Is it Coming to an End?
It has repeatedly been demonstrated that major international events have the ability to shift paradigms. The post-cold war period identified by the emergence of the United States as the sole super power with other regional hegemons roaming their localities pushed neoliberal policies to the forefront of intra and inter-state relations. With considerable external pressure to adhere to these neoliberal approaches along with the theory’s revamped academic acceptance worldwide, states jumped on board. Accordingly, opening up markets and export promotion became widely accepted approaches. The Coronavirus pandemic has, however, shown that the hectic international trade practices centered on import and export in a highly globalized world have left states, both developed and underdeveloped, a long way from self-sufficiency. EBR’s Ashenafi Endale looks into the impending rise of import substitution in a post-COVID-19 Ethiopia.
For Daniel Lemu, who runs men’s boutique on Tito Street around the Kazanchis area in Addis Ababa, holidays are not just a source of joy and happiness but also of huge sales that make a significant section of his profit. However, the last Easter broke that tradition. “We used to make our biggest sales during Easter. Our latest experience, however, indicates that this is no longer the reality,” says Daniel.
“Fears of an impending lockdown due to the Coronavirus pandemic weighed down on demand for clothes as consumers shifted their priority to food items. There was also no supply for almost a month and there is no alternative to substitute these items as local producers are banned from selling their products domestically,” Import dependent businesses could not get supply because containers stranded at Djibouti port could not reach the central market in Ethiopia as the government imposed strict regulations at custom stations in fear of the spread of the virus.
Industries, Wholesalers and retailers dependent on imported inputs have been left between a rock and a hard place as COVID-19 brought international trade to a standstill. Many factories that import raw materials from abroad have stopped production. Orders for Ethiopian products, particularly from the European market, have been cut sharply after many countries imposed lockdown.
The severity of the circumstances has left Ethiopia with no option but to allow manufacturers sell their products locally. “We have allowed fully-export oriented domestic industries to sell their products in the domestic market since they are not exporting. Even if we exported using cargos, most of our client countries were under lockdown,” said Abebe Abebayehu (PhD), Commissioner of Ethiopian Investment Commission. These former exporters include textile, garment and leather industries located inside and outside industrial parks. Despite the attractive domestic market, these businesses have been showered with numerous export promotion incentives so they can export 80Pct to 100pct of their outputs.
The World Bank identified international trade as the most affected economic segment by COVID-19. The pandemic has slowed global trade by reducing international travels and disrupting global value chains. ‘Sub-Saharan African countries are more vulnerable to the trade channel of transmission of COVID-19 on economic activity because of the region’s linkages with the global economy through exports of commodities and connectivity with China (including commodities and GVCs).’ The Bank urged developed countries to provide USD100 billion for SSA.
Especially Ethiopia, due to its policy of emphasizing export promotion over import substitution, has been heavily leaning on international trade for its daily economic activities ranging from consumption to mega projects and industries. Meanwhile, import substitution remained a missed opportunity in Ethiopia until Covid-19 came along. The pandemic has prompted countries to look inward and take a second look at the interconnected global economy.
Over the last five years, Ethiopia imported an average of USD20.5 billion worth of goods and services annually while its export was USD7.7 billion during the same period. Capital goods constitute 33.3Pct of the total USD15.1 billion imports of goods during 2018/19, of which industrial equipment constitute 70Pct. The National Bank of Ethiopia indicated that 25.9pct of the total import is from China while it is followed by the USA that makes up nine percent.
Ethiopia also imported consumer goods worth USD4.3 billion, 24.4Pct of which is pharmaceuticals while the share of food items is 18.6Pct. This is excluding the contraband import that is not registered at customs. In the meantime, output from domestic industries is far from matching the rising demands. Industries have been utilizing below 50Pct of their capacity across sectors over the last couple of years due to the absence of raw material, shortage of foreign currency, power interruptions, bureaucracy, lack of operational capital and political instability.
Currently, for instance, 17 of 89 industries in the metal, engineering, and electronic sector are closed while the rest are operating under shift with low output due to COVID-19, according to Fite Bekele, Communications Director of Metal Industry Development Institute (MIDI). “This is devastating,” he says. All the economic pockets Ethiopia has been relying on such as import, export, FDI, remittance and tourism drifted away when the pandemic made a landfall in the country.
The second most populous country in Africa with over 100 million people doesn’t have sufficient production domestically, despite robust potential to change things around. The declining international trade during the pandemic has hit hard developing countries like Ethiopia that have been pursuing export promotion strategy, sidelining the need for import substitution. “Ethiopia would be devastated, if Djibouti declared total lockdown let alone the rest of the world,” said Birhanu Gizaw (PhD), Senior Industrial Engineer at Addis Ababa Institute of Technology.
Import Substitution In the Face of Coronavirus
States took lessons from the Great Depression, Second World War, and the 2008 economic crises, all of which pushed them to adopt inward looking economic policies including import substitution industrialization (ISI). Import substitution starts from producing consumer goods locally and finalizes by establishing heavy industries. State protection of local industries against flooding of imported cheap products is also another requirement to pursue ISI.
Import substitution is largely a post second world war phenomenon that is also related with the end of colonialism in Africa in the 1960s. Colonial powers refrained from installing industries in Africa as they viewed it as a source of raw material and market for their manufactured products. The legacy has been kept alive by neoliberals under globalization. Some countries like Tanzania, Zambia and Nigeria explicitly introduced import substitution policies in the 1960s. However, their failure to replicate the success of Latin American and Asian countries is still up for debate and research. Many developing countries, at their early stage of development, adopted import substitution policies in order to improve standards of living and enhance output growth.
Globally, however, most of the countries that started import substitution industrialization in the 1960s gradually became competitive globally after addressing their domestic market, championing the strategy as a nationalist capitalist model of development. For instance, China still provides protection for domestic businesses even after joining the WTO. Other developing countries in Asia also adopted the same strategy in order to free themselves from the influence of industrialized countries and pave the way for efficiency gains based on local technological development.
Shortage of forex is also another pushing factor for countries to adopt import substitution, which is seen as a strategy to narrow trade gap by encouraging domestic production. Although doing so had not been simple because of technological constraints and limited supply of strategic resources, it remained as a tool to reduce reliance on global trade and protect the domestic economy.
With the Coronavirus disrupting global economic activities, import substitution is once again becoming a hot button issue amongst scholars, politicians and policy makers. In fact, experts argue that the outbreak is likely to have a lasting impact on global trade activities.
Coupled with other trends that were already undermining globalization, the pandemic has led to the fragmentation of international supply chains while limiting the mobility of global business travelers. While this is a big win for nationalists who favor more protectionist policies, it also exposed the risk of dependency by underscoring the pitfalls of China as the dominant global manufacturer.
Import substitution, hence, is believed to be instrumental in reducing dependence on markets abroad through local production of goods, especially basic necessities. For instance, India’s government tightened its policy on foreign direct investment (FDI) in order to prevent “opportunistic takeovers” of local companies and protect the domestic economy from foreign competition in the face of Coronavirus driven economic crisis.
“We will see a further retreat from hyper globalization, as citizens look to national governments to protect them and as states and firms seek to reduce future vulnerabilities,” said Stephen M. Walt, an American professor of international affairs at Harvard University.
Nonetheless, even though looking inward may seem as the best tool to conserve foreign exchange, it does not always yield positive out-come. Countries that practice import substitution may end up adopting trade protection policies and overvalued currency, which would result in a surge in domestic prices and a decline in export.
Where is Ethiopia?
Import substitution is not new to Ethiopia. As the forex crisis that the nation has been facing stems from its high import bills, there have been many half-hearted attempts to make the country self-reliant. The country still imports from toothpicks to wheat and refined petroleum products. Familiarization of customers with these products generates more demand, in turn creating a huge demand for forex and depreciating the birr. Mustering one of the lowest forex reserves that do not even cover a month of imports, the country’s heavy utilization of imported products has resulted in a dearth in external reserves.
Excessive import also killed the country’s manufacturing industry by flushing the market with cheap imports that could have been produced locally. A better performing manufacturing sector with growing contribution to GDP would also pave the way for more people to get employment. By embracing export promotion before a significant import substitution scheme came to maturity, Ethiopia abandoned its domestic businesses with barely any nurture and protection. Especially, Horn of African countries, as many new emerging economies of the post 1980s, gave little attention to import substitution due to the dominating ‘Washington consensus’ prescription.
Ethiopia’s intensive export promotion policy put manufacturers in a precarious position as the primary fell on generating forex than raising productivity internally. Mohamad Yusuf, CEO of Addis-Modjo Edible oil Factory, attests. “Raw materials like sesame are exported for higher prices. If we were to buy at that price and produce edible oil, the overhead cost and end price would double, rendering the product unaffordable for the average population,” says Mohammed. “Government also subsidized the import of substandard palm oil for cheap; this has given monopoly for few handpicked companies. The whole situation killed the domestic industries.”
Isaysas Kebede, CEO of Ethio-Agriceft, says Ethiopia must first focus on self-sufficiency through agricultural modernization to address food security. He pointed out: “Especially at a time when the world is under pressure from COVID-19, it is nearly impossible to receive aid and support from the international community. We must create systems and technologies that make us self-sufficient at any time.” Agriculture has not been modernized to produce surplus so that it can address consumption and feed industries. The industries established under the two Growth and Transformation Plans (GTPs) are, therefore, heavily reliant on imported raw materials. The paradox here is that Ethiopia does not have industries for surplus commodities like sesame and coffee while there are industries for scarce commodities like cotton. For years, Ethiopia has been exporting raw oilseeds and importing unhealthy palm oil.
Industries, especially industrial parks, are idle either due to lack of inputs or the foreign currency to import them. This grave failure is a result of resource and capital misallocation. Four agro-industry parks have already been established with more in the pipeline. A number of edible oil companies have joined the parks with plans to import the crude and refine it here. A local edible oil company owned by the renowned businessman, Belayneh Kinde, is also expected to start producing edible oil this year using domestic raw materials. The federal government has also started a scheme to produce wheat in lowland parts of the country. This is expected to save the half a billion dollars spent to procure wheat from abroad every year.
For Birhanu, Ethiopia remains net importer mainly due to lack of basic survival insights. Sharing his experience with Jima and Addis Ababa universities, he explained about the methods he used to locally manufacture medical equipment such as portable X-ray, sterilizer, thermometer, ventilators, those for blood test and many types of equipment essential for every clinic and hospital to treat COVID-19. “It is really simple to locally produce these equipment imported by the government for huge sums of foreign currency. I also proposed to make many types of equipment needed to fight COVID-19,” he says. Birhanu sadly explained that the ETB30 million loan the Development Bank of Ethiopia promised him after impressing the universities has been revoked as the bank claimed to have not found sufficient grounds for profit making. He further noted that the problem is similar in large and heavy industries that make up the second tier in import substitution industrialization, next to agriculture.
Mathewos Asele, CEO of Kaliti Metal Factory, notes that the absence of focus on import substitution has been felt long before COVID-19. Kalitit Metal Factors produces spare parts and assembles trucks besides producing construction and agricultural materials. “We can import billet and process it here but the imported products are cheaper. We tried to export locally made metal products to neighboring markets but our prices could not be competitive because we import the raw material and process it here, which escalates our cost of production,” he says.
Tilahun Abay, Planning Director of the Metal Industry Development Institute (MIDI), says the metal and metal products sector is the most affected sector due to absence of import substitution policy. “We imported basic metals, engineering products, electronics and machineries worth USD50 billion over the last decade alone. Without metal and chemical industries that make up its backbone, an economy cannot be broad based and sustainable,” he says.
Experts in the sector indicate that the two main methods of iron use in Ethiopia call for local iron ore extraction and processing imported iron ore locally. The latter is considered more viable to build capacity before going to local extraction. Tilahun suggested the government consider both in the ten years Homegrown Economic Strategy. Currently, a South Korean company is undertaking feasibility study for importing and processing iron ore in addition to assessment for extraction, which involved AAU and other governmental institutions.
Tilahun further noted that the government must mobilize the resources at its disposal along with joint ventures with the private sector and FDI to establish a heavy industry. He is adamant that it is only then that Ethiopia can replace the huge foreign currency going to import. He also noted that domestic industries also need protection in order to substitute import, pointing out that mobile assemblers and roof sheet producers are almost leaving the industry due to cheap and substandard products that are being distributed by contrabandists.
Ethiopia’s industrialization efforts in the contemporary economy can be seen from the perspectives of policy making, implementing institutional capacity and industry-market nexus. The Agricultural Development Led Industrialization strategy Ethiopia introduced in 1993 has been an overarching guide. It focused on modernizing and transforming the agriculture so it can provide surplus production. The first GTP was launched in 2010 to use agricultural surplus production as an input to the industrial sector. Accordingly, emphasis was given to textile, garment, apparel and leather. The GTP editions, which targeted achieving middle income status by 2025, primarily targeted boosting exports of these items. However, Ethiopia’s average share of imports to GDP over the decade stood at 27.4pct while export lagged at 10.7Pct.
“Relying on global trade might be recommended when the importing country wants to dismantle and assemble in order to imitate and copy a new technology as a way of knowledge transfer by reverse engineering. But importing that product all the time shows lack of policy direction,” remarked Birhanu. “For instance, none of the advisors around the PM and leaders of the country have technology background. Creativity cannot emerge where everything is politicized,” added Birhanu.
The core assumptions of Ethiopia’s 2002 Industrial Development Strategy (IDS) are upholding free market and limiting government support for domestic industry to help them become internationally competitive. ADLI, IDS and the GTPs focus on capitalizing on labor intensive industries with the aim of making Ethiopia competitive in the international market using cheap labor as comparative advantage.
The strategic directions of the manufacturing sub-sector during GTP two are ‘laying the basis for structural change; building labor-intensive light manufacturing industries that are globally competitive in terms of productivity, quality and price; transforming the medium and large manufacturing industries so that they become a reliable source of foreign exchange; and building the industrial engineering and technological capacity of the country.’ The objective was making Ethiopia the leading light industries manufacturing hub in Africa and among the leading countries on the globe by 2025. The share of manufacturing to GDP was planned to reach 18pct by 2025.
However, it overlooked the fact that the growing domestic demand indirectly flamed imports and stripped domestic industries off the protection they need. Even worse, the export primarily included raw agricultural commodities neglecting domestic value addition. In addition to the failure of domestic exporters to compete internationally, the strategy is also exposed to international price fluctuations, trade wars and unexpected scenarios like Covid-19.
Two fundamental industrial policy making flaws and why ADLI, IDS and the GTP editions failed
The first fact is that Ethiopia fulfils the criteria of ‘import substitution strategy’ rather than ‘export promotion’. The large population, growing market size and emerging middle class consumer should be ideal for domestic industries. A bulging demand cannot always be addressed by imports. This approach depicts Ethiopia as a country suitable for import substitution with potential to gradually become exporter after addressing domestic demand. Secondly, embracing the notion of free market just to appease western political allies and donors has severely exposed domestic industries to cheap imports and contraband. Ethiopia is almost net importer as it has no industrial output to export in exchange. OECD countries only buy organic agricultural products and raw materials from Ethiopia.
The only advantage Ethiopia gains through the export promotion strategy is that it can benefit from cheap labor and FDI. Particularly light Chinese industries that seek to combine the two would be attracted through the approach. There is no viable justification for Ethiopia to adopt export promotion approach except the need for foreign currency. As has been proven so far, the foreign currency contribution of the approach is insignificant. Every incentive to draw investment and boost exports, including developing state of the art industrial parks under heavy debt, is geared towards generating foreign currency. However, that is not a lasting solution for the country’s demands. Foreign currency shortages can be addressed through the use of other sources like remittance and tools like adopting floating foreign currency regime. However, ignoring import substitution does little, if anything, to boost access to foreign currency as empirical evidence suggests.
Of course the ‘Washington consensus institutions (IMF, WB) argue developing countries would have been better developed, had they fully adopted the neoliberal policy prescription rather than wrestling with it. However, evidence suggests that the policy misjudgment of these institutions was the reason behind the Asian currency crisis of 1997, the Argentine economic crisis of 1999 and Malawi’s bad experience with agricultural subsidies, according to a research titled ‘Does ISI hurt growth?: new evidence from Brazil and South Africa, by Aregbeshola R. Adewale published on 2012.
“Ethiopia learned much especially over the last 20 years. The dilemma of which one of the Asians or neoliberals to emulate comes now and then. What we need most is stop debating and take action on the ground. At least Ethiopia should not import cereals, edible oil and processed food,” argues Demese Chaniyalew (PhD), a repeatedly published author on ISI who tried to correct government policy directions to no avail.
Demese argues that there are two obstacles for experts to influence policy. “Experts who ask government to do the right thing are labeled political opposition but officials and advisors lack the expertise. Institutions established to promote industries also lack expertise and leadership quality,” he says. Secondly, he argues, there are external and internal forces that are purposely working systematically and in an institutionalized manner to make Ethiopia a net importer. “They do not want us to substitute locally because the import business is their livelihood. The Ethiopian government is always confused by wrong policy advisors who work on behalf of western governments and multinational companies. They want Africa for its raw material and dump their items,” he explains. He then underscored that COVID-19 is an alarming lesson for Ethiopia to shift towards import substitution after taking into consideration the failure of dependence on globalization.
Birhanu says Ethiopia’s Import substitution needs state protection because domestic industries invest millions, create jobs, add value and invest in infrastructure. On the Contrary, he argues, imports are not investments and they don’t add value. He also noted that domestic industries have high overhead cost; thus, their price cannot be as competitive as imported items. However, Birhanu noted, protection must be accorded with the state enforcing quality and competition standards domestically until they become competitive internationally. He cited Ethiopia’s bottled water sector as a good example.
Birhanu further pointed out that the government must prioritize strategic import substitution areas and direct its resources accordingly, learning from past mistakes. “The government invested a lot in sugar projects and many other mega projects at once. However, much of the projects are not even paying their debts yet, let alone augmenting productivity and replacing import. Import substitution could have been a success, had agriculture and basic industries like metal and chemicals been given the finance and attention provided to the indebted scheme of industrial parks,” he argues. He also identified livestock and crop agriculture as Ethiopia’s most competitive advantages. He pointed out that agriculture plays a pivotal role to maximize the benefit of light industries such as textile. As a sector the rest of the world including China is leaving for countries with cheap labor, analyzes Birhanu, surplus production in cotton can help Ethiopia capitalize on this global opportunity.
However, Endalkachew Sime, deputy Commissioner of the National Planning Commission (NPC) argues increasing the share of manufacturing to GDP, creating middle income population and improving the purchasing power of the people are critical to pursue import substitution. He noted that it is also equally important to stimulate the economy and accumulate capital through FDI.
However, Birhanu insists, pursuing IS post-COVID-19 is unlikely. In his opinion, Sub-Saharan Africa in general and Ethiopia in particular are further falling into the hands of the Washington consensus institutions through donations made by developed countries to fight the pandemic. His argument is that the current engagement might prove to be powerful enough to keep imposing neoliberalism on to developing countries, detaching them from ISI. Ethiopia’s ongoing negotiation for WTO and CFTA accession is also another reason he raised that might make it difficult to pursue ISI. This is why Birhanu says import substitution is now or never.
If the country has to survive current and future global economic crises, notes Birhanu, the government must act on local self-sufficiency. “This needs government policy shift and working with the universities and the private sector. Otherwise, the country remains an importer, which is a non-stop firefighting mission,” he concludes.EBR
9th Year • May.16 – Jun.15 2020 • No. 86