Will ‘New’ Value Addition

Will ‘New’ Value Addition Formula Help Manufacturing?

Value addition refers to a process whereby manufacturers make a product more useful or sophisticated for consumers. These goods earn more money in the market – an appealing prospect for developing countries looking to increase revenue and develop their economies. A key factor in assessing value addition is the manufacturing data itself and the formula used to calculate it. In Ethiopia, however, a new metric has been proposed to determine value addition among industries. This has many manufacturers up in arms over the decision. The government, however, thinks it will be useful and ultimately quell corruption in the private sector. EBR’s Ashenafi Endale spoke with key stakeholders to learn more about the issue’s complexity and the on-going debate surrounding it.

The history of economic development demonstrates that the growth of an economy often goes hand in hand with the degree and level of manufacturing. Countries like the United States – and more recently India and the East Asian Tigers – all amassed great wealth because of robust, export-oriented industries. The powerful performance of these nations has hinged largely on value addition – the process by which products are made more useful or sophisticated before they are sold, boosting revenues and raising average earnings per input.
This is crucial because manufacturing involves the transformation of raw materials and substances into new products. Although the transformation could be physical or chemical, the experiences of industrialised nations demonstrates that the success of the manufacturing sector lies in its efficiency and capacity to add value to raw materials that are derived from agriculture, forestry, mining and the manufacturing sector itself.
Despite this, Ethiopia’s sector is dominated by assembly and labour-intensive large and medium consumer goods, industries that add little value.
One such company is Tecno Mobile Ethiopia, which is engaged in manufacturing by assembling iTel and Tecno mobile brands. The company began operating four years ago in its factory in Addis Ababa. The factory has five production lines: 35 young Ethiopians work on each, while Chinese professionals are responsible for management. With the exception of the labour and some applications developed locally, the company assembles parts imported from abroad.
Manufacturing was first established in Ethiopia in the modern sense of the term in the early 20th century. Yet, the Manufacturing Value Added (MVA) as percentage of gross domestic product (GDP) has remained stagnant.
Data obtained from the World Bank testifies to this fact. Since 2008, the MVA as percentage of GDP, which is the net output of a sector after adding up all outputs and subtracting intermediate inputs, remained at 4Pct. This figure is lower than the decade preceding 2008, when the country’s MVA per GDP fluctuated between 5-8Pct, according to the data. Ethiopia’s performance is well below manufacturing giant China, which registered 36Pct in 2015.
MVA per GDP indicates the size of the manufacturing sector relative to the overall economy. Of its contribution locally, nearly 38Pct of the value added by manufacturing industries to the national economy came from the food and beverages sub-sector, while 18.7Pct came from non-metallic mineral products, according to the Large and Medium Scale Manufacturing and Electricity Industries Survey released by the Central Statistical Agency (CSA) last year.
On the other hand, the chemicals and chemical products manufacturing industry contributed 9Pct; while the contribution of the rubber and plastic as well as the leather tanning and dressing industries stood at 7Pct each.
Ethiopia also lags behind in terms of the MVA per capita measurement, which indicates the size of the manufacturing sector relative to the population. According to the World Bank, the country remained at the bottom end of the scale in sub-Saharan Africa, with USD15 in 2012, which is well below the average of USD173.
According to the International Monetary Fund (IMF), MVA is a key way to gain an advantage in the global market; yet, many African countries don’t benefit, as harnessing value addition isn’t commonplace. According to their analysis, “fostering greater participation in such trade by developing economies is important. [Value addition] offers countries the opportunity to exploit their comparative advantages without having to develop vertically integrated industries that provide the producers of final goods with the intermediate inputs they need.”
For Ethiopia, this is an especially difficult potential to harness, since the manufacturing sector is plagued by deep-rooted structural challenges. “It is no secret that the sector lingers behind the targets set by the government, which limits the contribution of the sector to the national economy,” says Tadesse Haile, State Minister for Industry. “This is the result of many factors, including the unavailability of raw materials in the local market, lack of skilled manpower and power shortages.”
To help assess the state of a country’s value addition prospects, the IMF suggests that data collection and calculation are crucial. This also helps in developing capacity. However, they note that the collection and assessment of data itself is often a point of contention in developing countries.
In this regard, Ethiopia is no exception, as the government is reconfiguring the way it determines the value addition of manufacturing industries, which angers some stakeholders.
Industrialists say this will be detrimental to their enterprises and the sector as a whole. “Our company’s value addition stood at 24Pct when it started production,” says Genet Gebremariam, Assistant Production Manager at Tecno. “Our value addition now stands at 6Pct because of the new formula the government adopted.”
Indeed, the government changed the formula that is used to determine value addition in order to introduce a new directive that will govern duty-free import privileges for companies engaged in the manufacturing sector.
The formula, while not new by international standards, is different from the way the figure’s been computed locally up until now. The previous formula, which was adopted from the Common Market for Eastern and Southern Africa (COMESA), uses the cost of raw materials sourced locally in order to assess the amount of value addition by each industrial complex. In Ethiopia, however, manufacturers rely heavily on imported goods, so the change will mean that each individual manufacturer’s overall production costs and sale revenues will be determined to calculate value addition; these may differ significantly year-to-year based on a number of variables, including number of sales and import costs.
The draft directive sets a new range of value addition – 5Pct to 41Pct – that is required in order for manufacturers to receive duty-free import of inputs. It will also set specific value addition quotas for each sub-sector. For instance, for electronics, the sector to which Tecno Mobile belongs, more than 12Pct of value addition is needed to enjoy duty-free import privileges after three years.
According to stakeholders, the formula will limit companies’ ability to use their duty-free privileges and will likely affect their overall performance.
Tecno’s operations may be greatly hindered if they don’t meet the 12Pct minimum, as they rely entirely on imported goods. The factory has the capacity to produce up to 2,000 smartphones and 17,000 feature mobiles per day, with the two brands, according to Genet. “We make it a complete cell phone here, which comes as separate parts produced in China, by Tecno Group, the main company.”
The new standard is contrary to the previous requirement, based on the COMESA formula, which was set below 30Pct. Since it’s in its infancy, the electronics sub-sector received duty-free incentives with just 0.5Pct value addition.
But government officials believe the manufacturing sector, which relies heavily on imported goods, often to the exclusion of local raw materials, needs a new formula. A committee comprised of 11 government institutions was formed to decide the actual amount of value manufacturers should add. However, because of the short time given to the committee to finalise the study, the Ministry of Finance and Economic Cooperation (MoFEC) decided to use the data organised by the CSA, according to Solomon Yohannes, a committee member and Director of the Cement and Related Productions Directorate at the Chemical and Construction Industry Development Institute (CCIDI).
As a result, the new formula uses overhead cost and sales to determine value addition. According to the new method, the ‘value added’ is the amount left over after all material and overhead costs have been deducted from sales, leaving an amount for wages and social benefit.
Officials say that setting a higher bar for privileges under the new formula operates on the assumption that the sector will perform better over time. “As manufacturers’ efficiency increases and their overhead cost decreases, their value addition increases. The value addition is calculated by dividing the overhead cost to the sales, but now, there are some costs, like promotion and warehouse costs, that are not included,” said Solomon.
Some private sector representatives think the new metric is flawed and counterproductive. “First, the formula has nothing [to do with] the device produced; the calculation is not scientific. Second, we do not know [what variables] they used for the formula, because our percentage of value addition has been decreasing since we started,” says Genene Azene, head of the administrative and law department at Tecno Mobile. “The question should be ‘with how much money did [the company] start [manufacturing] and how much does it have now?’”
Government representatives believe otherwise. “We have prepared nine new standards to calculate the amount of value addition. However, we did not have time to collect data from manufacturers, because some of them are not willing to provide accurate data in a timely manner, so the committee decided to use the CSA data,” argues Anteneh Birhanu, Acting Director of the Soap, Paints and Related Products Industry Development Institute at the CCIDI.
Genene argues that assembly industries are still new and the standard to calculate value addition must be based on technology transfer and local input usage. To facilitate this, Tecno is currently building its own factory with USD26 million in the recently completed ICT village. “We are also planning to produce accessories and source all possible parts locally, but the new draft law is totally discouraging, which will dwarf the manufacturing sector and its contribution to the economy,” he said.
However, Solomon says improvements have been registered in recent years. ‘‘This is the result of the government commitment to uplift the sector,” he adds. Indeed, the CSA’s report indicates that the total value added by manufacturing industries has increased tremendously and reached ETB47 billion in 2013/14, up from ETB17 billion five years ago.
But industry players say in order to maintain this momentum, the government has to rework its algorithm. “Government must redefine value addition and set a clear standard. At this moment, ‘value addition’ is all about foreign currency,” argues Sintayehu Gebremariam, Acting Plant Manager of Zemili Paint Factory. “What about using local labour and inputs?”
Mengistu Regassa, administration head of the Bole Lemi Industrial Park, has a differing perspective. “In terms of actual value addition, most of the industries do very little, because they only cut and sew the imported material. But the value added amount might be large when it is calculated based on their import cost and their export revenue,” he says. Mengistu oversees the six foreign textile and garment companies that work in the Park. The draft directive estimates that the current value addition in the garment sub-sector is 15.5Pct and requires that this figure grow to 21.1Pct within three years.
The new requirement has become unbearable to some. “Government sees some companies profiting and it wants to play them out of the market by cutting the incentives. It is really disappointing,” stresses Amare Tefera (PhD), who manages an electronics assembly company that employs 100 workers. He says that his company plans to execute an expansion project worth USD3.5 million, but investors have backed away because of the directive.
Six months ago, together with 10 other assemblers in the electronics sub-sector, Amare presented a proposal to the Ministry of Science and Technology. “We agreed to prepare a new standard to calculate value addition in the electronics assembly sub-sector, especially considering components that can be produced locally. However, the Ministry of Industry brought up the new directive [suddenly].” He wonders why the government only looks at profit to calculate value addition.
Whatever the debate may be, economists note that once a metric and standard is adopted, the creation of a value added industrial sector will be key to Ethiopia’s success. In a report featured on the United Nations Development Programme’s website, Gabriel Negatu, Eastern Africa Regional Director for the African Development Bank, puts it succinctly:
“In this new production and trade reality…countries will now be able to integrate into the global value chain by specialising and offering specific… [valued added] products to an expanding global production network. This ‘new normal’ will open up a new and quicker route for African countries to capture a growing percentage of the global value chain. What now remains is to ensure that this new normal is effectively harnessed to underpin the continent’s transformation.”
To that end, government officials say part of the new directive centres on fighting corruption in the manufacturing sector to better harness its potential. Mohammed Muzeyin, Director of the Engineering Service Directorate at the MIDI, says the new directive will only award those who are serious about value addition. “In the past, duty-free privileges were severely abused,” he says.
The government has forgone ETB191.2 billion due to duty-free privileges over the last five years, most of which resulted from misuse, according to a study presented by Ethiopian Revenues and Customs Authority (ERCA) officials at a meeting held on January 23, 2016 in Adama. Officials from the Authority, the MoFEC, the Ethiopian Investment Commission and regional bureaus were also in attendance. Additionally, 202 companies imported raw materials worth ETB654 million through privileges they accessed using fictitious documents.
Ultimately, however, officials claim the draft directives have to do with equity and transparency. “These companies are abusing the privilege and create unfair wealth distribution among companies and citizens,” said Alebachew Nigussie, Deputy Director General of ERCA, during the meeting. “That is why we could not see the forgone amount translated to the intended development of the economy.” EBR

4th Year • February 16 2016 – March 15 2016 • No. 36

Ashenafi Endale

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