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Fostering market systems for accelerated private sector growth in Ethiopia: The role of development partners as facilitators

Fostering market systems for accelerated private sector growth in Ethiopia: The role of development partners as facilitators

 

By Tesfahun Abay, Management consultant (tesfahunabay@yahoo.com)

05-18-15

The private sector in Ethiopian is still in its infant stage and market systems are ineffective and narrow-based due to various constraints that are intertwined to each other. In such a case, investments particularly in the manufacturing sector involve a lot of risks. Hence, private sector incentives and investments that aimed at solving key industry bottlenecks should be leveraged through various risk sharing schemes to expedite the undergoing industrial transformation in the country. The question is whether the Ethiopian government and development partners should continue to provide firm level capacity building assistances or re-focus their grants to address systemic change that prevail in the various markets. Another question is what amount of grants (incentives) should be given to those beneficiary firms who participate in the interventions implemented by the donors to bring about systemic change.

A brief donor inventory working in the Ethiopian manufacturing enterprises indicates that presently, over 10 development partners (donors) are providing, in one way or another, grants amounting to US$ 600 thousand per enterprise. Taking the period 2010-2015, these development partners supporting the manufacturing industry have been implementing various private sector development projects including grants at an aggregate cost of over US$ 400 million. (Source: USAID, PSD donor inventory in Ethiopia, 2011 and Ministry of Industry).

Arguably, however, much of these grants have been given directly to the private actors in the form of capacity building supports, for equipment purchase and operational subsidies irrespective of the level of risks they took in solving market constraints.The point is grants should be considered as incentives given to partners to offset risks which they take when investing their resources in solving market constraints. Therefore, grants should not be seen as gifts to be distributed to all actors operating in a given sector or market. Also, incentives should be given in the right amount. Therefore, grant providers operating in the private sector development should first start questioning as to what type of market constraints they want to address with their grants. Why are they providing hundreds of thousands of US Dollars per manufacturing enterprise even if the it has been in the business for years producing the same type of products? Is the grant size they provide the right size? What is the logic behind the magic figures of 75% or 50% donorís contribution?etc. have to be answered.The question is not because the grant size and proportions are too high or low. The issue is investments should be incentivised based on their individual merit. And applying a blanket formula for all firms/ investments irrespective of their contribution in doing away market constraints may leave loopholes for some rent seekers who spend time and energy knocking at the doors of donors and chase grants and subsidies.††††

I understand over the past decades, grant providing donor programs have performed a good job in solving firm level bottlenecks and improving firm level productivity and export performance. And taking the Dollar spent per job created into consideration, development partners operating in the country have brought impressive results at a far below international value for money averages. Questions that may arise here are many, though. Are these impacts sustainable or they are only short term gains? Do they have large-scale and market level impacts or have only limited scope? etc. have to be studied.Hence, the question is not about to have grant funds or not. But, fund providers need to tune these incentives/ grants to solve market constraints with a large scale, pro-poor and sustainable impact.



Letís take the below to see the situations on the ground.

One may argue that presently low level of overall enterprises capacity (systems, skills, HRM, marketing, waste disposal, etc.) is the major problem of the manufacturing enterprises in Ethiopia that worth fighting through grant funds. Maybe, yes for some of these constraints.And some are systemic indeed. Therefore, the issue that must come into our donorsí mind is the delivery mechanism. For instance, letís take one of the aforementioned constraints that our enterprises are faced with i.e., the low level of entrepreneurial and technical skills. These are pervasive across our manufacturing sector in textile, leather, agro-processing, etc.. Once identified, the two key questions that follow are: first, where and how do we confront with these constraints? Second, where do these industrial skills producing machinery are located at? No need of going far. The answer is we have to first develop the skills market system and the market oriented specialized TVETs and BDS service providers. Because these are the right partners we need to solve these. The existing regulatory environment in Ethiopia doesnít encourage the growth of such specialized training institutes and business development service providers.

What we have right now are the government TVETs that are mainly good at supplying young labour forces with some preparatory level of skills. However, because of their objectives, the mandate they are given, etc. their linkage with the industry is loose and hence difficult for them to flexibly respond to the demand for skills of individual industries. They supply what they produce and are not supplying the type and level of skills which the industry needs. The flow is one way with little or no incentive involved in the transaction between the government TVETs and the industry. Therefore, identifying the root-causes that hinder the expansion of the BDS market and incentivizing for growth is a key for industry development and transformation.

Once, the skills market system is developed and started to produce high quality and highly demanded products (the skills) at a competitive price, then the downstream producers, i.e. the manufacturing industries, can get the required quantity and quality of same at reasonable prices sustainably.

Therefore, what the grant providing donors need to do first is to develop market responsive industrial skills producing machinery (i.e., the specialized private TVETs) and market oriented BDS service providers. What the government and the donors have been trying so far is supporting the manufacturing enterprises to improve the skills of their labour without developing the institutions that can produce quality skills. Unless the manufacturing enterprises get disciplined and productive labour in sufficient quantity sustainably from the market, whatever skill development assistances we provide them, the result will no doubt be a short term and unsatisfactory.

The same goes true for solving other industry constraints, for instance, the garment accessories and the cotton market systems.

The lint cotton, weaving and knitting, garment accessories as well as the apparel manufacturing are among the interconnected market systems. In this value chain, the garment accessories market has remained to be a major bottleneck for the growth of the whole system. The garment industry needs over 150 types of accessories including packaging. And investment flow into these production businesses has remained daunting. Lack of local supply of these key items plus the longer lead time that takes to import them have remained to be the major bottleneck of the industry.Absence of competitive logistics facilities for importing the required accessories in to the country has also aggravated the problem in the apparel industry. Hence, solving this will have a widespread and triggering effect on bringing broader change in the overall textile market system. Therefore, development partners working in the manufacturing industry can apply their innovative grants in the development and expansion of garment accessories market in the country.

The cotton market system is another setback of the textile sector transformation. At its upper stream, the cotton value chain is the most disturbed production system caused mainly by excessive market distortions. Lint cotton market is one of the most price volatile markets and is characterized by oligopoly with 70 percent of the benefits skimmed by few downstream actors (Source: Factors Affecting Cotton Supply at the Farm Level in Metema District of Ethiopia by D.T. Bosena, f. Bekabil, G. Berhanu and H. Dirk, 2011). This together with the inefficient and unpredictable cotton market regulation have jeopardised its potential. Over the past decade, land under cotton cultivation and total production of same has dwindled the year in and year out. Therefore, development partners may work on the development and/ or introduction of lint cotton into the commodity exchange market or develop some forms of warehouse receipt system as well as establish national cotton (security) reserve, etc. or a mixture of some of these solutions by applying their innovative grants.

Ethiopia is among the largest potential cotton producing countries in the world: over 2.5 million hectares of land which is suitable for the cultivation of cotton, appropriate altitude and topography, suitable soil and weather condition, sufficient and high quality of water resources, availability of over 50 million young, cheap and easily trainable labour, etc. Therefore, facilitating investment for the expansion of large-scale commercial cotton production will have tremendous impact on the growth of the whole value chain.

Similar regulatory and market gaps are also pervasive in the livestock and leather sector too. Below is an example.

Currently, the slaughterhouses and the tannery factories are operating at an average of 30 percent of their production capacities mainly due to lack of raw materials, in this case live animals. This time the slaughterhouses fight among themselves to get enough live animals using, among others, network of local brokers as far deep as the remote rural areas and through increasing purchasing prices of the live animals. Some are already closed or operating at a very low capacity due to lack of sufficient raw materials (Abergelle Slaughterhouse and some of ELFORAís plants are just an example). In a similar way, the tannery factories fought neck-to-neck among themselves to get sufficient raw hides and skins.

This being on the ground, it is ridiculous to see Ethiopia allowing a mass export of its live animals. For instance, in its GTP, Ethiopia has planned to export 1.23 million heads of live animals over the period 2010/11-2014/15 and it managed to export 2,999,773 heads over the past five years (2010-2014). The export statistics of the Ethiopian Customs Authority indicate that Ethiopia has exported 1,073,341 heads of oxen, 1,427,689 heads of sheep, 136,188 heads of goats and 362,555 heads of camels over the period 2010- 2014. And taking the national export performance of the recent three years (2010/11-2012/13), live animals export with an average rate of growth of 85 percent per year has stood out most (source: NBE, Annual Report 2012/13, PP 16).

Diverting these live animals and pass them through the local slaughterhouses could have doubled the production capacities of same and significantly increase the operational efficiency and job creation capacity of the tanneries, leather article manufacturing enterprises, etc.. In an absence of export demand for Ethiopian meat products, it may make sense to allow export of live animals. But in our case, the export demand for meat is huge and the local processing capacity is enormous. Indeed, the slaughtering capacity of the existing seven export abattoirs in Ethiopia is estimated at 3.0 million heads of sheep and goats as well as 375 thousand heads of cattle per year (source: respective factories). Therefore, development partners (donors) may use their innovative grants to undertake sector and policy research studies as well as disseminating same to show the micro and macro level benefits to all concerned bodies and the general public.

Another weak performance of government regulation worth mentioning here is related to the poor quality of hides and skins. Presently, over 98 percent of households slaughter animals in their homestead and backyards with a lot of health and skin/ hides flaying problems.

In such situation, tanneries have no option except to buy hides and skins that are flayed by such unskilled flayers and exposed to different transport and handling problems. And so, tanneries incur a huge loss due to a high reject rate which is estimated as high as 40 percent of their hides and skins purchase on average (source: Ethiopian Leather Industries Association). Bringing the animals that are slaughtered in the backyards of major cities and towns into the modern facilities could have increased the operational capacities of the slaughterhouses and tanneries as well as create investment opportunities along these lines. The benefits in terms of job creation and value additions are again tremendous. Therefore, facilitating policy research and dissemination activities that aimed at showing tangible benefits for all actors working across the value chain is fundamental.

Ethiopia is a land of world class livestock skins. Bati goat skin and Debrebirhan sheep skin are the two globally renowned skin qualities needed for the production of high-end leather products. However, because of Ekek (skin disease) as well as the pervasive traditional animal health practices, Debrebirhan sheep skin type has already gone out of the international market while Bati goat skin is exported in small quantities. This together with the existing high rate of livestock mortality, i.e., 10 percent for cattle and 20 percent for sheep and goats, are causing great loss to the poor livestock holders and the country. Thus, improving livestock health has multiple benefits: improving income of livestock holders as well enhancing the performance of the factories operating in the downstream sectors.†††

Hence, development partners need to critically understand as to which constraint they are addressing at with their grants. Beyond this, they should offer the right size of grants (incentives) that would trigger investments on the required market systems.

This would take us into a proper application of some risk based incentive mechanisms for catalysing private investments. In turn, this leads into the issue of optimal level of grants beyond which will be a subsidy. In this regard, what are the international best practices? Can these be adopted in Ethiopia? If not, what other mechanism(s) can we use? I will touch these in my next article.


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