Ethiopia is being hailed as one of the most successful growth stories in Africa. Because of the country’s rapid economic growth, the high degree of state intervention in the economy, and the state’s focus on industrialization, people have started to compare Ethiopia to the Asian ‘tigers’ (Aglionby, 2017; Clapham, 2018; De Waal, 2013, Hauge and Chang, 2019; Oqubay, 2015) — four countries in East Asia (Hong Kong, Singapore, South Korea and Taiwan) that underwent rapid industrialization and maintained exceptionally high growth rates in the post-WWII era.
However, this emerging literature on Ethiopia-Asia comparisons has not yet sufficiently addressed one of the most important aspects of Ethiopia’s industrialization strategy — the attraction of foreign direct investments (FDI) into the manufacturing sector.
The rationale of my recently published article was this gap in the literature. In it, I ask the question: Should the African lion learn from the Asian tigers with respect to FDI-oriented industrial policy?
In short, my answer is yes. While Ethiopia’s policies are bringing about short-term economic success and showing promise for further industrialization, the state could arguably bargain harder with foreign investors, like it did in South Korea and Taiwan.
The increasing importance of FDI in developing countries
The motivation for investors from the West to relocate their production to developing countries (i.e. offshoring) has remained the same since the 1960s — the search for cheap labor, cheap land and cheap energy. However, the scale of offshoring started intensifying first in the 1990s, driven by falling transport costs, advances in information and communication technology, and lower trade and investment barriers. From 1990 to 2016, FDI inflows into developing countries increased from US$35 billion to US$646 billion. This represents an increase from 17% to 37% of world FDI inflows (UNCTAD, 2018).
This is why attracting foreign investments has become a more central part of economic development and industrialization strategies. From the perspective of developing countries, inflows of investments from higher-income countries can yield a number of benefits. In the short term, it can boost employment, it can increase foreign exchange and tax revenues, it can assist the integration of host countries in the world economy, and it can have a positive impact on infrastructure development (Farole and Winkler, 2014; Gallagher and Zarsky, 2007).
There are also benefits from attracting foreign investments that are more long term in nature, contributing to technological development and industrialization of the host country. This happens especially through technology transfer, production linkages to the host economy, and human capital development (OECD, 2002). However, these long term benefits are more difficult to achieve than the short term benefits. Some would argue that it boils down to the role of industrial policy, and how active the state is in utilizing foreign investments for developing domestic technological capabilities (Chang et al., 2016; Gallagher and Zarsky, 2007; Lall, 2000; Wade, 1990).
Not many developing countries have been successful at achieving these long term benefits, as it often requires hard bargaining with large transnational corporations. However, the Asian tigers were exceptions. This is why their experiences hold valuable lessons for today’s developing countries.
The ingredients to South Korea’s and Taiwan’s success
Among the Asian tigers, I chose to focus on South Korea and Taiwan because Hong Kong and Singapore are considered more special cases: they have small populations and their development process did not start from an agrarian or raw material base that is typically taken to be the starting point for industrialization.
Studying the policies in South Korea and Taiwan, I found two measures that stood out.
First, both countries actively pushed for joint ventures with foreign companies. South Korea best illustrates this. While South Korea had a restrictive stance towards foreign investors, investments from Japan were an exception. Between 1962 and 1974, 52% of Japanese direct investments in South Korea were with minority ownership (Castley, 1997). Joint ventures with the Japanese in which Koreans had majority stakes more easily facilitated the transfer of technological know-how, marketing skills and managerial techniques.
Second, both countries actively pushed for local content requirements. Taiwan probably best illustrates this. The strategy of linking foreign firms with local suppliers became a staple of industrial policies, especially in the 1970s and 1980s (Wade, 1990). Foreign firms’ links with local producers were assisted by proactive industry associations. For example, the electronics industry association TEAMA aggressively recruited members from both foreign and local firms and, with the support of the government, actively promoted the ‘local content program’ (Aw, 2002). Local producers wanted to take advantage of the technology, management skills and sales networks of transnational corporations.
How do Ethiopia’s industrial policies compare?
At this point, the part of Ethiopia’s industrialization strategy that is concerned with foreign investments is focused on attracting foreign investors and making them export. The most important measures include the construction of industrial parks, and handing out financial incentives to firms in industrial parks. To name a few of these incentives, they include the exemption from duties and other taxes on imports of capital equipment; no taxes on exports; subsidized land leases; and guaranteed remittance of capital for foreign investors (EIC, 2016).
To some extent this strategy has been successful. Manufacturing FDI inflows in the country has increased from US$570 million in 2007–2008 to US$3712 million in 2016– 2017 (from 2.5 to 5.1% of GDP) (Oqubay, 2019). The trajectory of exports is also positive: From 2004 to 2017, manufactured exports increased from US$21 million to US$389 million (led by exports in the textile and leather industries), representing more than a doubling of manufactured goods exports’ share of total merchandise exports (WTO, 2018).
But is this enough? Are technology transfers and linkages to domestic firms taking place? There is some evidence of this, but mostly anecdotal accounts of non-government facilitated technology collaborations between domestic and foreign firms and the formation of supplier relationships between domestic and foreign firms. At large though, domestic firms haven’t broken into the export market. Foreign firms still account for the majority of manufactured exports, and the value of these exports (US$389 million) is very low from a comparative perspective. For example, in Vietnam — a developing country of similar size, although at a slightly higher income level — the value of manufactured exports was US$1,750 million in 2017 (WTO, 2018). The near absence of domestic firms’ participation in international markets indicates that little technology transfer has taken place. So, while the trajectory in Ethiopia is positive, it’s nowhere near claiming ‘success’.
Should Ethiopia look to learn more from South Korea and Taiwan?
If Ethiopia should look to learn anything from South Korea and Taiwan, it seems to be clear what it is: the state should be more proactive in terms of pushing – not to speak of forcing – foreign investors to transfer technology to the domestic economy and to create backward linkages from foreign to domestic firms.
However, in some ways, today’s global economic environment has made such proactive industrial policy more difficult. In a world where cheap labor is more easily accessible and plentiful than before, transnational corporations can largely pick and choose outsourcing locations. For a country like Ethiopia, a non-liberal stance towards foreign investors will make it more challenging to attract them. Moreover, the protectionist measures that have been important for South Korea and Taiwan are not completely straightforward to apply in today’s global trade environment. For example, local content requirements are now prohibited by the World Trade Organization (WTO) for most countries. Therefore, Ethiopia’s strategy of simply attracting foreign investors and pushing them to export does make some sense.
The key point here is that a careful balance needs to be struck between, on the one hand, the benefits that a liberal stance towards foreign investors can bring about and, on the other hand, the need to develop domestic technological capabilities.
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Jostein Hauge is an economist and a Research Associate at the Centre for Science, Technology and Innovation Policy (Institute for Manufacturing) at the University of Cambridge.