# **1. Introduction**

It is often argued that African economies need to become less dependent on agriculture in order for poverty to decrease. Small rural nonfarm enterprises may play an important role in the early stages of diversifying beyond agriculture. However, very little is known about the characteristics, constraints and opportunities of nonfarm enterprises (Lanjouw & Lanjouw, 2001), which makes it difficult to assess how this class of enterprises might contribute to poverty reduction. There is dispute in the literature regarding precisely this issue as evidence in the discussion from Barrett et al. (2001), Davis & Bezemer (2003) and Reardon et al. (2002). One view is that nonfarm activities provide a dynamic pathway out of poverty; a less optimistic view is that nonfarm enterprises are set up by households primarily as a survival strategy, perhaps as a substitute for agriculture for the landless.

Understanding better the opportunities and constraints in Ethiopia’s rural nonfarm enterprise sector is the goal of this paper. In Ethiopia the topic is of crucial importance since the economy remains highly dependent (and vulnerable) on the performance of the agricultural sector, while ongoing population growth increases the need for income diversification strategies. Promotion of nonfarm enterprise activity is considered to be a promising catalyst for development by the Ethiopian government, as manifested in the Plan for Accelerated and Sustainable Development to end Poverty (PASDEP).

The empirical basis for this paper is the Rural Investment Climate Survey (RICS), fielded in Ethiopia in December 2006 and January 2007 in collaboration with Ethiopia’s Central Statistical Agency (CSA). Two complementary surveys were carried out as part of RICS: the _RICS-Amhara_ survey, based on which a very detailed dataset has been constructed, containing household, enterprise, and community level information on rural households in the Amhara region; and the _RICS-Annual Agricultural Sample Survey_ (RICS-AgSS), which is less detailed than the RICS-Amhara data but, covering the four major regions of Ethiopia, i.e. Tigray, Oromia, Southern Nations, Nationalities, and Peoples (SNNP) and Amhara regions, it has a much broader geographical coverage than RICSAmhara. The RICS-AgSS is representative of four major regions of the country which cover about 90 percent of Ethiopia’s population. RICS-Amhara covers about one-half of Amhara’s population, both food secure and food insecure areas. Map 1 shows the geographical coverage of these surveys.

In this paper we draw on these two sources of data to produce a comprehensive analysis of the most salient characteristics of the nonfarm enterprise sector in major regions of Ethiopia, assessing the determinants of participation, productivity, growth, entry and exit. Thanks to the detailed nature of these data, we can make a number of contributions to the literature on the performance of nonfarm enterprises. Firstly, the matched data enable us to uniquely assess the effects of the _rural_ investment climate and household characteristics on small enterprise performance. To our knowledge only Deininger et al. (2007) for Sri Lanka and World Bank (2007) for Tanzania – with a comparable rural survey – have studied in detail nonfarm enterprise performance and rural investment climate issues. Secondly, our data enable us to examine a wide range of aspects of performance – participation,

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