Structural Transformation of the Ethiopian Economy

A Population Growth Perspective

In the past, Ethiopia has experienced different defining moments that have allowed it to survive for thousand years. One moment, for instance, was the war against colonialist Italy during the second half of the nineteenth century, which culminated 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 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 sectors, 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 unbalanced territorial concentration of productive activities created primarily by rapid population growth throughout the country.
The country’s population has doubled since the early 1970s under conditions of a subsistence economy. It is now the second-most populous in Africa, with more than 90 million people. According the Central Statistical Agency, under the most optimistic low fertility scenario the population size is projected to increase to 137 million by 2037. This is an increase of 45million people with an average growth rate of 2.2Pct per annum, which means the population is increasing by about two million per year.
A rate this rapid will be burdensome for the country, as it makes crucial infrastructure (e.g., schools, hospitals, housing, roads) and resources (e.g., food, water, electricity) more scarce. Population growth has created not only gaps in the material well-being of the people; it has also created a fragmented economy.
Generally speaking, employment creation is done through the de-accumulation of assets or resources. In rural Ethiopia, output expansion and employment creation for the surplus labour that is created by 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 an input while other inputs remain constant. Not only is there low agricultural productivity, the principle of economies of scale is not applicable in a rural economy since it is not possible to increase all inputs in proportion. 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 create 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 has 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, averaging over 10Pct per year between 2003/04 and 2013/14. The expansion the services and agricultural sectors account for most of this growth, while manufacturing sector performance was relatively modest. Since 2004 the service sector accelerated and has overtaken agriculture as the largest in terms of output.
Real gross value added increased from ETB184 billion in 1999 to ETB571 billion in 2013. Services contributed to half of output growth during this period (50.2Pct), while agriculture contributed 35.2Pct. Industry, which apart from manufacturing also includes construction and utilities, contributed about 14.5Pct to growth, according to the World Bank’s Policy Research Working Paper released in 2014. This shows that structural change in Ethiopia did not follow the desired path of expanding the share of its small manufacturing sector. What’s more, the agriculture sector still employs more than three-quarters of all workers.
There are studies that attempt to interpret the country’s economic growth and structural transformation. At the macro level there are structural change studies in relation to 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.
Structural change is also discussed in relation to the analysis of intra-sector productivity growth. There are studies, such as the one conducted by Fantu Nisrane Bachewe, a researcher at the International Food Policy Research Institute, which document aspects of growth in the agriculture, manufacturing and service sectors. These studies discuss the sources of growth in the respective sectors and suggest policy adjustments to sustain growth in the sectors. As opposed to pure intra-sector productivity growth, there are also productivity growth studies reflecting sectoral shift and composition effects.
The results of 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 sectors and the expansion of the service sector are considered positive signs of meaningful structural change taking place in the country.
I have a different interpretation of the growth accounting results of the above studies. To begin with, the productivity growth models of the studies are based on officially registered data resulted from market exchange. The rural and urban informal economy (non-farm sector, subsistence production, non-farm activities and informal economy) that were created as a response to population growth pressure are missing from the official data, thus making it difficult to interpret structural transformation patterns of the country.
My own micro-level studies show that productivity growth within sectors is not the result of economies of scale in production, research and technological development. It is related to hard work, labour and management skill to improve efficiency under the pressures and threats of diminished per capita income, caused by a higher household dependency rate and density ratios and migration. In rural areas, output resulting from changes in total factor productivity is linked to allocative efficiency, not to technical efficiency.
Thus, my view is that the transfer of labour from agriculture and manufacturing to service sector is not the result of 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 compared to agriculture, it cannot absorb the growing surplus labour if it is 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 type of 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 tend to slow down.
Baumol’s cost disease – or the Baumol effect – is a phenomenon 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 of labour productivity, in response to rising salaries in other jobs that have experienced the 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 sector (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.
In the absence of growth mechanisms whereby a growing population increases the productivity with which factors are used, structural transformation is trapped in 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 economic scale, since scale is a function of division of labour and technological experience. Diminishing returns and dysfunction in scale brings no output growth.
Certainly, rapid population growth leads to a lower productive structural trap. To combat these adverse effects, it needs to be accompanied by technological, institutional (rules, regulations, property and market) and policy changes (incentives and disincentives).

4th Year • August 16 2016 – September 15 2016 • No. 42