

42.5

0

2

3

2

1

5

Brewery

72.5

69

0

1

1

0

1

2

All sectors

65

77.9

6

4

6

3

3

16

116

(wood, metal, leather, and tire) from the domestic market. The situation remains the same withlocal automotive firms as only one of the firms sources its input needs locally, while the othertwo use 100% (directly or indirectly) imported inputs. Only one of the FDI firms in this subsector confirmed that local sourcing involved technology transfer.
Similarly, all the FDI firms in the textile and garment sub-sector import their input needs
except for consumable supplies. As reported by our key informants, this is because thesemanufacturing enterprises enjoy duty-free importation while local procurement is expensive
because local suppliers import materials by paying taxes. FDI firms, therefore, have little
interaction with local suppliers. In the case of local textile and garment enterprises, except for
one firm which uses 100% locally sourced input, the rest use inputs that are directly or indirectly
imported. Table 4-2 thus provides little evidence of technology transfer via linkages between
FDI firms and their local suppliers.
By contrast, all leather factories in the survey procure leather from the local market andimport some from abroad. For chemicals, they mainly rely on imports. These factories indicatethat quality (softness, defects, color and thickness), volume and timely delivery are the main
constraints when dealing with local suppliers. Some firms report that they transfer technology
in how to process sheepskin for shoe production and support other firms to finish processedskin (previously exported as semi-processed) for domestic shoe production. Except for one firm,
all of the leather products manufacturing firms replied that their linkage with suppliers involved
technology transfer.
Meanwhile, as shown in Table 4-2, the breweries source about 20% to 30% of their input(barley malt) from the local market which involves technology and knowledge transfer to someextent. Currently, one of the breweries mainly purchases barley malt from local malt factories(Assela Malt factory and Gondar Malt factory) and the other foreign brewery procures its malt
from Assela Malt factory and (cooperative) farmers in Arsi, Bale, Shoa and Gojjam. To ensure
quality and consistent supply, this brewery is working, through the out-grower or contract
farming scheme, with 55,000 farmers in the said areas to build their capacities through training,
recruiting experts to supervise and support the farmers through research (extension service),
arranging a revolving fund, and supplying an improved barley malt variety from Europe. The
beer factories generally state that, even if they prefer to buy inputs from domestic suppliers,
they do not always do so as the local price is high, quality is low, and quantity is insufficient tomeet their demands.
Horizontal linkages and spillover
Table 4-3 summarizes the responses of both the FDI and local firms regarding horizontal
linkages and the technology spillover effect. The majority of the foreign firms, respectively

117

Table 4-3. Perceptions of FDI and Local Firms Regarding
Technology Transfer and Spillovers
Response# of % offirms firms

FDI firms
Have you observed domestic firms (competitors within the same
Little or
sector) changing production techniques/processes due tonevercompetitive pressure from your enterprise?
Have you observed domestic firms (competitors within the same
Little or
sector) trying to directly adopt production techniques/processes
never
by observing or copying from your enterprise?
Have you ever observed former employees leaving the enterpriseYes
to set up a business that is enterprise and becomes competitors?

11

69

12

75

0

0

Have you ever observed former employees leaving the enterprise
to set up a business that is enterprise and becomes customers?

Yes

2

13

Have you ever observed former employees leaving the enterprise
to set up a business that is enterprise and become suppliers?

Yes

0

0

Are you willing to work with domestic firms as a joint venture?

Yes

11

69

Have you ever been involved in any activity of capacity building
for your supplier?

Yes

3

19

16

100

Total number of FDI firms
Local firms
Have you ever changed production techniques/processes due tocompetitor pressure (in order to keep up) from MNCs/FDIs
within the same sector?

Yes

6

43

Has the firm tried to directly adopt production techniques/
processes (by observing or copying) from MNC/FDI
competitors?

Yes

7

50

If yes, have you ever felt that MNCs/FDIs try to prevent thistechnology transfer from occurring?

A greatdeal or
much

9

64

Has the firm ever hired employees trained in MNC/ FDI?

Yes

9

64

If yes, has the engagement of these employees ever directly
resulted in changes in production techniques/processes in theenterprise?

Yes

8

57

Is there any policy support (incentives) provided fortechnology/knowledge transfer by the government which you
find useful or want to receive?

Yes

3

21

Are you willing to work with foreign firms in any joint venturearrangements?

Yes

8

57

14

100

Total number of local firms

118

69% and 75%, stated their observation that domestic firms are neither changing their production
processes nor directly adopting production techniques from the foreign factories. In contrast,
43% and 50% of local firms responded to having changed their production techniques orprocesses to keep up with competition arising from FDI in the sector whether directly adopting
FDI production techniques or through other means. The difference in the observation between
FDI and local firms might be due to either the lack of formal assessments or lack of concern as
the foreign and local firms do not compete in the same market. On the other hand, about twothirds of the local firms interviewed feel that MNCs try to prevent technology transfer fromoccurring.
Unlike the other sectors which mainly produce for the export market, there is severe
competition among the breweries to increase or maintain their domestic market shares. In
Ethiopia, according to the key informants, the beer companies compete through process
configuration, accessibility and expansion, upgrading technology, and aggressive promotion
and advertising. Because of the influence of foreign investors, domestic firms have been forced
to partner with foreign firms to introduce foreign technology to standardize their products.
Foreign beer factories that we interviewed suggested that domestic beer firms have madechanges and adjustments in their production process and techniques to cope with the increased
competition. One key informant pointed out that “to keep their place in the competition,
domestic breweries have partnered with foreign beer companies to adopt technology andprocess. As such, all have their own technology and standard, and don’t directly adopt ours.”
The FDI firms state that there have been no cases where their former employees set up
businesses to become either their competitors or suppliers of raw materials and intermediate
inputs. There were, however, two cases where former employees upon leaving the enterprise
became customers. They opened a hotel or restaurant which purchased beer from the factory.
Concerning the hiring of skilled workers, 64% of local firms responded that they hired
employees trained in an MNC or FDI. 57% admitted that the engagement of these employees
directly resulted in changes in production techniques or processes in their enterprises. There are,however, different stories regarding skill poaching depending on the sector. In the automotive
sub-sector, despite the high demand and relatively limited supply of skilled workers, all three
foreign firms had never felt competition in the labor market. In the textile and leather sectors,
where foreign firms recruit unskilled workers and train them internally, there is little
competition for a skilled labor force in the market. However, skilled employees do sometimes
leave FDI firms to join other foreign firms or local firms which results in technology transfer.
In contrast, in the beer industry, there are severe competition and active poaching of skilledworkers. To retain their employees, they must compete in salary and other incentive packages.
Joint venture

119Joint venture with foreign firms is another key channel for technology transfer, which has
been widely employed particularly in China. Foreign investors may also benefit from joint
ventures by bypassing restrictions imposed on foreign ownership, understanding local customs
and practices, and better access to the local market. The government of Ethiopia encourages
joint ventures with foreign investors but lacks a comprehensive framework to attract, manage
and benefit joint ventures.
In our sample, three firms registered as local (two beer and one automotive) and two as FDI(both automotive) are already joint ventures. The survey asked both FDI and local firms if they
were willing to work in joint venture arrangements (Table 4-3). The responses show that 69%
of foreign firms are willing to form a joint venture. For FDI firms, the main motivation forchoosing a joint venture is to access the growing domestic market and share the costs ofexpansion. Foreign firms in the textile and leather sectors are particularly interested in joint
ventures due to the restriction imposed on them not to sell in the local market as they aredesignated as export-oriented FDI and entitled to several export-related incentives. But we donot see a similar appetite in import-substituting FDI, for example in the brewery industry, as
they already have full access to the local market.
Table 4-3 also shows that 57% of local firms are willing to have a joint venture arrangement.
They perceive that joint ventures can help them to earn an international reputation andstrengthen their firms through technology and skill transfer. Several local firms do not showinterest in joint ventures although they do not give clear justification for this.
Government’s requirement and support for technology transfer
Except for two small automotive firms, all other FDI firms in the survey agree with therequirements set by the government of Ethiopia for knowledge and technology transfer.
Nonetheless, the majority acknowledges that they are doing little in technology transfer except
for training their own employees. In general, firms comply with the requirements through thefollowing methods.
 Training their employees (pre-employment and on-the-job training), often by inviting
foreign trainers.
 Providing an opportunity for their employees to visit and obtain training at the parent
company.
 Allowing domestic firms to visit their factories and share experiences.
 Cooperating with Technical and Vocational Education and Training (TVET) colleges anduniversities for factory visits, practical teaching and apprenticeship.
 Collaboration with researchers who can document and share insights (knowledge)
through seminars and conferences.

120

A concern has, however, surfaced that, while firms are willing to support technology transfer,government bodies are not doing what is expected of them in facilitating the knowledge andtechnology transfer. There are general support and incentives such as duty-free imports and tax
breaks for foreign textile and garment firms, these are not distinctly or directly tagged as
incentives for technology transfer. Beer factories feel that they are no longer required by thegovernment to engage in any knowledge or technology transfer because they have become a“disfavored sector” by the imposition of a 25% exercise tax on alcohol and banning its
advertisement in the media.
The following suggestions were forwarded by the respondents to resolve the prevailingproblems regarding knowledge and technology transfer.
 Proper and strict supervision and evaluation of knowledge and technology transfer to
identify which companies are doing well in such transfer and which ones are not.
 As foreign trainers are paid in foreign currency, standards are needed to determine
whether foreigners are transferring knowledge to workers, and license renewal should
depend on the extent of knowledge they have transferred.
 The human resource on the Ethiopian side should also be assessed if it is capable ofacquiring the knowledge transferred; There should be distinctive incentives (priority allocation of foreign currency, low shedrents, tax reduction, etc.) and official certificates for those who can transfer knowledge ortechnology.
4-5-2. Management practices
Companies with best management practices have a clearly defined organizational culture,establish clear communication with employees, engage workers, reward efforts, focus on
teamwork, share responsibility, and update the organizational community through regularmeetings. This sub-section asks whether the firms that participated in the survey implement
good practices to manage their organizational resources and create smooth linkage withcustomers. We analyze the differences in managerial practices of foreign versus local firms andsee if there are lessons local firms may learn from their foreign counterparts in Ethiopia.
Organizational culture and socialization
All the firms, local and foreign, we interviewed have well-articulated vision and mission
statements, although they differ in the effectiveness of communicating such visions andmissions to their employees (Annex Table A4-1). All the local and foreign automotive firms,
except one, have a well-communicated vision and mission that is widely communicated and121understood by the employees. The majority of the textile and garment firms have well-written
and articulated vision and mission statements but they are not widely communicated to theiremployees. Table A4-1 also shows that the leather firms, except one, have a similarly wellwritten and articulated vision and mission. Both breweries have well-written, articulated andcommunicated vision and mission statements.
Business companies usually use identifying slogans to nurture their business values andproducts to their customers and the public at large. All of the foreign automotive and beer
factories as well as the majority (three out of five) of the foreign leather factories have well
written, articulated and communicated company identity (slogan) to distinguish themselves andtheir products from those of competitors. In the case of local firms, on the other hand, it is only
the breweries and some automotive assemblers that have a clearly stated company slogan. Only
one domestic garment factory uses a slogan to show the unique company and product identity
to customers and the public.
In internal communication and sharing information of decisions, financial updates, relevant
news and other company information with their employees, all firms combine different options:informal discussion with individual employees, formal feedbacks and letters as well as regular
employer-employee meetings. While 13 out of the total 15 foreign firms indicate using a
combination of these options, nine out of the total 13 local firms mainly use employer-employee
meetings.
Teamwork is also an essential ingredient of the operations of all foreign firms surveyed
except one tannery where teamwork is rarely practiced and performance is predominantly basedon individual targets. In all other foreign firms, teamwork spirit remains one of their core
principles. Foreign firms instill teamwork spirit through setting targets, competitive teamrewards (bonus for higher achievers), feedback, recognition and appreciation letters, open andtransparent discussion about the company’s successes and failures, training, and family-liketreatment of employees. Meanwhile, at local firms, teamwork is rarely practiced and emphasis
is given to individual performance. Specifically, out of the 14 domestic firms, only one
organizes shop floor work teams as a common practice. This is one aspect of corporate
management that distinguishes local firms from foreign ones.
Foreign and local firms also differ in the way they use social events to motivate theiremployees. Whereas the majority of the foreign firms, 14 out of 16, had company-sponsoredsocial gatherings and entertainments, this is largely missing among local firms. Out of the total
14 local firms, only three have this practice. Social gatherings and entertainments at foreign
firms include public holidays and entertainment during (semi) annual meetings as well as
regular drinks (monthly open bar drinks) with open talks with top management. Apart fromentertainment, the companies use these occasions to give recognition, rewards and certificatesto their best-performing employees. Recently, however, most firms had to cancel such events122

in compliance with COVID-19 rules and some reduced their costs.
The decision-making process
There are differences in the decision-making process across firms depending on the number
and composition of shareholders and other aspects of the firm. Nevertheless, there is a clear
general tendency, also detected in our survey, that corporate decisions are made mostly by the
top management either solely or in consultation with middle and frontline heads depending on
the issue. There are also firms with more decentralized decision-making where middle andfrontline managers make decisions in their respective responsibilities. These patterns can also
vary with time, for example, when a decision is made by the top management in the previous
year is delegated to the lower management in the following year.
Annex Table A4-2 presents the comparison of the decision-making culture of foreign andlocal firms in the four sub-sectors. The dominant majority of foreign firms say that the way
decisions are made depends on the type of the decision, and only 12.5% indicated that decisions
are made solely by the top management. Specifically, decisions are made either by the board,
the owners at the head office and/or the top management. Decisions related to strategic issues
such as new market entry, production cuts, discontinuation of a product line and retrenching
employees are initially decided by the top management of FDI, possibly in consultation withthe head office or the parent company. Selection of employees for a visit, training or rewards isdone more locally in consultation with section or department heads and line supervisors. The
decisions can subsequently be discussed with employees’ representatives.
The culture of involving employees in certain decision-making does not substantially differ
between foreign and local firms. In such cases, decisions on the lower side are predominantly
proposed by employee representatives (see Table A4-2 in the annex). While responsibilities forsome issues are taken collectively (e.g., quality assurance), individuals take responsibility for
their own decisions and specific tasks (targets) assigned on the production line. In the twointerviewed breweries, the top manager is authorized to make decisions as per the direction
given to him or her from the head office of the parent company. Decisions are executed inconsultation with production, marketing, finance and human resource directorates.
Responsibilities are taken either collectively (e.g., for quality, organizational success and failure,etc.) or individually (e.g., the volume of sales by salespersons).
Foreign and local firms do not show significant differences in the way they make decisions
whether collectively or individually. Collective decision-making is more common than
individual decision-making. However, virtually all firms say they combine both types ofdecision-making. The local firms in our study encourage collective decision-making and argue
that it is better because it is participatory, receiving inputs from different perspectives and123

making it evidence-based. However, the decision-making approach may vary depending on thetype and urgency of the issue at hand. Some decisions can be made at the individual level but
need to be communicated to the top management for transparency and collective responsibility.
Regarding taking responsibility, local firms prefer promoting individual responsibility to
avoid potential risks for the company and be able to maintain the organizational reputation andensure quality. Individuals of each production unit are being led by experts and they are jointly
responsible for their respective unit, which is regularly supervised and monitored by technicalmanagers to ensure maximum quality.
4-5-3. Labor practices
Incentive structure and promotion
The survey confirms that firms provide both monetary and non-monetary incentive
packages to their employees. The companies use performance indicators for individuals, teams,
and the entire factory for evaluating and incentivizing employees. Here, there is somedistinction between foreign and local firms in terms of how they measure performance. Most
foreign firms provide incentives based on all levels of performance indicators including
individual, team and company. Most domestic firms, on the other hand, give more weight toindividual performances (4) and team performances (3) as shown in Annex Table A4-3.
The foreign automotive firms and the textile and garment factories give bonuses when
individuals and teams meet or exceed targets and/or when the firms achieve high profitability.
The incentive structure in the leather companies varies from factory to factory. While one of
the factories incentivizes (provide a bonus) to its employees based on individual, team andcompany performance, the rest in the leather sub-sector use different packages such asindividual performance as measured by target and firm performance. The beer factories
incentivize their employees based on individual performance (e.g., number of sales for sales
employees), team performance (e.g., number of produced bottles) and factory performance (e.g.,
profitability).
Commonly provided non-monetary incentives for employees include transportation service(or allowance) and coverage of medical expenses for incidents that occurred at work. One firmin the automotive sub-sector, three in the textile and garment sub-sector, two in the leather
industry and one in the brewery industry provide career development opportunities, albeit for a
few selected employees, by sending them to visit and be trained at the head office of the parent
company. Except for the automotive firms, all have food programs, typically a lunch on working
days, for their employees. Housing allowance is mainly for expatriate staff. For promotion,
virtually all firms, domestic and foreign, indicate that the performance and ability of their124

employees are the basis of promotion.
Employment policy, recruitment and selection
This sub-section looks at the policies related to the human resource of the firm. The foreign
firms unanimously focus on permanent employment when recruiting the production workforce.
However, two firms in the automotive sector reported that 26 out of 166 and ten out of 150,
respectively, were temporary employees at the time of the survey. In the leather sub-sector, one
foreign firm had 120 temporary employees, whose contract depended on the volume of work.
The contract that governs temporary employment relates mainly to the loading and unloadingof products. The beer firms say that they outsource such tasks as loading, unloading and security.
Concerning the criteria for hiring production workers, 62.5% of the foreign firms indicatethat they give education less than average weight. This is particularly so in the case of the textile
and leather products sub-sectors as their production processes do not demand a high level of
education compared with the automotive or beverage sub-sector. They recruit low-skilled,
relatively young (18 to 35) and predominantly female workers with little or no education. In
these factories, education serves as a criterion for employing only administrative workers. By
contrast, dominated by male workers, the automotive and brewery sub-sectors essentially focus
on education and experience followed by age in recruitment. Young and energetic workers
between the age of 18 and 35 are preferred.
At the foreign firms, regardless of sector, marital status is not considered for recruitment.
Meanwhile, some local firms (five out of 13) give marital status at least an average weight. The
majority of the local firms also consider skills as an important criterion for the recruitment of
their production workers. Skill is given more than average weight by the majority of firms, bothforeign and local. Among local firms, we detect no particular difference in recruitment criteria
across sectors, unlike foreign firms where education is valued highly only in the automotive
and beverage sub-sectors.
4-6. Summary and policy implications
In this chapter, we studied the impact of FDI and the possible channels through which FDI cantransfer technology, knowledge and managerial practices to host developing economies. The
review of the empirical literature revealed that the impact of FDI on technology diffusion was
mixed and different for different countries. The main reason for the contrasting results acrosscountries is the difference in local policies and incentives of the host countries to strengthen theabsorptive capacity of domestic firms. The review also presented the best global practices ontechnology and knowledge transfer and spillover. Successful Asian countries including China,

125

Singapore and Malaysia opted for pragmatic FDI policies which were designed to advanceindigenous capabilities through policy requirements and incentives.
A review was also conducted on the recent Ethiopian investment proclamation andregulations. It showed that the Ethiopian policy had its limitations in setting specific strategies
and incentives for technology diffusion from MNCs to local firms. Furthermore, empiricalevidence was examined on the presence or absence of technology and knowledge spillover aswell as transfer of managerial practices in Ethiopia. It was discovered that spillover was very
little in Ethiopia due to several challenges as a host country. The major challenges include thefollowing.
 FDI firms in Ethiopia are mostly market and resource-seeking; this, coupled with thelimited absorptive capacity of local firms, makes technology and knowledge transfer adaunting challenge.
 Foreign companies are mainly engaged in simple and labor-intensive production systems
requiring unskilled cheap labor only.
 FDI firms in Ethiopia are not inclined to transfer technological know-how and managerial
practices to local firms; this can be explained partly by Ethiopia’s weak technology transfer
policy and the absence of incentives for technology and knowledge transfer.
 Problems related to political and macroeconomic instability constitute additional challenges.
They include failure to maintain law and order, rent-seeking and corruption, policy
incoherence, distorted incentive structure and coordination failure.
Our field survey also examined the status and depth of different mechanisms of technology
and knowledge transfer in Ethiopia. It investigated vertical and horizontal linkages as well as
joint venture arrangements between FDI and local firms. It was revealed that both FDI and local
firms were largely dependent on imported inputs, leaving little room for domestic supply
linkages. Perceived benefits from vertical linkages are therefore close to nonexistent. The
automotive and textile sub-sectors are more import-dependent in comparison with the leather
and brewery industries. Even in the latter, however, the lack of quality, sufficient volume,
reasonable price and timely delivery are the main constraints for dealing with local suppliers.
Regarding horizontal linkages, the common observation of FDI firms is that domestic firms
do not adopt foreign knowledge and technology. However, local firms testify to the contrary.
About half of the surveyed local firms indicated that they changed their production techniquesor processes to keep up with competition from FDI by directly adopting FDI firms’ production
techniques or through other means. About two-thirds of the local firms complain that foreign
firms prevent technology transfer from occurring. Competition is particularly intense in thebrewery industry where domestic firms made changes and adjustments in their production
process and techniques to cope with the competition. The beer industry is also where muchcompetition and poaching of skilled workers is detected unlike in other sub-sectors.

126

The presence of joint ventures differs by sector. While some foreign firms have shown
interest in joint ventures, they are mostly in export sectors and there is little appetite in importsubstituting sectors. The main motivation for FDI to choose a joint venture arrangement is toaccess domestic market opportunities as foreign firms, particularly those designated for export,
are restricted in selling products to the domestic market.
While the government provides various incentives to attract FDI and encourage productionand exports, there is no incentive distinctively and directly tagged to technology transfer. Thereis also a complaint that the government does little to create linkages between FDI and domestic
enterprises. Furthermore, the government lacks a comprehensive framework to attract, manage
and benefit joint ventures.
From the survey results, it was found that foreign and local firms in Ethiopia differed greatly
in their organizational culture and that local firms have a lot to learn from their foreigncounterparts. Well-articulated and widely communicated visions, missions, values andcompany slogans are common among foreign firms but they are generally lacking in local firms.
In communicating with employees, local firms mostly rely on formal employer-employee
meetings while foreign firms use various options mixing formal and informal channels ofcommunication. Moreover, while the foreign firms inculcate teamwork and organize social
events to motivate and incentivize employees, these practices are largely missing among the
local firms we interviewed.
The incentive structures for employees used by the foreign and local firms are similar. While
five out of the ten foreign firms use targets set at the individual, team and company level, fourout of the ten local firms indicated that they base bonuses on individual targets. We do not
observe significant differences between the foreign and local firms in terms of the promotion
criteria. They are performance and ability, performance and ability plus loyalty, or mainly
loyalty and family connection.
In conclusion, we reiterate the policy implications and suggestions for a successful
technology and knowledge transfer based on the extensive review of global and Ethiopian
studies as well as the field survey conducted for this report as presented above.
 A comprehensive investment policy must be established which reflects the development
strategies and priorities of the country. Although requirements of local input procurement
and technology transfer requirements that China used in its early years (before joining theWTO) may seem attractive, these can be counterproductive in Ethiopia where local supply
capacity and absorptive capacity are low. The policy should instead provide incentives forthe use of local materials and induce production linkages between foreign and domestic
firms. The existing platform, if properly adjusted and operated, can encourage forward andbackward linkages between MNCs and local firms and stimulate managerial knowledge127

and technological transfer. The adoption of a strategic approach to establish a smoothconnection between foreign investors and local firms is critical for host countries.
 Encouraging joint ventures is also critical as they are likely to boost technology andknowledge transfer because daily interaction in the production management process
induces explicit and tacit management knowledge transfer.
 One means to promote technology and knowledge spillover is for government to encourage
local firms to learn about export markets through different fiscal incentives such as tariff
protection, subsidized credit and facilitating financial access. Priority and tax incentives
should be given to high technology activities by local firms along with incentives for theformation of vertical and horizontal linkages between MNCs and domestic firms.
 Industrialization and export promotion in FDI host countries will prompt local firms toengage in R&D activities, raise the interest among them to acquire managerial andtechnological knowledge spillover, and enhance production process management to theglobal standard. Besides this, the identified obstacles to technology and knowledge transfer
in Ethiopia must be rectified by the exhaustive engagement of all stakeholders.
 Investing in the human capital of FDI host countries is important for an easy and effective
transfer of technology and managerial know-how from MNCs to local firms. The methods
include R&D activities, encouraging innovation, initial and recurrent training, incentives,
staff exchange, and so forth. This increases the absorptive capacity, productivity andcompetitiveness of local firms.
 Development of such infrastructure as power, water, internet and road, rail and air transport
increases the probability of smooth interaction between MNCs and local firms and creates
the necessary platform for knowledge transfer.
 Policy as the core bridge must be consistent and effective to guide linkages, competitiveenvironment, incentives, requirements, human capital development, labor mobility, joint
venture arrangement, innovation and R&D activities, the absorption capacity of local firms,
the rules for FDI management, and so forth.
 If Ethiopia is to attract FDI and maximize its knowledge and technology transfer to local
firms, the government should go beyond economics and become proactive with sufficientcommitment to assure political stability and sustain a conducive political environment forinvestment. The government should also wisely manage and bargain with MNCs forknowledge and technology transfer and backward linkage creation while offering attractive
incentives to those who contribute to national development objectives.

128

Annexes
Table A4-1. Comparison of Organizational Culture between Foreign and Local Firms
Vision/Mission/
ValuesSectorIdentify/
sloganWritten/
WellWritten/
articulated
articulated
articulated
but not
andbut not
widelyunderstoodwidelycommunicated by everyone communicated

Communicate
employees

Wellarticulated
andunderstoodby everyone

InformalChannelEmployeremployee
meeting

FormalUnion

TeamworkAll
options

Rare

Organized
shop
floor
work
team

Companysponsored
Social event
No./Per Year
4X

2X

1X

FDI Firms
Automotive

1

2

1

2

0

0

0

3

0

3

1

0

1

Textile

4

2

0

0

1

1

0

4

0

6

4

1

1

Leather

2

2

1

2

0

0

0

4

1

4

0

1

3

Food & Bev

0

2

0

2

0

0

0

2

0

2

2

0

0

Total

7

8

2

6

1

1

0

13

1

15

7

2

5

Local Firms
Automotive

3

0

0

0

0

1

0

1

3

0

0

0

0

Textile

2

2

0

1

0

3

0

1

4

0

0

1

1

Leather

4

1

2

0

0

4

1

0

5

0

0

0

0

Food & Bev

2

0

1

1

1

1

0

0

1

1

1

0

0

Total

11

3

3

2

1

9

1

2

13

1

1

1

1

129

Table A4-2. The Decision-making Process of Foreign and Local Firms
Employees involvement in decision
makingWho makes the decision
Sector

A top manager
Joint
Top
Depends onin consultation
Decision is
Employeeconsultation
manager with middle
the type ofand full
decentralized
representativeand frontline
only
decision
participation
managers

Collective vs individual decision
makingBoth

Collective

Individual

Both

FDI Firms
Automotive

0

1

2

3

0

0

1

0

2

Textile

0

2

4

2

3

1

1

0

5

Leather

2

1

2

4

0

1

1

3

1

Food& Bev

0

0

2

2

0

0

0

0

2

Total

2

4

10

11

3

2

3

3

10

Local Firms
Automotive

2

1

0

2

1

0

1

0

2

Textile

0

4

0

4

0

0

2

0

2

Leather

0

2

3

5

0

0

0

0

5

Food& Bev

2

0

0

1

0

1

0

0

2

Total

4

7

3

12

1

1

3

0

11

130

Table A4-3. Incentive Structure and Promotion Practiced by Foreign and Local Firms
Monetary incentive/bonus (as measured by target)
SectorIndividual
employee
performanceTeam
performance

Company
performance

Solely on
performanceand ability

All

Employees’ promotion
Partly on
Mainly on
performance andloyalty andability and loyalty
familyand family
connection
connection

Mainly on
seniority

FDI Firms
Automotive

0

0

1

1

3

0

0

0

Textile

1

1

0

1

5

1

0

0

Leather

1

1

0

1

3

2

0

0

Food& Bev

0

0

0

2

2

0

0

0

Total

2

2

1

5

13

3

0

0

Local Firms
Automotive

2

1

0

0

3

0

0

0

Textile

1

1

0

0

3

0

0

0

Leather

1

0

2

0

4

1

0

0

Food& Bev

0

1

0

1

1

1

0

0

Total

4

3

2

1

11

2

0

0

131

Chapter 5
Foreign Direct Investment in Ethiopia: A Survey Report5-1. Introduction
Ethiopia is implementing the Ten-year Perspective Development Plan 2021-2030 with a visionof becoming an African Beacon of Prosperity by 2030. Private sector-led economic growth isone of the pillars of this plan in which the private sector is expected to play a pivotal role ineconomic growth and structural transformation.
In promoting private sector development, Ethiopia has been striving to design policies thatcreate a level playing field for both domestic firms and foreign direct investment (FDI). The
important role of FDI for economic development, structural transformation andindustrialization of developing economies is well recognized both in academia and the policy
arena (see, for example, Gebreeyesus et al. 2017; Makki and Somwaru 2004). The potential
benefits of FDI to developing countries include technology and knowledge transfer, transfer ofmanagement and marketing skills and practices, enhancing employment opportunities, andexport earnings. According to UNCTAD (2005), attracting FDI is crucial in bridging theresource gap of low-income countries and hence avoiding further debt accumulation while
directly tackling the causes of poverty. To maximize the benefits and minimize the costs of FDI,
governments of developing countries need to take active policy measures to create an enabling
environment. These include, but are not limited to, timely entry approvals, ease of access toland, improved infrastructure such as roads, electricity and ICT, reliable and safe logistics, anda stable macroeconomic environment (Rajan 2004).
Like many other developing countries, Ethiopia has been taking measures to increase theinflow of FDI after liberalizing its economy in 1992 (Haile and Hirut 2006; Mohapatra 2014).
The government has gradually relaxed the constraints imposed on foreign investors, offers ahost of incentives, and has invested in the development of industrial parks that host foreign
investors. The government has also revised investment policy and expanded the sectors that areopen to FDI. These measures have contributed to an increased inflow of FDI to Ethiopia until
the nation became one of the largest FDI recipient countries in East Africa (UNCTAD 2020b).
To what extent the increased inflow of FDI to Ethiopia has brought the expected benefits oftechnology transfer, enhanced managerial skills of domestic firms, boosting international
market integration, and product quality improvement and standardization is an open empiricalquestion.

133

With a particular focus on the manufacturing sector, this qualitative study aims toinvestigate issues related to marketing, standards, export performance, and challenges faced by
local and foreign firms operating in Ethiopia. The study also assesses the impacts of the
COVID-19 pandemic on firm performance and government requirements and support to
manufacturing firms in selected sub-sectors including automotive, textile and garment, leather
products, and food and beverage. In the rest of the chapter, section 5-2 gives an overview of thesurvey, section 5-3 presents the major findings, and a final remark is given in section 5-4.
5-2. Overview of survey
5-2-1. Sample size and sector composition
We have collected qualitative information from a randomly selected sample of thirty firms
operating in the manufacturing sector in and around Addis Ababa. Out of this total, sixteen ofthem are foreign firms and the remaining fourteen are local firms. They belong to four
production sub-sectors including six (four foreign and two local) firms in the food and beverageindustry, ten (six foreign and four local) firms in the textile and garment industry, six (three
foreign and three local) firms in the automotive industry, and ten (five foreign and five local)
firms in the leather industry. The profile of these firms is provided in section 5-2-3 as well as
in Table A5-1.
Concerning the response rate, the sampled firms actively participated in the study andprovided required information except for three local firms (two firms in the leather industry andanother in the textile and garment industry) and two foreign firms (in the food and beverageindustry) that declined to respond or already ceased operation. These were replaced with similarfirms from a pre-identified list of replacement firms in the respective sectors. Two beveragefirms that were unwilling to cooperate despite our frequent approaches were dropped, and it
was not possible to replace these firms due to time constraints. This study uses information
obtained from thirty firms after these substitutions.
5-2-2. Survey implementation
The study was conducted from November 2020 to January 2021. Qualitative data wascollected using a semi-structured questionnaire with one key informant from each firm. An
effort was made to collect information from senior managers, directors, technical experts andother officials who were expected to have good exposure to policy matters. In transcribing thequalitative information obtained through open-ended questions, care was taken to correctly
capture the realities, practices and opinions expressed by the respondents.

134

Although data collection was done by in-person interviews, phone calls were also used for
additional information and follow-up clarification to complete the data collection work. In someinstances, for convenience and physical distancing, interviews were conducted through Skypeor Zoom meetings.
5-2-3. Profile of surveyed companies
Table A5-1 presents the profile of firms covered in this survey. In terms of ownership, there
were 14 firms fully owned by foreigners, 13 firms fully owned by Ethiopians, and three firmsthat are jointly owned with a local share of 70%, 50%, and 20%, respectively. Among them, thebeer companies had been transferred to foreign ownership through privatization before thesurvey. Meta Abo Brewery, established in 1963, was transferred in 2012 to Diageo while Hararand Bedele breweries were sold to Heineken in 2011. Heineken also added Walia Brewery to
its beer conglomerate in Ethiopia.
In terms of product types, the interviewed firms in the automotive sector produce
commercial vehicles (trucks and minibusses), steel structures, trailers, fuel containers,
motorbikes and three-wheel bajajs. The automotive companies sell their products mostly to thedomestic market. In terms of firm size, all firms employ more than 100 workers except for one
firm that has only five workers.
The local firms in the textile and garment sector produce mattress covers, bed sheets, Tshirts, trousers, hoodies and blankets. Except for one firm that exports its products to Central
Africa and the EU, all firms sell their products locally. The foreign firms operating in the same
sector produce jeans, trousers, jackets, shirts, underwear, uniforms, children’s wear and safety
clothes for construction workers. They export their products to different destinations (see Table
A5-1). In terms of firm size, while the non-micro local firms hire 289 to 600 workers, theforeign firms in the sector employ 300 to 1,900 workers. Out of the six foreign firms surveyed
in the sector, three employ more than 1,000 workers each.
For the foreign and local firms engaged in the leather and leather products sector, major
products include footwear, bags, belts, gloves, shoelaces and finished leather. All surveyed
leather firms, foreign and local, report that they export their products but to different market
destinations. On average, the local firms in the sector employ 693 workers, while the foreign
ones employ 1,650 workers.
The surveyed local firms in the food and beverage sector are limited to the production ofbeer which is predominantly for local consumption, with only a small amount being exported.
The foreign firms in this sector are also beverage factories (beer factories or breweries).
Although these firms are expected to export their products, only one of the breweries exports asmall proportion of its products, estimated at 3%, to different destinations including the US, the135EU and Japan. Beer export is insignificant due to uncompetitive prices and various other export
challenges including unreliable and inefficient logistics, a bureaucratic customs system, and aone-way bottle problem. While two breweries, one local and one foreign, employ more than
1,000 workers, the other two employ 345 and 450 workers, respectively.
5-3. Major findings of the survey
5-3-1. Impact of Covid-19 on firms’ performance
In April 2020, the Ethiopian government declared a state of emergency to curb thetransmission of the COVID-19 pandemic that lasted for five months. The state of emergency
prohibited organizations from retrenching their employees. In return, the government promised
to support business organizations, including foreign firms, with the postponement of tax andpension contribution payments for three months so they would be able to cope with the impactsof the pandemic. Although some local firms acknowledged receipt of the indicated support, theforeign firms that we interviewed indicated that the government failed to extend any support tothem. However, all of the surveyed firms refrained from laying off workers during the state of
emergency which lasted from April through August 2020. They were forced to retain idle
employees until the end of the state of emergency despite the slowing down of business. One
firm pointed out that it had no other choice but to retain idle employees as the state of emergency
prohibited retrenching workers.
The COVID pandemic has affected different manufacturing sub-sectors (and firms)
differently. All firms tried to get through the pandemic using different mechanisms. Some of
the automotive firms indicated that the pandemic does not jeopardize their operations as muchas the chronic shortage of foreign currency. They stated that the latter was by far a greater threat
to their survival. To get through the pandemic, some automotive firms rearranged work
schedules such as working in shifts or office staff working from home. Others requested loan
repayment extension and solicited financial contributions from business partners (owners) for
the survival of the firm. For one firm that had only five employees and outsourced most of its
operational activities, coping with the pandemic was not a big issue.
Companies in the textile and garment and leather sectors covered in this study have several
things in common. They are 100% owned by foreigners, their products are entirely for export(or for indirect export24). They all recruit many unskilled women whose skills are upgradedthrough pre-employment training of 45 to 90 days, depending on their capacity to acquire
knowledge and skill, and through on-the-job training. During the pandemic, these factories did
Indirect export here means selling tanned (finished) leather to FDI footwear factories and other leather factories
whose production is fully for export.
24

136

not cut back their employees either because they were not severely affected or because the stateof emergency prohibited them from doing so. The majority of the textile factories continued toexport as they had long-term contract orders and hence COVID did not immediately affect them.
On the other hand, the remaining textile firms faced a decline in export and had to cut
production to reduce operational costs.
After the state of emergency is lifted, two textile factories and three leather factories
released some of their employees to cut operational costs and thus to cope with the effects ofthe pandemic. One leather firm retrenched 3,000 employees including both permanent andcontract workers because its export had fallen almost to zero. There were also factories in our
survey that took other measures after the state of emergency, including instructing theiremployees to take paid leaves which economized transportation and lunch costs, cutting
production, and minimizing overhead costs by, for example, avoiding travel to reduce fuel costs.
One textile factory had to freeze its operation with 20,000 shirts stocked without being exported
and faced a financial crisis following the pandemic.
The outbreak of the COVID pandemic posed a unique challenge to beer factories and otheralcohol-producing firms as some people abstained from consuming alcohol to avoid health risks
and shifted their disposable income to other necessities. Recently, even without the pandemic,
brewing factories have faced challenges in connecting and communicating with customers,
introducing new product lines, and keeping the prices of their products reasonable for theirconsumers. These challenges are mainly due to the banning of advertisements of alcoholic
products on billboards and broadcast media, and the imposition of a stiff excise tax which
resulted in beer price hikes. They forced breweries to close outlets and distribution centers, cut
production, and stop expansion to adjust the supply capacity to the declining demand.
The COVID pandemic has also adversely affected exporting firms through schedulemismatches among various firms and services, including changed working hours at the Port ofDjibouti. Apart from the COVID-pandemic, many interviewed firms reported the shortage of
foreign currency and political instability as the most serious problems over the last three to four
years.
5-3-2. Export activities, challenges and standards
There are visible heterogeneities in the export market participation of firms across sectors
and ownership types. Most of the local firms, eight out of the fourteen firms we haveinterviewed, indicated that they sold all of their products locally. Some of the local firms are
struggling to satisfy the local market demand, and have no production capacity left for export.
The foreign firms, especially those in the automotive sector, also face the same situation. For
instance, one foreign automotive firm sells its products to individuals and organizations based137

on orders received in advance. According to this respondent, since there are more orders than it
can possibly satisfy, customers usually have to wait for seven to ten months before the deliveryof the automobiles they ordered.
In terms of sectoral differences in export market participation, we observe that none of thefirms in the automotive sector export their products regardless of ownership type. On the other
hand, in the textile and garment and leather products sectors, all foreign firms and all but two
local firms actively participate in the export market. It is important to note here that the leather
tanneries supply their finished leather to companies producing and exporting footwear and other
leather products. The tanneries consider their local sales as (indirect) export.
The leather factories routinely complain about the quality and volume of leather supply inthe local market. They acknowledge that they are doing little in technology transfer except
training their own employees. To resolve the problem of leather quality and supply constraints,
some foreign firms producing footwear and other leather products are moving in the upstream
direction by, for example, tanning and finishing leather to be used in their footwear production.
Concerning the food and beverages sector, two firms, one local and one foreign brewery,participate in the export market while the remaining two do not export. Although the Ethiopian
government makes it mandatory for foreign beer factories to export a certain proportion of theirproducts, nearly 100% of their beer production is currently supplied to the domestic market
because of the constraints, discussed below, that the sector is facing. To fulfill the obligation,
the foreign breweries have tried to export mainly to the US and Europe by targeting Ethiopian
Diaspora there. One of the beer factories admitted that “we have tried to export only because
the government has made it mandatory for us.”Firms currently exporting their products indicated that they face the following challenges.
 Shortage of foreign exchange, which limits firms’ ability to buy intermediate inputs andraw materials necessary for their production processes. Because of this problem, several
firms indicate that they operate below capacity most of the time.
 The lack of a well-organized, reliable and scheduled logistics and transportation systemforces firms to use private shipping companies whose price is three times higher than theofficial (monopoly) price charged by the Ethiopian shipping lines.
 Highly bureaucratic customs clearance and inaccurate information about policies andregulations create delays and complaints from customers.
 Variation between actual prices of imported inputs and customs evaluation of invoicevalues.
 Political unrest hinders the regular transportation of goods between the factory and the Portof Djibouti.

138 Global political crises including the US-China trade war25.
 Global market instability due to COVID (e.g., shoes are not a priority item for manyfamilies under the pandemic situation).
 The lack of skilled manpower necessitates extra training of recruits which pushes up the
production cost.
One of the critical challenges almost all firms in this study indicated was the shortage of
foreign exchange which led to a lack of access to inputs, a high production cost, and low
capacity utilization. As mentioned above, firms in the automotive sector sell their products
entirely in the domestic market. At the moment, they are not able to satisfy domestic demand,
let alone participate in the export market. They argue that the shortage of foreign currency
undermines their intention to export by constraining their supply capacity. They also express
their intention to start exporting when the shortage of foreign currency is resolved. Similarly,
one local firm says its capacity to export is limited because of poor bargaining power, which isexacerbated by a high production cost caused by difficulty in securing crucial inputs.
The automotive firms also point to high transportation and customs processing costs andinefficient logistics scheduling in Ethiopia as a major cause of weak competitiveness relative
to firms in other countries. One respondent stated that its automobile export to Egypt would
cost $3,000 more than the same model exported from China to Egypt.
In addition, the beer factories said that there were factors that negatively affected their effort
to export, including: The government’s policy to discourage consumption of alcohol by levying an excise tax
makes the prices of made-in-Ethiopia beer less competitive than those in destination
countries.
 The one-way bottle problem, i.e., beer bottles not returned from destination markets.
 Delay in revenue collection, which causes long deferment of revenue recognition in
financial reports.
A limited supply of skilled labor has also been cited as an additional cost to firms since thisforces them to train newly recruited low-skilled workers for 45 to 90 days before being put towork and additional on-the-job training. Some firms consider this as their contribution to the
local capacity building despite additional costs. Most firms also contribute to local capacity
building through cooperation with Technical and Vocational Education and Training (TVET)
institutions, especially in the textile and garment and leather sectors, by allowing their
The firms with Chinese origin stressed that exporting to the US had become increasingly difficult even if allprocedural requirements were fulfilled. They also pointed out that the lack of discipline of Ethiopian workers wasan additional problem for their production.
25

139

workshops to be used for practical demonstration and apprenticeship up to six months. Someforeign firms also invite domestic firms to visit their factories and share experience andcollaborate with local farmers. For example, to resolve the foreign currency problem, somebreweries collaborate with local farmers by providing a suitable barley malt variety, technicalsupport and a revolving fund.
Policy measures for export promotion produce mixed results. They help some firms to growand penetrate the market both locally and internationally. For instance, export promotion
incentives that cover packaging and production costs in the food and beverage sector arereported by some to be effective. Imported production inputs used in manufacturing products
for export are exempted from taxes, a measure which is recognized by many firms as effective
policy support. However, there are also reports that export promotion incentives are very poorand not appreciated by most firms. Some firms say that the existing incentives are not specificor targeted enough to the type of export (performance) and the type of firms that should bepromoted (beneficiaries) and that they lack clarity and their impact on the export effort is quite
limited. Some firms are not even aware of the export promotion incentives available to them.
Although duty-free imports of inputs and other incentives are given to exporters to maketheir products more competitive in foreign markets, surveyed firms generally noted that theyfell short of overcoming the constraints firms were facing. Firms also complain about theexaggerated invoice prices that the Ethiopian customs authority uses for calculating taxes onimported goods. Processing their appeal and getting a decision on it also takes a long time,
which greatly discourages exporters. Besides these policy challenges, one firm in the textile
and garment sector added that a high employee turnover, partly due to inflation and economic
disorder, is a major problem that undermined its capacity to produce and export.
5-3-3. Standards
The last column of Table A5-1 shows the export markets of each surveyed firm. For the
local firms that engage in export activity, the main markets are the US, the EU, and some partsof Africa. For foreign exporting firms, the main markets are the US, European countries suchas the United Kingdom, the Netherlands, Italy and Germany, and Asian countries such as China
and India. One brewery firm exports also to Japan. The foreign textile factories export theirproducts to firms (markets) with whom they have had long-term contract orders. On the other
hand, some of the local firms indicate that their markets are decided on an ad-hoc basis and thatthe absence of long-term contracts between local firms and foreign buyers is quite common.
Foreign customers have different requirements and impose various preconditions related
mainly to the quality, safety and delivery of products. One firm explained that “every year, ourproduct is evaluated in Italy to ensure the quality is maintained, in particular, thermoplastic

140

rubber sole evaluation as specified by customers.” Other requirements mentioned by the
respondents include: Quality and compliance with standards (meeting product specifications) Timeliness and consistency of delivery
 Compliance with the labor law (ILO Better Work certificate; labor safety and security)
 Environmental audit and evaluation (this is a must document)
 Certification of origin, bill of loading, factory set-up and management audit
 Documents on employee salary and benefits African Growth and Opportunity Act (AGOA) visa (eligibility and beneficiary status inexporting to the US) Energy sustainability
Preconditions concerning labor treatment and environmental protection are less common
and are limited to few foreign customers. For domestic sales, the situation is different from theexport market. One respondent from a beer factory said, “Of course, domestic consumers areless likely to impose or demand explicit and overt requirements”. However, even without
explicit requirements in the domestic beer market, their sales fluctuate from time to time due tocompetition in quality, delivery and, in the past, aggressive promotion and advertising (which
is now banned).
5-3-4. Product quality and ethical correctness
In this section, we examine more closely the situation surrounding product quality andethical correctness, focusing on textile and garment firms that engage in export.
Buyers and importing countries impose and monitor required conditions and standards
using different ways. One way is to check whether a firm possesses certain standard
certifications without demanding any further examination. Others conduct an initialinvestigation and regular and/or unannounced follow-up inspections that require the submissionof documents, data and proforma invoices for purchases. Standardizing institutions may provide
quality certification which the firm can show to its customers.
Requirements mentioned by foreign exporting firms include (i) presentation of documents
for annual evaluation of certain quality and standards; (ii) submission of various procedural
documents concerning export registration, environmental audit, certificate of origin, bill of
loading, social compliance, customs clearance, and so on; and (iii) AGOA visa for the US
market.
In our interviews, the foreign firms unanimously agreed that their products had to meet thenecessary standards and quality specifications imposed by buyers. If their products fail to meet141

any of them, they will face an automatic rejection. Most of the local firms also confirmed thatstandards could affect their performance in different ways. They indicated that meeting
standards would raise the reputation of the firm and hence increase profits. Some local firms
indicated that they already considered standards as part of their business philosophy, accepting
them as part of doing business and even welcoming them. However, other local firms consider
standards as costly, difficult to obtain, and irrelevant to the market they serve.
Regarding buyers’ support for quality specifications and standards, the majority of theforeign firms (five out of six) and all domestic firms responded that they did not receive any
support from buyers except that buyers demanded firms to comply with standards and meetrequired specifications. Moreover, both the foreign and local firms did not receive any support
from either the government or an industry association to adopt and comply with standards. One
respondent stated that “except for the rare awareness creation program by the Ethiopian Textile
Industry Development Institute (ETIDI) and the Industrial Parks Development Corporation(IPDC) to adopt and comply with standards, there was nothing in this edge.” One foreign firm,
however, reported that it did receive assistance from more than ten customers to comply withrequirements in document processing, early warning and evaluation. The same firm additionallyreceived training from ETIDI and IPDC to comply with standards.
The local firms also indicated that it was mostly up to foreign buyers and sometimes aid
agencies such as the German Corporation for International Cooperation (GIZ) to decide whether
technical assistance should be provided to garment firms concerning compliance. This
assistance mostly consists of skill training of technical staff responsible for meeting standards.
The Ethiopian Kaizen Institute has also supported local firms through technical capacitybuilding to comply with standards. Business associations such as the Addis Ababa Chamber ofCommerce also engage in assistance in obtaining quality standard certifications though this was
not mentioned by the firms in our survey.
Textile and garment firms recognize that meeting product and process standards are critical
to approaching customers and competing in the global market. They consider compliance as an
essential part of organizational philosophy. Standardization and compliance help them to know
precisely what is required and must be focused on, smoothly process orders and communicate
with customers, avoid product rejection, and thus minimize cost and increase efficiency.
Foreign textile and garment firms even regard standard compliance as an essential andpositive method to promote business and increase competitiveness. It dictates their input
procurement and production processes. They consider product standards as the decisive factor
to build competitiveness and success in the global market while other requirements such ascompliance with the labor law, environmental protection, AGOA visa, certificate of origin, andexport registration as mandatory obligations to remain in this business. One foreign firm notedthat “complying with and meeting product standards is about a question of survival and success142

in a market, while the requirements like creating a safe working environment for employees isan obligation.” That means product standards are the key information for aligning production
processes to what customers require, which can differentiate one firm’s products from those ofothers. Similarly, the local firms noted that quality standards were more effective in helping
them to improve performance than any other forms of standards including process andproduction.
The survey inquired the six foreign textile and garment firms (Firms no. 4 to 9) which
certification they had among ISO 9000s, ISO 14000s, Kaizen, Total Quality Management(TQM), SA 8000 and ILO Better Work. All except one had secured the ILO’s certification andapproval for Better Work because compliance with relevant labor laws was an obligation forexport. The remaining one firm had completed 90% of the process for certification. As for ISO
9000s, two firms were in the process of obtaining this certification and the remaining firms
indicated that they do not have a plan of obtaining it. For kaizen, respondent firms typically
replied that their factories were physically arranged as per the standard layout approved by theircustomers, ETIDI and IPDC but certification for kaizen had not yet been secured. Regarding
the remaining three standards (ISO 14000s, TQM and SA 8000), the six foreign firms did nothave them.
A parent company in the home country may obtain other types of certification not listed inour survey but essential for doing business for subsidiary firms abroad. They include Registered
Exporter (REX), Supplier Ethical Data Exchange (SEDEX) and Worldwide Responsible
Accredited Production (WRAP). While REX is a requirement to export, the surveyed firms
opted to register for the other certificates by their own initiative and bore the costs to comply
with standards and requirements. Few firms saw any trade-off or excessive cost burden in
adopting different standards. Some said that associated costs were not significant if the benefitsof easing the export process and creating a smooth linkage with customers are considered.
To ensure that factory operations and products are consistently up to standards, all six
foreign firms in our survey have established an internal quality and standard department that
conducts regular supervision and testing of products, purchases raw materials, inputs, andmachinery, and checks if trained workers have the required skills. They assert that maintaining
standards is a collective responsibility. One firm explained, “Textile manufacturing is acollective responsibility that requires all members of the factory to work in a coordinatedmanner to achieve and maintain quality and standards.”
As for local firms, nearly half of them in the survey have ISO 9000s. Other certification
obtained by some includes TQM and ILO Better Work. These were acquired mostly with theirown initiative. Some local firms confided that implementing several standards created a tradeoff regarding costs and capacity. Many have internal units or persons to implement standards,
but concrete implementation methods are different from one firm to another. Multiple

143

approaches are taken including internal rules and procedures, purchase of testing equipment,
staff training with monitoring, evaluation and promotion. These may be conducted either in acompanywide coordinated manner or by a special unit. In the latter case, the designated unit or
person does regular monitoring to ensure compliance and takes corrective measures whennecessary.
5-4. Summary
This qualitative survey studied local and foreign manufacturing firms in the automotive, textile
and garment, leather, and food and beverage sectors in and around Addis Ababa. It explored
COVID-19 related challenges, firm reactions, and government support during the pandemic;
export activities and related challenges; and quality standards and ethical correctness.
During the COVID pandemic, manufacturing firms in Ethiopia faced different challenges
that hampered their operation and export performance. There were sectors that were relatively
less affected by the pandemic than others. Some firms in the textile and garment and leather
sectors continued to produce despite the pandemic mainly due to long-term contract orders. But
many others were forced to cut back production below capacity as the demand for their products
declined. Exacerbated by an ongoing problem of shortage of foreign currency, the pandemic
posed an additional serious challenge to the automotive and beer factories as their products
became less of a priority for consumers during the pandemic. The beer factories had alreadybeen suffering because beer demand had declined following the imposition of an excise tax on
alcoholic beverages.
Regardless of the severity of COVID challenges, firms covered in the survey did not
retrench employees during the pandemic. A state of emergency in place from April throughAugust 2020 prohibited firms from laying off workers. When the state of emergency was lifted,
a few firms released employees. One foreign firm reported that it discharged up to 3,000permanent and contract employees out of 4,500 due to a total disappearance of its exports
following the pandemic.
The major challenges the firms in this study faced included unreliable logistics and schedulemismatch, bureaucratic customs clearance, a large gap between the import price declared by
the firm and the valuation of the customs authority, political instability, and, most importantly,
the shortage of foreign currency. A limited supply of skilled labor is also a problem that adds tothe production cost. Some firms consider worker training as a contribution to local capacity
building even though they may not be able to retain them for long. Others assist upstream
domestic suppliers to increase local procurement and ameliorate the foreign currency problem.
The automotive and beer companies supply their products to the local market, while the
FDI firms operating in the textile and garment and leather sectors do not sell in the domestic

144

market as their products are entirely for export to the US, Europe, China, India and others. The
leather factories complain about the low quality and volume of domestic leather supply. Someforeign firms producing leather products have decided to tan and finish leather for use in theirfactories.

145

Annexes
Table A5-1. Characteristics of Surveyed Firms(a) Foreign or foreign-majority joint venture firms
Firm
no.

Country oforiginFirst year of
Ownership
production at
Domestic Foreign
current(%)(%)
location

Number of
employees

Export

166

No

150

No

5

No

Babyware (shirts, pants)
Denim and non-denim(jeans) trousers, shirts,
men's underwear
Children's ware (shorts;
shirts, pants)
Jackets, T-shirts, shorts,
pants, uniforms for kids andadultsSafety clothes forconstruction, traffic, sanitary
Fleece jackets

1,860

EU, US

1,900

India, EU, US

1,500

USA

699

UK, Germany,
Netherlands, US

Main products

Automotive
1

China

2009

-

100

2

Ethiopia

2018

50

50

3

Ethiopia

2013

20

80

Automobiles andmotorbikes
Three-wheel bajajs
Three-wheel bajajs totransport goods

Textile and garment
4

India

2015

-

100

5

India

2015

-

100

6

India

2015

-

100

7

China

2019

-

100

8

S.Korea

2015

-

100

9

S.Korea

2016

-

100

10

China

2010

-

100

11

India

-

100

12

Taiwan

2015

-

100

13

China

2013

-

100

14

Hong Kong

2011

-

100

300

US

500

Germany

Tanned leather, gloves
Finished leather, men's andwomen's footwear
Women's shoes, leather
Men's and women's shoes,
shoe parts
Casual flats, moccasins,
sandals, boots, heels, bags

1,000

China

850

India

400

US, China

4,500

US

1,500

US, Italy

LeatherFood and beverages
15

Netherlands

2011

-

100

Beer

1,120

16

UK

1963/2012

-

100

Beer

345

US, Europe, Japan(see note)
Not currently

Note: firm 15 exports around 3% of its output, and it is not actively or consistently exporting. The target is the
Ethiopian Diaspora.

146

(b) Local or local-majority joint venture firms
Firm
no.

Country oforiginFirst year of
Ownership
production at
Domestic Foreign
current(%)(%)
location

Number of
employees

ExportCommercial vehicles
Trucks and minibuses
Steel structure, trailers,
trucks, fuel tractors

111
340

No
No

146

No

ShirtsT-shirts, pillows, sports
clothes, trousers, hoodies
T-shirts, blanket
Polyester, Tetror,
mattresses, bed sheets

289

No

600

Central Africa, EU

547

No

320

No

EU and Africa
Madagascar, US,
Somalia, Nigeria,
AngolaMain products

Automotive
17
18

Ethiopia
Ethiopia

1975
2018

70
100

30
0

19

Ethiopia

1975

100

0

Textile and garment
20

Ethiopia

2003

100

0

21

Ethiopia

1993

100

0

22

Ethiopia

1961

100

0

23

Ethiopia

1970

100

0

24

Ethiopia

1970

100

0

Shoes

755

25

Ethiopia

1935

100

0

Shoes, belts, bags, gloves

1,650

26

Ethiopia

1998

100

0

Shoes, bags, garment,
related goods

84

27

Ethiopia

1989

100

0

Shoes

420

28

Ethiopia

1993

100

0

Shoes, bags, belts, soles

556

EU, North America,
AfricaUS, Africa

2016
2000

100
100

0
0

450
1,100

No
EU

Leather

AfricaFood and beverages
29
30

Ethiopia
Ethiopia

Beer
Beer

147

Table A5-2. Firm responses to survey questions(a) Organizational culture
Written/articulated but not widely
communicatedWell articulated and understood byeveryoneAutomotive

1

2

Textile and garment

4

2

Leather2

2

Food processing

02

Identity, sologan

Written/articulated but not widely
communicatedWell articulated and understood byeveryoneAutomotive

1

2

Textile and garment

00

Leather

1

2

Food processing

0

Vision, mission, values

2

Informal channel

Employer-employee meeting orformal channel (union)

All options

Automotive

0

0

3

Textile and garment

1

1

4

Leather0

1

4Food processing

00Communication with employees

2

Teamwork practiceRarely practiced

Organized shop work teams

Automotive

0

3

Textile and garment

06

Leather

1

4

Food processing

02Company-sponsored social events

Four times a year

Twice a year

Once a year

Automotive

1

0

1

Textile and garment

4

1

1

Leather0

13Food processing

2

0

0

(b) Decision-making process

Top manager only

Top manager in
consultation withmiddle and frontline
managers

Decision isdecentralized

Depends on thetype of decision

Automotive

0

1

0

2

Textile and garment

0

2

0

4

Leather

2

1

0

2

Food processing

0

0

0

2

Employeerepresentative

Joint consultationcommittee

Both

Automotive

3

0

0

Textile and garment

2

3

1

Leather401Food processing

2

0

0

Collective

Individual

Both

Automotive

1

0

2

Textile and garment

1

0

5

Leather023Food processing

0

0

2

Collective

Individual

Both

Automotive

1

0

2

Textile and garment

0

1

5

Leather023Food processing

0

0

2

Who makes the decision

Employees involvement in decision making

Collective vs individual decision making

Collective vs individual responsibility148

(c) Incentive structure and promotion
Monetary incentive/bonus (as measured bytarget achievement)

Individual employee
Team performance
performance

Company
performanceAll

1

Automotive

0

0

1

Textile and garment

1

0

1

4

Leather111

3 (see note)

1

1

Food processing

00

Non-monetary incentives

Cover medical
expenses andtransport service

House allowanceand transport
service

Cover medical expense, transport
service, and career development
opportunity

Automotive

1

1

1

Textile and garment

2

1

Leather2

3
3
1

Food processing

1

1

Employee promotion

Solely on
performance andability

Performance,
ability, loyalty &family connection

Mainly on loyalty
and family
connection

Mainly on seniority

Automotive

3

0

0

0

Textile and garment

5

1

0

0

Leather

3

2

0

0

Food processing

3

0

0

0

Employment policy

Short-term and contract

Long-term employment

Automotive

0

3

Textile and garment

06

Leather

05Food processing

02

Note: the tables show the number of surveyed firms responding to prepared questions. Answer formats are
not exactly the same across sectors. No reply or inapplicable question is not counted. In subtable (c), count3 in the last column of leather in monetary incentive bonus includes All 3, 1&2 and 1&3. The last question(employment policy) is asked separately but is combined with subtable (c) in this presentation.

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Chapter 6
Current Status and Challenges of the Garment Sector:
A Comparison of Vietnam, Bangladesh and Ethiopia
6-1. Introduction
The Policy Studies Institute (PSI) of Ethiopia and the National Graduate Institute for Policy
Studies (GRIPS) Development Forum of Japan jointly produced a three-country comparative
study of the garment industry in the framework of the Ethiopia-Japan Industrial Policy Dialogue.
Firm surveys were conducted simultaneously in Vietnam, Bangladesh and Ethiopia between
November 2020 and January 2021 after coordinating the content of the questionnaire among
the three countries. It was agreed that surveys should contain comparable information acrosscountries but also address issues that were unique and critical in each country.
The survey in Vietnam was organized by Dr. Le Ha Thanh of the Vietnam Development
Forum (VDF) and the National Economics University and her colleagues. The survey inBangladesh was implemented by a team led by Dr. Monzur Hossain of the Bangladesh Instituteof Development Studies (BIDS). Surveys in these countries focused exclusively on the garment
sector. The survey in Ethiopia was conducted by Dr. Mulu Gebreeyesus and Dr. Kiflu Gedefe
Molla of PSI, covering four sectors including garment (as reported in Chapter 5). The numberof surveyed garment firms in each country was as follows.
- Vietnam: 31 firms—21 domestic private, 5 FDI, 5 former state-owned (now“equitized”26)- Bangladesh: 30 firms—25 domestic, 1 joint venture (50:50), 4 FDI- Ethiopia: 10 firms—4 domestic, 6 FDI (besides this, 20 firms in food processing,automotive and leather sectors were interviewed)
Additional information, in possession of the joint team or newly collected, was used tocomplement survey data in each country. The profile of surveyed firms is given in the appendix
table.
The objective of the three-country survey is to identify the current status of each garment
exporting country as well as the challenges they face in the context of global dynamic shifts intechnology, competitors, industrial organization, and various shocks. To save time and cost, andin the presence of the COVID pandemic, surveys were conducted in the vicinity of the capital
In Vietnam, equitization means transforming state-owned enterprises into joint stock companies whose initialshares are held by designated stakeholders, among which the state usually holds an overwhelming proportion.
26

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city of each country with a sample size of about 30 firms. Our aim was not to obtain average
results over a large number of firms but to extract analytical points that should inform
policymakers. The findings mainly focus on long-term structural issues including
competitiveness and value creation, but we also look at the impact of the COVID pandemic of
2020. Results are arranged by topic and reported in ten relatively short sections below.
6-2. The time factor
As we begin our international comparison, it must first be recognized that the three countries
are at different stages of economic development in general, and the development of the garment
industry in particular. Bangladesh and Vietnam are large and well-established exporters ofgarments while Ethiopia is a newcomer with growing but still small garment export.
In terms of per capita income in 2019, Vietnam stands at $2,715, Bangladesh at $1,856 andEthiopia at $856 (World Bank data). The first two are lower middle-income countries while
Ethiopia is a low-income country by the World Bank income classification. Turning to theexport value of textile and garment, in 2019, Vietnam exported $40.3 billion and Bangladesh$34.6 billion while Ethiopia’s export was mere $143 million (UNCTADstat data)27. Ethiopian
export value is between a two-hundredth and a three-hundredth of the first two, though it madea great jump from virtually zero in 2000 and $36 million in 2010. Vietnam boasts 7,627 garment
firms which hire 1.56 million workers (General Statistics Office, 2018 data). Bangladesh has
3,500 garment firms, over 1,000 buying houses (Uddin 2017) and garment-related employmentof roughly 4 million (Bakht and Hossain 2017). In Ethiopia, the number of medium and large
garment firms in 2018 was 176 (ETIDI data). The number of garment employees grew recently
in Ethiopia but is uncertain. The Central Statistical Office reports 78,786 employees in 2017/18
but this includes workers at micro and small establishments. Meanwhile, many large garment
factories came into operation after 2017/18.
Vietnam’s modern garment export started in the mid-1990s when its economy was opened
up to the Western world and FDI began to arrive from Japan, Korea, Taiwan, and so on. Since
then, garment export has grown steadily backed by cheap and good unskilled labor and anincreasing number of bilateral trade agreements and Free Trade Agreements (FTAs) vis-à-vis
the United States (US), European Union (EU), Japan, China, Korea, India, Russia, etc 28 .
Vietnam is also a member of regional economic groups such as the Association of Southeast
Asian Nations (ASEAN), the Trans-Pacific Partnership Agreement (TPP) and the Regional
Comprehensive Economic Partnership Agreement (RCEP). Its status as the leading “China Plus
The National Bank of Ethiopia data for textile and garment export gives $153 million for 2018/19 and $169
million for 2019/20.
28
As of August 2021, Vietnam has 15 concluded FTAs and 2 under negotiation with bilateral trading partners or
regional associations (Center for WTO and International Trade, Vietnam Chamber of Commerce and Industry).
27

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One” country—favored destination for FDI firms that exit or diversify from China for various
reasons—gives it a strong advantage for securing major overseas markets. Every time China
faces friction with other large nations, Vietnam receives more FDI and trade. The main products
include jackets, T-shirts, trousers, shorts, dresses, coats, ladies’ underwear, kimono, etc.
Vietnam is a member of the World Trade Organization (WTO) since 2007.
Bangladesh’s modern garment export started in 1974 when it began to cooperate with
Daewoo (Korea) to take advantage of its Multi Fiber Agreement (MFA) status29. Its modern
ready-made garment (RMG) sector has the longest history among the three countries. Apparelexport continued to grow rapidly despite such major shocks as the disappearance of the MFA
quota in 2005 and the Rana Plaza collapse in 2013. The main products are T-shirts, polo shirts,
jackets, sports items, hoodies, sweatshirts, woven top items, pants, innerwear, underwear, etc.
Bangladesh has been a member of the General Agreement on Tariffs and Trade (GATT, now
WTO) since 1972. It is expected to graduate from the Least Development Countries (LDC)
status and lose preferential treatment (tariff exemption) in 2026. Bangladesh has so far
concluded no regional or bilateral FTA or similar trade agreement with major overseas RMG
markets. Like Vietnam, it is considered as one of the “China Plus One” countries that benefit intrade and investment as a result of the China-US trade confrontation30.
In Ethiopia, modern garment export started in the late 2000s with the arrival of Turkish,
Indian and Chinese FDI. This was a result of active top sales, favorable policy which included
investment incentives and generous public loans 31 , and the availability of cheap labor. The
aggressive construction of state-owned industrial parks in recent years attracted many foreign
apparel firms, especially in Bole Lemi and Hawassa Industrial Parks, but also in other locations.
Ethiopia’s main products are relatively simple knitted apparel such as T-shirts, sportswear, jeans,jerseys, babywear, socks, etc. Ethiopia enjoys the African Growth and Opportunity Act(AGOA) status with the US32 and the Everything but Arms (EBA) status with the EU (zeroimport duty privilege for exporting countries satisfying certain conditions). Ethiopia is not amember of WTO. It has no regional or bilateral FTAs with its major garment importing
MFA of GATT controlled, from 1974, the trade flows of the garment from developing countries to developed
countries, permitting an annual increase of 6% but imposing quotas on countries that exceeded this limit(Chowdhury, Ahmed and Yasmin 2014).
30
According to the JETRO annual survey of Japanese FDI (JETRO 2020), Japanese firms operating in Vietnam
and Bangladesh had the highest business prospects because of the China-US trade war, among 19 Asian economies
surveyed. In Vietnam, 15.3% and 16.1% of Japanese firms said they had a positive impact in 2020 and expected apositive impact within 2-3 years, respectively, from the change in the global trade situation. In Bangladesh, thecorresponding ratio was 13.8% for both in 2020 and the near future. Most other economies reported no or little
such prospect.
31
Generous low-interest long-term public loans were provided by the Development Bank of Ethiopia to Turkish
investors. Subsequently, however, most of such Turkish garment firms went into default within a decade, for which
Ethiopia was the first overseas investment destination. They failed to achieve profitability despite (or because of)huge capital investment.
32
However, in January 2022, the US suspended the AGOA privilege to three African countries including Ethiopia.
29

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countries or areas.
6-3. Key players and business associations
Among the three countries, Bangladesh has the longest history of garment production for export
and boasts highly developed domestic garment producers. Domestic firms dominate thenation’s about 3,500 garment producers (98% are estimated to be domestic firms)33 and over
1,000 buying houses (of which 80% are domestic). Domestic garment producers areinternationally competitive if we confine our attention to physical production, while their main
shortcomings are such capacities as brands, global logistics and retailing, and fabric supply.
Very few Bangladeshi producers carry their own brands or engage in global marketing. Their
activities consist of the production of foreign brand products on a contract basis (sections 6-6
and 6-7 below).
Our survey indicates that production cooperation among Bangladeshi garment firms is notuncommon in the form of subcontracting production of finished garments or intermediate inputs
and accessories to smaller or less busy firms. This is done regularly as well as temporarily,
based on the size of the received order relative to the factory’s capacity. Such subcontracting
may be done with or without the consent of buyers. Traders also seem active in arranging input
procurement and matching foreign buyers with domestic producers. Surveyed firms use both
direct contact and indirect contact via traders in finding and communicating with buyers.
Another important feature of Bangladesh’s RMG sector is the existence of two powerfulindustry organizations, the Bangladesh Garment Manufacturers and Exporters Association(BGMEA) and the Bangladesh Knitwear Manufacturers and Exporters Association (BKMEA).
As of May 2021, BGMEA has about 4,500 members, of which 60% are woven garment
exporters and 40% are knitwear exporters. BGMEA’s membership coverage is wide andincludes almost all woven garment exporters in the country, 95% of sweater exporters, andaround half of the light knitwear exporters. The number of member companies of BKMEA is
2,320 (there may be a double-counting of membership between the two associations).
According to Bakht and Hossain (2017), active members of BGMEA are about 2,700 and thoseof BKMEA are about 800. BGMEA and BKMEA are powerful summit organizations of theindustry responsible for over 80% of the nation’s total export. They have strongly promoted theinterests of the industry and its workers, extended necessary support to members, and secured
significant policy assistance from the government (section 6-10).
In Vietnam, the ownership profile of garment producers is more varied, reflecting thenation’s socialist history, which shifted from 100% state monopoly to permission of private
Information provided by the Bangladesh Institute of Development Studies. Formal data on the ownership of
RMG firms is unavailable to the author, but tenant firms in Export Processing Zones (EPZs) are mostly FDI firms.
33

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enterprises and arrival of FDI in the 1990s, and a great increase of private firms in the 2000s.
Table 6-1 shows the current number of textile and apparel producers in Vietnam. Focusing on
apparel, there are still a small number of virtually state-owned or state share-dominated firms
as well as “equitized” former state enterprises with majority state shareholding34. These areremnants of yesteryears but some are large enterprises. The army is also a very active business
operator within the state sector of Vietnam. Nonetheless, at present, dominant players in termsof number are purely or mostly private firms with the state share of 0-50% (private individualcompanies, and private limited liability companies and joint stock companies with 50% stateshare or less) accounting for 86.8% of total apparel establishments. Adding 100% FDI firms
and joint ventures with foreign firms, whose share is 11.8%, domestic and foreign private
establishments comprise 98.6% of the Vietnamese apparel sector. The situation in the textile
sector is similar.
Table 6-1. Vietnam: Number of Textile and Garment Establishments
by Ownership Type
TextileApparelTotal

One owner limited liability company, 100% state
owned

Count

2

4

6

%

0.0%

0.1%

0.0%

Joint stock company or limited liability company,
with state share over 50%

Count

17

15

32

%

0.4%

0.2%

0.3%

Cooperatives
Private individual company
Private limited liabililty company or limited liability
company with state share of 50% or less
Joint stock company with no state share
Joint stock company with state share of 50% or
less
100% foreign owned
Joint venture between state firm and foreign firm
Joint venture between non-state firm and foreign
firm
Total

Count

69

58

127

%

1.5%

0.8%

1.0%

Count

176

185

361

%

3.9%

2.4%

2.9%

Count

3,290

5,611

8,901
72.7%

%

72.3%

72.9%

Count

449

880

1,329

%

9.9%

11.4%

10.9%

Count

14

31

45

%

0.3%

0.4%

0.4%

Count

508

865

1,373

%
Count
%

11.2%
2
0.0%

11.2%
2
0.0%

11.2%
4
0.0%

Count

26

42

68

%

0.6%

0.5%

0.6%

Count

4,553

7,693

12,246%100.0%

100.0%

100.0%

Source: calculation based on General Statistics Office, Vietnam Enterprise Survey 2019.

Through a series of state enterprise reforms since the 1990s, Vietnam’s small state companies were privatized
and large ones have been “equitized” or transformed to corporations owned by shareholders, with the majority of
initial shares allocated to the state and employees. This increased management autonomy of such enterprises but
ownership of many of them still largely remains in the state’s hands.
34

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The Vietnam National Textile and Garment Group (Vinatex) was created in 1995 bymerging state-owned textile and garment enterprises to form a large “general corporation 91”(GC91) as was also done in other sectors. Currently, Vinatex has 45 member companies
including 12 spinners, 10 weavers and 24 garment manufacturers35. Initially, Vinatex members
were dominant in the nation’s production and export of textile and garment and played a keyrole in executing the government’s policy, but their weight gradually eroded as private and FDI
firms expanded and the equitization process progressed. Even so, the export share of Vinatex
members is still significant at 10-15% of total textile and garment export.
Meanwhile, the Vietnam Textile and Apparel Association (VITAS), established in 1999, isan industrial association that supports member companies with such standard activities asexport promotion, linkage with foreign firms, global marketing, standard-setting, and working
with government and foreign development partners. As of May 2021, its website has nearly
1,000 corporate, institutional and individual members of which corporate members are 236.
VITAS is not very politically influential unlike BGMEA and BKMEA in Bangladesh where thegarment is the leading manufacturing export.
In Ethiopia, the number of garment firms is far fewer than in the other two countries.
According to the Ethiopian Textile Industry Development Institute (ETIDI) data, the number ofgarment firms, excluding micro and small establishments, was 176 in 2018 (section 6-2). Startz
et al. (2016) reports that 66% of large and medium garment firms were domestic private(including diaspora-owned) firms while 34% were FDI as of 2016. Domestic firms are smaller
than FDI firms in terms of employment size. There are also three state-owned or party-affiliatedlarge firms. Most apparel export is conducted by FDI firms. An unpublished survey of industrial
parks found 39 active exporters in Ethiopia, the majority of which were garment exporters whileothers exported footwear and leather products (EIC and JICA 2021). Of the surveyed 39
exporting firms, all but one were FDI firms (there are also garment exporting firms outsideindustrial parks). This suggests that the number of garment factories with export capability is
far less than 100, and they are all foreign operators except one. If MAA Garment and Textiles
Factory, a member of MIDROC Ethiopia Group owned by an Ethiopian-Saudi billionairebusinessman, is counted as “domestic,” as Ethiopians do, it is the only domestic firm thatengages in substantial export to EU and US markets.
ETIDI is a state-run sector support organization with the backing of government and donors(India is the most generous supporter). Its original mandate is the provision of training,
consultation, marketing and policy support on technical matters but it also provided nontechnical services such as investment facilitation following government instruction. The
Ethiopian Textile and Garment Manufacturers’ Association (ETGAMA), with over 100 member
The numbers do not exactly add up. This may be due to firms performing more than one function, members notlisted here, or different timing of membership data in the Vinatex website.
35

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factories which include both domestic and FDI firms, conducts promotional activities for thenation’s textile and garment industry. It also works with government and development partners
but its advocacy and lobbying influence is relatively small.
6-4. Securing markets
The largest markets of ready-made garments are high-income economies with a large
population that no longer produce apparel domestically. They are the EU and the US, followed
by Japan, Korea and other advanced economies. The three garment exporting countries under
our investigation differ significantly in their major markets. Vietnam’s main markets are the US(47%) followed by Japan (12%), the EU (11%) and Korea (10%) (2020 data). For Bangladesh,
main markets are EU (61.8%), US (18.2%) and Canada (3.4%) (2019 data, BGMEA (2021)).
For Ethiopia, the main markets are the EU (67%) and the US (19%) in 2016. Among thesurveyed firms in Ethiopia, FDI firms all export while domestic firms, except one that sells toCentral Africa and the EU, do not export.
At the level of an individual firm, some garment producers have regular large-volume
contracts which permits expansion, long-term planning and smooth production management,
while others rely heavily on short-term contracts which are susceptive to volatility, external
shocks and price-cutting pressure. In Vietnam, producers are mostly of the first type. Meanwhile,when a global brand apparel retailer sets up a subsidiary factory abroad, production orders andmarkets are specified by the head office. By contrast, nonaffiliated producers may run the riskof being captured by one or a few buyers, supplying products exclusively to them by contract
stipulation or due to the lack of marketing skill36. Having a regular but diverse customer baseand retaining sufficient bargaining power is a good business strategy, but this must be backed
by high managerial and technical competence. Another good strategy is to accept temporary
orders during slow seasons to keep up the operation ratio.
At the national level, it is important for a country to conclude as many trade, investment,
and other economic agreements as possible with its current or potential major markets. This
ensures significant tariff privileges, a stable business relationship, and ease in market expansion.
In this regard, Vietnam is the winner among the three countries studied here. As noted above(section 6-2), through active economic diplomacy, Vietnam has concluded such agreements
bilaterally with the US (2000), Japan (2008), EU (2020), Korea (2015), and Russia and former
Soviet republics (2015), to name the most important. Vietnam is also a member of the ASEAN
This statement is true for both domestic and FDI garment manufacturers. In Ethiopia, a large verticallyintegrated knitwear producer from Turkey went into default within a decade of operation. The main reasons forthis were (i) over-borrowing from the Development Bank of Ethiopia for investment too large for its businessscale; and (ii) reliance on only one German buyer and the resulting lack of customer diversification and bargaining
power.
36

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Free Trade Area (1995) as well as economic agreements ASEAN concluded with China, Korea,
Japan, Australia-New Zealand, India and Hong Kong. Moreover, it is a founding member ofsuch multilateral economic arrangements as TPP and RCEP. This covers virtually all major
trading partners of Vietnam. Bangladesh has no such FTA or similar agreements with its major
markets, especially the EU and US. The situation is similar with Ethiopia, but it has enjoyedtrade privileges (duty-free imports) offered by the EU and US in the form of EBA and AGOA.
Vietnam has an additional advantage of being the top “China Plus One” country—the mostfavored destination for FDI which exits or diverts from China for various economic and politicalreasons. Every time China experiences a political or economic conflict with other nations,
Vietnam receives more FDI and trade diverted from China. In the annual survey of Japanese
FDI firms conducted by the Japan External Trade Organization (JETRO), Vietnam is by far themost popular destination of Japanese investors.
WTO membership is also important for promoting a nation’s trade and investment.
Bangladesh is a member of WTO (formerly GATT) since 1972. Vietnam joined WTO in 2007.
Ethiopia is currently in accession negotiation with WTO but it has not made much progress sofar.
6-5. Vertical integration of the firm
Some firms specialize in one process along the value chain such as garment production (cutting,sewing and finishing only) while others internalize many processes from upstream todownstream such as cotton ginning, spinning, weaving/knitting, dyeing, garment production,marketing, retail, and so on. The degree of vertical integration37, or how a firm draws its activity
boundaries along the value chain, is one of the topics of the theory of the firm. The theory
presents various angles including transaction cost economics, agency theory and property rights
theory (Kim 2019). Business transactions with other firms permit a firm to focus on corecompetence and give more flexibility in dealing with shocks, but entail costs to monitor
cheating and enforce contracts. By contrast, doing everything internally gives a firm a strong
grip over the entire value chain but requires additional costs in managing and coordinating
multiple activities. Firms choose boundaries to balance these merits and demerits (Coase 1937;
Williamson 1981). If a firm possesses a valuable asset, it may want to build activity boundaries
around that asset. Additionally, agency theory points to different contractual possibilities
depending on the objectives, incentives and uncertainties of a principal and an agent.
There is an additional issue for latecomer countries with a less-than-perfect businessenvironment. If the physical flow of goods from upstream to downstream (input procurement

37

In Bangladesh, vertically integrated producers are often called “composite” factories.

158

and product sales) is slow or unpredictable due to bureaucracy, poor logistics, shortage of
foreign currency, external shocks, and so on, a manufacturing firm may opt for a more
integrated production mode than otherwise, and hold sufficient raw materials and intermediate
inputs to guard against production stoppage even at a high inventory cost. This is opposite to
Toyota’s just-in-time production where inventories are kept to a minimum, but such an
approach does not work if supply chains move slowly and with many disruptions.
We observe many patterns of vertical integration or the lack of it among apparel firms in
Vietnam, Bangladesh and Ethiopia. Choice of integration also seems to depend on thenationality and ownership of firms. For example, highly integrated firms include Ayka, MAA
Garment, Velocity and DBL in Ethiopia38 and some former state-owned factories in Vietnam.
Meanwhile, most factories in Bole Lemi and Hawassa Industrial Parks in Ethiopia engage ingarment production only. In Bangladesh, most firms specialize in garment production, but someinternalize weaving and knitting processes (“composite” factories). These firms are contract
producers of apparel for large global brand retailers. PVH, a holder of global brands including
Calvin Klein, constructed its own factory in Hawassa Industrial Park in 2017, but this was arare case and the firm later decided to pull out of Ethiopia after four years of operation. Most
global brand corporations contract out production to a large number of garment firms in many
countries without investing in production facilities of their own.
We should therefore distinguish three types of apparel FDI: (i) global brand holders thatspecialize in downstream marketing and retailing, and outsource production to others (GAP,
H&M, Uniqlo, etc.); (ii) brand holders that also build and operate their own factories abroad in
addition to marketing and retailing (Tommy Hilfiger, Triumph, etc.), and (iii) global garment
producers without own brands, who manufacture brand products of others on a contract basis(DBL, Velocity, Arvind, etc.) Type (i) is the buyer, type (iii) is the manufacturer, and type (ii)does both. Meanwhile, domestic garment firms in the three countries under our investigation
engage in activities of type (iii).
6-6. Domestic value creation
In the early stage of industrialization, latecomer countries often attract labor-intensive lightmanufacturing FDI. Production of relatively simple low- to middle-range apparel is an activityof such kind, along with food processing, footwear production, and assembly of electrical andelectronic devices.

Startz et al. (2016), supplementing ETIDI data, says there were 127 textile and garment firms in Ethiopia as ofJanuary 2016, of which 24 were integrated mills, 23 were spinning, weaving or knitting, 72 were apparel, and 8
were handloom factories.
38

159

Figure 6-1. Value Chain and Business Models of the Garment Industry

Source: the General Statistics Office of Vietnam as quoted in VDF (2021).
Note: percentages in the diagram show the share of each business model in Vietnam in 2019.

Figure 6-1 illustrates the physical flow of garment production as presented by the
Vietnamese statistical authority, which is also applicable to most other garment exporting
countries (there are slight variations in terminology across countries). The following concepts
are often used.
- CMT (cut-make-trim), CM (cut-make) or CMP (cut-make-pack)39- OEM/FOB (original equipment manufacturing/free onboard)- ODM (original design manufacturing)- OBM (original brand manufacturing)
Their meanings as used in the garment industry are often different from those in othersectors. CMT (or CM, CMP) is the production mode where all materials including fabric, thread,buttons, zippers, labels, etc. are provided by the foreign buyer, and the manufacturer
concentrates on producing final products to the buyer’s specs and receives processing fees only.
OEM/FOB (or just FOB)40 is the mode where materials are not given by the buyer but procured
at the manufacturer’s cost and risk, provided that they satisfy the buyer’s requirements, and the
manufacturer receives the total export product value including both labor and physical inputs.
ODM is the mode where the contracted manufacturer not only engages in production but also
CMT is common in Vietnam and Ethiopia, CM is used in Bangladesh while CMP is more popular in Myanmar.
In the electronics and IT industries, OEM means contract manufacturing of brand products of other firms. In
the automobile sector, however, OEM often means global carmakers with established brand names such as Toyota,
Volkswagen and General Motors. These are diametrically opposite meanings, and the meaning in the garment
industry is closer to the former. FOB generally means product value at the time of loading onto a ship at the portof export exclusive of ship charge or insurance, or contract terms based on it. Thus, in the garment industry, FOB
means the manufacturer receives the entire value of products at shipment because it procures (not the buyer
provides) materials that fit the order specification of the buyer.
39
40

160

proposes the design, materials and specs of products for the buyer’s approval. Finally, OBM
occurs when the manufacturer graduates from the supplier status by designing, producing andselling its own brand products instead of producing for others.
Domestic value creation rises as a garment manufacturer shifts from CMT, which is simplest,
to FOB, ODM, and OBM. Industrial officials in garment exporting countries usually wantdomestic producers to advance along this path and produce more value. But this also increases
the cost and risk of managing and coordinating more complex and diverse activities andtherefore calls for additional knowledge, judgment and networking on the part of domestic firms.
Figure 6-2 is the famous Smile Curve illustrating that greater value is created at the twoends of the global value chain than in the middle stream which developing countries tend to
take up initially. It must be stressed that there is nothing wrong for latecomer economies tostart industrialization from simple manufacturing. However, they should not be stuck in thisposition forever but should grow out of it as quickly as reasonably possible by improving
management and technology. In the 1990s, Malaysia drafted the Second Industrial Master Plan
(IMP2) 1996-2005 which featured the Manufacturing Plus Plus strategy. For each of the eight
key “clusters” (manufacturing subsectors and their support activities), this strategy expressed
the two-dimensional desire to (i) improve the productivity of existing middle-range processes
and thereby uplift the value chain curve; and (ii) expand the business scope to encompass more
upstream and downstream activities with higher value-added41 . In the figure, these are
Figure 6-2. The Smile Curve and Manufacturing ++Source: adapted from Malaysia’s Second Industrial Master Plan 1996-2005, with the author’s editing.
According to the terminology of Staritz et al. (2016), the vertical move includes “process upgrading” and“product upgrading” while the horizontal move includes “supply chain upgrading” (upstream) and “end market
upgrading” (downstream). The transition from CMT to FOB and beyond is called “functional upgrading.” They
also define “social upgrading” (labor skills and welfare) and “environmental upgrading.” Despite more detailed
naming, the ideas are similar to those of Malaysia’s Second Industrial Master Plan.
41

161

represented by the vertical and horizontal arrows, and hence the name Manufacturing Plus Plus.
It must be admitted that Malaysia’s effort to do this did not produce significant results.
Nevertheless, even today, ideas behind this strategy should be valid for all latecomer economies
including Vietnam, Bangladesh and Ethiopia which start industrialization from the “bottom” of
the Smile Curve.
How much progress did the garment industry make in the three countries we are examining?
Movement from CMT to FOB can be regarded as the first step in moving from the bottom
position to the left (upstream), and ODM and OBM are a further expansion in the horizontal
direction.
In Vietnam, as Figure 6-1 indicates, 65% of garment firms engaged in the CMT mode of
production in 2019 while the shares of FOB, ODM, and OBM were 25%, 9%, and 1%,
respectively, despite the awareness of the need to move away from CMT during the last three
decades. According to our survey, the main challenges facing Vietnamese apparel exporters aretechnical and social requirements demanded by buyers. Vietnam has the upstream textile sector(spinning, weaving and dyeing) but its output hardly satisfies the specs required by foreign
buyers and is therefore used only for garments sold to local consumers. Fabric production andgarment production are separated in Vietnam. There is a domestic supply of accessories but its
operation size is still small, covering only 30% of domestic demand according to VITAS.
In Bangladesh, apparel history is longer, domestic garment firms are dominant, and garment
industry associations are very active. Our survey shows that 70% of the sampled firms engage
in FOB while 30% conduct CMT42. FOB firms source fabrics mainly from Hong Kong/China,
and accessories and some knitwear fabrics from domestic markets. Large Bangladeshi firms
can even propose materials for buyers’ approval. Thus, Bangladesh is more advanced than
Vietnam in producing domestic value through material procurement at the manufacturers’ costand risk. It must also be noted, however, that frequently cited challenges in Bangladesh are highcost and access to finance for technology upgrading, the multiplicity of compliancerequirements by buyers, and downward price pressure due to severe competition. These arechallenges associated with existing processes rather than expanding the business scope along
the global value chain. Domestic firms are generally aware of their lack of access to financeand global markets in comparison with FDI firms.
In Ethiopia, a survey conducted by the Ethiopian Investment Commission (EIC) and theEthiopia Industrial Promotion Project (EIPP) of the Japan International Cooperation Agency(JICA) from December 2020 to March 2021 found the following (EIC and JICA 2021). Among
garment firms that were located inside industrial parks and actually exporting garments, which
totaled 31, 21 firms (68%) were conducting FOB and 10 firms (32%) were engaged in CMT.

42

All CMT firms in our Bangladesh survey are domestic firms except one FDI firm (Japanese).

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At Hawassa Industrial Park, which is Ethiopia’s flagship garment industrial park, the numbers
were 14 FOB firms (70%) versus 6 CMT firms (30%), which were similar to national results.
It must be noted that all surveyed firms are FDI because foreign firms dominate Ethiopia’s
garment exports. There are very few domestic garment firms that are capable of exporting. The
high FOB ratio of Ethiopia, equivalent to Bangladesh, surely reflects the strategy of FDI firms
rather than the capacity of Ethiopian firms 43 . MAA Garment, the only domestic firm that
regularly exports garments abroad, was not surveyed due to security reasons surrounding the
Tigray conflict44.
One technical problem is the interpretation of garment export data when CMT firms and
FOB firms are mixed in data collection and analysis. The former tend to report the processing
fee only (without material cost) which is a small part of garment value, while the latter’s
statistics correspond to the total value of the garment at shipment. Export data obtained by justadding the two without clarifying the definition of export value does not make much economic
sense.
6-7. Participation in the global value chain
Another indicator of domestic value creation is the degree of a nation’s participation in global
value chains. Instead of counting the number of CMT firms and FOB firms, this method
decomposes total export value into the value of imported inputs, domestically added value, andothers. Our information in this regard is quite limited and fragmentary, but what we tentatively
have can still tell an interesting story.
Nguyen Viet Khoi and Shashi Chaudhary (2019) define the “backward participation” as theamount of domestically produced intermediate products and services contained in a nation’s
total export, and “forward participation” as the amount of value-added earned abroad in anation’s total export. The sum of these two is defined as the “degree of participation in global
value chains.” Note that export value here is FOB (shipment value at the port of export), not
the retail price at final markets which is unknown to producers and may be considerably higher.
The value accruing after product shipment is captured by foreign buyers and distributors.
Figure 6-3 shows some data, incomplete yet suggestive, for Vietnam (Nguyen Viet Khoi
and Chaudhary 2019) and Bangladesh (information from the Bangladesh Bank). It reports value
addition through domestic production processes (backward participation) and profits generated
Staritz et al. (2016) showed that most garment exporters in Ethiopia were doing CMT. The CMT-FOB ratio
seems to have changed dramatically when additional garment FDI arrived at newly established industrial parks
after 2016.
44
The EIC-JICA survey covered all garment exporting firms which were operational at the time of interviews
except those located outside industrial parks (due to survey design), those in Tigray (due to security problems),
and those in Bole Lemi Industrial Park (which has eight garment exporting firms but the preliminary survey
conducted in this park did not ask the FOB-CMT question).
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by exporters (forward participation). Vietnam’s data is for overall export, not just for garment45.
Nguyen Viet Khoi and Chaudhary (2019) shows five-yearly results for Vietnam from 1995
to 2015 in table format (Table 6-2). Participation (i.e., domestic value creation as a share ofexport value) rose from 34.2% to 55.6%, but there are two cautions worth noting: (i) a large
jump was recorded between 1995 and 2000, after which progress was slo w; and (ii)
improvement was observed only in backward participation (upstream) while forward
participation (downstream) showed no progress during the two decades. This suggests that
Vietnam’s progress has been slow and that downstream encroachment is more difficult thanFigure 6-3. Export Value Structure of Vietnam and Bangladesh (Preliminary)Note: Vietnam’s data also covers sectors other than the garment. Bangladesh’s information (imported
materials occupy 36% of final garment value) does not give information on other components
individually. In Ethiopia, we suspect that domestic value is much smaller than Vietnam or Bangladesh.

Table 6-2. Vietnam: Participation in Global Value Chains

Source: Nguyen Viet Khoi and Chaudhary (2019).
For the garment industry only, we have the following information. In 2019, Vietnam imported up to 89% of
fabrics, of which 55% were from China, 16% from South Korea, 12% from Taiwan, and 6% from Japan (GSO
data).
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upstream advance. In Vietnam, backward participation is often associated with the developmentof “supporting industries,” or domestic supplier firms which produce materials and components
for firms that manufacture final products in Vietnam. Supporting industries include both
domestic and FDI suppliers.
The latest figure for Vietnam’s participation (the sum of backward and forward
participation) is 55.6%. Meanwhile, the RMG sector of Bangladesh reports that imported
materials occupy 36% of total export value. Ignoring miscellaneous costs and charges related
to taxes, domestic transport, and export and import procedures, we may presume that Vietnam
and Bangladesh share similar ratios of domestic value creation amounting to 50-60% of totalexport. Whether this is high or low depends on the perspective of each reviewer.
For Ethiopia, foreign garment firms generally do not procure materials from local sources
due to problems in cost, quality and prompt delivery (Staritz et al. 2016). Local subcontracting
is very limited for export items except among some diaspora firms. Local cotton and materials
derived from it are used exclusively for products destined to domestic markets. A trial
calculation by the aforementioned EIC-JICA survey shows that domestic labor cost ($62.6
million) is 38% of total garment exports from Ethiopia’s industrial parks ($165 million) in
2019/2020. This number is hard to interpret as export value is a mixture of CMT and FOB
receipts. If it is all CMT, 38% seems rather low. If it is all FOB, 38% is incredibly high.
It must be reminded that, in this and previous sections, we are looking at value addition by
moving slightly upstream along the Smile Curve. This is just one possibility of additional value
creation. It is a great challenge for garment firms originating from developing countries to movehorizontally—especially downstream—in the Smile Curve to establish their own brands andcompete squarely with such giants as H&M, Zara, Calvin Klein, Uniqlo, and Levi’s. In otherwords, attaining OBM is very difficult. This requires not just production efficiency but a strong
grip on the retail networks and consumer tastes in advanced markets, outstanding and costly
advertisement, excellent international coordination and logistics, and a constant battle to defend
and upgrade one’s brands. The fact that even global garment producers such as Arvind, DBL,
MAS, Shin Textile Solutions, etc. operate as subcontractors of famous brands and without
consumers’ recognition of their names points to the difficulty in establishing a new global brandin this industry. For countries engaged mostly in CMT production, the road to greater value
creation is steep and long. Bangladesh appears eager to take up this challenge, but Vietnam
seems more content with the quantitative expansion of CMT than achieving higher value per
piece exported.
6-8. Wage, labor productivity and labor quality
According to the 2020 survey of overseas operations of Japanese firms (JETRO 2020), the165average annual labor cost of manufacturing workers in Vietnam was $4,132 and that in
Bangladesh was $1,848, which includes salary, bonuses, overtime and social security. As for
Ethiopia, our joint survey shows that, in 2016, the average annual wage cost of garment workers
was 21,710 Birr or $994 (PSI and GRIPS 2020). Division by 12 yields monthly cost per worker,
which is $344 in Vietnam, $154 in Bangladesh, and $83 in Ethiopia46. Minimum wages are set
in Vietnam and Bangladesh, and Ethiopia is preparing to introduce them. In all these countries,
we detect workers’ dissatisfaction with low wage levels. Since low wage advantage is the key
attraction of these countries for garment FDI, CEOs and policymakers constantly face adilemma between wage demand and cost competitiveness. In Vietnam, where the labor market
is tightening thanks to the arrival of many FDI firms other than the garment, there is an acuteshortage of entry-level workers, especially at factories located in or close to urban areas.
Worker training, graded salary schedule, bonuses, non-wage benefits such as subsidized
insurance, food, transport, clinic, family picnic, etc., and incentives and promotion for good
performance are commonly observed though details may differ across countries. Management
style where instructions come from the top, except daily operational issues which are handled
by middle managers, also seems standard. Not many firms allow bottom-up initiatives andsuggestions by workers even in countries where kaizen is popular.
Turning to labor productivity (value creation per worker per year), the Asian Productivity
Organization (APO) database reports $12,700 for Vietnam and $10,400 for Bangladesh in 2018.
PSI-GRIPS (2020) indicates that the labor productivity of the Ethiopian garment sector was
27,760 Birr or $1,271 per worker in 2016, considerably lower than those in Vietnam or
Bangladesh.
Based on these data, and ignoring differences in the precise year of data collection, the unit
labor cost (labor cost per $1 of value creation) is calculated as follows: Vietnam $0.325,
Bangladesh $0.178, and Ethiopia $0.065.
If these calculations are correct, we may conclude that Vietnam has the most expensive
labor and Ethiopia the cheapest labor in terms of both nominal wage and unit labor cost, andBangladesh comes in between. However, Ethiopia’s low labor cost does not necessarilytranslate into global competitiveness. Competitiveness requires not just low labor costs but
many other conditions. Three issues must be mentioned here.
First, the fact that labor contributes less and materials contribute more to the final productvalue in Ethiopia simply reflects its industrialization stage where unskilled labor-intensive
production of relatively simple products is dominant. As skills and wages rise, cost shares will
shift toward more labor and less physical inputs, and more sophisticated apparel will be
manufactured.
The basic monthly salary was $250 in Vietnam and $115 in Bangladesh, occupying 73% and 75% of total laborcost, respectively.
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Second, the quality of labor is low in Ethiopia compared with Vietnam and Bangladesh.
Many Ethiopian workers are new to urban areas and have never seen a factory before. Their
educational achievement is also generally low. Such basics as punctuality, observing rules,
personal hygiene, how to use a canteen or toilets, etc. must be taught before technical skills arelearned. In Vietnam and Bangladesh, workers have graduated from this level and are asked tohave a positive attitude, long-term perspective, teamwork spirit, problem-solving capability,
aspiration to excellence, etc. which are higher requirements suitable for more advanced
manufacturing.
Third, non-labor impediments to manufacturing are formidable in Ethiopia. The EIC-JICA
survey of garment factories in Ethiopian industrial parks found many serious—and wellknown—problems of foreign currency shortage, the lack of material inputs, inefficient logistics,
bureaucratic customs clearance, difficulty in bank access, theft, power and internet interruptions,and water supply (EIC and JICA 2021). These are problems largely unheard of in Vietnam or
Bangladesh47. But in Ethiopia, they halt and delay production more frequently than the labor
problem.
The World Bank Doing Business ranking also confirms the problem of non-labor
impediments, but only partially. The 2020 ranking results were as follows: Vietnam (70th),
Ethiopia (159th), and Bangladesh (168th) among 190 economies. It is curious to see Bangladesh
below Ethiopia. This is because Doing Business scores evaluate the efficiency of various
procedures necessary to conduct a business, which constitutes only a small part of the overallbusiness climate and attraction for investors.
Another important issue is worth mentioning. In such countries as Vietnam, Indonesia andThailand, minimum wage—which also triggers overall wage—tended to be politically decided
above labor productivity growth by pressure from labor unions or a government shortly facing
an election. This reduced labor competitiveness in these countries and was bitterly criticized byboth domestic and FDI firms. For any country, the two-track strategy should be adopted
whereby labor productivity growth is accelerated as much as possible on the one hand and wage
increase is kept within the bounds of labor productivity growth on the other hand. In somecountries mentioned above, a balance between wage increase and labor productivity growth has
been restored. More recently in 2020, JETRO (2020) reports that the ratio of Japanese firmsthat regard the minimum wage level of a particular nation as appropriate relative to its
productivity level was 59.6% in Vietnam, 53.6% in Bangladesh, and 49.5% in Thailand while
it was only 20.6% in Indonesia. Ethiopia is on the verge of instituting a minimum wage. The
problem of wage-labor productivity nexus should be duly studied in advance.
Bangladesh also faces a shortage of foreign currency and administers capital control, but garment firms are
permitted to retain 10% of their export earnings which significantly eases the problem. As of August 2021, there
is information that this privilege is about to increase to 15%.
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6-9. Ethical correctness vs. product quality
Garment firms must fulfill certain conditions presented by buyers as a precondition forreceiving any order. These conditions reflect the demand of consumers in the final market whichis relayed to garment firms via buyers.
The EU and the US, which are the largest garment markets, impose strict rules on producers
regarding the protection of workers and the environment. They cover many issues including theban on child or forced labor, working hours and conditions, safety, health and living standardsof workers, gender equality, freedom of collective bargaining as well as environment-friendly
production methods, carbon neutrality, energy and material efficiency, proper treatment ofwastes and sewage, and so on, which collectively define globally accepted conduct for all
manufacturers. Western buyers also impose quality standards which are, however, less strict
than Japanese quality standards48. Japan, which is a smaller market than the West, requires
high—some say excessively high—standards on quality, cost reduction and on-time delivery(QCD). Japanese buyers mind both ethical correctness and QCD, but more attention and support
are given to the latter as Japanese consumers are extremely sensitive to the perfection ofphysical conditions of the product.
For garment producers in developing countries, the question is how to satisfy imposed
conditions under their budget and time constraints. Fulfillment requires management’s attention,
the introduction of new rules and methods, learning and training, and sometimes a large
investment in equipment and facilities. External help is usually available from buyers, industry
associations, government, bilateral donors or international organizations (section 6-10).
Bilateral donors of targeted market countries often provide assistance to expedite learning andtraining. Needless to say, if garment producers sell only to domestic consumers, they are notobliged to comply with global ethical and product standards. This tends to widen the gap
between garments for export and those sold domestically in terms of both production method
and product quality, which perpetuates two totally separate garment subsectors within a national
economy. FDI firms usually do not have problems with ethical and quality standards as they
practice them as a normal part of the business all over the world.
In Bangladesh, where most garment exports are destined to the Western markets, ethicalstandards for labor and the environment are of paramount importance. Virtually all exportoriented garment firms must—and do—fulfill such requirements, but to different degrees as
domestic producers are many and diverse. Strong producers have globally established methods
but smaller firms may struggle to keep up with foreign demands. One special feature in
Bangladesh is the sharp focus on fire and building safety, which became a critical issue afterUpon inspecting garments or footwear destined to Western markets, Japanese garment buyers usually commentthat many products which pass EU or US quality standards will be rejected as defects in Japan.
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the collapse of the Rana Plaza in 2013 that killed 1,100 garment workers and wounded over
2,600. This drew great international attention to Bangladeshi’s workplace safety and initiated
two actions to redress and improve compliance, namely the Accord with the assistance of EU
buyers and the Alliance with the assistance of US buyers. However, smaller producers often
find it difficult to fully comply as that calls for additional investment (Hossain et al. 2020;
Hossain 2021).
In Vietnam, a similar situation regarding compliance is observed, as all garment exporters
must conform to external standards. For domestic firms, compliance requires additional
investment to install required machines and equipment, upgrade the production process, andhire and train workers. On the other hand, the opening of new export markets enhances revenue
and broadens the business scope, which is highly rewarding. Concern over building safety is
not as prominent as in Bangladesh. Our survey in Vietnam finds that domestic firms targetinginternational markets are under pressure to comply with the International Organization forStandardization (ISO) 9000s and 14000s, the Social Accountability (SA)-8000, the Worldwide
Responsible Apparel Production Certification (WRAP), and other codes of conduct. The
perception of their importance for export is shared among all exporters regardless of size orownership, but actual acquisition and practice of these standards are higher in large domestic
firms and FDI firms. According to interviewed companies, buyers from Northern and Western
Europe are most strict about compliance, followed by the US and Japan. Japanese buyers
additionally require strict technical compliance49. Meanwhile, buyers from Korea, Russia and
Poland are more lenient on both corporate social responsibility (CSR) and product quality (VDF
2021).
In Ethiopia where FDI garment firms dominate, compliance and quality are handledindividually by internal rules of each FDI firm. All six of the surveyed FDI firms have aninternal quality and standard department, consider quality maintenance as a collective effort ofall staff, and participate in the International Labour Organization (ILO)’s Better Work. A
concerted national effort is still embryonic even though ETIDI, the Industrial Parks
Development Corporation (IPDC) and the Addis Ababa Chamber of Commerce and Sectoral
Association (AACCSA) occasionally assist firms to obtain necessary certificates. Ethical andquality standards have not become the goals pursued vigorously by government or domestic
businesses. Some development partners such as ILO, EU, Germany and Sweden support labor
code compliance and labor union formation, together with FDI garment firms from these areasand countries. However, a Swedish aid official in Addis Ababa admitted in 2017 that workers’
rights and labor unions were new concepts in Ethiopia. International cooperation must begin
It is customary for Japanese garment buyers in any country to hire a third-party quality inspector at each factory
to check the quality of all products before shipment (not random inspection). This includes a metal detector for a
broken needle or any other foreign object in all products. This requirement is “challenging” to some Vietnamese
producers.
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with such basics as the definitions and significance of these rights and activities. On theenvironment front, Ethiopia adopted a novel and unestablished Indian technology of zero liquid
discharge (ZLD) in all state-run industrial parks at an unknown but probably high operation andmaintenance cost. Yet, overall environmental laws and compliance remain primitive nationwide.
It will take some time before labor and environmental protection becomes an internally driven
and nationally owned endeavor.
Two additional pieces of information may be useful.
Sri Lanka exports high-end apparel to Western markets with high-quality standards andethical correctness. The industry is led by a handful of global contract manufacturers such as
MAS, Brandix, Star Garment and Hirdaramani. The government also actively supports workers’
rights. The Sri Lanka Institute of Textile and Apparel (SLITA) thinks its quality, labor andenvironmental standards are much higher than those in neighboring countries, and dispatches
experts to or receives trainees from Vietnam, Bangladesh, Philippines, and other garment
exporting countries.
Myanmar is a burgeoning garment exporter where Chinese (most numerous), Japanese andother firms operate. The Myanmar Garment Manufacturers Association (MGMA) counted
about 500 exporting companies as its members in 2019. Myanmar’s garment export is still
modest. Japan was the largest market but the EU grew rapidly in recent years with theconferment of the EBA status. In both cases, development partners from Japan and the EU
greatly helped Myanmar to export to their markets. Japan did so by establishing two training
centers to teach and produce local trainers in industrial engineering, sewing skill, quality
management and equipment maintenance. Germany assisted with trade exhibitions and buyer
matching support, and the EU with environmental and social compliance support. Some
Myanmar firms are shifting from Japanese to EU customers because Japanese quality standards
are extremely strict while EU’s compliance criteria are easier. Myanmar has no domestic fabricsupply, and garment firms are engaged in CMP production. Entry-level workers are abundant
but their mindset and discipline are problematic, with frequent job-hopping. While reliable
statistics are missing, it is suspected that labor productivity is much lower than in China or
Vietnam. Furthermore, Myanmar’s political situation may hamper the development of its young
garment industry.
6-10. Policy support
The government of Bangladesh has since the 1970s generously and continuously supported andprotected the RMG sector to help it become the leading export sector of the nation. In thisregard, the industrial promotion policy has been successful. The current policy menu includes

170cash incentive equivalent to 5% of the use of domestic yarn for garment export50, a measurehighly appreciated by 65% of the firms in our Bangladesh survey. Some even want it to be
increased to 10%. Other measures in support of RMG exporters are the Export Development
Fund51, the retention quota of 10% (or 15%--see footnote 47) of export receipt which alleviates
foreign currency shortage particularly for garment exporters, exchange rate management whichkeeps the Taka undervalued, bonded warehouse facilities, and discouragement of FDI. The
government’s support was also critical for the RMG sector to overcome the difficulties
following the termination of the MFA quotas in 2005, the Rana Plaza collapse in 2013, and thesuspension of the generalized system of preferences (GSP) facility after this accident. However,Bangladeshi policy support is confined to non-technical areas rather than technical support(such as technology, kaizen, safety, quality, logistics, etc.) which many other governments offer.
It must also be noted that the strong lobbying of BGMEA and BKMEA is behind theseincentives and protection. At the same time, we should ask whether the current incentives andprotection of the RMG sector are excessive privileges that discourage further development oftechnology and business scope and also prevent the diversification of economic structure, andwhether they are not regarded as unfair by other countries52. Infant industry promotion cannot
continue forever even though some garment firms demand more, not less, policy support. These
will become critical issues when Bangladesh graduates from the LDC status, which is expected
to occur in 2026.
In Vietnam, the garment is a significant, though not overwhelmingly important, export item
accounting for 12% of total export in 2019. Moreover, the garment association (VITAS) is not
as politically powerful as Bangladesh’s. The development of Vietnam’s garment industry
appears to owe more to market forces than active government policies. Vietnamese market
advantages include young workers famous for their dexterity and diligence, and foreign buyers
and manufacturers attracted to this advantage. General policy actions such as economic
liberalization, global integration, and membership in many trade arrangements certainly
contributed to the sector’s growth. At the micro-level, however, the Vietnamese government
has introduced few effective measures to help domestic firms to climb up or expand along the
Smile Curve. From the beginning (the 1990s), the government seemed more interested in “highThis cash incentive supports domestic spinning mills whose prices are higher than imported yarn. An RMG
producer purchasing local yarn receives certificates against the use of local yarn (normally 50-60% of export value)
but the government routinely reduces the claimed amount. Moreover, a 10% tax is levied on the certificate valueof the assistance. We thank Mr. Akhter Hossain of BKMEA for clarifying this policy.
51
The Export Development Fund is a short-term loan facility provided by the Bangladesh Bank (central bank) via
commercial banks to exporters for preparing and facilitating shipments as well as for product development andaccess to international markets. In 2021, the Fund’s lending size was expanded to Tk 5.5 billion, the repayment
period was extended from 3 to 6 months, and the interest rate was reduced from 2.0% to 1.75% in October 2020
(it is currently 6-month LIBOR plus 2%) partly to ameliorate the impact of the COVID pandemic.
52
Cash incentive and the Export Development Fund may constitute export subsidies which are prohibited by
WTO. But we are unaware of any international complaint or action against these measures of Bangladesh.
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tech” areas and less concerned about the garment which Ministry of Industry officials often
regarded as “simple, low value, and passé for Vietnam.” Vinatex, a group of “equitized” former
state-owned large garment firms, supports its members by allocating foreign orders. But othergarment firms do not benefit much from government policies. There is no effective national
strategy to increase the domestic value creation of the garment. The existing supporting industry
policy includes strengthening of domestic supply of garment materials and accessories but it isproducing little impact. This policy detachment may partly explain the perpetuation of CMT in
Vietnam (65%) in comparison with Bangladesh (30%).
In Ethiopia, the government has paid great attention to the garment sector in the last two
decades in a drive to promote manufacturing, together with other priority sectors such as leather
and food processing. The Monthly Export Steering Committee carefully monitored progress, atechnical support center (ETIDI) was created to expedite technology absorption and training,and FDI and official development assistance (ODA) were vigorously mobilized to this sector.
Moreover, several state-run industrial parks specializing in garment production were
established where foreign buyers and development partners assisted operation. Despite theseactions, the problem of Ethiopia’s policy effort is that garment export remains disappointingly
small. Reasons may include (i) support measures that do not match the industry’s requirements;(ii) bureaucracy and policy ambiguity; (iii) the lack of enabling environments such as reliable
labor, stable power supply and efficient logistics; and (iv) too optimistic expectation thatassumed a great jump in export and foreign exchange earning once FDI started to arrive. So far,
Ethiopian export is dominated by primary commodities such as coffee, flowers, gold, live
animals, oilseeds and khat. Garment export remains small and stagnant, at about $300 million
or 4% of total export. There is an internal debate on whether promotional measures forprioritized sectors, including garments, were cost-effective. Moreover, the government’s
demand or expectation that FDI firms should build big, employ many, export 100%, integrate
vertically and transfer technology as a condition for license approval, incentives or foreignexchange allocation may go against the preferred global business model of individual foreign
firms and may backfire. Policy reform seems inevitable if Ethiopia is to accelerateindustrialization.
6-11. Impact of the COVID pandemic
The COVID pandemic began to seriously deter domestic and global human mobility in the early
spring of 2020. Our three-country surveys, conducted in the last few months of 2020, containedquestions on the impact of this pandemic on garment manufacturing.
Our surveyed firms in Vietnam reported no or little impact. None of them cut down on labor
force, export volume or product items even though some work shift adjustments were needed172to comply with social distancing. On the supply side, the import of materials (mostly from Hong
Kong/China) was interrupted in March 2020 but resumed in the following month, with noserious damage in input availability. Many producers had sufficient material inventory stocks
to cope with such short-term problems. On the demand side, the survey conducted by Deloitte(2021) shows that, amid the pandemic, clothing was still a priority item of consumers after
pharmaceuticals, food and savings. Consumption shifted from luxury to basic products, andglobal demand for casual clothing such as jackets, T-shirts, trousers, shorts and coats which
Vietnam produces remained strong, unlike high-value suits and blazers whose demand declined.
Producers who had long-term contracts with buyers were scarcely affected in order volume. No
order cancellation was reported by our sample firms and many even had a backlog of unfilled
orders several months ahead. Some manufacturers additionally produced face masks andpersonal protective equipment (PPE) whose demand skyrocketed. The Vietnamese government
introduced many rescue measures for COVID-affected firms53, but few garment firms usedthem because they were not seriously affected, because the reduction of taxes and land rents
was of no use as they were already paid on an annual basis in advance, and/or because theapplication procedure was too cumbersome and time-consuming.
In Bangladesh, as of December 2020, about one-third of the responding firms suffered a
substantial decline in export (ranging from 40% to 80%) and 57% of the firms reported that
their exports declined slightly (ranging from 5% to 30%) in the face of the pandemic. These arein sharp contrast to Vietnam’s case where the pandemic damage was slight to none. It is notclear what is behind such a dramatic difference between the two leading garment exporting
countries. About 50% of the surveyed firms ventured into the production of face masks and
PPE. The share of such COVID-related products in total sales was 1-10% for about 40% of thefirms, 10-20% for 13% of the firms, and there was one firm whose COVID-related items
occupied as high as 50% of its total production. This also suggests that Bangladeshi garment
producers were more seriously affected by the pandemic than their Vietnamese counterparts.
In Ethiopia, the state of emergency due to the COVID pandemic was declared for fivemonths from April to August 2020. During that time, discharge of labor force was prohibited,
and all 32 firms in our survey observed this instruction (besides 10 garment firms, the survey
also covered 22 firms in the food processing, automotive, and leather sectors). In return, thegovernment promised to support all businesses, including FDI, by postponing tax and pension
payments for three months. Our survey indicates that some local firms enjoyed this privilege
but none of the interviewed FDI firms, regardless of sector, benefited from it. In terms of
Measures introduced by the Vietnamese government include (i) financial support for unemployed workers withor without a labor contract; (ii) subsidies and loans for businesses for paying salary, debt, etc.; (iii) temporary
reduction or postponement of business costs such as land rents, fees, airline-related fees, etc.; and (iv) suspension
or postponement of social security contributions, value-added tax, corporate income tax, etc.; and (v) an order tocommercial banks to conduct debt restructuring and interest exemption/reduction on enterprise loans (VDF 2021).
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demand, four FDI garment firms were not affected by the pandemic or the state of emergency
as they produced according to long-term contracts. By contrast, two FDI garment firms
experienced export reduction and production cuts. After the state of emergency was lifted, two
FDI firms retrenched some of their employees. One of them even faced a financial crisis andfroze operations with a stock of 20,000 unsold shirts. Many firms reported that, rather than the
pandemic, the chronic shortage of foreign currency and worsening political instability were themajor causes of their business disruption. The pandemic also impacted exporting firms withschedule mismatches and delays at the Port of Djibouti, through which most goods are imported
to and exported from Ethiopia. The survey of industrial parks (EIC and JICA 2021) shows thatthe export from Hawassa Industrial Park, which specializes in garments and accounts for halfof the total export from all industrial parks, was about $8 million per month in August-October
2019 but fell to less than $3 million per month in April 2020, then recovered partially to $5-6
million by early 2021.
6-12. Concluding remarks
Comparing the three garment exporting countries, the most striking fact is that they are diverse
in size, history, players, production mode, policy support, business associations, the way tosecure markets, and even the COVID impact. Domestic situations are different from one
country to another, and there seems no uniform path which all can follow to become a leading
garment exporting nation. Each country has achievements and weaknesses, and there are many
lessons they can learn from each other.
One evident fact is that Vietnam and Bangladesh are way ahead of Ethiopia which only
recently joined the club of garment exporters. Ethiopia’s initial difficulties and policy
inexperience are understandable given its early stage. Our study could not determine whether
Ethiopia’s problems are common to all newcomers or unique to Ethiopia. If the latter is the case,solutions require policy innovation in addition to learning from others who went ahead.
While both Vietnam and Bangladesh are leading exporters of the garment, they are quite
different in certain characteristics. Domestic private producers dominate in Bangladesh while
Vietnam is home to more diverse producers including private, formerly state-owned and foreign.
Vietnam is very skillful at joining bilateral and regional trade agreements that greatly matter toits export, a feature that Bangladesh lacks. The RMG sector of Bangladesh is effectively
supported by its government and two garment associations, but the evolution of Vietnam’s
garment export is left more to market forces. During the COVID pandemic, Vietnam’s garment
exporters were much less affected in comparison with their competitors in Bangladesh or
Ethiopia.
However, there are common factors as well. The most prominent is the challenge of174

increasing domestic value creation by, starting from the bottom of the Smile Curve, raisingproductivity or encompassing more processes along the global value chain, or both. The
movement from CMT to FOB, or material procurement at its own cost and risk, contributes tothis effort, and Bangladesh has progressed more than Vietnam in this direction with thecontinued support of government and industry associations. But this is only a modest move
relative to the total value created by the global apparel industry. A further evolution to ODM
and OBM where manufacturers produce and sell their own designs and brands is extremely
difficult, and whether that is an appropriate goal for latecomer garment exporting countries isalso arguable.
This research study did not address the impact of automation, AI, IoT, robotics and othertechnological advances on the garment industry, an important issue that must be dealt with byanother study.

175

Annex: Profile of Surveyed Garment Firms
VietnamNo.

Ownership

V1

Domestic

Cotton bag, eco bag

Main products
Japan, USA

Main markets

Employees
85

V2

Domestic

Sweater

Eastern Europe, Korea

65

V3

Domestic

Knitted shirts, jackets, blankets, bed cover, face masks

USA, EU, Korea

6,200

V4

Domestic

Personal protective cloths

Europe(Spain, Poland, France)

1,000

V5

Domestic

Jackets, T-shirts, trousers and shorts, dress

France, Cuba, USA, Korea

47

V6

Domestic

T-shirts, shirts

USA, Korea

100

V7

Domestic

T-shirts, face masks

Japan, Eastern Europe

100

V8

Domestic

Children's wear

Vietnam

100

V9Domestic

Jackets, T-shirts, coats

China, Taiwan, USA

135

V10

Domestic

Sport wear, coats

USA, EU, Korea

2,500

V11

Domestic

Knitted shirts

Poland, German, France, Czech

151

V12

Domestic

Denim cloths

Korea, USA

60

V13

Domestic

Knitted cloths, swimwear

EU, USA500

V14

Domestic

Man's wear

Vietnam

1,000

V15

Domestic

T-shirts

EU, USA, Korea

200

V16

Domestic

Shirts

Korea, Rusia

150

V17

Domestic

Knitted cloths

USA, Czech, Hungary, Poland, Italy

200

V18

Domestic

Knitted cloths

Korea, EU, Latin America

120

V19

Domestic

Knitted cloths

USA

200

V20

Domestic

Shirts, traditional dress

Denmark, Malaysia, Korea

150

V21

Domestic

Shirts, trousers

USA, German, Korea

9,000

V22

Equitized former SOE Shirts

Vietnam (Canifa, Aristino), Korea

300

V23

Equitized former SOE Shirts, trousers, dress

USA, German

200

V24

Equitized former SOE Children's wear, shirts

USA

158

V25

Equitized former SOE Knitted cloths, underwear

USA, EU, Korea, Taiwan

139

V26

Equitized former SOE Cotton towels (napkins, face towels, bath towels)

USA, Korea

317

V27

FDI

Sewing thread, Embroidery shirts

USA, Korea

47

V28

FDI

Knitted cloths

Korea, USA

118

V29

FDI

Carpets, blankets

USA, Korea

203

V30

FDI

Embroidery shirts

Korea, USA

110

V31

FDI

Knitted cloths

China, Korea

220

Note: “Equitized former SOE” means a former state-owned enterprise that was transformed into a joint stockcompany with a substantial state shareholding.

176

Bangladesh
No.

Ownership

B1

100% domestic

Toursers715

B2

100% domestic

Pants (male & female)

1,100

B3

100% domestic

All kind of pants, jackets

1,524

B4

100% domestic

Pants (male & female)

750

B5

100% domestic

Pants, jackets

187

B6

100% domestic

Pants, jackets

830

B7

100% domestic

Knit garments

1,300

B8

100% domestic

All kind of knit items

815

B9

100% domestic

Knit fabrics

1,200

B10

100% domestic

Bottoms

350

B11100% domestic

Men's shirts, ladies' tops

190

B12

100% domestic

Knit items

600

B13

100% domestic

Knit tops and bottoms

6,250

B14

100% domestic

Under garments

2,000

B15

100% domestic

Sweaters

300

B16100% domestic

Knit items

416

B17

100% domestic

Ladies', gentlemen's, kids'

4,838

B18

100% domestic

T shirts

830

B19

100% domestic

T shirts, polo shirts

1,020

B20

100% domestic

Sweaters

600

B21100% domestic

Shirts, ladies' items

219

B22

100% domestic

Lingerie

1,000

B23

100% domestic

Woven tops

257

B24

100% domestic

T shirts, polo shirts

1,808

100% domestic

T shirts, polo shirts

2,400

B25
B26

Main products

Main markets

Employees

Domestic 50% / foreign 50% Pants, jackets, sports

550

B27

100% foreign

Tops and bottoms

3,460

B28

100% foreign

T shirts, polo shirts

1,067

B29

100% foreign

Sweaters

300

B30

100% foreign

T shirts

2,400

Note: the Bangladesh survey did not ask main markets of each company.

Ethiopia
No.

Ownership

E1

FDI(100%)

Babywear

Main products

EU, USA

Main markets

Employees
1,860

E2

FDI(100%)

Trousers, shirts, men underwear

India, EU, USA

1,900

E3

FDI(100%)

Children's wear

USA

1,500

E4

FDI(100%)

Jackets, T-shirts, shorts, pants, uniforms

EU, USA

699

E5

FDI(100%)

Safety clothes

USA

300

E6

FDI(100%)

Fleece jackets

Germany

500

E7

Domestic(100%)

ShirtsDomestic

289

E8

Domestic(100%)

T-shirt, pillow, sports cloth, Trousers, hoodies

Central Africa, EU

600

E9

Domestic(100%)

T-shirts, blankets

Domestic

547

E10

Domestic(100%)Polyester, mattresses, bed sheets

Domestic320

Note: besides these 10 garment firms, 20 firms belonging to the food processing, automotive and leather
sectors were surveyed in Ethiopia.

177Chapter 7
Pursuit of Product Quality and Ethical Correctness in
Developing the Garment Industry
7-1. Introduction
The garment industry is a typical “starter” industry for low-income countries that promote
export-oriented industrialization (Gereffi 1999; OECD/WTO/IDE-JETRO 2013). For
latecomer countries, apparel production serves as the first entry point into global value chains(GVCs) with its low fixed costs and labor-intensive manufacturing (Fernandez-Stark et al.
2011). Moreover, as China relocates its labor-intensive industries to other countries due to risingdomestic wages, many developing countries actively court garment factories leaving China tobuild their own garment industry and be a part of the apparel GVC. The recent US-China trade
war has accelerated this trend of relocation and diversification of Chinese foreign direct
investment (FDI). Sri Lanka, Bangladesh and Vietnam have been successful in attracting FDI
and building their manufacturing capabilities for apparel production and export. More recently,
Myanmar is emerging as a new location of apparel production in Asia, and Ethiopia is beginningto follow a similar path in Africa.
Because it is labor-intensive, the garment industry contributes greatly to job creation in lowincome countries, especially for young female workers. On the other hand, if it is not properly
managed, the industry may generate labor mistreatment and exploitation. Partly for this reason,and pushed by the growing interest in the sustainable development agenda, harsh working
conditions at garment factories in several countries have been severely criticized by activists
and consumers in developed countries. There is a rising awareness of the need to strengthensocial and environmental compliance in the sector, in addition to conventional requirements for
quality, cost reduction and on-time delivery (QCD).
Today, latecomer countries must satisfy the twin global standards—economic and industrial
upgrading as well as social and environmental upgrading—to successfully participate in theapparel GVC. This requires different and complex sets of capabilities at both managerial andworkers’ levels. Investors, buyers and aid agencies in Asia led by Japan and South Korea havegiven high priority to QCD requirements to satisfy strict product standards demanded in theirhome markets. In the West, by contrast, European and American consumers who havetraditionally been conscious about the sweatshop issue emphasize ethical correctness andadequate labor conditions. More recently, with increasing attention to the Sustainable

179

Development Goals (SDGs) and the ongoing global economic restructuring in response to the
COVID-19 pandemic, there is a strong drive among international investors and buyers to give
greater attention to labor conditions, human rights, and environmental standards. Bothrequirements are crucial in securing market access and raising productivity. At the same time,complex and proliferating standards set by lead firms, international organizations and nongovernmental organizations (NGOs) are placing a considerable burden on apparel firms indeveloping countries that face resource and technical constraints.
Against this background, the current chapter studies how today’s latecomers and theirgarment firms are coping with the global twin standards and identifies remaining challenges.
Our analyses are based on the recent firm surveys conducted in Bangladesh, Vietnam andEthiopia as well as the National Graduate Institute for Policy Studies (GRIPS) Development
Forum (GDF) missions to Sri Lanka and Myanmar. They are supplemented by literature review
and additional research.
The rest of the chapter is structured as follows. Section 7-2 introduces the concept of
economic and social upgrading. Section 7-3 explains concrete standards and regulations thatgovern these twin requirements. Section 7-4 discusses the role of international development
cooperation by various donors. The study then turns to concrete and diverse country cases.
Section 7-5 compares the profiles of the five countries and gives two issue points. Sections 7-6
to 7-10 explain the experiences of Bangladesh, Vietnam, Ethiopia, Sri Lanka and Myanmar.
Section 7-11 concludes with three implications for today’s latecomer garment producers andthe possible impact of the COVID pandemic on our problem.
7-2. Economic and social upgrading in the garment GVC
The apparel value chain is highly globalized and governed by a buyer-driven structure where
foreign buyers and lead firms—large retailers, brand owners and brand manufacturers—have astrong power over producers on “how, when, and where manufacturing will take place, and how
much profit accrues at each stage” (Fernandez-Stark et al. 2011). Labor cost advantages,
favorable trade agreements and proximity to end markets are key factors to attract lead firms
for their investment destination. The first task for low-income countries is to invite foreign
buyers and lead firms for simple apparel production. Then, after entering into the apparel GVC,
host countries must continue to sustain partnerships with buyers and lead firms which is an evenmore challenging task. It requires continuous economic and social upgrading of the production
firm and workforce capabilities.
As will be explained below, economic upgrading is essential in remaining in and moving
up the chain ladder to higher value-added stages, while social upgrading is a precondition formarket entry in the first place. Many developing countries benefit from the Generalized System180

of Preferences (GSP) to export including the African Growth Opportunity Act (AGOA) by theUnited States (US) and the Everything But Arms (EBA) privilege by the European Union (EU).
However, if they cannot meet social compliance requirements, especially those concerning
labor conditions, the benefits of preferential market access may be temporarily suspended evenafter initial entry.
7-2-1. Economic upgrading
Economic upgrading is defined as a move from low-value to higher-value activities in
global production networks. There are four types of upgrading (Gereffi et al. 2001, 2005;
Humphrey and Schmitz 2002; Kaplinsky and Morris 2001):
 Product upgrading—moving into more sophisticated or complex products lines withincreased unit values; Process upgrading—transforming inputs into outputs more efficiently by reorganizing the
production system or introducing superior technology;
 Functional upgrading—acquiring new, superior functions in the chain (or abandoning
existing low value-added function) to increase higher-value tasks; and Chain upgrading—using the competence acquired in a particular chain to move into new
sectors.
Some authors may propose additional types of economic upgrading (Gereffi and Frederick
2010; Fernandez-Stark et al. 2011).
 Channel upgrading—diversifying buyers and geographical areas of product markets; and Supply chain upgrading—establishing backward and forward linkages within the supply
chain.
Related to functional upgrading and supply chain upgrading, Figure 7-1 illustrates the curveof value-added stages in the apparel GVC which include R&D, design, purchasing and sourcing
inputs and related inbound logistics, production and assembly, outbound distribution, marketingand branding (advertising and pricing), and sales and services. This figure also shows different
business models in the garment industry, according to the stages of functional capabilities:
 Cut, make and trim (CMT)54: production and assembly of imported inputs;
 Original Equipment Manufacturing/Free on Board (OEM/FOB): local production,
sourcing of materials and other inputs, and packaging for delivery to the retail outlet;
 Original design manufacturing (ODM): design of products sold under the brand names ofother firms; and54

This is also called CM (cut-make) or CMP (cut-make-pack). See chapter 6.

181

Figure 7-1. The Curve of Value-Added Stages in the Apparel GVC

Source: elaborated by the authors based on Fernandez-Stark et al. (2011).

 Original brand manufacturing (OBM): upgrading to the sale of own-brand products inaddition to product design and manufacturing.
Higher-value activities in the apparel value chain are normally associated with R&D, design,and marketing and branding of the products rather than manufacturing itself. These are often
performed by lead firms, i.e., large global retailers and brand owners in the apparel industry. In
most cases, lead firms outsource the manufacturing process to a global network of suppliers,and developing countries are in constant competition for attracting FDI and obtaining theircontracts (Gereffi and Frederik 2010). It is important to note that CMT is only the entry pointof GVC with the lowest value addition where manufacturers carry out cutting, sewing andfinishing of products only. Suppliers in developing countries are forced to make great effort forfunctional upgrading or there is a risk of “the race to the bottom” and receiving only the lowest
returns under intensive competitive pressures in GVC.
7-2-2. Social upgrading
Social upgrading is defined as improvement in the rights and entitlements of workers associal actors and enhancement of the quality of their employment (Gereffi and Lee 2016). It is
composed of two broad elements (Barrientos et al. 2011; Barrientos and Smith 2007). The firstelement is measurable standards for social protection such as wages, working hours, health andsafety conditions at the workplace, and employment security which are usually stipulated in thelabor contract. The second is enabling rights such as freedom of association and collective
bargaining, the right to freely choose employment, non-discrimination, and voice. Besides these,182

but similar to the second element, there are other measurements of social upgrading that include
formalization of employment, youth unemployment, education levels, overtime policies, and“decent work” standards, among others. The notion of “decent work” has been developed overthe last ten years by the International Labour Organization (ILO). It comprises four aspects ofwork, namely, employment, social protection, workers’ rights and social dialogue (Ghai 2003).
Gender, environmental rights and the use of natural resources or land ownership are still otheryet nowadays common dimensions of social upgrading.
The garment industry is divided into high-end and low-end production and brands (in terms
of product value). High-end production is performed by factories that use better technology andmore skilled workers. On the other hand, low-end production is governed primarily by pricefocus. It is in such production that social upgrading is not easy to achieve because it faces
mounting pressure for cost reduction and regards labor as a cost factor. There are even cases
where “social downgrading” has taken place in the face of intensification of competition(OECD/WTO/IDE-JETRO 2013).
The relationship between economic and social upgrading is not straightforward. An
independent assessment of the ILO and International Finance Corporation (IFC)-supported“Better Work Programme” (see section 7-4) reports positive effects of improved compliancewith labor standards on factory profitability, productivity and gender equality, and thus the two
efforts are complementary (ILO and IFC 2016). However, existing literature suggests that
economic upgrading does not automatically translate into social upgrading (OECD/WTO/IDEJETRO 2013; Barrientos, Gereffi and Rossi 2011). This is so particularly when economic
upgrading is pursued through cutting labor costs and forcing poor working conditions. There
are also cases where temporary and casual workers are excluded from social upgrading. Genderbias has often been found, with female workers tending to be engaged in insecure and low-paid
work, often in temporary and seasonal employment arrangements (Gereffi and Lee 2016). To
address this concern, business organizations, donor agencies and Non-profit Organizations(NPOs) are increasingly engaged in a new development partnership to promote social
upgrading (Ohno and Uesu 2020) (see section 7-4).
7-3. Standards and regulations for quality and sustainable GVC
Regulations and standards play a vital role in ensuring quality, reduced costs and on-time
delivery, as well as meeting social and environmental compliance of products and production
processes along the value chain. Recent decades have seen a growing number of standards andcompliance requirements in pursuit of the Triple Bottom Line covering: (i) the economic bottom
line to increase the efficiency of supply chains (QCD), (ii) the social bottom line such as
working conditions; and (iii) the environmental bottom line such as sustainability, organic

183

standards, and so forth (Kaplinsky and Morris 2017). Traditionally, governments assumed
responsibility for setting a regulatory framework for business activities. However, as global
trade and production networks have expanded into developing countries where governments
have weak regulatory and enforcement capabilities, multinational corporations face
increasingly strong demand by consumers and civil society for sustainable and inclusive
production and consumption.
Three points are worthy to note. First, there is a multitude of standards produced by different
parties, such as firm-level codes of conduct, standards created by industry consortia or civilsociety actors, or those governed jointly by business, civil society, and internationalorganizations and donor agencies. Second, the economic bottom line standards are primarily
driven by lead firms while social and environmental standards often come from externalpressures to the chain (Kaplinsky and Morris 2017). Third, there is a risk that small or marginal
producers in developing countries who are unable to comply with standards may be excluded
from participation in GVCs. Therefore, it is important to strengthen the capability of local
suppliers and small firms and promote the skill development of their workforce.
Below we describe major international guidelines, standards, and codes of conduct thatgovern the economic and social upgrading of GVCs of the apparel industries. Compliancemonitoring is conducted in various methods including internal auditing by buyers, lead firms
and suppliers themselves; external auditing; and auditing by non-affiliated parties.
For economic upgrading, common standards in the apparel industry involve quantity
produced, visual appearance, product specification, labeling and marking, packing andpackaging, and various tests including needle detection, smell, colorfastness, seam strength,
and restrictive use of chemical substances, among others. There are different approaches toachieving them. Acquiring the International Organization for Standardization (ISO) certificate
is a widely recognized one. ISO 9001 series (ISO 9001: 2015) focus on the documentation ofprocedures to ensure the Quality Management System. It installs internationally uniform qualityand document management systems in companies. The general practice is that garment
producers in developing countries must be certified with ISO 9001 and additionally comply
with standards specified by buyers and importing markets.
A package of productivity methods comprising kaizen, Total Quality Management (TQM),
Lean Management, Six Sigma, etc. is another approach to quality improvement. It provides
guiding principles and management tools that can be used to initiate and monitor the progressof improvement efforts within a firm and at its suppliers in the value chain. Among them, kaizen
is the Japanese way of continuous improvement of quality and productivity featuring aparticipatory process involving the entire workforce from the top management to middle

184managers and line workers55. It is frequently implemented in the production process (factory
floors) but can also be applied to offices, services, schools and government bodies. Kaizen
improves quality through an endless quest for zero defects and waste elimination. It also assists
other dimensions of economic upgrading such as cost reduction and delivery time by reducing
overproduction, excess motion, unnecessary processing and waiting, excess inventory, and soon.
Japanese consumers are said to be most demanding on quality, paying meticulous attention
to details. Reflecting such a market feature, Japanese apparel buyers and lead firms request their
suppliers to strictly conduct the third-party inspection, both in-line inspection and pre-shipment
inspection based on the Acceptance Quality Limit (AQL). While the latter is widely practiced
by international buyers, the in-line inspection is less so (JICA and T’s Network 2018), whichshows the extent to which Japanese buyers and firms are obsessed with quality.
Turning to social upgrading, the history of social responsibility and the formulation of thecode of conduct by private firms date back to the 1970s, when several internationalorganizations recognized the need to provide guidelines for the business conduct ofmultinational corporations operating in developing countries. During the 1980s, European
NGOs started to alert on the poor labor condition of sweatshops in the garment sector andinitiated templates for the code of conduct and systems for monitoring compliance. One of theearliest initiatives was the Clean Clothes Campaign (CCC) formed in 1989 by a European
network of labor unions and NGOs. The Ethical Trading Initiative (ETI), a United Kingdom(UK)’s multi-stakeholder organization created in 1998, established a code of conduct based on
the ILO convention. During the 1990s, the European civil society agreed on charters and codesof conduct for several sectors. For example, the European Trade Union Federation of Textiles,
Clothing and Leather (ETUF/TCL)56 adopted charters for the footwear industry in 1995, thetextile and clothing industry in 1997, and the tanning industry in 2000 (Plasa 2015).
In the US, the Apparel Industry Partnership (AIP), a coalition of apparel and footwear
companies, consumer groups, NGOs and universities to improve labor conditions was formed
in 1996, and a code of conduct and monitoring principles were adopted in 1997. It became thebase for another code of conduct by the Fair Labor Association (FLA) and the Worker Rights
Consortium (WRC) with a tighter monitoring mechanism. In 1997, the American Apparel
Manufacturers Association (now the American Apparel and Footwear Association) founded theWorldwide Responsible Apparel Production (now called the Worldwide Responsible
Kaizen means continuous improvement involving the entire workforce from the top management to middle
managers and line workers. Moreover, kaizen is an umbrella concept for a large number of Japanese businesspractices such as 5S, suggestion system, Quality Control Circle (QCC), Total Quality Management (TQM), theToyota Production System, the Just-in-Time System, the Kanban System, etc. (Imai 1986, xxxii).
56
Through the merger with other industry trade unions, ETUF/TCL was integrated into IndustriALL European
Trade Union in 2012.
55

185

Accredited Production or WRAP) to serve as an independent facility for certifying social
compliance. In the same year, the Social Accountability International (SAI) was established toadvance human rights at work. It developed the SA 8000 standard based on the ILO convention.
This was the first auditable standard in the field of corporate social responsibility (CSR) (Plasa
2015).
However, as individual codes and various certification and monitoring mechanisms
proliferated, buyers and suppliers have started to face “monitoring fatigue” or “code overload”57.
To solve this problem, the CCC, the FLA, the WRC, the AIP, and the ETI developed common
definitions and concepts to standardize their codes. This convergence was pursued alongside
the differences that remained across organizations. For instance, the WRC includes higher
requirements while the SA 8000 standard and the ETI Basic Code include explicit references
to human rights. The SAI created the Social Accountability Accreditation Services (SAAS),
which accredits and trains third-party organizations that conduct audits for social compliance.
The FLA and the WRAP also established the global auditing standards and started to train theirown auditors58. In 2010, ISO 26000 was established to provide guidance and direction for allcompanies to follow in terms of social responsibility that includes human rights, labor practices,
environmental responsibility, fair operating practice, consumer issues, and community
involvement and development. The Global Social Compliance Programme (GSCP) of 2006 is
another initiative to create a common platform of standards and codes that member companies
agree to implement throughout their supply chain (Mayer and Pickles 2014).
In parallel, international organizations also began their initiatives. In 1998, ILO adopted the
Declaration on Fundamental Principles and Rights at Work (ILO convention) in four areas,
namely, freedom of association, elimination of forced labor, abolition of child labor, andelimination of discrimination of employment and occupation. Together with the United Nations(UN)’s The Global Compact launched in 2000 and the Organisation for Economic Co-operation
Development (OECD)’s updated Guidelines for Multinational Enterprises59, they set the norm
for social compliances with stress on labor issues. Moreover, recent years have seen an
increased emphasis on corporate responsibility to respect human rights. The UN Human Rights
Council adopted The Guiding Principles on Business and Human Rights in 2011, which
reaffirms the obligation of the state to protect human rights as well as business enterprises’
responsibility to respect human rights in their corporate activities and value chain. The OECD

Mayor and Pickles (2014) reports that some factories are subject to as many as 30-40 annual inspections andmay be required to meet the requirements of different national governments and several brands for which they
produce.
58
However, Plasa (2015) notes that the impact of the code of conduct is somewhat limited and that the goals forsocial responsibility and the objective of maximizing profits may sometimes be in conflict.
59
The OECD first formulated the Guidelines for Multinational Enterprises in 1976. Since then, the guidelines
have been revised five times in 1979, 1984, 1991, 2000 and 2011.
57

186

Table 7-1. Social Standards that Regulate GVCs in Developing Countries
Activity

Organizational features

Social responsibility & sustainability
IndustriALL
Focus on working conditions. Adopted
European Tradecharters for footwear industry (1995),
Union
textile & clothing industry (1997) andtanning industry (2000).
SA 8000
Created in 1997. The first auditable(by SAI: Social
standard for decent work (human
Accountability
rights); separately provides the Social
International)
Accountability Accreditation Services(SAAS).
Ethical Trading
Created in 1998. ETI Basic Code.
Initiative (ETI)
Information sharing & training among
members.
Initiative forCompliance andSustainability(ICS)
SEDEX Members
Ethical Trade
Audit (SMETA)
ISO 26000

Created in 1998. Social &environmental code of conducts(voluntary system, not certification);
audit working conditions across GVCs
(retail, textile, footwear, food, furniture& electronics).
Created in 2004. Social compliance
audits on labor standards, humanrights, worker health & safety,
environmental compliance, businessethics.
International standard on social
responsibility; adopted in 2010.

Textile & apparel industry-specificWorldwide
Created in 1997; incorporated in 2000.
Responsible
Independent facility that audits andAccredited
certifies apparel industry on safety,
Productionsocial and ethical standards; focusing(WRAP)
on operations at production facilities.
certification
Also provides training.
Global Organic
Established in 2008. Internationally
Textile Standard
recognized organic certification;(GOTS)
requirements for ecological & labor
conditions across GVCs.
Better Cotton
Established in 2009. International
Standard System
voluntary sustainability standard(by BCI: Bettersystem.
Cotton Initiative)
Sustainable
Incorporated in 2011. Developed
Apparel Coalition standardized measurement “Higg(SAC)
Index,” a set of five tools that assess
social & environmental performanceof value chain.

Originally, the European Trade
Union of Textiles, Clothing andLeather (ETUF/TCL); renamed in2012.
US-based NPO (with participationof private sector, governments,
NGOs, labor unions, academia).
UK-based NPO. Created by private
sector NGOs, trade unions, with thesupport of the Department forInternational Development (DFID).
France-based initiative; members ofFrench Federation of Commerce &Distribution (multilateral retailers& brands).
UK-based non-profit membershiporganization.

ISO as a worldwide federation ofnational standards bodies.
US-based NPO with a global
network. Certification program forapparel, footwear and sewn
products.
Germany-based. Founding
members are four organizations
from Germany, Japan, US and UK.
Switzerland-based. Global coalitionof NGOs, cotton industry
organizations, retailers and brands.
Also supported by donors (mainly
Europe & US).
Netherlands-based. Global, multistakeholder non-profit alliance forfashion industry (brands, retailers,
suppliers, service providers, tradeassociations, NGOs, academia).

Source: elaborated by the authors based on the website information of respective organizations.

187

updated the guidelines in 2011 by adding a human rights chapter, and the ILO also revised the
Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy in2017 by addressing decent work and forced labor issues. Following the 2011 UN Guiding
Principles, member countries are encouraged to formulate the National Action Plans on
Business and Human Rights (NAP)60.
Table 7-1 shows a selection of social standards and compliances mentioned above. They are
diverse in terms of functions (certification or voluntary system), organizational features(variously initiated by business associations, trade unions, or NPO in alliance with multistakeholders), and scope (sector-specific or theme-specific).
7-4. International development cooperation
The apparel industry in developing countries has been assisted by governments, foreign buyers,
donors, and NPOs in such areas as technical and skill training, quality and productivity
improvement, and social and environmental compliance. As explained in the previous sections,the recent decades have seen an increasing number of corporate and sectoral actors and issuespecific alliances among the private sector, NPOs, donor agencies and internationalorganizations which set, certify and monitor criteria for social and environmental complianceand, if necessary, provide assistance for capacity development of local institutions and people.
Each country and organization provide services that are of great interest to that country ororganization and that can most professionally be rendered by it.
In economic upgrading, Japan has traditionally promoted public-private partnerships toenable local suppliers to meet high Japanese QCD requirements and become long-term
manufacturing partners with Japanese FDI. Germany also has a long experience in skill
development and manages large cooperation programs for technical and vocational educationand training (TVET) in developing countries. The German Corporation for International
Cooperation (GIZ), the German Foundation for Economic Development and Vocational
Training (SEQUA), and chambers of commerce and industry are actively engaged in promoting
TVET.
For example, the Japan International Cooperation Agency (JICA) and the Association for
Overseas Technical Cooperation for Sustainable Partnership (AOTS), a public-private body set
up in 1959 for human resource development in developing countries, have for several decades
been supporting the training and education of skilled workers, technicians and engineers in Asia

Following the UK (2013), more than 20 countries have already formulated NAPs. In October 2020, the Japanese
government formulated the NAP to encourage Japanese companies to take further action in light of the recent
increase in public demand regarding corporate activities and human rights (Ministry of Economy, Trade andIndustry HP: https://www.meti.go.jp/english/policy/economy/biz_human_rights/index.html).
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so local workers and experts can familiarize themselves with Japanese-style production andmanagement emphasizing quality and productivity. This can be done through either on-the-job
training (OJT) or formal education. Examples include support to TVET at the Thai-Nichi
Institute of Technology (Thailand) and the Hanoi University of Industry (Vietnam). In addition,
Japanese public and private institutions have supported the introduction and diffusion of kaizen
in factories and the fostering of kaizen trainers in the public and private sectors. Starting with
Singapore in 1983, JICA has implemented various projects to promote the kaizen method not
only in Asia but also elsewhere. For instance, since 2006, JICA has implemented kaizen projects
in nine African countries and has promoted the Africa Kaizen Initiative (AKI) in collaboration
with the African Union Development Agency of the New Partnership for Africa’s Development(AUDA-NEPAD) and the Pan-African Productivity Association (PAPA).
In the area of social upgrading, the ILO and the IFC introduced the “Better Work
Programme” in 2006 to improve labor standards and competitiveness in GVCs, especially forlabor-intensive industries in developing countries. It assists companies to improve practices
through the application of core ILO labor standards and national labor laws, and the provisionof technical assistance in such areas as worker-management cooperation, working conditions
and social dialogue. The Better Work Programme is supported by Australia, Denmark, Germany,
Netherlands, the US and other bilateral donors as well as by major apparel brands, civil society
organizations (CSOs) and the governments of developing countries. Regarding cotton
production, there are multi-stakeholder platforms including the “Better Cotton Initiative (BCI)”
initiated by the World Wildlife Fund in 2005 and established in 2009 as an alliance of NGOs,
cotton industry organizations, and retailers and brands. It sets criteria for environmental,
economic and social sustainability, trains farmers in cultivation methods, and implements thirdparty verification. Similarly, the “Global Organic Textile Standard (GOTS),” initiated in 2002
and established in 2008 by four NPOs from Germany, Japan, the US and the UK, sets theprocessing, ecological and social standards for organic fibers which are backed by independent
third-party certification over the entire textile supply chain.
Business and human rights issues became widely known to the international community
after the Tazreen fire tragedy in 2012 and the Rana Plaza collapse in 2013 killing over 1,000
local workers in Bangladesh. These incidents raised consumer awareness of the poor working
conditions at garment factories in developing countries. In response, the Accord and Alliancewere established as legally-binding agreements between brands and trade unions to address fire,electrical and structural (building) safety standards in the ready-made garment (RMG) factories
in Bangladesh 61 . The German government also launched the Partnership for Sustainable
The Accord on Fire and Building Safety in Bangladesh (2013-18, extended to 2020) was formed by European
RMG retailers. The Alliance for Bangladesh Workers Safety (2013-18) was formed by American RMG retailers.
In June 2020, a national supply chain initiative (RMG Sustainability Council) was formed in BGMEA to take over61

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Textiles in 2014, a multi-stakeholder platform including the business community, to foster acontinuous improvement of social, environmental and economic sustainability along the entire
textile value chain. With GIZ serving as a secretariat, the Partnership for Sustainable Textiles
developed its Plan of Action, which laid down binding partnership standards for the productionof raw materials, textiles and clothing.
As noted above, relatively speaking, Asian buyers and donors including Japanese andKoreans emphasize “quality over anything else” (El-Shahat and di Canossa 2018) while
European buyers and donors give a greater focus on social and environmental issues. However,this does not mean that European buyers neglect quality or technical issues, nor do Japanesebuyers solely work on quality and cost reduction. There is much overlapping between theirconcerns. Moreover, we can also detect a converging global trend. With the advancement of thesustainable development agenda, there is a tendency to reorganize and manage the value chain
more sustainably. Environmental management is increasingly incorporated in TQM or Lean
Management, and skill upgrading and labor issues are addressed for productivity improvement.
Kaizen traditionally and always addresses the improvement of quality, productivity, safety andsustainability in a holistic way, and is thus expected to reinforce cooperation between managers
and workers as well as among workers (Hosono, Page and Shimada 2020). This is particularly
important in the current COVID-19 crisis which has increased the vulnerability of workers at
small and medium-sized enterprises and local suppliers in developing countries.
7-5. Comparison of five garment exporting countries: an overview
This and subsequent sections explain the experiences of selected apparel exporting countries—
Bangladesh, Vietnam, Ethiopia, Sri Lanka and Myanmar—regarding how these countries andtheir apparel sectors have coped with the simultaneous challenges of economic and social
upgrading of the apparel GVC. These countries are at different stages of garment industry
development with Sri Lanka, Bangladesh and Vietnam far ahead of Myanmar and Ethiopia. The
analyses are based on the results of firm surveys conducted by researchers in Vietnam,
Bangladesh and Ethiopia during November 2020-January 2021 (see Chapter 6) and findings
from the GDF missions to Sri Lanka in October 2017 and Myanmar in November 2019. They
are supplemented by additional interviews, data research and literature review.
In the three-country survey, the general questions asked to apparel producers in Bangladesh,
Vietnam and Ethiopia are: (i) quality and social compliance standards required by buyers andimplemented by firms; (ii) nature of interaction with buyers, governments and industry
associations concerning inspection, document submission, guidance, technical support andthe work of the Accord.

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training; and (iii) ongoing efforts to meet buyers’ requirements and any challenges with meeting
both quality and social compliance standards.
Table 7-2 provides basic information on the five selected countries. Bangladesh andVietnam are the largest garment exporters in the world after China. In Bangladesh, the readymade garment (RMG) sector continuously accounts for over 80% of exports contributing
significantly to the country’s foreign currency earning and job creation. Vietnam’s reliance on
apparel in total export is much lower at 9% in 2020. For both Bangladesh and Vietnam,
domestic private firms are dominant in the garment industry. In Bangladesh, an increasing
number of firms are moving up from CMT to OEM/FOB production, sourcing raw materials
independently instead of being given by the buyer. In Vietnam, CMT continues to be the mainmode of production and the shift to OEM/FOB remains limited.
Sri Lanka is a South Asian country that liberalized the economy and successfully attracted
FDI to develop high-end segments of the garment industry. The volume of Sri Lankan garment
exports is smaller than Bangladesh or Vietnam, but the country has secured a leading positionas OEM supplier to European and American markets which are seriously concerned with laborrights and environment protection. It has gained a reputation for strict adherence to both quality
and ethical standards, and top local firms are moving up to the ODM and OBM stages.
Myanmar’s garment export is small but rapidly rising, driven by tariff-free privileges of
EBA (EU) and ASEAN free trade, at least until the military coup d’etat in February 2021. The
country currently focuses on CMT, the first stage in the apparel GVC. Ethiopia’s garment export
Table 7-2. Key Indicators of Garment Industry in Selected Countries

GNI per capita(current US$, 2020) 1/
Textiles and clothing exports(1,000 US$) 2/

Bangladesh

Vietnam

Ethiopia

Sri Lanka

Myanmar$2,010$2,660$890$3,720$1,260$39,428,374(2019)
14.9%(2019)
2,658,700(2020)
6000(2017)
US, EU, Japan,
China, Korea$60,174(2018)
3.9%(2018)
39,000(2013)$28,332,567(2015)
89.3%
Export product share 2/(2015)
Formal labor force in apparel
3,315,100
manufacturing (before COVID-19) 3/(2017)
Number of Garment Factories
4620(before COVID-19)(2019)US, Germany, UK,
Main export destinations
Spain, France(developed underPreferential schemes (2020）
MFA), EU-GSP
CMT, OEM,
Vaue-added stages of production
ODM

GSP
CMT, FOB/
limited OEM$5,208,801(2017)
44.4%(2017)
445,300(2018)
850
177(2010)US, Italy,
US, UK, Italy,
Germany, China
Germany(developed under
AGOA, EU/EBA
MFA), GSP +CMTODM/OBM$5,095,427(2019)
28.1%(2019)
904,300(2019)
600(2020)
Japan, EU,
Korea, US
EU/EBA
CMP→gradualmove to OEM

Source: elaborated by the authors based on the data from the World Bank’s World Development Indicators(1/), the World Bank’s World Integrated Trade Solution (2/), and the ILO’s ILOSTAT (3/). The data on theother items are compiled by the authors from publicly available information.

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is even smaller, as it has just begun to receive FDI for CMT production. Foreign firms investingin Ethiopia include leading apparel firms in Sri Lanka and Bangladesh in addition to China,
India and Turkey.
The following sections explain how the five countries cope with the twin global standards.
Information on Sri Lanka and Myanmar was gathered by policy missions for another purpose andis therefore more limited than information on Bangladesh, Vietnam and Ethiopia based on ourrecent surveys. Two points deserve prior mention.
First, it is clear from the discussions above that relative weights placed on quality obligationand ethical correctness differ from one buyer country to another. It is the buyer country that decides
what standards are needed to what degree, and this must be fulfilled by all suppliers that export tothat country. Nonetheless, once imposed, each standard is applied to all producers uniformly.
Buyers do not distinguish producers by giving stricter requirements to some and permitting
leniency on others. Thus, a buyer country can mind only a few standards set by itself but producers
must cope with a large number of standards. Partly because of this, there are many common
answers among producing firms in five countries concerning the need to satisfy externally imposed
requirements and difficulties arising therefrom.
Second, given this situation, different responses to a growing number of standards arise fromdiverse capacity and constraints on the producers’ side, not from global policies on the buyers’ side.
Countries in different stages of garment industry development in terms of private capacity andpolicy competency, with different historic backgrounds and social structures, must deal with theproliferation of standards in different ways most suitable for their reality. Furthermore, eachproducer country and company may select a particular strategy for business survival and expansion
concerning, for example, a shift from CMT to more value creation, targeted garment segments andmarkets, degree of vertical integration, etc.
7-6. Bangladesh
The survey in Bangladesh focused on 30 garment firms (25 domestic, 1 joint venture, and 4
FDI). The largest market is the EU accounting for 70-80% of the export share followed by the
US, Canada, the UK, South Africa and Japan (Hossain 2021). The Korean connection was
critical in starting the export-oriented RMG industry in Bangladesh. Industry associations havealso played an important role in strengthening the position of local firms in GVCs incollaboration with international buyers and donor agencies.
Historically, Bangladesh’s export-oriented RMG sector was triggered by a joint venture
between Desh Garments (a local firm founded in 1974) and Daewoo Corporation of South
Korea (Kathuria and Malouche 2016) which was formalized in 1978. Desh Garments sent 130
new employees to Daewoo’s factory in South Korea where they received eight-month intensive

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training covering sewing skills, factory management and international marketing. Within two
years of training, most trainees left Desh to start their own garment businesses. By the late
1990s, there were many garment companies started by ex-Desh workers generating substantial
export earnings for the country. Other ex-Desh workers became garment traders intermediating
buyers and manufacturers. South Korea and other newly industrialized countries continued toinvest in the Export Processing Zones in Dhaka and Chittagong and send local trainees to homecountries for training. After returning to Bangladesh, trainees again moved to other factories orstarted their own factories or trading houses (Khondoker and Sonobe 2009). This was how
knowledge and skill were diffused broadly in the sector.
As for apparel industry associations, the two powerful associations are the Bangladesh
Garment Manufacturers and Exporters Association (BGMEA) and the Bangladesh Knitwear
Manufacturer and Exporters Association (BKMEA). According to BKMEA, quality-related
standards and regulations that most of their member firms follow are ISO 9001: 2015 (Quality
Management System), ISO 14000 (IT Service Management System), TQM, ASTM
International 62 , and AQL as required by buyers. Some firms have established technicaldepartments which implement Industrial Engineering (IE) and Lean tools and techniques suchas Work Study, 5S, kaizen and kanban63.
With the phasing out of the Multi-Fiber Agreement (MFA) quota in 200464, productivity
enhancement became a major concern among local exporting firms. Assisted by ILO andGerman Technical Cooperation Agency (GTZ) (currently GIZ), the garment sector and industry
associations (BGMEA and BKMEA) initiated skill upgrading programs for local factories. GIZ
supported the establishment of the Productivity Improvement Cell (PIC) within BKMEA. PIC
runs the Productivity Enhancement Program, training and consultancy services with a focus on
the Lean Manufacturing System and various lean techniques. Since 2006, it has introduced suchmodern manufacturing systems as Industrial Engineering (IE), Lean Manufacturing, TQM,
fabric optimization and cutting technology, and supply chain management which had asignificant impact on productivity at member factories. PIC collaborates with internationalorganizations including GIZ, the United Nations Industrial Development Organization(UNIDO) and ILO, buyers such as Primark, as well as the Ministry of Finance, the Ministry ofFormerly known as the American Society for Testing and Materials, ASTM is an international standards
organization that develops and publishes voluntary consensus technical standards in a wide range of materials,
products, systems and services.
63
Based on online interviews and supplementary email communications with BKMEA in July/August 2021.
64
MFA was effective from 1974 to 2004 as a quota system to regulate textile trade from developing countries toadvanced ones. It was intended to prevent excessive export of developing country products, but some producer
countries may have benefited from it by increased output and FDI inflow if rival countries had already exhausted
their quotas. After the expiration of MFA, textile and garment trade was determined more by competitiveness thanpolitical allocation, and economics began to rule over the international competition as well as domestic competition
among exporting firms.
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Commerce, the Ministry of Industry, the National Productivity Organization, the Export
Promotion Bureau, etc.
BGMEA and BKMEA also manage various skill development programs in partnership withdonors. The Skills and Training Enhancement Project (STEP), financed by the World Bank in
2010-2019, supported the training of operator-level workers into a more skilled workforce. The
Skills for Employment Investment Program (SEIP), financed by the Asian Development Bank
(ADB), has since 2014 strengthened skill development institutions in priority industries
including RMG in partnership with industry associations65.
According to BKMEA, most factories were initially doing CMT production. Currently,
some factories develop designs and products on their own (OEM and ODM). In the knitwear
industry, Bangladesh local firms are almost “self-sufficient” as they import cotton from abroadbut other processes are done within the country. This implies that functional upgrading has beentaken place in the RMG sector.
In social compliance, the unique feature of Bangladesh is a high priority given to the issueof workplace safety. This reflects lessons from past accidents. Most RMG firms participated in
the EU-initiated Accord and the US-initiated Alliance, two major safety initiatives started in2013 just after the Rana Plaza collapse which killed over 1,000 workers. They expired in 2020
and 2018, respectively. Most of the interviewed firms agreed that these initiatives helped
improve compliance standards in their factories despite the high costs associated with them.
However, a few firms did not find these compliance initiatives useful because they had alreadyobserved them even before Accord and Alliance were launched. An assessment made by the
Bangladesh Institute of Development Studies (BIDS) points out that these initiatives havecontributed to increasing confidence among workers on workplace safety and reducing labor
unrest, but there was no visible increase in output or revenue at least in the short run (Hossain
et al. 2020).
After the completion of safety upgrading support of Accord and Alliance, the RMG
Sustainability Council (RSC) was formed under the leadership of BGMEA in 2020 to carryforward the significant accomplishments made on workplace safety. It has equal numbers ofrepresentatives from industry, brands and labor unions. Besides that, workers are more aware
than ever of their safety thanks to awareness campaigns and training66. The interviewed firms
stated that maintaining all three compliance standards—building safety, fire safety and social

SEIP has been supporting skill development of priority industries in three tranches (tranche 1: 2014-2018,tranche 2: 2017-2021 and tranche 3: 2020-2024) (ADB website). For example, under SEIP, BKMEA has been
conducting training at its five institutes and factory-based outsourced training institutes in various areas: social
compliance & CSR, IE & lean manufacturing, production planning & supply chain management, textile testing &lab. Management, fire safety management & risk assessment, market analysis & export promotion, and others(BKMEA website).
66
BGMEA Press Release dated August 29, 2021. https://www.bgmea.com.bd/page/BGMEA_Press_Release
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compliance for workers’ well-being—contributed to their better business performance (Hossain2021).
All BGMEA member factories maintain international safety and compliance which areassessed by BSCI, WRAP, SMETA, ICS, Higg index, GTW, RTM, Join Life, ZDHC, Blue Sign,
ISO 14000, OCS, GOTS and OEKO-TEX67. The key challenge for local suppliers is the needto meet different standards and compliance requirements set by buyers from diverse regions
and countries. This creates a huge workload and delays at factories and often results in increased
costs. Regarding quality standards, American companies use the American Association of
Textile Chemists and Colorists (AATCC) while the EU is more familiar with the ISO and Japanapplies the Japanese Industrial Standards (JIS). Regarding chemical standards, the US andJapan follow the Manufacturing Restricted Substances List (MRSL) and Restricted Substances
List (RSL) while the EU more frequently uses the General Product Safety Directive (GPSD)
and Registration, Evaluation, Authorization and Restriction of Chemicals (REACH).
Similarly, there is no uniformity in the social and environmental standards. Because
different buyers demand different standards, factories need to maintain several certifications
including BSCI, OEKO-TEX, WRAP, SEDEX, GOTS and Higg Index, which is costly.
Factories have to assign an additional human resource to maintain these certifications. Also,
managing different wage requirements for the same workers is impractical and poses a serious
administrative burden (Kathuria and Malouche 2016).
In partial response to this problem, the Bangladeshi government updated and consolidated
the old laws into a uniform code of conduct in 2006. Furthermore, the industry has invested a
lot of money to address social and environmental compliance by offering decent wages forworkers, introducing group insurance, ensuring a healthy work environment, maintaining safety
and integrity of structures, installing green buildings, and embracing eco-friendly technology
and techniques. Today, the Bangladesh RMG sector is regarded as a role model for chemicals
and the labor-intensive manufacturing industry. Currently, Bangladesh has 91 green garment
factories certified by the Leadership in Energy and Environmental Design (LEED) of the US
Green Building Council (USGBC), which is the largest in the world. It is also home to thehighest number of platinum-rated garment factories in the world. 25 Bangladeshi factories haveachieved this highest honor of USGBC, with six out of the top 10 LEED-certified factories
being Bangladeshi. Over 500 RMG local factories are registered with USGBC for LEED

Website of BGMEA. The meanings of these acronyms are as follows: BSCI (Business Social Compliance
Initiative), WRAP (Worldwide Responsible Accredited Production), SMETA (SEDEX Members Ethical Trade
Audit), ICS (Initiative for Compliance and Sustainability), Higg index, GTW (Green to Wear), RTM (Recyclable
Textile Management), Join Life (social and environmental sustainability), ZDHC (Zero Discharge of Hazardous
Chemicals), Blue Sign (sustainable textile), OCS (Organic Content Standard), GOTS (Global Organic Textile
Standard), OEKO-TEX (safety and environmental sustainability of textile leather). See also Table 7-1 for WRAP,SMETA, ICS, Higg index and GOTS.
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certification (ADB 2020)68.
However, there are views that the cost of installing these best practices has not fully paid
off as foreign buyers are not offering reasonable product prices in response to local efforts.
Satisfying the quality and ethical requirements while responding to cost pressure from buyers
is a big challenge for local suppliers. This underscores the importance of enhancing productivity
and upgrading products, processes, and value chain functions for higher-value addition whenlabor and environmental correctness is pursued.
7-7. Vietnam
In Vietnam, 31 garment firms (21 domestic private, 5 FDI and 5 former state-owned enterprises)
were surveyed, among which 29 were engaged in export activities. Main overseas markets are
the US, Western Europe, Eastern Europe and South Korea. Only two companies said theyexported to Japan. All surveyed firms are CMT manufacturers on a sub-contracting basis withnone of them engaged in OEM or ODM. They consider technical and capital constraints as themain challenge for exports in addition to required compliance with technical and social
standards set by buyers (VDF 2021).
Exporting firms consider certification of international quality standards, typically ISO 9001,
as the pre-condition for penetrating and expanding apparel markets in developed countries suchas the US, the EU and Japan. In addition, the products must meet health and safety requirements
which are a top concern of consumers in those markets. Foreign buyers and lead firms set strict
standards and regulations on apparel exports including flame resistance, needle detection test,
labeling, the use of chemicals, etc. Buyers often provide on-site quality controllers (QCs) orhire an independent outside inspector of product quality in local factories. Once approved by
QCs or independent inspectors, products are exported in the name of the buyer. While garment
exporters may be aware of technical details of products as stipulated by contracts or orders,
they are usually unaware of the bigger picture regarding the rules and regulations in importing
countries. According to some respondents, QCs and independent inspectors often inspect only
certain random samples (except Japanese buyers who demand inspection of all items—see
below). As a result, buyers occasionally find non-compliance after products have reachedimport destinations, and send back the entire consignment to Vietnam to be repaired or removed.
In such cases, local garment companies have to bear all the costs incurred.
Turning to social compliance, the CSR principle is widely understood and adopted in the
textile and garment industry. Garment exporting firms normally adhere to the following socialand environmental standards: ISO 14001 (environmental management system), eco-labeling

68

Cited from “Bangladesh Leads World in Green Production,” The Daily Star, dated September 19, 2020.

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standards to ensure health and safety of users, environment protection and pollution prevention,
SA 8000 (social accountability standards) and WRAP. While not legally binding, these are de
facto mandatory because firms cannot export to developed markets in case of non-compliance.
Suppliers are required or encouraged to adopt one or more of them. Industry associations suchas the Vietnam Textile and Apparel Association (VITAS) and the Vietnam Leather and Footwear
Association (LEFASO) offer basic information and CSR requirements to suppliers.
The survey in Vietnam revealed two interesting trends. First, there is a significant differencein awareness of and compliance with quality, environmental and social standards between local
firms that export and local firms that sell only in the domestic market. Local firms targeting theinternational market are under strong pressure to comply with such standards as the precondition for export and must adopt the standards and codes of conduct decided by buyers. The
incentive to embrace quality and CSR standards is stronger among FDI and Vietnamese large
companies. About two-thirds of the interviewed firms have applied for and been acknowledged
as in full compliance with ISO 9001, ISO 14001 and so on, and one-third of them have been
granted the WRAP certificate. By contrast, none of the firms targeting the domestic market haveobtained quality standards or certifications. They are also reluctant to disclose their financial
records and environmental reports. This may be because domestic consumers pay little attention
to such standards and information. Some interviewed firms recognized that their products
needed to be certified in order to expand their market and especially to initiate export, but they
did not have any concrete idea about how to address this challenge. Others, especially small
local garment firms without export experience, rarely pay attention to global quality standards
and only try to comply with the minimum legal requirements set by the Vietnamese government.
Many Vietnamese garment producers continue to operate in low-value segments of GVC andheavily depend on foreign buyers for required information even when they export.
Second, while there are common requirements across markets, there are also differences by
the nationality of buyers regarding the emphasis placed on certain categories of standards andcompliance. Relatively speaking, buyers and lead firms from Nordic and Western Europe(especially Germany) are strict on CSR including working conditions, living standards, working
time and gender equality. They are concerned not only about the legal minimum wage, but theminimum income workers need to receive to meet their basic needs. The Vietnamese companies
found it most difficult to acquire SA 8000 and WRAP certifications when exporting to theNordic and EU markets. These two standards have very high and strict provisions regardingchild labor, forced labor, health and safety, freedom of collective bargaining, discrimination,
disciplinary forms, working hours and payrolls. By comparison, the buyers and lead firms from
Russia, Poland and Korea tend to be more tolerant of both CRS and product quality. The
surveyed firms stated that Japan and the US were far more demanding and Japanese technicalrequirements were particularly difficult to meet compared to those for other markets. The needle

197detector test for all items required by Japanese buyers is among the most challenging for
Vietnamese garment companies. The Japanese Needle Inspection Law orders all textiles and all
wearing items which touch human skin to be tested for any sharp metal matters before retailing.
7-8. Ethiopia
The survey in Ethiopia covered 30 firms in four sectors including ten garment firms (4 domestic,
6 FDI) in the garment sector. The main export markets are the US, the EU (especially the
Netherlands, Italy, and Germany), the UK, China, India and some parts of Africa (PSI 2021).
FDI garment factories export to firms and buyers with whom they have had long-term contract
orders. On the other hand, local firms do not have such contractual agreements with customers
abroad, and their export markets are decided on an ad hoc basis (see Chapter 5).
Compared to Bangladesh and Vietnam, the garment industry in Ethiopia is in the early stageof obtaining international standards and certificates. This is probably because of the country’s
relatively short history of joining the apparel GVC. Regarding quality standards, two of the six
foreign firms surveyed are in the process of obtaining ISO 9000, and nearly half of the local
firms have obtained ISO 9000 and are said to practice TQM. The other foreign firms stated that
their factories and process were arranged as per standard layout approved by their customers,
the Ethiopian Textile Industry Development Institute (ETIDI) and the Industrial Park
Development Corporation (IPDC), although they did not yet have formal certificates.
In Ethiopia, social standards and compliance seem to be more observed than quality
standards. Five of the six factories surveyed have already joined the ILO Better Work
Programme, while the remaining one has completed 90% of the registration process. They also
have other CSR-related certificates such as SEDEX and WRAP. Some local firms haveregistered for the ILO Better Work Programme by their initiative.
Both foreign and local firms stated that standards for product quality contributed to
improving their performance in procurement and production processes. They consider suchstandards useful to (i) understand what is required by buyers and focus their efforts on specificrequirements, (ii) facilitate processing orders and interacting with customers, (iii) avoid productrejection by buyers, and (iv) minimize costs and achieve efficiency by focusing on a particularquality standard. There is a general perception among supplier factories that meeting quality
standards is essential to compete and succeed in export markets while satisfying other standards
and requirements in such areas as lobar codes and environmental protection are mandatory
obligations. Firms clearly distinguish between quality standards and ethical requirements.
All six foreign firms surveyed explained that, for export, they must satisfy specific standards
and quality specifications which were checked by buyers through annual quality and standard
evaluation documents. If they fail to do so, they will be automatically rejected by buyers. They

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have quality and standard departments that regularly test their products, purchased inputs andraw materials, and machinery, as well as check whether trained workers have the required skills.
One interviewee at a foreign firm stated that “textile manufacturing is a collective responsibility
where all factory staff must work in a coordinated manner to achieve and maintain quality andstandards.” Some foreign firms mentioned a trade-off (cost burden) in implementing different
standards, while others considered it less significant than the benefits in easing the export
process and creating smooth linkage with customers.
Most of the local firms also stated that quality standards could affect their performance but
in a different way. They said that meeting such standards contributed to maximizing theiroverall reputation and hence increasing profits. Some local firms have already considered
quality standards as part of their business philosophy, accepting and welcoming them as part of
doing business. Nevertheless, other local firms consider standards costly and difficult to obtain.
For these firms, quality standards do not matter within their market domain. Most of the local
firms surveyed also have internal units or persons to implement standards though methods for
implementation differ from one firm to another. Multiple approaches are used such as settinginternal rules and procedures, purchasing testing equipment, training staff on monitoring,evaluation, and promotion either in a coordinated manner or by a specialized unit. The
responsible unit or person regularly monitors activities to ensure that production takes place as
per standards and adopt corrective measures whenever necessary. At the same time, many local
firms said that implementing several standards creates a trade-off between costs and capacity.
The majority of the foreign firms (five out of six) responded that they have not received any
support from buyers to comply with quality specifications and standards. The same applies toall local firms. Moreover, many firms (foreign and local) indicated that they have not received
any support from either the government or an industry association on quality standards. One
respondent pointed out that: “except for the rare awareness creation program by ETIDI and
IPDC to adopt and comply with standards, there is nothing in this edge.” There was one
exception where a foreign firm responded that it received support from more than 10 customers
to comply with requirements such as document processing, early warning and evaluation. Thisfirm stated that it also received training from ETIDI and IPDC to comply with standards.
Local firms indicated that aid agencies such as GIZ sometimes provided technical assistanceto help them adopt and comply with standards and that it was up to respective firms whether
and how to use this knowledge. Technical assistance mainly focuses on the skill developmentof technical staff responsible for quality standards. The Ethiopian Kaizen Institute (EKI) has
also supported local firms through technical and capacity-building intervention for standards
compliance. Apart from these, there are business associations such as the Addis Ababa Chamberof Commerce and Sectoral Association (AACCSA) which sometimes assist firms in getting
quality standards and certifications.

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7-9. Sri Lanka69
The history of Sri Lanka’s export-oriented garment industry dates back to the late 1970s when
the country liberalized the economy and succeeded in attracting FDI from Asia, Europe and the
US to develop the local apparel industry. Sri Lanka in those days faced low wages and highunemployment, but literacy was high and workers spoke English. The government createdExport Processing Zones (EPZs), constructed industrial infrastructure and provided tax
incentives. Foreign best practices were combined with strict Sri Lankan labor codes, leading to
the development of a unique apparel industry with top performance in quality and productivity
as well as protection of workers’ rights. Initially, FDI and joint ventures with foreigners
accounted for about 50% of total investment in the garment sector in the early 2000s (USITC
2004). They brought crucial technology, know-how and skills to Sri Lanka which enabled the
local industry to climb up the ladder from CMT of simple products to a producer of ladies’
underwear and other complex products. Over time, about a dozen domestic knitted productmanufacturers emerged with international competitiveness.
MAS Holdings, the largest apparel producer in Sri Lanka, had the first joint venture with
MAST Industries, a US-based clothing supplier, in 1986. This allowed MAS to learn the
manufacturing of fine fashion lingerie of Victoria’s Secret. Brandix, another leading firm, hada joint venture with the UK’s Textured Jersey in 2000, which sent ten managers to train local
counterparts for three to five years (Staritz and Frederick 2013). The company was later bought
by Pacific Textiles of Hong Kong, which sent seconded personnel full-time to transfer bestpractices and technical expertise.
Sri Lanka currently specializes in high-end, niche, downstream and knitted garment
segments including lingerie and swimsuit which require high skill and attention of workers.
Upstream cotton and textile are not prioritized as the country concentrates on the production
segment of GVC. With the end of MFA in 2004, many experts predicted that the Sri Lankan
apparel industry, which was not vertically integrated, would decline. To anticipate and copewith this crisis, the Joint Apparel Association Forum Sri Lanka (JAAFSL), a public-private
partnership forum, was created in 2002 with the leadership of the chairman of MAS. A strategy
was drafted with eight initiatives covering taxes, backward linkage, labor market, and so on. Its
execution doubled export within five years. The second five-year strategy followed. Throughthese efforts, a mechanism was established where the apparel industry acted as one to overcome
challenges instead of individual firms or processes implementing separate actions, and where
the private sector led the government.
MAS Holdings, as the top company with 90,000 employees in 17 countries, still leads
This section extracts relevant information from the GDF mission report to Sri Lanka in October 2017 (GRIPS
Development Forum 2017).
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JAAFSL. It has an integrated process to produce high-quality garments through design,
weaving, cutting and sewing (ODM), and is currently strengthening R&D and innovation to
upgrade its global business capability. The company has developed innovative training andmarketing systems of its own. MAS has also introduced the Japanese management system suchas the Toyota Production System, and regularly sends staff to AOTS training courses. Internallydeveloped capabilities such as direct access to buyers, strong management, technical skills,
quality and delivery standards, product development and creativity have been the factors thatelevated its status within GVC (Cattaneo et al. 2010).
Ethical practices have long been a great concern of Sri Lankan industries and government.
They are also adopted fully in the apparel industry. Labor standards and employment relations
are strictly regulated and monitored by the government. The Industrial Relations Departmentof the Board of Investment facilitates labor-management cooperation and harmony, andprovides advisory service and guidance to employers and employees. Sri Lanka is also known
for environmental excellence and has won many green manufacturing awards such as LEED
Platinum and Gold Certificates. This unique combination of social correctness andenvironmental distinction has attracted many global brands such as Victoria’s Secret, Gap, Nike,
Tommy Hilfiger, H&M, M&S and others which have built a longstanding partnership with Sri
Lankan apparel companies. Sri Lanka received “GSP Plus,” a duty-free export privilege with
the EU for countries strictly observing labor and environmental standards. This was suspended
in 2010 but resumed in 2017.
7-10. Myanmar70
Another interesting case is the garment industry in Myanmar, which has grown rapidly after thelifting of economic sanctions of the West and the start of economic liberalization in 2012. Until
the military coup d’etat in February 2021, the EU was Myanmar’s largest and fastest-growing
export market, followed by Japan and South Korea. The industry works on a Cut-Make-Package(CMP) pricing model, which means a nascent stage in the participation in GVC.
When Myanmar was shut out from the Western market about a decade ago, it turned to
Asian markets for garment export. Two training centers were established under the Myanmar
Garment Manufacturers Association (MGMA)71 with Japanese assistance. Training equipment
was provided by the Japanese Embassy (Grant Assistance for Grass-Roots Human Security
Project). Initially, the Japanese Ministry of Economy, Trade and Industry (METI) and later theThis section is largely drawn from the GDF mission report to Myanmar in November 2019 (GRIPS
Development Forum 2020).
71
MGMA has 560 member firms, many of which are Chinese. About 500 engage in garment production andexport. The revenue of MGMA consists of membership and license fees which are large enough to subsidize
students and university professors who take MGMA-organized courses for free.
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Japan External Trade Organization (JETRO) dispatched Japanese experts for training of trainers.
Courses included IE, sewing skills, quality control and maintenance of JUKI machines72. Aftera few years of training, Myanmar garment firms made good progress in economic upgrading
and greatly increased export to Japan by 2010. By now Japanese cooperation has ended.
The EU offered the EBA status to Myanmar in 2013, which opened up the EU market. Thiswas followed by the restoration of American GSP in 2016. The EU cooperated to satisfy therequired compliance conditions of Myanmar firms. This included environmental support for theproper treatment of dyes, chemicals and disposed materials. The EU also created the Social
Compliance Academy whose courses were taught at one of the MGMA’s two training centers
as well as at the Ministry of Education’s Training Institute (at the level of industrial college).
At both places, instructors were dispatched by MGMA. MGMA also cooperates with the
Ministry of Education to establish a Garment Module and Textile Module at the School ofFashion Technology.
Both Japan and the EU thus provided the necessary support for Myanmar firms to export totheir home markets. El-Shahat and di Canossa (2018) report a common view that Myanmar’s
export presence during the past decade in the Japanese and Korean markets where quality wasstrongly emphasized contributed greatly to improvements in the production capability of thecountry. On the shop floor, Japanese investors and managers taught local employees theimportance of product quality and piece-by-piece inspection. It should be noted, however, that
Myanmar garment producers have recently shifted from the Japanese market to the EU market
because the EU’s compliance requirement is easier to fulfill than Japan’s requirement for highproduct quality73.
7-11. Three implications for latecomer garment producers
The above case studies have shown country variation in adopting standards and compliancemeasures and the degree of their implementation by garment factories. Sri Lanka is an
exemplary model achieving both high quality and ethical standards. The Bangladeshi RMG
sector has a special focus on the fire and safety of buildings following the 2013 Rana Plaza
collapse and has also accumulated experiences in quality improvement to cope with the postMFA era. In Vietnam, significant differences exist between firms targeting international markets
and those staying in the domestic market, with the former fully conscious of global quality andethical requirements while the latter is less so. Myanmar started to learn quality control and

JUKI is a Japanese company specializing in the production and sales of industrial and home sewing machines.
It is a global company whose products are used by customers in more than 180 countries, and 80% of its total
sales come from overseas business.
73
Interview with the Secretary General of MGMA at the time of the GDF mission in November 2019.
72202technical skills of garment production first through Japanese cooperation, which provided thebasis for subsequent learning of social compliance measures through EU cooperation. As a
beginner, Ethiopia has just started to learn both quality improvement and social compliance. As
remarked earlier, these differences reflect diverse circumstances and readiness of producer
countries rather than intentional differentiation by global apparel brands and buyers.
Despite such country variations, there are common issues that have emerged from our study.
This final section extracts such cross-cutting issues which should be relevant to Ethiopia andother latecomer garment producers promoting both economic and social upgrading.
7-11-1. Differences and proliferation of required standards
The country cases indicate that garment factories need to take an integrated and balanced
approach to acquire and continue to upgrade export capability in the face of many required
standards. Three points are worth noting.
First, garment firms clearly recognize and distinguish the nature of the twin standards for
quality and social compliance. In Vietnam and Ethiopia, the surveyed firms understand thatmeeting quality standard is essential for enhancing their competitiveness, while social
compliance is mandatory for their entry into the apparel GVC. With increased global awarenessfor inclusiveness and sustainability, the latter can be regarded as “the social license to operate”
for garment production.
Second, many requirements for advanced markets are common but there are also differences
between Western and Japanese markets in emphasized standards. European and American
consumers are highly conscious of the labor and environmental conditions of garment
production in developing countries and oblige international buyers and brands to purchase frommanufacturers that adhere to global standards and conventions. In contrast, as the Vietnameseand Myanmar cases show, Japanese consumers are very strict about the physical quality of
products. They do not accept clothes with even tiniest frays and request a needle detection test
and inspections of all products before shipment from the factory.
Third, there is a problem of the proliferation of standards and compliance measures. In
Bangladesh, there is “compliance fatigue” as firms face mounting workloads and costs to copewith similar but slightly different procedures of certification, inspection, auditing, and so on. In
Ethiopia, local firms reported a trade-off between capacity and responsibility in implementing
several standards. There is a need for harmonization efforts among buyers and the international
business and development community and for supporting the capacity building of producers indeveloping countries.

2037-11-2. Importance of public-private partnership and the role of industry associations
The study also suggests an important role industry associations can play in developing thecapacity of local garment producers in quality and productivity improvement as well as socialand environmental compliance. They can also promote the skill development of workers andengage governments to improve business conditions and foster economic and social upgrading
through a public-private partnership.
Sri Lanka and Bangladesh provide good examples. Their garment industry associations
actively and competently support local firms in achieving the twin global standards. In Sri
Lanka, JAAFSL, a joint public-private partnership initiated by the private sector, wasinstrumental in introducing concrete measures to overcome the industry’s challenges. JAAFSL
continues to work closely with the government. In Bangladesh, BGMEA and BKMEA, the two
powerful industrial associations, support member firms with skill development, factory-based
consultancy, sharing of global and sectoral information, and policy discussion with thegovernment. Some training programs are supported by donors. In advancing workplace safety,
a national mechanism was established by BGMEA in 2020 to replace the foreign-initiatedAccord and Alliance. In Myanmar, MGMA organizes various training courses for skill
upgrading of member firms which build on the support it received from donors.
Vietnamese industry associations provide their member firms with basic information on
CSR requirements. In Ethiopia, industry associations are in an early stage of development. Most
surveyed firms did not receive any support from either the government or industry associations.
Latecomers should learn the experiences of more advanced countries in such aspects as theconcrete menu of support services and the formation of an effective public-private partnership.
Industry associations must also establish a close working relationship with the government andits support agencies.
7-11-3. External support from buyers, lead firms and donors
In Sri Lanka and Bangladesh, knowledge and technology transfer from FDI partners andbuyers was critically important in establishing a modern export-oriented apparel sector. In
Myanmar, the sequenced support by Japan and the EU to MGMA in enhancing the technicalskills and social compliance of its member firms contributed greatly to expanding the country’s
apparel exports to these markets. This shows the importance of external support by buyers, leadfirms and donor agencies in upgrading industry associations and local factories.
In our surveys, varying degrees of buyer support to local firms were detected. Some firms
responded that buyers only gave them information on standards and proceeded to inspection
without providing any practical support to local factories. On the other hand, in Vietnam, some204

buyers provide on-site quality controllers in local factories or hire independent third-party
inspectors to ensure the quality of products. In Bangladesh, the Accord and Alliance for fire andbuilding safety were initiated by foreign buyers but it was local factories that were responsible
for necessary investment for safety, which meant additional compliance costs.
7-11-4. Final thoughts: preparing for the future
In concluding this chapter, it is important to consider the implications of the COVID-19
crisis for the future of the garment industry. Apart from its immediate impacts (see Chapter 6),
COVID-19 will likely have a long-lasting effect on the social and environmental sustainabilityof the garment sector. Especially, the pandemic has heightened the need for a human-centeredapproach and green recovery.
Governments and garment factories are under increasing pressure to bolster economic
resilience and extend social measures to safeguard workers from future shocks. Furthermore,
green recovery from COVID-19 is emphasized, which makes such issues as carbon emission,energy and resource efficiency, and waste management critically important for factories, buyers
and lead firms (ILO 2020a). In the post-COVID-19 era, current global trends for inclusive,
sustainable and resilient industrial development are likely to be accelerated. There will also begreater demand for transparency, flexibility and agility in production processes, which requires
the introduction of advanced technology and sophisticated production management. Moreover,after the crisis, the perception of workers will be activated toward their working conditions
including wages, working hours, safety, healthcare and social benefits. This will enhance theproductivity of workers and the firm in the long run. This in turn will help producers to gain
buyers’ confidence as responsible producers.
At the same time, it should be noted that such social and environmental gains can besustained only if firms successfully keep upgrading their products and processes in theeconomic sphere because enhanced standards require investments in human capital, technology
and machinery. Some investments, for example, for fire and building safety and green recovery,
may incur significant costs and affect the financial viability of firms. Therefore, a parallel effort
is necessary to combine social and environmental upgrading with improvement in productivity,
products, processes and value chain participation for higher value addition. An integrated andcomprehensive approach will be more keenly needed in the post-COVID-19 world.

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Chapter 8
FDI Strategy in the Age of Industry 4.0 and
Post COVID-19
8-1. Introduction
Industry 4.0 is expected to bring rapid changes to manufacturing and other industries, byutilizing emerging technologies such as the Internet of Things (IoT), Artificial Intelligence (AI),
big data, robotics, 3D printer, Virtual Reality (VR)/Augmented Reality (AR), blockchain, andso on. Because it requires a lot of advanced technologies, knowledge, human resource andfinancial inflow which are not readily available in the least developing countries, there is a highpotential that foreign direct investment (FDI) can act as an important pathway to bring thebenefits of Industry 4.0 to them. Ethiopia is no exception. This chapter discusses how FDI
strategy should be reoriented in the age of Industry 4.0, from a viewpoint of developing
countries.
Industry 4.0 poses various questions on FDI strategy in developing countries. For instance,
what are the priority/promising FDI sectors? How can local firms get benefits from Industry
4.0 which FDI might bring? What is the best use of Industry 4.0 technologies or informationand communication technology (ICT) for investment promotion and facilitation including
RegTech (Regulation x Technology)? How can startups and entrepreneurs contribute to making
these happen? How can African nations and Ethiopia accommodate Industry 4.0 in theirdevelopment strategies? How can development partners work together? Among such researchquestions, a most debatable topic can be whether Industry 4.0 is harmful or helpful for job
creation.
This chapter attempts to respond to these questions, based on the experiences of selected
Asian countries. Many Asian countries such as Japan, Malaysia, Thailand and Indonesia havedeveloped respective industrial advancement strategies of Industry 4.0-type tailored to theirown ecosystems. It further considers how Industry 4.0 might work in the context of Ethiopia,
which currently focuses on labor-intensive and light manufacturing industries, and how
Ethiopia should cope with the above-mentioned questions. An analysis of Ethiopia deservesattention because Kaizen, which has been implemented in the country for a decade or more,
could provide a good link to Industry 4.0.
The chapter also discusses the likely impact of the Coronavirus Disease 2019 (COVID-19)
pandemic on Industry 4.0-based development and FDI. As the pandemic has brought the largest

207socio-economic impact since the Great Depression of 1929, many foresee a big paradigm
change in the post-COVID-19 era as the New Normal. There is ample room where Industry 4.0
could contribute to mitigating the negative impacts of the pandemic and creating innovativeand inclusive societies and economies in the post-COVID-19 world including Ethiopia.
8-2. Evolution of Industry 4.0 in the worldSince the era of the First Industrial Revolution in the 18th and 19th centuries when steam-driven
production methods were introduced and disseminated, the industry has been evolving (Schwab2016). The landscape of industrial development has again changed significantly in the firsttwenty years of the 21st century, with the emergence of distinct megatrends such as
globalization, digitalization, a series of unexpected giant external shocks including the COVID19 pandemic, and growing international concerns about the environmental and social impactsof development (Homma 2021).
The shape of the industry is radically changing with new technologies, globalized
production processes and diversification of product needs coming to the fore. The rapid
evolution of electronic technology and the consequent emergence of ICT have changed theshape of industries in developed and developing countries at the same time. Many innovations,
new industries, and epoch-making business models are emerging, as represented by global giant
platforms. Existing industries are also experiencing significant changes through digitaltransformation (DX). The Fourth Industrial Revolution (4IR) is characterized by virtually
networked production systems, represented by Industry 4.0, and is associated with up-to-datetechnologies such as IoT, AI, robotics, 3D printing and big data.
8-2-1. Overview of the Fourth Industrial Revolution (4IR)
The 4IR is recognized as introducing “smart applications that integrate virtual and physicalproduction systems,” following the First Industrial Revolution (1760-1900, the use of steam
and mechanically driven production facilities), the Second Industrial Revolution (1900-70,
mass production driven by electricity and based on division of labor), and the Third Industrial
Revolution (1970-present, extensive use of controls, information technology, and electronics
for an automated and high-productivity environment) (ADB 2018, based on Schwab 2016).
The overall concept of Industry 4.0 (Industrie 4.0 in German) was established in Germany
around 2013 through the initiatives of German manufacturing and other industries backed byits government. Putting the IoT and Cyber Physical System (CPS) as its core, Industry 4.0
harnesses the three concepts of connecting, replacing and creating to achieve more efficient
production and productivity improvement (Nagashima 2015). The overall concept of Industry

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Figure 8-1. Technology Associated with Industry 4.0

Source: World Bank (2017) as cited by Hallward-Driemeier and Nayyar (2017).

4.0 is sometimes interchangeably used with the term 4IR. The United States (US) followed theGerman movement, and the Industrial Internet Consortium was created by the US industries.
A World Bank Group publication by Hallward-Driemeier and Nayyar (2017) shows that the
top 10 technologies associated with Industry 4.0 are: IoT, big data analytics, 3D printing,robotics, smart sensors, AR, cloud computing, energy storage, AI/machine learning, and nanotechnology (Figure 8-1). Utilizing such digital technologies, the idea of 4IR/Industry 4.0 isbeing tested and/or has already materialized in the global industry.
While these trends originated in developed countries, developing countries, in particular
relatively advanced ones, are also getting involved in Industry 4.0. Mischke (2019)
demonstrates that developing economies are beginning to close the gap through rapid adoptionof new technologies starting from a low base as shown in the growth of the Country Digital
Adoption Index. Some of the technologies with Industry 4.0 such as AI become more easily
available even in the least developed countries including those in Sub-Saharan Africa. On theother hand, close to 50% of tasks could be automated by 2030 affecting 760 million workers inemerging economies (Mischke 2019). Furthermore, the digital divide, which means 4 billion
people in the world being outside the digital economy, may be becoming more serious
especially in developing countries. It is important to analyze the pros and cons of the impactsof 4IR on the future of the industries in developing countries.
8-2-2. Industrial policies in developing countries concerning Industry 4.0
Several countries in Asia have been attempting to accommodate 4IR into respective
industrial policies in response to rapidly growing interest in this movement in western countries.
In 2015, China set forth ‘Made in China 2025,’ which contains innovation of manufacturing asa target utilizing digital technologies. In 2016, Japan advocated the concept of ‘Society 5.0’ in
its science and technology plan as the cyber-physical integrated social system for a humancentered society, which fully utilizes IoT, AI and robotics to provide solutions. Society 5.0 is
considered as the next society following Society 1.0 (hunting), Society 2.0 (agriculture),
Society 3.0 (manufacturing) and Society 4.0 (information). It is considered that Japanese209

industry has strength in ‘integral architecture’ on manufacturing products from numerous parts
with optimal adjustment thanks to its technological capability. However, “modular architecture,”
which represents a simple assembly of units with less coordination than the “integral
architecture” becomes more mainstream under the global digitalization era (Lim and Fujimoto2019). Japan needs to reconsider how to survive in the era of 4IR with digital technology and asystemic approach.
Meanwhile, several Southeast Asian countries have published national industrial policies
inspired by Industry 4.0. These include Thailand 4.0 in 2015, Making Indonesia 4.0 in 2018
and Malaysia’s National Policy on Industry 4.0 (Industry 4WRD) in 2018 (Figure 8-2). Whilethese policies have the contents and flavor of Industry 4.0, they are considered as updated
versions of more comprehensive national industrial policies.
Such national industrial policies essentially demonstrate the positive impacts of Industry
4.0 as a key driver to create innovation, raise efficiency and improve the productivity of theindustry. However, negative concerns such as job opportunity loss due to the introduction of
up-to-date automation technologies, and safety and data security issues caused by newtechnologies, tend to be left out of their consideration. The Donor Committee for Enterprise
Development (DCED) Annual Conference held in 2019 discussed as its main topic the effectof Industry 4.0 on private sector development in the age of digitalization. The Conference
summarized great opportunities for developing countries’ development through innovation in
the private sector including startups geared by digitalization and Industry 4.0-type technologies.
At the same time, it voiced concerns about the possible negative effects on job markets caused
by AI and automation and stressed the need for education and vocational training to meet the
emerging requirements for digital skills. The United Nations Industrial Development
Organization (UNIDO) suggests 4IR technical cooperation including convening/awarenessraising, road mapping and policy advice, readiness analysis and industry 4.0 observatory,
demonstration, learning and innovation centers, Industry 4.0 absorptive capacity building, andinternational twinning (Memedovic 2019).
Figure 8-2. National Industrial Policies Inspired by Industry 4.0 in Southeast Asia
(Thailand, Indonesia and Malaysia)

Source: Board of Investment, Thailand (2015), Ministry of Industry, Indonesia (2018), and Ministry ofInternational Trade and Industry, Malaysia (2018).

210

In general, renewed industrial human resource development should be the key fordeveloping countries. Advanced Southeast Asian countries such as Thailand, Malaysia andIndonesia are already faced with rapid increases in the cost of labor and the emerging necessity
for accelerating automation and factory IoT (JICA and NRI 2019). Industrial human resource
development is required to support human resource shifts from simple labor-intensive workers
to advanced technological engineers. In many developing countries including those in SubSaharan Africa, there is also increasing demand for fostering entrepreneurs who can initiate
digital technology-driven businesses utilizing AI, IoT and big data. However, this requires earlyeducation and training in advanced ICT. Industrial policy should accelerate this dynamic shiftof industrial human resources by providing learning opportunities for digital technology andsystem engineering at higher education or Technical and Vocational Education and Training(TVET) level and the skill development opportunities for technicians in the industry, andestablishing a fiscal and non-fiscal incentive framework for enhancing such opportunities.
8-2-3. Japan’s possible intervention in Industry 4.0
Introducing Industry 4.0 is still new even to Japan, particularly in its technical cooperation
for developing countries. Under such a situation, it is important what Japan and the Japan
International Cooperation Agency (JICA) can contribute to adding value in this area. JICA
commenced the “Data Collection Survey on Upgrading Manufacturing Industry using theLatest Technology” in 2019 with some field surveys in the target countries such as Thailand,
Vietnam, Indonesia, Malaysia and Myanmar, as well as literature surveys on the benchmark
countries such as Germany, the US, China, India and Japan. The Survey’s purposes are: (i)analyzing the impact of rapidly advancing new technologies in industrial development; (ii)mapping out the current situation of Industry 4.0 in selected Asian countries; and (iii) proposing
plans for the cooperation program of JICA in this area.
The Survey so far has found that the industries in the target countries are generally not fully
equipped to accommodate Industry 4.0 developments such as IoT in their industry. Nevertheless,it has identified some trial cases and potential needs. The Survey has also found that Industry
4.0 has an affinity with Kaizen74 which (i) has the distinct feature of data visualization, (ii)originates from statistical quality control, and (iii) is fairly well disseminated in the surveyed
Southeast Asian countries (Homma 2020a). Furthermore, Japan may have a comparativeadvantage over other countries in certain areas of manufacturing industries, in particularrobotics and factory automation where hardware technology and software technology are
Kaizen is an inclusive and participatory approach to the continuous improvement of quality and productivity,
resting on a distinctive philosophy, tools and methods. It forms the basis of multiple management systems
including Total Quality Management (TQM) and Toyota Production System (TPS) developed in Japan and adapted
for use in other countries (Hosono et al. 2020).
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integrated. These areas could be prioritized and promoted.
As was implied previously, Industry 4.0 is still new even in Japan, especially from theviewpoint of technical cooperation. While there is a great potential for Japan to contribute tothis area, it has not yet developed policies on how to make this future concept a reality. To
realize this potential, it would be good to accumulate experiences in finding solutions together
for industrialization challenges in developing countries. Therefore, it seems that a co-learningand co-creation approach is needed and suitable rather than the traditional type of one-way
technology transfer. It should be appropriate for Japan to think together and learn together about
how to accommodate Industry 4.0 in host developing countries, utilizing a hands-on approachwith a problem-solving methodology such as Kaizen.
8-3. Paradigm change in the post-COVID-19 era
8-3-1. Overview of the COVID-19 pandemic
The COVID-19 pandemic brought huge unexpected impacts on the world economy in 2020and beyond. The World Bank Group (2021a and 2021b) projects that world real GDP growthin 2020 declined by 3.5% and that COVID-19 is likely to cause a global recession whose depth
is surpassed only by the two World Wars and the Great Depression over the past century and ahalf. World trade volume in 2020 decreased by 8.3% compared with the previous year. The
International Labour Organization (ILO) (2021) confirms the massive impact that labor markets
suffered in 2020 with 8.8% of global working hours being lost in the whole year (relative to thefourth quarter of 2019), equivalent to 255 million full-time jobs or approximately four times
greater than the number lost during the 2008 global financial crisis.
Industry in the world has heavily suffered from COVID-19 through a massive economic
slump, huge demand losses, trade volume losses, liquidity losses, job opportunity losses anddifficulties in access to finance. Developing countries faced all these problems even before the
COVID-19 but the picture has become worse, up to a fatal situation, due to COVID-19. The
ILO (2020b) reveals that enterprises in the surveyed developing countries claim they stopped
operations due to COVID-19 (70% of respondents), experienced a shortage of cash flow (86%),
and received less than half the number of orders compared with before-COVID-19 (33%).
Furthermore, global value chains (GVCs) are damaged or interrupted due to massive lockdowns
affecting national borders and factories, less human mobility, a mismatch in demand and supply,
a logistics slump due to demand loss, and concern for the rise of protectionism against free trade
regimes. Thus, the benefits of GVCs for developing countries have deteriorated.
Meanwhile, this unprecedented global crisis also provides positive impacts for the industry.
First, extra-ordinary immediate demands are created for certain products including medical212

products such as masks, gloves, personal protective equipment (PPE) and ventilators. Second,
digitalization and DX have accelerated to meet the huge demand for remote working,contactless procedures and automated production. Third, a wide variety of new technologies
called ‘Corona-Tech’ are being rapidly developed especially by startups to solve the huge social
issues created by COVID-19. Fourth, due to the interruption of GVCs and general trade, local
production with tailor-made technology and home-grown solutions are being enhanced.
8-3-2. Policy support in response to COVID-19
The world is being forced to devote massive resources to alleviate the negative impacts
caused by COVID-19. The World Bank Group (2021c) suggests three-stage policy support: (i)relief, (ii) restructuring; and (iii) resilient recovery. Initially, immediate actions are required tomitigate shocks, and short-term financial schemes should be provided for mainly small andmedium enterprises (SMEs) and for job security. On this point, the ILO (2020b) reveals thatenterprises in the surveyed developing countries need support in the form of business continuity
advice (50% of respondents), advice on export and logistics restrictions and requirements (38%),
and other information. In the restructuring stage, policy support for restoring their businesses
and accelerating their reopening through policies to enhance demand is required. Finally, in a
resilient recovery stage, there is a need to secure a firm foundation and “build back better.”
JICA has formulated a framework for supporting its private sector development (PSD)
program in response to COVID-19 (JICA Private Sector Development Group (2020), cited in
Homma (2020b)). This identifies four major consequences of COVID-19 to PSD, namely: (i)lost cash flow, (ii) damaged supply chains, (iii) emerging demand for medical and sanitary
products and business continuity planning (BCP) or business contingency planning of local
SMEs, and (iv) demand for a “new normal.” In response, JICA has been providing: (i)emergency financial support, (ii) support for supply chain rebuilding by business development
services (BDS) and new technology, (iii) support for BDS and Kaizen, and (iv) innovative
startup support.
An example to associate with (iv) above is the JICA NINJA75 Business Plan Competition
in response to COVID-19, based on its startup support “Project NINJA.” This is essentially abusiness contest in 19 African countries to provide support for startups and the acceleration of
new businesses in response to COVID-19 such as remote medical services, infection
information delivery, remote business or education tool, online sales, logistics and delivery
system, and other Corona-Tech-based business. It supports proof of concept (POC) for thewinners for their business ideas and attracted 2,713 applicants by August 2020 from 19 African

75

NINJA stands for ‘Next Innovation with Japan’ (JICA’s startup support activities).

213

countries, including 127 applicants from Ethiopia. In Ethiopia, JICA conducted a similar kindof business competition and incubation program for startups called the “SolveIT 2019” programfrom December 2018 to August 2019 prior to the NINJA program. More than 2,000 applicantsparticipated in SolveIT 2019, and this experience in Ethiopia formed the basis of the COVID19 NINJA program for 19 African countries.
Each donor agency has created a COVID-19 specialized website. DCED created one of thefastest knowledge portals on its website called “Private Sector Development and COVID-19”
immediately after the pandemic declaration in March 2020. The portal provides useful content
such as (i) information on socio-economic impacts and national responses, (ii) how to adjust
PSD interventions in the short term with a greater focus on (a) conducive investment policies
and procedures, (b) tax relief or other measures to ease the financial burden on businesses, and(c) digitalizing administrative procedures, (iii) promoting economic recovery and resilience,and (iv) building agency knowledge portals, statements and funding activities.
8-3-3. Resilience and future pandemic and other challenges
As discussed above, COVID-19 has presented tremendous challenges as well as newopportunities such as the possibility of Corona Tech-based businesses. In either case, “resilience”
is critically important to cope with these impacts.
COVID-19 is indeed one of the heaviest shocks in a century. Nevertheless, similar
pandemics and other unexpected external shocks including natural disasters may hit theindustry again in the future. To prepare for such anticipated events, it is necessary to enhance
the resilience of industries. To strengthen resilience, the recovery process is quite critical. This
is why many donors call for “building back better” post-pandemic. The European Union (EU)’s
recent policy on green recovery is a typical example. It is crucial for the world including thegovernments of developing countries to draw up comprehensive recovery plans involving
various sectors horizontally and deepening each sector vertically.
Furthermore, it is likely that the pandemic will greatly affect the Industry 4.0-based
development and FDI and may lead to a great paradigm change. There is a great potential for
Industry 4.0 to mitigate its negative impact and create an innovative and inclusive society andeconomy under the post-COVID-19 world.
In a nutshell, the COVID-19 experience suggests that the governments of developing
countries should take this opportunity to accelerate transformation in the short run and tostrengthen the resilience of industries in the long run through well-articulated industrial policies.
8-4. Impact of Industry 4.0 and COVID-19 on FDI and possible FDI strategy

214

8-4-1. Impact of Industry 4.0 on FDI
As the United Nations Conference on Trade and Development (UNCTAD) (2017)recognizes, the digital economy has important implications for investment, and investment is
crucial for digital development. Likewise, Industry 4.0 has important implications for FDI andvice versa. Such technologies will have profound effects on the forms of international
production. Depending on the project scale and ecosystem, these could range from centralized
large-scale production utilizing big-data technology to nimbler and distributed 3D printing
technology.
Some argue that Industry 4.0 could bring distinct impacts on FDI, particularly in terms ofthe decision on the location of labor-intensive FDI. Strachan (2020) notes that cheap labor costs
are no longer a strong incentive for greenfield investors to select factory locations in developing
countries because Industry 4.0’s excelled automation will level the playing field between
developing and developed countries. This could affect negatively less-developed countries
which are endeavoring to attract FDI by taking advantage of their cheaper labor costs.
Industry 4.0 requires a significant amount of inflow of technologies, facilities andinvestment. 4IR-related technologies and their markets are expanding rapidly. Therefore, it ispossible to consider Industry 4.0 itself as a promising FDI sector. UNCTAD (2020b) estimatesthe combined market of IoT (IoT and analytics revenues) to be more than doubling in five years
from $240 billion in 2017 to $520 billion in 2021; the stock of industrial robots tripling in 10
Table 8-1. High-level Classification of New Industrial Revolution Technologies

Source: UNCTAD (2020b).

215

years from 1.3 million in 2013 to 4.0 million in 2022; and the market size of additive
manufacturing (such as 3D printing) growing 10 times in 10 years from $5 billion in 2015 to$50 billion in 2025, up to over $350 billion in 2035 (Table 8-1).
This suggests that FDI investors may seek partners with more knowledge-intensive andhighly-skilled human resources rather than those with abundant unskilled labor. In light of theirlimited capacity for mobilizing knowledge and digital skills, developing countries may startwith small-scale technologies (such as 3D printing and AI) and then go up to a larger scale (suchas robotics and IoT). There is more room for technology-driven startups and entrepreneurs tocontribute to small-scale but highly knowledge-intensive activities.
8-4-2. Impact of COVID-19 and beyond on FDI
The COVID-19 pandemic caused a dramatic fall in FDI in 2020. According to the UNCTAD
report, the global FDI flows dropped by 35% from $1.5 trillion to $1 trillion in 2019 (UNCTAD
2021). This is almost 20% below the 2009 trough after the global financial crisis. In developing
countries, the number of newly announced greenfield projects fell by 42%, much more than adrop in global FDI flows. In particular, Africa experienced a sharp drop in greenfield projects
by 75% in the same period. This compares to a 19% decline in greenfield investment indeveloped economies.
On the other hand, there is a rapidly growing demand for FDI in emerging sectors in
response to the pandemic such as the medical, health and food sector. The UNCTAD reportprojects that global FDI flows are expected to bottom out in 2021 and recover some lost groundwith an increase of 10-15% thereafter (UNCTAD 2021).
Looking ahead towards the post-COVID-19 era, the ICT sector is considered as one of themost associated and required sectors in the New Normal world. Fully utilizing a further
advanced digital network, e-commerce, remote technology, and Industry 4.0-related technology
and industry are considered to be targeted sectors for attracting FDI.
8-4-3. Implications for FDI strategy in developing countries
The previous sections discussed how Industry 4.0 and COVID-19 could affect FDI andconsidered its possible implications. The governments of developing countries should also takeaccount of these movements in respective national strategies to promote FDI.
One obvious change in FDI strategy is an increased focus on ICT and the new technology
sector. Strachan (2020) argues that governments should recognize this change toward ICT andnew technology and consider policies to prioritize technological literacy through their education216system to foster a new workforce that is technically competent so that this becomes a key toattracting inward investment. Meanwhile, UNCTAD (2017) cautions that many digitaldevelopment strategies either fail to address investment needs or discuss them only at a very
general level. According to this report, less than 25% of digital development strategies containdetails on investment requirements for infrastructure, and only below 5% of such strategies
include details on investment needs beyond infrastructure including for the development ofdigital industries. Investment Promotion Agencies (IPAs) are rarely involved in the formulationof digital development strategies.
In response to COVID-19 and a sharp decrease in newly announced greenfield investment
due to economic turmoil and difficulties of traffic, many IPAs in the world have attempted totackle this situation. In the initial phase of COVID-19, IPAs were required to take care ofexisting investors to secure their businesses by facilitating their daily activities which wereheavily affected by the COVID-19 pandemic by, for example, labor management, visa
extension for home country staff and other immediate means. In the next phase of the pandemic,
fresh greenfield investment is still difficult. But, as a short-term measure, IPAs might consider
working with some of the existing investors who have already roots in the host country and areinterested in reinvestment or investment extension to capture rapidly growing demand forcertain commodities and provide home-grown solutions to address cross-border tradedifficulties. After surviving these phases, IPAs could consider, as mid-term measures, greenfield
investment attraction for those who seek business information on a remote basis. A JICA projectin support of investment promotion in Bangladesh has been taking these staged approaches(Figure 8-3). The previously mentioned 3-step phased approach of the World Bank Group(2021c) ((i) relief, (ii) restructuring, and (iii) resilient recovery) is based on a similar idea.
It is important to identify priority investment sectors in light of new demand in the era of
COVID-19 and beyond. It is also useful to identify strategically important sectors which may
provide a larger impact on people’s lives and need emergency assistance by the government.
The JICA investment promotion project in Bangladesh provides analysis and suggestions for
identifying investment sectors (Figure 8-4).
Figure 8-3. Mode of Measures for Targets for Investment Promotion
during and after COVID-19

Source: JICA Project for Promoting Investment and Enhancing Industrial Competitiveness in Bangladesh(2021).

217

Figure 8-4. FDI Industrial Sector Identification during and after COVID-19

Source: JICA Project for Promoting Investment and Enhancing Industrial Competitiveness in Bangladesh(2021).

8-5. Industry 4.0 / COVID-19 and FDI in the context of Ethiopia
Industry 4.0 has not been discussed yet in the policy documents of the Ethiopian government.
Neither “Ten Years Development Plan: A Pathway to Prosperity 2021-2030” by the Planningand Development Commission (PDC) of the government of Ethiopia (PDC 2021) nor “10 Year
Perspective Plan Priorities (2020/21-2030/31): Major Reform Agendas and Support Areas” by
the Ministry of Trade and Industry (MOTI 2021) explicitly refers to Industry 4.0 or the Fourth
Industrial Revolution. Digitalization and the ICT sector are well captured in the above longterm policy documents as one of the most distinct areas for priority. However, these sectors are
not necessarily linked with industry, in particular the manufacturing industry. No significant
influence of Industry 4.0 or digitalization is observed on the list of priority manufacturingsectors and other parts of the MOTI’s 10 Year Perspective Plan Priorities (Figure 8-5).
On the other hand, it is worth noting that certain Industry 4.0 technologies such as AI are
partially utilized well by the private sector. For example, iCog Labs is a well-known Addis
Ababa-based R&D and software development company, which is collaborating withinternational AI research groups and serving customers around the world. There might beprivate sector-driven development of Industry 4.0.

218

Figure 8-5. Manufacturing Sub Sector Prioritization for the Coming 10 years

Source: Ministry of Trade and Industry of Ethiopia (2021), “10 Year Perspective Plan Priorities (2020/212030/31): Major Reform Agendas and Support Areas.”

Ethiopia lacks a well-developed digital infrastructure which provides an essential basis for
Industry 4.0. As Pathak and Zewdie (2019) suggests, “Industry 4.0 can be used for sustainablechanges in country for solving many problems” (page 4) in Ethiopia. Considering Ethiopia as
one of the potential African countries, they further suggest the importance of infrastructure andeffective policies to create a favorable environment for the development of Industry 4.0 in
Ethiopia.
In this sense, it is a positive development that the telecom sector is being liberalized andthat the first private telecom operator license is given to an international consortium formed by
Vodafone, Safaricom and Sumitomo Corporation to meet international standard telecom
network. Ethio ICT Park is also a prospective attempt. Misikir (2020) reported that “four new
data center companies have secured land to make their home at Ethio ICT Park, which is called
Ethiopia’s Silicon Valley” (page 1). One of the data center companies revealed that it received
interest from multinational companies. This implies that data centers or other forms of ICT
platforms might further attract FDI.
Dissemination of Kaizen could also work advantageously for Ethiopia to contribute todigitalized industrial development and readiness for Industry 4.0. This is because Kaizen is adigital-friendly approach as it originates from statistical quality control (SQC) and has strong
features of data-drivenness and visualization (Cirera and Maloney (2017); JICA/JDS/Abeam(2022 forthcoming); Homma (2021)).
Ethiopia is a typical developing country that has a distinct comparative advantage in light219

manufacturing, such as garment, shoes and leather products, which fully utilizes its low-costlabor. As the previous section implies, Ethiopia might lose this labor cost advantage in the
global competition in the era of Industry 4.0. At this moment, it is not clear whether there are
any alarming signals on the future of Ethiopian light manufacturing development. Meanwhile,
there might be a future potential to upgrade these light manufacturing industries utilizing
Industry 4.0-type technology without losing cost competitiveness. Less expensive hardware
technology such as sensors and software technology such as locally-available AI technology
may provide solutions for quality and productivity improvement at light manufacturing
factories and create rooms for the large workforce to work on extended production.
In terms of the IPA’s response, the World Bank Group (2021c) collected information on theefforts of several IPAs in the world to retain existing foreign investors. This includes Ethiopia’s
efforts in immediate response to COVID-19 such as: Using social media to communicate closely with investors to gather feedbacks, share thelatest initiatives and best practices; and Facilitating the expansion of companies that receive FDI into new production lines in lightof COVID-19 by supporting local suppliers’ business continuity and strategic reorientation
to products and services most in demand.
8-6. Conclusions and the way forward
This chapter has attempted to capture the concept of Industry 4.0 or 4IR and assess the impactsof COVID-19 to obtain insights into industrial development in the post-COVID-19 era. Then,it has considered their implications for FDI promotion strategies from the perspective ofdeveloping countries including Ethiopia.
Due to limited prior research and quantitative evidence, it is premature to judge from thisinitial attempt and draw concrete implications for Ethiopia’s FDI strategy in the age of Industry
4.0 and post-COVID-19. However, the following points are worth noting for further studies.
First, it is not clear yet what would be potential positive and negative impacts of Industry
4.0 on FDI attraction in Ethiopia. The government should study the potential impacts ofIndustry 4.0 on Ethiopia’s industrial development and incorporate the analysis into its national
policy in general and industrial policy in particular so that hidden threats can be transformed
into opportunities. History shows that labor-cost advantage cannot last long and that the next
step beyond labor-intensive industrialization should be thoroughly analyzed including testingof the Industry 4.0 concept towards the digital economy. It is also important to analyze how theEthiopian garment industry can be associated with or benefit from Industry 4.0.
Second, it is important to build “resilience” in response to the future pandemic and othertypes of external giant shocks. FDI strategy, national industrial policy and their action plans

220

need to aim at strengthening the fundamental capacity to be ready for unexpected negative
shocks. To achieve this, the government must formulate a proper industrial strategy andestablish the foundation for the digital economy.
Third, “learning” is quite meaningful for Ethiopian policymakers and the private sector tofamiliarize themselves with a less-experienced concept such as Industry 4.0. There are several
useful ways to learn Industry 4.0. Attracting FDI is one of them as it is expected to facilitate thetransfer of technology that does not exist in a host country. Kaizen is another approach tolearning and applying the new concept in the workplace.
Finally, as this chapter offers only preliminary thoughts, it is suggested that further studies
on the nexus among Industry 4.0, post-COVID-19 and FDI strategy be conducted in Ethiopia
to secure these trends as advantages of the industrial sector of Ethiopia.

221

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