Financing Agriculture for Sustainable Structural Transformation

Structural transformation requires long-term investment to expand productive capacities, as well as infrastructure development that underpins industrial activities and reduces systemic bottlenecks. Rapid transformative growth will also require a relevant and context-based development strategy.

Three decades ago, the Ethiopian government devised an agricultural-led industrial development strategy, with the aim to boost economic growth and to foster food security. Although many experts in the field have repeatedly criticized the move stating that it is difficult to realize a sustainable economic development through fragmented land, however, there is no doubt that in the current context of Ethiopia, agricultural policy is a viable option. This is mainly due to the fact that more than three-quarters of the population is living in rural areas and agriculture is a major source of livelihood, foreign exchange earnings are mainly dependent on agricultural product exports.

With these in mind, it is hard to imagine that Ethiopia should have had an alternative policy option at the time other than the pro-agriculture strategy. The experience of other countries also shows that success in agricultural transformation laid the foundation for industrial sector expansion. It has been said that the successful Asian economies followed a similar path. Japan in the 19th century, Korea in the 20th century, and China in the 21st century all followed agricultural-driven industry growth strategy. As the industry expands, it not only provides a market for raw materials and foods but also supplies improved inputs crucial for agricultural growth. A growing agriculture also helps to expand the industry supplying food and raw materials, as well as finance for investment and markets.

With this in mind, the government invested a substantial share of the national budget on agriculture in the 2000s in promoting sustainable agricultural production, improving food security, and reducing poverty. Ethiopia, along with a few other countries, has done better in delivering the promise of investing at least 10Pct of the total national budget in agriculture as agreed in the Comprehensive Africa Agriculture Development Program (CAADP) commitments. However, this could not be sustainable. According to a recent report, Rwanda is the only country that fulfills Africa’s agriculture plan, which is outlined in the Malabo Declaration. Although agriculture plays an important role in many developing countries, including Ethiopia, per capita spending on agriculture and the share of public expenditure to agricultural GDP is low. In his recent speech to the parliament, Prime Minister Abiy Ahmed (PhD) cited the fact that among the loans allocated to major sectors of the economy, the smallest beneficiary is agriculture.

Following state-led substantial spending on agriculture in the late 1990s, total production of all crops in Ethiopia increased substantially. This sharp national production increase was exclusively driven by area expansion (extensification) in response to liberalization and improved inputs prices strategies. The second growth episode occurred during the 2000s and this was tied to production increases arising from both area expansion and yield improvement (intensification). The most visible growth in this time has taken place in maize and wheat cultivation due to the widespread adoption of new varieties and suitable agronomic practices in the potential surroundings.

However, there are various indications that Ethiopia’s implementation has significantly deviated from the Asian strategy. Above all, investment in research and development (R&D) is very limited in Ethiopia. To radically transform Ethiopia’s agriculture, it is imperative to invest in developing and diffusing agricultural innovations that raise productivity in the face of population growth, locust invasions, and climate shocks; the major challenges that threaten agricultural production.

The Asians’ best practices experience in designing context-specific policies is a reminder to nations like Ethiopia to learn lessons from history. One of the key elements in the Asians’ policy formula is strict control of finance allocated for developing agricultural and industrial sectors. The lesson is to focus on financing the two main pillars of the economy. Apparently aware of this, Hailemariam Desalegn, former Prime Minister of Ethiopia, was once heard saying, “We will follow a strict direction as a key incentive to finance manufacturing and agricultural entrepreneurs who contribute more to economic development than the gum and candy importers.” But his speech did not seem to have materialized during his tenure. Overall, the government should tighten its financial controls and direct these resources towards the financing of investments that have a huge impact on national economic development. We have learned from history that strict financial control is needed to encourage the long-term competitiveness of the private sector in manufacturing.

The anticipated structural transformation towards an industrial-led economy is not yet successful in Ethiopia after three decades of implementation. There are several reasons to mention regarding this failure. Above all, it is a well-known fact that agricultural development, which laid the foundation for industrial development, has not materialized. A good example is that the country is unable to meet domestic food demand using its own production despite several years of agricultural-led development experiences. Thus far, the government has been investing hard currency to import wheat and other foodstuffs to control surging food inflation caused mainly by shortages and supply chain disruptions. Moreover, the Central Statistical Agency (CSA) reported that current food inflation reached above 41Pct. Similarly, it should also be noted that the raw materials used for the textile and other agro-processing industries are sourced from imports.

Ethiopia is striving to realize its vision of becoming Africa’s leading manufacturing hub by 2025. To this end, agro-processing industries are promising to achieve structural transformation. Agro-processing-industry development immensely contributes to job creation, accelerates rural development, and in the substitution of imports through domestic production. Agro-processing is the practice of converting major agricultural products into semi-finished products and adding value to the finished product. To this end, the development of Integrated Agro-Industrial Parks (IAIPs) is prioritized in various potential areas of the country to create strong linkages between agriculture and industrial sectors. This opportunity is believed to create enabling conditions for consistent supply of food and raw materials by integrating value chain actors. Accordingly, the expansion of agro-processing industries is believed to play a key role in achieving Ethiopia’s transformation agenda. In addition, agro-processing development has a direct impact on the lives of the poor by increasing employment opportunities and creating market access for agricultural products.

Although there has been significant progress in the development of agro-processing industries in Ethiopia, the sector has faced many challenges at this early stage of development. Many studies indicate that industrial development in many African countries is hampered by a number of institutional bottlenecks, particularly associated with the lack of consistent supply of raw materials and development financing. It has been widely reported in the media that agro-processing operators in Ethiopia often face the problem of producing below capacity due to lack of quality raw materials.

One of the major constraints might be the weak linkage between agro-processor industries and smallholder farmers. The knowledge of farmers in producing better-quality raw materials so as to take advantage of the expanding agro-processing sub-sector is very limited. As a result, there is limited or no incentive for farmers to invest in high quality agricultural inputs, or to increase their productivity with the adoption of suitable agricultural technologies and practices to produce high quality raw material for the industry. In addition, brokers are involved in the exchange process without adding any value, which plays an important role in the inefficiency of the supply chain.

As the shortage of raw materials in Ethiopia is a major stumbling block for many industries, business operators need to consider alternative and sustainable solutions to ensure sustainable and uninterrupted supply of raw materials. For example, major supermarket chains and agricultural companies in Europe and the United States produce high-quality agricultural products by farming on their own (vertical integration) or rely on contract farmers to buy directly (vertical coordination). Agribusiness companies and farmers enter into a contractual agreement to ensure the supply of high-quality products are delivered to the consumer consistently without interruption. This practice of agricultural production involves agreement between a buyer and farmers, i.e., contract farming.

The growing interest in contract farming is associated with recent transformations in food and agricultural systems which make it increasingly difficult to meet consumer demands under the usual open market-based procurement strategies. At the heart of contract farming (CF) there is an agreement between farmers and buyers of agricultural products: both agree in advance on the terms and conditions for the production and marketing of farm products. These conditions usually describe the price paid to the farmer, the quantity and quality of the product that the buyer wants, and the date on which the product will be delivered to the buyers. In addition, the contract might include more detailed information on how the production will be carried out (a need for supervision by the buyer) or if inputs such as seeds, fertilizer, and technical advice are provided by the buyer.

However, there are different views regarding farmers’ involvement in contract farming. On the one hand, political economists explain it as an arrangement that exacerbates existing inequality problems in the farming sector. On the other hand, institutional economists emphasize the role played by contract farming in resolving market imperfection problems. Hence, it helps small-scale farmers in overcoming the challenges of higher transaction costs that deter their market participation. A transparent and binding contractual arrangement that includes farmers’ preferred contract design attributes is necessary for both contracting parties to honor the terms and conditions of the contracts and to control the opportunism behavior of the contracting parties.

In fact, there are some efforts of contract farming arrangements in Ethiopia, but it is incomplete from a legal point of view. Evidence indicated that the Ethiopian Ministry of Agriculture (MoA) is working to finalize the preparation of a ‘Contract Farming Proclamation’ to initiate an out-growers scheme in Ethiopia. Benefiting from the new approach, smallholder farmers can aggregate their lands in clusters and supply the desired quality of raw materials (as stipulated in the contract farming agreement) for the agro-processing industries without interruption. This enhances agricultural commercialization and enables farmers to earn more income.

Access to better-quality inputs, credits, and market information systems (extension services) in a competitive market are crucial to boost agricultural productivity. With population numbers booming in Ethiopia, mechanized agriculture can also make the sector more attractive to the youth, according to studies, in contrast to the assumption that agricultural mechanization reduces employment. Overall, smallholder agriculture is characterized by low productivity which has been linked to the limited use of technologies for a number of reasons. The rate of improved seed-fertilizer technologies adoption is far below the regional average. The government initially liberalized the fertilizer sector in 1991. Unfortunately, the private sector exited the fertilizer market within a few years of its entry and the share of private sector operation in the market went to none in 1999 and totally replaced by state monopoly in importing and distribution. Current fertilizer prices might force farmers to reduce their use even further than they used to. Lack of access to finance is the other challenging factor that deter farmers from investing in these beneficial improved seed-fertilizer technologies.

Access to financial inclusion is critical for agricultural development. Farmers’ organizations could overcome the supply challenges and providing support should make these enterprises sustainably competitive. Hence, financial institutions should provide innovative financial products and services to capacitate farmers. Banks, for instance, in collaboration with local microfinance institutions, can provide investment financing for farmers’ organizations that rely on machine-based production systems and irrigation techniques and are commercially tied with the agro-processing industries. Overall, establishing an effective agricultural input sector and rural financial system should be a priority to realize agricultural development by drawing lessons from the experience of others in enabling farmers to benefit from a larger choice of better-quality services. Only in this way can agro-processing industries alleviate the chronic shortage of raw materials supply in a sustainable manner and the anticipated transformation be achievable.

10th Year • Apr 2022 • No. 106


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