Trade liberalisation, firm productivity, and exit in Ethiopian manufacturing firms

Prior to the early 1990s, Ethiopia pursued an inward looking state-­‐led industrial development strategy, based on import substitution policies through high tariffs and entry barriers. Since the mid-­‐1990s, the country has undertaken gradual process of unilateral trade liberalization and reform measures reducing tariffs significantly and lifting entry restrictions implemented in six phases over 10 years. Despite this progress and ongoing negotiations, Ethiopia remains one of the few countries in the world that is not yet a member of the WTO.

This research proposal investigates three issues on the relationship between trade and manufacturing in Ethiopia. (1) What is the effect of liberalized trade on firm productivity? (2) How differentiated is the productivity across sectors  and firms within the same sector based on whether the firms are owned by the government or private individual and how that might vary with exposure to foreign trade? (3) Does trade liberalization lead inefficient, lower productivity firms to exit the industry? To investigate these questions we use a 13­‐year manufacturing  census and employ novel estimation techniques that accounts for differences between firms and how those firms might choose different production plans.

The goals of this project, analyzing productivity growth and exit from the industrial sector fit directly into the Ethiopian government’s long-term strategies of growth and opening the economy to trade. For example, Ethiopia’s last 2010 Growth and Transformation Plan (GTP), a five-year development strategy designed to bring structural transformation of the country’s economy and sustain the recent growth success, emphasizes that industry and industrial development should play a key role in the economy. The government sets out in this document spending priorities for its limited resources that privilege efforts to raise the capacity of firms to improve their productivity and output. How these resources should be most efficiently allocated across heterogeneous firms in terms of size, industry and location, is an open question. Our research results can contribute an important input for policy makers by providing a rigorous estimation of productivity of all medium and large manufacturing firms in Ethiopia using the census data we have. We will provide information on how heterogeneous is this productivity that will allow the government to more effectively target firms or industries when it is allocating its limited resources to enhance the capacity of the industry sector.

The Ethiopian government has set a goal of becoming a member of the World Trade Organization. This study will provide information on the impacts of unilateral tariff reduction measures on the productivity of firms. Our analysis of the effects of tariff reductions on different firms will allow assess the distribution of costs and benefits from WTO accession. The work we are doing on the relationship between trade and resource allocation will analyze whether the tariff reductions actually lead to the exit of less efficient firms and bring overall improvements in productivity.

Our research should provide important information on the relationship between trade liberalization and firm performance that is relevant for policy makers, industry associations, and government agencies in Ethiopia.