Structural Transformation of the Ethiopian Economy

A Population Growth Perspective

Ethiopia has experienced different defining moments that have allowed it to survive for thousands of years. One moment, for instance, was the war against colonialist Italy during the second half of the nineteenth century, culminating in the Battle of Adwa. Today, Ethiopia has to choose another defining moment to ensure the material well-being and unity of the people and the survival of its cultures: Embracing industrialisation-led structural transformation.

Historically, structural transformation has been understood as the transfer of labour and capital from traditional sectors – like agriculture – to the modern sectors of the economy – like manufacturing. In this article, structural transformation is defined not only as a shift between industries but also as an increase in labour productivity within sectors and changes in the location of economic activities (urbanisation) as well as demographic burdens (consumption requirements and saving capacity).

Economic growth arises not only through technological advancement but also via structural change. The experiences of developed countries demonstrate that the movement of labour and other resources from agriculture to industrialisation increases overall productivity and expands incomes.

Ethiopia needs such a transformation because it faces material scarcity, low labour productivity and an unbalanced territorial concentration of productive activities created primarily by rapid population growth.

The country’s population has tripled since the early 1970s under conditions of a subsistence economy. It is now the second-most populous in Africa, with more than 120 million people. The population will reach 145 million in 2030, 205 million in 2050, and 294 million in 2100.

This rapid rate will burden the country, making crucial infrastructure (e.g., schools, hospitals, housing, roads) and resources (e.g., food, water, and electricity) more scarce. Population growth has created not only gaps in the material well-being of the people but it has also created a fragmented economy.

Generally speaking, de-accumulating assets or resources will help create employment opportunities. In rural Ethiopia, output expansion and employment creation for the surplus labour resulting from rapid population growth are achieved mainly through land partition and redistribution, area expansion into fragile environments, share-cropping and farm wage labour.

Under conditions of a fragmented economy, more intensive use of land and labour inputs leads to diminishing returns. This means extra output decreases when we add additional doses of information while other inputs remain constant. Not only is there low agricultural productivity, but the principle of economies of scale is not applicable in a rural economy since it is impossible to increase all inputs proportionally. Scarcity and a low level of productivity, which is the difference between the actual output performance and the desired or necessary situation created by the growing population, require transformation – activities and industries that make new products.

The lack of the expansion of output in rural areas, the fragmentation of the economy and an increase in the size of surplus labour have created rapid migration-led urbanisation. This process is outpacing the financial and human resources available for managing it. As a result, the spatial effects of population growth need an urban development programme that provides job opportunities and affordable services.

According to official sources, the Ethiopian economy has experienced rapid economic growth since 2005. The expansion of the services and agricultural sectors accounted for most of this growth, while the manufacturing sector’s performance was relatively modest. Since 2004 the service sector has accelerated and has overtaken agriculture as the largest in terms of output.

According to the World Bank’s Policy Research Working Paper, structural change in Ethiopia needed to follow the desired path of expanding the share of its small manufacturing sector. Moreover, the agriculture sector still employs more than three-quarters of all workers in the two decades of rapid economic growth.

 Some studies attempt to interpret the country’s economic growth and structural transformation. At the macro level, there are structural change studies about the recent growth performance of the country. In 2014, the World Bank studied the sources of aggregate and sectoral growth to explain Ethiopia’s growth acceleration and how to sustain it. Public infrastructure investment and restrained government consumption were the key drivers of growth. Though that’s changed in some way in recent years, with the government trying to give more space for the private sector, the government is still a dominant actor in the economy.

Structural change is also discussed in the analysis of intra-sector productivity growth. Some studies, such as the one conducted by Fantu Nisrane Bachewe, a researcher at the International Food Policy Research Institute, document aspects of development in the agriculture, manufacturing and service sectors. These studies discuss the sources of growth in the respective industries and suggest policy adjustments to sustain growth in the sectors. As opposed to pure intra-sector productivity growth, productivity growth studies also reflect sectoral shift and composition effects.

These studies show that Ethiopia’s overall labour productivity growth in recent years has been driven by growth in individual sectors, while the inter-sectoral contribution (structural change) contributed to a third of the total labour productivity growth. Nonetheless, the increasing labour productivity within industries and the expansion of the service sector are considered positive signs of meaningful structural change in the country.

There is a different interpretation of the growth accounting results of the above studies. The productivity growth models of the studies are based on officially registered data resulting from market exchange. The rural and urban informal economies (non-farm sector, subsistence production, non-farm activities and informal economy) that were created as a response to population growth pressure should be included in the official data, thus making it challenging to interpret structural transformation patterns of the country.

My micro-level studies show that productivity growth within sectors differs from the result of economies of scale in production, research and technological development. It is related to hard work, labour and management skills to improve efficiency under the pressures and threats of diminished per capita income caused by a higher household dependency rate, density ratios, and migration. In rural areas, output resulting from changes in total factor productivity is linked to allocative efficiency rather than technical efficiency.

Thus, the transfer of labour from agriculture and manufacturing to the service sector is not the result of the sale of services (labour productivity and specialisation). It stems from desperate household responses to population pressure and massive government public investment. Even if the service sector is less land-intensive than agriculture, it cannot absorb the growing surplus labour if non-tradable.

Studies conducted on sub-Saharan African and Latin American countries show that the gain in productivity from the service sector is less than that which would have occurred from a shift to industry. Such structural change is considered a burden in the form of ‘Baumol’s disease’. As the share of the service sector increases, aggregate per capita growth will slow down.

Baumol’s cost disease – or the Baumol effect – was first described by William J. Baumol and William G. Bowen in the 1960s. It involves the rise of salaries in jobs that have experienced no increase in labour productivity in response to rising wages in other jobs that have experienced labour productivity growth.

According to these experts, the pattern of structural change in Ethiopia, the shift of labour from a low-productive sector (agriculture) to a higher productive industry (services), can be described as “static gains at the expense of dynamic losses”. I also see the current structural transformation in Ethiopia as being trapped at a lower productivity level due to high scarcity effects caused by population growth.

Without growth mechanisms whereby a growing population increases productivity, the structural transformation will be a challenge in a self-reinforcing process of lower-productivity activities: high consumption, low investment, low human capital development, low labour productivity, annual population growth and massive scarcity.

Rapid population growth creates dysfunction in economies of scale and product differentiation. In the case of input growth, it creates diminishing returns, while vis-a-vis total factor productivity; it creates dysfunction in the economic scale since the scale is a function of the division of labour and technological experience. Diminishing returns and dysfunction in scale bring no output growth.

Indeed, rapid population growth leads to a lower productive structural trap. So if we want to address this trap, we must use technological, institutional (rules, regulations, property and market) and policy changes (incentives and disincentives).

11th Year • August 2023 • No. 120 EBR