Structural Transformation

Introduction

Structural transformation is a necessary precondition for both social and economic development. From historical perspectives, many economies were able to rapidly raise societal welfare and living standards by reallocating resources from subsistence agriculture to modern manufacturing and service sectors. SET does not only stimulate growth, but also, it can lead to accelerate its pace, pattern of growth in developing countries, like Ethiopia. In this chapter, I explore the pattern of structural changes in sectoral composition that characterizes the dynamics of structural change and economic growth of Ethiopia.

Little is known about the pace and patterns of structural transformation and its effects on economic growth of Ethiopia. Because of this and the process of SET is continuing throughout development, it is desirable to document its properties using relatively long time series for individual least developed country like Ethiopia.

To achieve the purpose, I apply a decomposition model and a dynamic causal relationship between the agricultural sector and economic growth using the bounds testing (ARDL) approach to co-integration for the period from 1981 to 20018 to identify the existence of long-run and dynamic short-run inter-sectoral linkages among different sectors in the economies.

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In order to understand the pace, pattern and the relationship between structural change and economic growth, relative importance of agriculture, industry, and services in Ethiopian economies, I compared the performance of Ethiopia with some selected African and East Asian economies. In the analysis an emphasis has given to core strategies of ADLI and its effectiveness in stimulating the pattern and structural changes of Ethiopia compared to some selected countries of Africa and East Asia.

The rest of the chapter is organized as follows: The first section presents the pace and patterns of ST of Ethiopia's economy by focusing on its dynamic evolution and overall performance in comparative perspective, the role of public policies in promoting structural change in Ethiopia and the future outlook. The second section focuses on the role of SET and its effects on economic growth, the current state labor productivity growth in Ethiopia and the structural impediments currently slowing the rate of progress. The Third section examines the determinants of SET of Ethiopia with a special focus on role of policy reforms. Finally, it presents summery and conclusion of the chapter.

Pace and patterns of structural Transformation

The dynamics of Economic Evolution and Its Structural change

Modern political economic history of Ethiopia can be characterized by several radical policy changes and blows. The pre 1974 was a period of Monarchical rule, mainly known to be a feudal economic system. The monarchic regime (1950-1974) oversaw a complex land tenure system, the state and church maintained control over one-third of agricultural land. During this period trade and foreign investment policies were quite open and liberal. The industrial policy regime was somewhat restrictive and did not act as a major barrier to private initiative.

The period 1974-1991 was characterized by centralized planned economic system under the rule of dictatorial military regime, marked by banned necessary institutional conditions for efficient resource allocation and work incentives. After 1974, the Derg government nationalized rural land, abolished tenancy, took state control of commercial farms, and redistributed lands to peasants (Dorosh, Schmidt, and Shiferaw, 2012). During this period, capital accumulation and rapid increases in labor productivity were impossible because of low productivity performance in every sector. The farmers have no right over land and its products, private sector was banned and considered as a reactionary force. Because of this, foreign aid declined, economic policies emphasized equity (sometimes at the cost of efficiency), and progress with poverty alleviation was unsatisfactory. For all practical purposes, until the early 1990s, Ethiopia pursued a strategy of import substitution. The country has also suffered from conflict and economic mismanagement, which inhibited both rural and urban economic activities.

After the fall of the Derg regime in 1991, the Ethiopian People's Revolutionary Front (here after EPRDF) officially denounced the socialist system and supported the free market-economy. The period, since 1991 is a land mark in Ethiopian history, characterized by many political, economic and social reforms. This period can be best viewed as a beginning of the transition period from stagnation to recovery and continual economic growth (Bharu, 2002). Since then, Ethiopia has experienced substantial progress in most economic and social indicators. Accompanying with both the enlargement of human & physical capital and key policy shifts, comprising extensive openness of external and internal trade, unification of exchange rate, and improved support for peasant agriculture, integrated active public participations in development, good governance and democratization processes, building capability through the implementation of grand projects with national and regional significance such as the grand dam, railway and sugar projects, etc. which create huge national significance, becoming a source of national motivation, inspiration, aspiration and commitment for Ethiopians.

After adopting ADLI, since 1991, Ethiopia has succeeded in achieving high economic growth. In the last three decades, Ethiopia adopted over four five year plans for its socio-economic and political progress based on the key pillar strategies of ADLI. Its fundamental development strategy aims to ensure rapid economic development, making the country free from dependence on food aid and poor people are the main beneficiaries of economic growth. The first five year plan (2001-2005) called Sustainable Development and Poverty Reduction Program (SDPRP) was formulated to eradicate poverty, carries toward important strategic directions related to infrastructure, human development, rural development, food security and capacity building . Evaluation of first five year (Table 2) showed that agricultural production was increased by 17.3% & 13.4% due to the pervasiveness of favorable conditions like adequate rain & supply of agricultural inputs .

Table-2: Trends of Economic performance (SDPRP) in Ethiopia from 2001-2006

Source: Own compilation based MoFED, 2007 and NBE Annual report (2001-2006)

The plan for accelerated and sustained development to end poverty (PASDEP) was a guiding strategic framework for the second five year period (2006-2010) aiming in boosting agricultural production via intensification and yield growth, an industrial and export earnings strategy based around industries with linkages to agriculture . Evaluation of PASDEP shows that the GDP growth rate, in comparison with an average population growth rate of 2.6%, implies that the average annual per capita income growth rate was 8.4 %. The robust growth in pro-poor focus of the government budget has resulted in significant poverty reduction from 38.7 percent in 2004/05 to 29.6 percent in 2010/11. Horticulture was encouraged with great success, but attempts to boost leather processing and other industries were initially less successful .

Ethiopia adopted a 5-year Growth and Transformation Plan (GTP I) in November 2010 which is the third plan, and in October 2015 launched, the fourth plan called GTP II (2015 to 2020), aimed to be a lowest middle-income country by 2025, by attaining 11 percent average annual real GDP growth. GTP II gives an emphasis to private sector development and FDI, particularly in ensuring an export-oriented light manufacturing sector and zero tolerance to rent seeking .

Assessment of overall economic performance of the country disclosed that (see Graph-1) real GDP growth averaged 10.9 percent from 2004 to 2014. If population growth of 2.4 percent per year considered real GDP growth per capita average growth indicates 8.0 percent growth rate per year (MoFED, 2017).

This substantially exceeds per capita growth rates achieved in the first decade after the country's transition to a market-based economy (1992-2003: 1.3 percent; 1993-2004: 4.5 percent), under the communist Derg regime (1974-91: 1.0 percent), and during monarchy (1951-73: 1.5 percent). Droughts and conflict produced volatile growth patterns prior to 2004, but growth has been rapid and stable since then an impressive performance from a historical perspective , which indicates differences in role of states in economic performance and policy reforms.

The growth acceleration was driven by services and agriculture on the supply side, and, private consumption and investment on the demand side. More recently, there is evidence of a boom in investment and construction activity. The services sector has overtaken agriculture as the largest in terms of output (see Table-3 and graph -1). This shift has been ongoing for a decade, and it accelerated since 2004 (World Bank, 2016). Since 2004, the sectorial drivers of growth have shifted further towards services. The construction sector is growing rapidly on the back of significant infrastructure spending by the state as well as private money being channeled to residential and commercial property. The tertiary sector's largest component is the financial industry, accounting for around 10% of GDP (World Bank, 2016). While the insurance industry is in the very early stages of development, commercial banking is growing quickly as robust economic growth raises disposable incomes, thereby boosting demand for credit and transactional accounts (MoFED, 2017).

As a third and fourth five-year plan to implement ADLI's recommendation, GTP I and II seeks to transform Ethiopia towards an industrialized economy and to increase per capita income of its citizens by 2025. To this effect, the Government has adopted a policy focused on the development of the manufacturing sector through the use of industrial parks to attract FDI and to support SMEs. However, with services and agricultural sectors contributing almost 80 percent of GDP, the GTP has not been able to accelerate SET. At the same time, the share of the manufacturing sector in GDP remained just above 5 percent of GDP for most of the past decade.

The services and agriculture sectors are the backbone of the economy, together accounting for almost 80 percent of GDP between 2003/04 and 20115/16. This implies that Ethiopia's SET has been towards (non-tradable) services, not tradable manufacturing (Rodrik, 2016), indicating ADLI's major strategy is not satisfactorily successful. As the economy is experiencing a rapid growth, there is a clearer trend toward a transformation form of economic growth, improved total factor of productivity and a more rational structure. With the new structure formation rapid shift and transformation from agriculture to industry is critical. Agricultural modernization is still experiencing only very modest development, new drivers of growth are not in the making, all-around efforts to strengthen and deepen reform and make progress in institution building seems critical for Ethiopia.

To realize the pattern of structural transformation of Ethiopia and its contrast with some selected east Asian and African countries, it would be useful to look more closely at their share in growth rates and pattern. Developed countries, such France, Germany, the UK, and the USA experienced a decline in the share of agriculture accompanied by an increase in the share of industries at the initial stages of growth and a decline in the share of industries at a subsequent stage along with increase in the share of services. The share of agriculture in GDP ranged from a third to half in the UK during the early part of nineteenth century, in France in 1835, and in the USA in 1872. A similar pattern seems to have followed (Table) by emerging economies of Republic of Korea, China, Indonesia, Malaysia, and Thailand. In these countries, the decline in the share of agriculture and increase in that of industries have been quite notable. Quite clearly, manufacturing in these countries has acted as the engine of growth. But the experience of the countries of Africa (Burkina Faso, Ethiopia, Kenya, Mozambique and Tanzania) and South Asia (India, Pakistan) have been different. As clearly indicated by Table2-2 In economies of Africa and South Asia, for instance India and Pakistan, the decline in the share of agriculture has not been followed by a similar increase in the share of industry; the increase has been more than proportionate in services (look Table-2-2).

Table 2.2 Change in the sector composition of GDP in selected developing countries, 1960-2010

Source: World Development Indicators 2004, 2012 and 2018 and World Development Report 1990