Report No. 38662-ET Ethiopia Accelerating Equitable Growth Country Economic Memorandum Part II: Thematic Chapters June 2007 Poverty Reduction and Economic Management Unit Africa Region Document of the World Bank CURRENCY EQUIVALENTS (as of February 2007) Currency Unit = Ethiopian Birr (ETB) US$1 = Br 8.9 FISCAL YEAR July 8 ­ July 7 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS ADLI Agricultural Development Led Industrialization AEZ Agro-ecological Zone BOFED Bureau of Finance and Economic Development CBO Community-based organisation CEM Country Economic Memorandum CFAA Country Financial Accountability Assessment CPAR Country Procurement Assessment Report CPIA Country Policy and Institutional Assessment DAC Development Assistance Committee DAG Development Assistance Group EDRI Ethiopian Development Research Institute EEPCo Ethiopian Electric Power Corporation EMCP Expenditure Management and Control Program EPRDF Ethiopian People's Revolutionary Democratic Front FDI Foreign direct investment GDP Gross domestic product GOE Government of Ethiopia HIPC Heavily Indebted Poor Countries ICT Information and Communications Technology IDA International Development Association (of the World Bank Group) IFPRI International Food Policy Research Institute JBAR Joint Budget and Aid Review JBS Joint Budget Support MDGs Millennium Development Goals MDRI Multilateral Debt Relief Initiative MOARD Ministry of Agriculture and Rural Development MOFED Ministry of Finance and Economic Development NBE National Bank of Ethiopia NEPAD New Partnership for Africa's Development NGO Nongovernmental organization ODA Official development assistance PANE Poverty Action Network Ethiopia PASDEP Plan for Accelerated and Sustained Development to End Poverty PBS Protection of Basic Services PER Public Expenditure Review i PPA Participatory poverty assessment PSCAP Public Sector Capacity BuildingProgram SDPRP SustainableDevelopment and Poverty ReductionProgram SNNPR SouthernNations, Nationalities and People's Region VAT Value Added Tax Vice President : Obiageli Ezekwesili Country Director : Ishac Diwan SectorDirector : SudhirShetty SectorManager : Kathie Krumm Task Leader : JeniKlugman .. 11 ACKNOWLEDGEMENTS This report evolved out of policy discussions and debates during 2005 and 2006. Michael Walton played a catalytic role and was lead author of Part I. Part I1 reflects the contributions of severalmembers of the country team, inparticular, Derek Byerlee leadingon the rural development chapter, Magdi Amin on private sector development, Emily Kallaur on infrastructure, and BrianLevy on governance. Discussionswith Ishac Diwan andwith key stakeholdersinEthiopia played a critical role in shapingthe report. The authors are grateful to the Ethiopian Development Research Institute, in particular Ato Newai and Hashim Ahmed, for valuable discussions and contributions. A number of Bank colleagues, including Alwaleed Alatabani, Philippe Auffret, Antonio Estache, Vivien Foster, Kevin Kelly, Jemal Omer, Caterina Ruggeri Laderchi, Jee-Peng Tan, and Roberto Zagha have provided valuable advice and insights, as did Rupert Bladon. The report also benefited from comments by David Andrews, IMF. Many colleagues provided direct inputs to Part 11, including Yusuf Ali, IJsbrand de Jong, Madhur Gautam, Nagaraja Harshadeep, Rumana Huque, E.V. Jagannathan, Shyam Khemani, Yasuo Konishi, Berhanu Legesse Ayane, Arianna Legovini, Negede Lewi, Gareth Locksley, Luiz Maurer, Paul Moreno-Lopez, Jeeva Perumalpillai-Essex, Bob Roche, Caterina Ruggeri Laderchi, Aisling Quirke, Menbere Taye Tesfa, Yitbarek Tessema, and Boris Utria. We are also grateful for advice and feedback from our peer reviewers, Brian Levy and BennoNdulu. Large thanks are also due to Emily Kallaur and Mesfin Girma Bezawagaw for excellent support on data and analysis, and to Lucy Kang'arua and Monica Wachera Ndungu for efficient and cheerful processing. Dora Harris and Marjorie Kingston were also very helpful in finalizing the report. Tim Carrington andEyerusalemFasikaprovided guidance on dissemination. ... 111 CONTENTS 1. LONG TERM AND RECENT ECONOMIC DEVELOPMENTS............................ 1 1) Poverty. Human Development. and Demographics................................................ 1 2) Macroeconomic Policy Regime ............................................................................ 11 3) Regional Differentiation....................................................................................... 17 2. AGRICULTURE AND RURALDEVELOPMENT FOR PRO-POOR GROWTH25 1) Agricultural GrowthPerformance: TheNeed for New Approaches .................... 25 2) The Multiple Challengesto Pro-Poor Growth...................................................... 31 3) Continuing Debates for Moving Forward ............................................................. 41 4) The Way Forward: Strategies and Implementation .............................................. 54 Annex 2.1. The Three Ethiopias ....................................................................................... 61 3. ACCELERATING PRIVATE SECTOR-LED ECONOMIC GROWTH................ 67 1) The Context of Reform ......................................................................................... 67 2) Policy Constraints ................................................................................................. 73 3) What Explains the Lack of Value AddedExports? Horticulturevs Leather . .......91 4) Towards a RenewedPrivate Sector Strategy........................................................ 96 4. THE INFRASTRUCTURE CHALLENGE ............................................................. 99 1) Initial Conditions and Plans.................................................................................. 99 2) The Case for Scaling Up..................................................................................... 107 3) Policy Options..................................................................................................... 114 4) Sectoral Stories ................................................................................................... 121 5) The Way Ahead .................................................................................................. 147 Annex 4.1 Maps............................................................................................................. 150 Annex 4.2 PopulationProjections.................................................................................. . . 153 5. THE GOVERNANCE AGENDA: FOCUS ON DECENTRALIZATION ........... 155 1) Decentralization: From Subject to Citizen.......................................................... 155 2) Implementing Fiscal Decentralisation ................................................................ 161 ResourceManagement.................................................................................................... 3) Empowerment through Information: Benchmarking InstitutionalChange and 167 Annex 5.1 Woreda Benchmarking Tables..................................................................... 178 iv List ofBoxes Box 1.1 International Education and Health Comparisons................................................ 6 25 Box 2.2 Recent Success Stories....................................................................................... Box 2.1 EthiopianAgriculture inaNutshell................................................................... 26 Box 2.3 Fertilizer Marketing Policy: ItPaysto Liberalize .............................................. Box 2.4 I s Agriculture's Role inPro-Poor Growthnow Different?................................ 35 44 Box 2.5 GrowthPotential inPastoralAreas .................................................................... Box 2.6 Building Horticultural Exports with Small FarmersinMali and Guatemala ....47 51 Box 2.7 Farmer Cooperatives: International Experiences............................................... 53 Box 3.2 Benefits of Retail Sector Reform: International andEthiopianExperience ......73 Box 3.1 WTO: What's init for Ethiopia?........................................................................ 75 Box 3.3 Ethiopia's Politically-Affiliated Holding Companies........................................ 82 Box 4.1 Externalities and Complementarities inInfrastructure Investments ................ 110 Box 4.3 Determining User Fees for Public Services ..................................................... Box 4.2 Distributive Analysis of Current and Simulated IncreaseinElectricity Tariff 115 Box 4.4 Political Risk Guarantees................................................................................. 116 118 Box 4.5 Impact Evaluation inEthiopia .......................................................................... 120 Box 4.6 Prospects for Bio-energy inEthiopia ............................................................... Box 4.7 EthiopidSudan-EthiopidDjiboutiTransmission Interconnection ................... 130 125 Box 4.9 Costs and Benefits of Small-scale Irrigation................................................... Box 4.8 The Nile BasinInitiative: Harnessingthe Potential of the EasternNile..........131 137 158 Box 5.2 Healthcare inBosat: A Major Service Challenge ............................................ Box 5.1 Getting Decentralization Right - Some Ongoing Challenges.......................... Box 5.3 Citizen Report Cards inBangalore................................................................... 167 174 V List of Figures Figure 1.1 Primary Completion Rate................................................................................. 6 6 Figure 1.3 Real GDP per Capita, 1962-2006..................................................................... Figure 1.2 Immunization. DPT.......................................................................................... 8 Figure 1.4 GrowthRates, Real GDP and Per Capita GDP, 1992-2006............................. 8 Figure 1.5 Evolutionof Sectoral Composition (percent of GDP) ................................... 10 Figure 1.6 Overall Budget Deficit (share of GDP), 1991-2004....................................... 12 Figure 1.8 Core Inflation and MinimumDeposit Rate.................................................... Figure 1.7 Overall and Food Inflation............................................................................. 13 13 Figure 1.9 Public vs. Private Investment (share of GDP), 1996-2005 ............................ 15 Figure 1.10`Pro-Poor Expenditure, Cross-country Comparison, 2004........................... 16 Figure 1.11 Trends inPublic Investment, 1981-2006...................................................... 17 Figure 1.12 Primary (Grades 1-8) Gross Enrolment Ratio (GER) by Region, 2004/05.. 19 Figure 1.13 Under-5 Mortality, 2005............................................................................... 19 Figure 1.15 The "Three Ethiopias".................................................................................. Figure 1.14 Federal Block Transfer to Regions per capita vs. Regional Population.......20 22 Figure 2.1 Real Agriculture GDP per Capita, 1962-2006 ............................................... 27 Figure 2.2 Total Fertilizer Consumption ......................................................................... 28 Figure 2.3 Public Expenditures on Agriculture as a Share of Budget ............................. Figure 2.5 Performance of Cereal Crops (Meher Season Index 88/89 = 100) ................29 Figure 2.4 Agricultural Land and Labour Productivity (constant 1995 US$) .................28 30 Figure 2.6 Agricultural Sector Growth Rates Since 1994............................................... 30 Figure 2.7 Agriculture Leads Recent Export Growth (US$m) ........................................ 36 Figure 2.9 Simulations of Alternative Sub-sectoralGrowth Strategies, 2003-2015 .......43 Figure 2.8 Returnswith/ without Fertilizer inNormal and Poor Rainfall Years.............31 Figure 2.10 Per capita Agricultural Growth and RuralPoverty Reduction inthe 1990s 54 Figure 3.1 Investment inEthiopia.................................................................................... . . 70 71 Figure 3.3 Fairly Low Trade Levels ................................................................................ Figure 3.2 No Shift from Agriculture to Manufacturing Share of GDP.......................... 71 Figure 3.4 ProgressinPrivatization................................................................................. 79 Figure 3.5 Privatization by Modality............................................................................... 79 80 Figure 3.7 RegisteredInvestment, by ownership, 2001-2005 ......................................... Figure 3.6 Public vs. Private Share of Manufacturing Value Added............................... 80 Figure 3.8 Ranking of Investment Climate Constraints, 2004 85 Figure 3.9 Marketing inthe Leather Industry.................................................................. ......................................... 94 Figure 4.2 Capital Expenditure on SelectedInfrastructure Sectors (percent of GDP) .. 103 Figure 4.1 Coverage Gaps BetweenUrbanand RuralHouseholds............................... 101 Figure 4.3 Capital Spending on Road Construction: Actual as percent of Budgeted.... 103 Figure 4.5 Composition of Electricity Financing Requirements,2006-2010................ 104 Figure 4.4 Current Expenditure (percent of GDP)......................................................... 104 Figure 4.6 Composition of Financing for Public Enterprises, Budgeted, 2005/06........ 105 Figure 4.8 Water Storage Infrastructure -International Comparison ........................... Figure 4.7 Composition of ODA for Infrastructure, Ethiopia vs.SSA, 2003................ 105 134 140 Figure 4.10 The Cost of not Reforming......................................................................... Figure 4.9 Mauritania: The Rewards of Telecom Liberalization................................. 140 vi Figure 4.11 Mobile Teledensity in42 AfricanCountries.............................................. 140 Figure 4.12 Mobile Teledensity vs. GDP ...................................................................... 141 Excluding Addis.............................................................................................................. Figure 5.1 Sources of Regional Revenue: Block Grants vs. Own Revenue-all Regions 162 Figure 5.2 Regional Budgets with and without Special Purpose Grants (millions of Birr) ......................................................................................................................................... 162 Figure 5.4 Block Grants to Woredas (percent of total regional budget)........................ Figure 5.3 Breakdown o f Regional Expenditure: Basic Services vs. Other Sectors- . 163 165 ListofTables Table 1.1 Poverty Incidence and Inequality ...................................................................... 2 Table 1.2 Export Earnings by Item(percent oftotal export earnings) ............................ 14 Table 1.3 Regional Rankings Basedon Selected Indicators (l=poorest; 1l=best) ......... 19 Table 2.1 Yields inOn-farm FieldTrials vs. Farmers' Yields (t/ha) .............................. 32 Table 2.2 Actions to Promote IncreasedFertilizer Sales................................................. 34 Table 2.3 Comparative Statistics on Production and Price Variability ........................... 37 Table 2.5 Simplistic Framework of RuralDiversity inEthiopia..................................... Table 2.4 Share o f RuralNon-farm Income (RNFI) inRural Household Incomes.........41 Table 3.1 Trends inEmployment Ratesby Region, ages 15+ (percent) ......................... Table 2.6 Summaryof Five Thrusts for Supporting the Rural GrowthAgenda..............45 56 Table 3.2 High UrbanYouth Unemployment Rates, 2005 (age 15-24) (percent) Table 3.3 Investment inEthiopia..................................................................................... ........... 69 69 70 Table 3.4 Ethiopia's Assessment and Global Ranking inDoing Business...................... 74 Table 3.5 Restrictions on Investment............................................................................... . . Table 3.6 Public and Private Shares inMedium-Large IndustrialManufacturing .......... 76 79 Table 3.7 Top Ten Registered Investmentsby Ownership .............................................. Table 3.8 Ethiopia's Flower Exports (US$) ..................................................................... 81 92 Table 3.9 Leather Exports inMillionBirr ....................................................................... 94 Table 3.10 Leather Export Quality Problems: An Illustrationof Defects Found ............ 95 Table 4.1 Comparison o f SelectedInfrastructure Indicators (% of population) ............ 100 Table 4.2 Projected PASDEP Program Cost Requirements Based on MDG Needs Assessment (millions of Birr) ......................................................................................... Table 4.4 Returnsto Government Investment inFeeder Roads inRuralUganda......... 110 Table 4.3 Impacts of Unreliable Infrastructure Services on Firms................................ 106 108 Table 4.5 Matrix of Infrastructure Objectives, Costs, Design and Expected Impacts... 111 Table 4.6 Composition of Roads Program (2002-2005)................................................ 121 Table 4.7 IncreaseinSelected Indicators (year 2005 vs . 1997) andPlannedTargets... 122 Table 4.8 Planned Spending inRoads Sector (2005-2015) (% oftotal) ........................ 123 Table 4.9 Average Rates of Return to Electrical Generating Capacity, and Rates of Returnto Capital, Selected Countries............................................................................. 132 Table 4.10 Economic Growth and Poverty Rates under Different Investment Scenarios Table 4.11 GDP Growth Rates UnderDifferentIrrigationInvestment Scenarios ........ 135 ......................................................................................................................................... 136 Table 4.12 Fixed and Mobile Teledensities ................................................................... 138 Table 5.1 Progress on Selected Human Development Indicators and Spending on Poverty Sectors, 1995/96-2004/05 ............................................................................... 159 vii Table 5.2 How Sectors Measure Up (% completely satisfied) ...................................... Table 5.3 The FY 2005/06 Budget ................................................................................ 159 163 Table 5.5 Benchmarking Ethiopia's Public Financial Management with PEFA........... 172 Table 5.4 MonitoringEthiopia's Woredas and Municipalities -The Indicators .......... 170 ... Vlll 1. LONGTERMAND RECENTECONOMIC DEVELOPMENTS Introduction 1.1 The role of this chapter is to first, provide the broader economic context for the thematic chapters that follow, second, to highlight key trends and challenges at the sectoral level through a growth lens, and third, to provide a spatial analysis of growth potential and challenges. As described in Part I,there are promising signs and potential for structural transformation, and enabling these to come to fruition will be critical to the urgent task of reversing long term economic trends to combat deep-seatedpoverty. 1.2 We begin with a brief review of trends in poverty and inequality, then turn to growth performance and the macro-economic policy regime. A specific focus on regional differentiation is used as a way of grounding the analysis, challenges and policy options inthe reality of Ethiopia. 1) Poverty,Human Development,and Demographics 1.3 Consumption poverty is widespread and deep in Ethiopia, with a consumption- based national poverty headcount index of about 39 percent (MOFED 2006). Over the last ten years, three Household Income, Consumption, and Expenditure Surveys (HICES) have been conducted, and suggest that poverty rates fluctuated somewhat in the mid to late 1990s, without showing a clear decreasingtrend(World Bank 2005b). However, the 2004105 survey data suggest a notable drop in the incidence of rural poverty, with a decline inthe rural headcount index from 45 percent to 39 percent. This suggests that the economic recovery following the drought of 2002/03 has contributed to poverty reduction. There have also been statistically significant decreases in the poverty gap index (which measures how far the average adult's consumption is below the poverty line, among the poor population) and the poverty severity index (which measures inequality among the poor population) since 1999/00. 1.4 Over the same period, estimates o f Gini coefficients (where 0 represents perfect equality of income distribution and 1 is perfect inequality) derived from the same household surveys show that inequality at the national level has been steady at around 0.30. This implies that Ethiopia has relatively low inequality compared to other poor African countries, such as Tanzania (Gini of 0.35), Burkina Faso (0.40), Zambia (0.42), and Madagascar (0.47) (World Development Indicators). However, measures of aggregate inequality are primarily driven by the consistent level found in rural areas, where most of the population lives. Urbaninequality has risenmarkedly over the period, from 0.34 in 1995/96 to 0.44 in2004/05. Coupled with a slight increase inurbanpoverty since 1995/96 (the decline between 1999/00 and 2004/05 i s not statistically significant; MOFED 2006), this highlights the policy challenges associated with increasing urbanization. Steady growth inthe quantity and quality of employmentopportunities will 1 outcomes in urban areas seem to be partly explained by labour market segmentation- which has weakened in recent years with increasing mobility between the formal and informal, and public and private, sectors-but remains significant. In short, relatively highwages inthe public sector (including the civil service andparastatals) likely drive up formal private sector wages, thereby limiting labour demand (the total number of jobs overall). As a result, the informal sector is effectively the only option for a large part of the population, yet given the high degree of competition among relatively undifferentiated and low productivity informal sector operators, many end up in unemployment or become discouragedworkers (World Bank 2006b). 1.8 Widespread disempowerment along several dimensions (economic, social, and political) characterizes poverty in Ethiopia. This is associated with longstanding structural causes, such as inter alia low asset bases at the individual level, physical remoteness, hierarchical cultural and political traditions, and the prevalence of violence against women. The series of events around the 2005 elections illustrated that progress is neededtoward allowing an open dialogue insociety. 1.9 Absolute levels of human capital inEthiopia are amongst the lowest inthe world, which has seriously constrained labour productivity, innovation and entrepreneurship. More positively, there have been sharp improvements in the recent past, especially in education, which are already flowing through to the educational achievements of the labour force. The Government's massive scale-up inprimary education has resultedinan increase in the primary gross enrolment rate from 20 percent in 1993 to 79 percent in 2004, and secondary enrolment has surpassed the 2004/05 SDPRP target2 The share of the total urban employed population that is illiterate declined from 37 percent in 1999to 28 percent in 2004, and a comparatively low 13 percent of urban youth are illiterate (World Bank 2006b). 1.10 Overcoming the education and skills deficit should have important payoffs for growth and poverty reduction. Although it is difficult to quantify the drag on growth created by low levels of human capital, recent simulations suggest that bringing all men and women in Ethiopia up to at least a 4* grade education could potentially reduce poverty by 23 percent, and indicate particularly strong benefits to reducing the striking gender gap in educational access and outcomes (World Bank 2005b). Weir (1999) finds that increasing education by one year at the household level leads to a 5 percent increase inagricultural output (or 12percent for non-farm activities). Increasingthe averageyears of schooling of all adults ina village by 1 year increases farm output by half, suggesting that social returns may be even higher than private returns (although the reliance on cross-sectional data means that we should be cautious about drawing firm conclusions about the direction o f causality). 1.11 Realizing Ethiopia's ambitious targets for scaling up education has created its own challenges. The rapidly increasing primary enrolments prompt quality concerns, as survival rates are poor (one in four primary students drops out of school after grade 2, and almost half by grade 5), and student-teacher ratios are rising (World Bank 2005f). 2Figure for 1993 is from World Bank (20050 and figure for 2004/05 is the baseline inGOE(2006b). 3 The prevalence o f child labour in Ethiopia (about half o f 5-14 year olds work), and its importance to household income, likely contributes to high drop-out rates (UCW 2006). While efforts have been initiated to reduce the unit costs o f service delivery and address some o f the more egregious gaps within the system, through lower-cost primary school construction models, multi-grade teaching, more local level flexibility in teachers' qualifications and teacher hiring, and greater emphasis on in-service training and supervision, these measures are yet to bear fruit. 1.12 "Brain drain'' poses a serious challenge to efforts to build human capital. The enormous wage differentials between low income countries like Ethiopia and industrial countries (or wealthier African countries, like Botswana and South Africa) serve as powerful "pull" factors enticing skilled migrants. Political developments at home can also serve as "push" factors (many emigrants left Ethiopia during the Derg regime). The effects o f brain drain may be most acute inthe healthcare field, given the intense demand for medical professionals in countries like the U.S. and U.K., which also do active recruiting in developing countries. There are currently only about 2,700 doctors in Ethiopia (World Bank 2005g), while Ethiopia's medical schools have been producing about 400 annually. In effect this means the Ethiopian government, through public education, is subsidizing the healthcare systems o f much wealthier countries, whose immigration regulations often favour highly skilled migrants. Shortages of highly skilled labour are also evident in academia and the private sector-for example, Ethiopian Airlines tends to hire foreign consultants (generally of Ethiopian origin) for most o f its core business and development efforts. According to a report by Addis Ababa University, only about a third of the 600 AAU academic staff who went abroad to study duringthe period 1980-2000 returnedto Ethiopia (Shim 2002). 1.13 The debate about the net effect o f skilled out-migration on developing countries is ongoing. While the departure o f migrantsmeans a reduction inreadily available skills, in the long term the net impact o f increased remittances and potentially the return o f migrants after they have acquired skills could be positive. The success o f migrants abroad could serve as an incentive to students to increase their own skill levels (Commander, Kangasniemi, and Winters 2004). Also on the positive side are the networking effects that can create opportunities for exporters in the home country, and potentially boost foreign direct investment as well-as, for example, in the cases o f China and India, which have benefited from large diasporas in developed countries. Regardless o f the potential benefits in the long term, however, at least in the short to medium term-or until incentives to stay at home improve-brain drain is likely to continue to complicate development efforts inEthiopia. 1.14 Severe poverty, illiteracy and remoteness all take their toll on the health status, and productivity, o f ordinary Ethiopians. Undernourishment affects 46 percent o f the population-compared to the averages o f 32 percent in Sub-Saharan Africa and 24 percent in low-income countries (World Bank WDI). Data on individual physical performance reveal clear correlations between malnutrition and the ability to perform standardtasks linked to agricultural production, implyingthat chronically undernourished people may be so unproductive that they are not employable at any wage. For example, Croppenstedt and Muller (2000) found that increasing weight for height o f the household 4 headby one standarddeviation at the meanwould increase the total value of output by 27 percent, suggesting that returns to nutrition are of the same order as those to education- though in any such analysis endogeneity biases are likely to be significant, so effects could be overstated. 1.15 Some progress has beenmade on key health indicators, but the overall situation is still grim (Box 1.1). Infant and child mortality rates have improved, and are now lower thanrates insome countries with comparable per capita incomes, while coveragerates of polio immunizations and Vitamin A distribution have risen. Yet differentials across household income levels and regions are stark, and overall healthcare coverage remains poor. Child mortality rates are 31 percent higher for those in the poorest quintile than those in the richest. Gambella has the highest regional infant mortality rate (123 per 1,000 live births), while Addis Ababa has the lowest IMR (81 per 1,000 live births). About 80 percent of Ethiopian women have undergone female circumcision, which tends to worsen maternal health. Rates of access to safe drinking water and sanitation are well below SSA averages (World Bank 2005g). 1.16 Malaria and HIV/AIDS have important implications for Ethiopia's economic prospects. One cross-country study argues that by weakening key determinants of economic growth, including social capital, domestic savings, and human capital, these diseases create a vicious cycle that deepens poverty. It found that HIV/AIDS reduced Africa's per capita income growth by 0.7 percentage points, and malaria (in affected countries) by an additional 0.3 percentagepoints, per year from 1990 to 1997. Compared with an average annual growth rate of 0.4 percent, this is a huge impact, implying that growth inthe absence of HIV/AIDS might have beenalmost triple the actual rate (Bonnel 2000)3. As noted below, the incidence of malaria has a distinct regional dimension in Ethiopia, which appears to haveheldback development in large parts of the country. 1.17 Strategies in place to address the health challenge relate to the health sector as well as cross-cutting issues like water and sanitation. Programmatic implementation in the health sector has tended to suffer from lack of financing and low procurement capacity, and financing of health services remains extremely fragmented. Retention of trained staff is a major issue for government facilities, and particularly so in rural areas. The country's latest health sector strategy proposes to address these issues through the creation of a capacity-building fund at the central level, which will be used for training and human resource development, among other programs. There are also capacity building programs in the water supply and sanitation sector, in line with the Government's commitment to decentralization. 1.18 Demographics are a central part of Ethiopia's growth and poverty reduction prospects. Ethiopia i s Sub-Saharan Africa's second most populous country (after Nigeria), and its population density i s double the Sub-Saharan Africa average (World Bank WDI). With a total fertility rate of 5.9, meaning that the average Ethiopianwoman Evidence on the per capital income effect o f HIV/AIDS is, however, mixed, with some studies findingthe reverse (there are a variety o f estimates o f effects, some controversial; see for example Young, 2004). There is no question that the epidemic poses a serious threat to Ethiopia's development efforts, in addition to its devastating humantoll. 5 has about six children, Ethiopia also has hadone of the highest populationgrowth rates in the world. Recent analysis shows that the population growth rate peakedat 3 percent in 1990, and has since fallen to about 2.5 percent per year, which puts Ethiopia in line with the African average. Ethiopia's population will still double in about 30 years, and by 2050, will become one of the world's 10most populated countries (World Bank 2006~). Box 1.1 InternationalEducationand HealthComparisons The UN's 2005 Human Development Report shows that Ethiopia's Human Development Index ranking is roughly the same as its ranking based on GDP per capita alone, implying that the state of human development in Ethiopia is approximately as one would expect based on international income comparisons. Ethiopia has made significant progress on primary enrolment, but as Figure 1.1 illustrates, the increase in primary completion has been modest. The picture on health outcomes i s mixed, with Ethiopia making progress in some key areas, but remaining far below regional standards on other indicators. For example, as shown in Figure 1.2, DPT immunization coverage dipped rather dramatically during the border conflict with Eritrea, but has since recovered and improved beyondthe pre-war rate. Figure 1.1 Primary CompletionRate Figure 1.2 Immunization,DPT T- 100 , 100 - 1 X r 4r"m 90 - .. * 8 0 - 11 ...+A- `p 7 0 - 60 - B 5 0 - 4 0 - 30 3 0 - :q 20 3 i 2 0 - 2 10 , , , , , , , 0 2001 2002 2003 2004 0 1997 1998 1999 2000 2001 2002 2003 2004 +Burundi -+-Ethiopia -+-Ethiopia --- -IC- Kenya Madagascar ---Rwanda Mozambique Tanzania Source; World Bank WDI. On one important indicator of healthcare coverage-births attended by skilled health personnel- Ethiopia ranks at the bottom. The rate in Ethiopia (9 percent) i s just over half the rate in the second-worst countries on this indicator, Chad and Niger (16 percent), whereas Tanzania has 36 percent coverage, Uganda 39 percent, and Mozambique 48 percent (UNDP 2005--data from the latest available year-except Ethiopia data from GOE 2006b). 1.19 Nearly half the population is younger than 15 years o f age, so the dependency ratio-the proportiono f the population of non-working age (children and the elderly)-is very high. Rural-urban differences are striking, as fertility rates have fallen much faster in urban centres (and are around replacement rate in the exceptional case of Addis Ababa), leading to a much lower dependency ratio in urban (54) than in rural (90) areas (World Bank 2006~). 1.20 Froma spatial perspective, about 45 percent of the populationlives inthe Western and Eastern highlands, although these two climatic zones represent less than one-fifth of 6 the total landarea (World Bank 2004a). Three regions-Oromiya, Amhara, and SNNP- account for 86 percent o f the total population. Total fertility rates are high in each of these regions, with Oromiya at 6.0. At current growth rates, the population of Amhara, SNNP and Oromiyawould double in30,28 and 26 years, respectively. 1.21 In a subsistence economy like Ethiopia's, a fast-rising population is a major constraint on economic growth because net savings per capita are too small to allow capital deepening. Saving and investment inhuman capital may be insufficient to foster growth because so much of income is spent on food, to avoid starvation. In addition to this direct effect, highpoverty rates can impede growth through indirect mechanisms, like social unrest, which in turn adversely affect saving and investment decisions. Because people cannot invest in capital formation or the acquisition of skills, the country may be caught in a trap whereby population growth exceeds the rate of capital accumulation, leading to increasing evidence of poverty and famine. Inthe context o f Ethiopia's severe landdegradation problem (Part 11, Chapter 2), a growingpopulation puts a huge strain on the already fragile environment. 1.22 These demographic issues are reviewed in depth in the World Bank Population Study (2006~)~ which finds that a variety of policy and program options-for example, addressingthe huge unmet demand for contraceptives-could be followed to improve the outlook. Indeed,the youth bulge resulting from the demographic transition could become an economic boon, as inthe case of the East Asian success stories. It i s also possible that population pressure, by raising the returns to capital, can lead to improvements in technology that offset the negative effects of the declining land-labour ratio. Realizing the optimistic rather than pessimistic population scenario will depend in large part on having the right policies inplace to facilitate equitable growth. Recent Performance 1.23 Growth. Ethiopia's growth record has been one of significant volatility around a low base, ina context of rapid population growth, such that the annual average has beena mere 0.6 percent on a per capita basis (Figure 1.3). Incomes actually fell during the 17- year rule of the communist Derg, with the largest single-year drop coinciding with the 1984 famine. Recovery since then has beenerratic overall, and real per capita GDP only regainedits 1970speak in2005/06. 1.24 While growth has remained highly volatile, the overall trend since the end of the Derg regime has nonetheless been much better than the long term story, with annual growth averaging 4.9 percent4 Under a growth strategy known as Agricultural Development-Led Industrialization (ADLI), the government implemented a range of reforms and active policies intended to boost agricultural productivity and facilitate private sector development. ADLI's objective is to enable the transformation of 4In2005 the GoE revisedits national accounts data to reflect improved information, including from recent household and enterprise surveys, and changed the base year from 1980/81 to 1999/00. A comparison reveals that nominal GDP inthe new base year is 22 percent higher than inthe previous series, while GDP growth rates at factor cost are approximately the same, albeit with some exceptions. Atlas GNI per capita changed significantly, and i s now estimated at US$lSO in 2004/05, compared to the previous estimate o f US$lOO-110. This report uses the new series. 7 subsistence farming into production for the market, thus relying on agriculture as an initial engine of growth that will raise average incomes and foster rural-urban linkages through product and factor market^.^ Figure 1.3 Real GDP per Capita, 1962-2006 1200 1150 1100 1050 t1000 950 900 850 1 Haile Selassie's 800 750 1.25 Yet the rate of growth has not been sufficient to translate into significant welfare improvements, in large part due to high population growth (about 2.5 percent per year), which has dampened growth per capita, as shown in Figure 1.4. Moreover, Ethiopia's growth remains highly vulnerable to drought and terms of trade shocks, suggesting that a rapidupward trajectory has not yet beenfirmly established. Figure 1.4 Growth Rates, Real GDP and Per Capita GDP, 1992-2006 1 10% - c 5% - 28 re 0% -- 2 -5% - L -10% 1 d -15% I 1 -+-Real GDP &Per Capita GDP Source: MOFED. For a discussionofADLI, see MOFED(2002) andChapter 2 ofthis volume. 8 1.26 There is nonetheless an overall positive economic trend associated with the current regime, which is cause for cautious optimism. Ethiopia registered impressive GDP growth of 11.9 percent in 2003/04 and 10.5 percent in 2004/05, mainly due to a recovery in agricultural output following two consecutive years of drought. Growth was again robust at 9.6 percent in 2005/06. Performance in the non-agricultural sectors was also strong by historical standards: value added in the industry and distributive sectors grew roughly 7 percent from 2004-2006, against the 5 percent average o f the previous 3 years. 1.27 Moreover, growth has been increasingly driven by private consumption, in contrast to the pattern inthe 199Os, and has been accompaniedby a surge incredit to the private sector. Innominal terms, growth of private consumption expenditure accelerated from 10 percent in2002/03 to 32 percent in 2003/04 and 15 percent in2004/05. Growth of nominal public consumption expenditure was slower. Private consumption, at 92 percent of GDP, accounts for the majority of demand inthe economy. However with the expansion planned to meet public investment and development needs in 2005/06, projections suggestedmuch faster expansion inpublic (27 percent growth) thaninprivate spending (13 percent growth). Chapter 3 discusses private investment inmore detail. 1.28 In addition to the major challenge of addressing population growth, structural transformation of the economy is necessary to lift Ethiopia out of its perpetual cycle of crisis management. We turn now to review the nature of these challenges. 1.29 Sectoral Composition. The changing composition of GDP shows the increasing importance of services over time, but confirms that Ethiopia remains in the very early stages of structural transformation (Figure 1.5). Over the ten years from 1996-2005, average growth rates have been roughly similar in agriculture (4.8 percent), industry (5.9 percent), and services (6 percent). However, agricultural growth was highly volatile, posting negative rates as low as -12 percent and peaks as high as 18 percent, which created overall volatility. Real GDP in the non-agricultural sector surpassed that of the agricultural sector for the first time in 1998/99, and has accounted for just over half of production since then; however, 85 percent of the population still works inthe agriculture sector. The share o f agriculture inGDP may be inchingback upward. 9 Figure 1.5 Evolutionof Sectoral Composition(percent of GDP) 100% - 75% - . L . 2 ---.-- , 2 -.*--'r 50%- L\ .I "%+ L s 25% - ** I - * . * . - _ . - . - * - I - O % . ,I , I I ,I ,, ,,I , , , , , ,,I I ,,I , ,I I , I , I , , ,, , ,, , ,, ,, 1.30 Amid large year-over-year fluctuations, real agricultural GDP per capita has shown a consistently downward trend since the 1960s. Chapter 2 presents a detailed diagnostic. Suffice to say here that crop production accounts for about two-thirds of agricultural output. Peasant livestock production i s also a significant source of value for Ethiopia, which has Africa's largest livestock population, and oxen are the main source of draft power for cultivation and the largest source of cash income for rural households, as well as the primary store of savings and investment. 1.31 The share of industry in GDP has been fairly steady over time, rising modestly from 11to about 13 percent of total output inthe decade to 2005. Eventhough per capita productivity is three or four times higher in industry relative to agriculture, a major shift in labour from agriculture to the industrial sector has not taken place (World Bank and EDRI 2004). Manufacturing output as a share of GDP has been essentially stagnant at about 5 percent in the last decade, which reflects Ethiopia's slow structural transformation. State-owned enterprises account for about half of private sector output, and their prominent role, along with the status of ongoing privatization, is discussed in detail in Chapter 3 (however, it i s noteworthy that the number of enterprises privatized increased from 7 in 2005 to 10 in 2006, perhaps signalling increased momentum in the process). Overall, manufacturing's share of total industrial output has fallen by about 6 percentage points, due to strong growth (averaging 10 percent annually from 2002 to 2005) in construction activity. However, more recent data are positive, showing a one third increaseinrevenue for the first halfof 2005/06 over the same periodayear earlier. 1.32 Large and medium scale manufacturing is dominated by agro-manufacturing enterprises. Exports are less than 1 percent of output, despite Ethiopia's comparative advantage in several products such as leather and leather products, floriculture, and horticulture. Traditional food, beverage processing, grain milling, and handicraft textiles production dominate cottage and small-scale industrial activity, which takes place mainly in rural areas, with grain milling being an especially important source of employment. As described inChapter 3, there are important opportunities to be exploited. 10 1.33 The services sector, representing 38 percent o f Ethiopia's output, i s evenly divided between distributive (including trade, hotelhestaurant, and transportatiodcommunication activities) and "other" services (financial, public administration, and educatiodhealth). The subsector shares have changed little inthe last decade. Trade and related services are the largest single service category, followed by real estate. The size o f the service sector in the economy i s on the low side relative to other African countries, such as Mozambique where it i s 47 percent, and Zambia (52 percent) or Kenya (56 percent) (World Bank WDI). This i s likely related to the low level o f urbanization in Ethiopia, and the relatively limited off-farm activity in rural areas, which are still overwhelmingly based on subsistence agriculture. 1.34 A social accounting matrix (SAM) built for World Bank (20049 shows that Ethiopia has weak and uneven inter-sectoral linkages (Tafesse and Ferede 2004).6 The wide disparities between sectoral growth multipliers mean that the expected overall impact o f growth depends on its sectoral composition. Agriculture and services have the highest multipliers in absolute terms, and share the largest linkages. A shock in the service sector has the strongest growth impact: a rise o f US$1 in income from services generates US$O.80 in indirect benefits, while a rise o f US$1 in income from agriculture generates only US$0.54 in indirect benefits. Interestingly, however, no statistically significant production linkages exist between industry and agriculture. Modern industrial output i s essentially unrelated to agriculture-which neither supplies inputs to modern industry nor provides substantial demand for its output. Inputs consist primarily o f mineral resources and imported capital and outputs consist mainly o f intermediate goods. The industrial sectors also have a relatively limited impact on services. By contrast, output intraditional industriesi s determined by output ineach o f the other sectors. 1.35 The commodity composition o fEthiopia's final demand is typical o f economies at low levels o f development. Spending on agricultural goods (mainly food) represents about half o f final demand, and the rest i s shared roughly equally by industry and services. For industrial goods other than agro-industrial products, Ethiopia relies on imports to satisfy more than half o f its final demand. 2) Macroeconomic Policy Regime 1.36 Domestic revenue as a share o f GDP i s fairly high given Ethiopia's level o f development, though the recently revised national accounts data imply that both total revenue and grants as a share o f GDP are lower than previously estimated. Together they accounted for about 20 percent o f GDP in 2005/06 (17 percent revenue and 3 percent external grants). However, revenue i s overly dependent on foreign trade taxes, which make up the largest share (37 percent o f domestic revenue in2004/05). Recent tariff and tax reforms have improved the tax policy framework, although potential fiscal pressures are large (Figure 1.6). In the medium term, the tension between maintaining macroeconomic stability and financing Ethiopia's huge investment needs prompt concerns about inflationary and crowding out impacts o f increased fiscal deficits. Block (1999) finds that robust linkages only exist between the agriculture and service sectors, and to some extent between agriculture and traditional industry. 11 I -16' +Incl Grants +Excl Grants Source: MOFED. 1.37 The macro and fiscal policy regime over the past several years had been very good, and underpinned a solid record of macro-stability-but this has become increasingly fragile over the past year. In general, relatively low levels of overall inflation were maintained, albeit with significant fluctuations and a spike during the 2002/03 drought (Figure 1.7). Recently, inflationary pressures were rising. In 2004/05, inflation was higher than expected, and in 2006 overall inflation reached 12.3 percent. Non-food inflation has been consistently creeping upward since 2003 (Figure 1.8); it appears that the boom in the construction sector has affected prices for inputs such as cement, steel, and iron sheeting. 1.38 The relatively high level of food inflation in the past two years despite reported bumper crops is difficult to explain, and is presently the subject of further analysis. Possible explanations on the supply side include an overestimate o f agricultural production, or the lower level of external aid in the form of food (with a shift to a cash- based safety net program). On the demand side, there could be a growing demand for exports, increasedown consumption and/or building up of stock by traders. 1.39 Symptoms o f increasing macro-economic fragility include a worsening o f the current account balance and trade deficit in 2004/05, and again in 2005/06. Net private transfers, which grew by 21 percent in 2004/05 and 6 percent in 2005/06, have helped offset the pressures on foreign exchange reserves. Cash remittances from Ethiopians livin abroad grew by 66 percent in 2004/05, following 50 percent growth the previous year. Foreign direct investment is limitedbut growing, though it i s not yet known how 9 the post-election events couldbe affecting this trend. 'Most private remittances are not capturedinprivate transfers since they do not pass through the banking system; the informalis believedto be as large as the recordedvolume. 12 Figure1.7 Overall and FoodInflation Figure1.8 Core Inflation and Minimum Deposit Rate I 301 1 10 f 25 20 9 1 f15 8 -E l 0 E 5 [: $ 0 -5 -10 -15 'i 2000 2001 2002 2003 2004 2005 2006 0 4 2000 2001 2002 2003 2004 2005 2006 -Overall Inflation -Food Inflation [ +Nan-foodInflation -Minimun Deposit Rate Source: MOFED. 1.40 Over the past decade, the combination of a prudent aggregate fiscal stance and increased public spending was enabled by external resources. This has been accompanied by a strong revenue effort and an increase in domestic borrowing. The combination of very low levels of absolute income and low savings rates, alongside large and lumpy spending needs, mean that the need for external development assistance remains highdespite increasing revenue-GDP shares. 1.41 A successful ADLI strategy depends inpart on expansion of agricultural exports to absorb the initial increases in output-since urban demand is growing only slowly- and to generate foreign exchange. Overall, export performance has been variable, and subject to shocks. Total exports of goods and non-factor services were 13 percent of GDP in 2004/05 (GOE 2006b), which is low compared to an African average of 35 percent (World Bank WDI), but nonetheless reflects an impressiveexpansion of some 71 percent in merchandise, and 55 percent in non-factor service, export earnings between 2002/03 and 2004/05. Overall, export revenue grew 22 percent in 2005/06. The traditional staple crop, coffee, remains Ethiopia's most important export, but its share in total merchandise export earnings has fallen from 59 percent in 1997 to 35 percent in 2006 (Table 1.2). With a recent recovery ininternational coffee prices after a devastating crash, volumes have rebounded, suggestingresponsivenessto improved prices. 1.42 Emerging sectors with highpotential now account for an increasing share of total exports, signalling the potential for diversification. Exports of flowers grew from US$660,000 in 2001 to US$5 million in 2004. Oilseeds are also increasingly important exports, accounting for 2 percent of total export earnings in 1997 and 21 percent in2006. Chapters 2 and 3 look into options for expanding and replicatingthese stories. 13 Table 1.2 Export Earningsby Item (percentof total export earnings) Cotton 0 2.0 0.2 0.7 Other 8.8 7.6 9.1 8.1 Total export value (US%mil) 598.7 600.4 817.9 1,000.3 Of which non-coffee 243.7 376.9 482.5 646.0 1.43 While the export picture i s increasingly positive, Ethiopia remains vulnerable to shocks. Over 2001 to 2005, the rising prices of strategic imported inputs, in particular fuel and fertilizer, undermined efforts to keep external balances within the target. The fuel import bill reached about US$700 million in 2005/06, compared to US$300 million in2003/04, while fertilizer priceshavebeenincreasing steadily. 1.44 Turning finally to the levels and structure of investment inthe economy, we see that rising infrastructure investment in recent years has made significant inroads into the geographical isolation and lack of access to information that characterizes Ethiopia, but the network is still very thin, even by African standards. 1.45 Public infrastructure investments have led to significant results from a very low base. The share of paved roads classified as in "good" condition increased from 17 percent in 1997 to 49 percent in2004 (for gravel roads, there was an increase from 25 to 35 percent, and for rural roads, from 21 to 36 percent). The proportion of the country more than 5 km from an all weather road dropped somewhat over the same period (79 to 72 percent). The Government has also made development of Information and Communication Technology (ICT) a key priority, and the number of mobile phone subscribers increased from 98,000 in 2003 to 350,000 in 2005. However, the agenda remains considerable, as described inChapter 4. 1.46 Private investment contracted in the wake of the war with Eritrea, but recovered in2002/03 and expanded vigorously in 2004/05 with 52 percent growth. The share of private investment in GDP is about 15 percent which compares reasonably well with neighbouring countries such as Mozambique (10 percent), Tanzania (11 percent), Uganda (17 percent) and Madagascar (14 percent). According to the new national accounts data, private has surpassedpublic sector investment every year inthe last decade (Figure 1.9). Bank credit to the non-governmental sector increased by 11 percent in 2004 and 58 percent in2005. 14 Figure 1.9 Publicvs. Private Investment(share of GDP), 1996-2005 18 I 16 14 8 g 12 10 c, t 6 4 2 0 1 +Private fixed capital formation -c-Gov'tfidcapitalformation I Source: MOFED. 1.47 Saving and lending rates are characterizedby nominal rigidity and have followed the minimum saving (deposit) rate. Since March 2002, the interest rate on savings deposits has been 3 percent while the minimum and maximum lending rates have been 7 percent and 14percent, respectively (as of Dec. 2006). The 91-day Treasury Bill rate has been consistently lower than the minimumsaving rate, reflecting the excess liquidity of banks. Real interest rates (based on non-food inflation) have been relatively stable but the minimum deposits rate and 91-days Treasury bill rates turned negative during 2004/05. Domestic savings effort has been steadily falling, from 9 percent of GDP in 2000/01 to only 3 percent in2004/05, inspite of higher economic growth. Pro-poor Expenditure 1.48 There have been significant increases in public spending over the past several years, and rising pro-poor spending. A full analysis of fiscal trends is beyond the scope of this document, but a detailed discussion of short and mediumterm issues can be found inthe Reviewof Public Finance (World Bank 2006g). Innominal terms, aggregate pro- poor spending (definedto include agriculture and natural resources, health, education and roads) more than tripled between 1997/98 and 2004/05. Defence spending was cut back significantly, falling as a share of GDP from 11percent in 1999/00 to 2.6 percent of GDP in2005/06. 1.49 The share of pro-poor spending increased from 41 percent in 1997/98 to 62 percent in 2005/06 (or from 8 percent to 15.8 percent of GDP). Ethiopia compares very well by international standards (Figure 1.lo), an achievement supported by external financing. It should however be noted that Ethiopia's definition of pro-poor expenditure has expanded in recent years as well, and now encompasses capacity building, food security, and rural electrification, along with the traditional elements (e.g. education and health). 15 Figure 1.10 Pro-PoorExpenditure,Cross-Country Comparison,2004 Sources: Authorities and IMF Staff Estimates. Pro-poor spending figures are not standardized, but defined according to each country's poverty reduction strategy, and are therefore indicative only. 1.50 The plan for 2005/06 was to continue and expand these efforts, with a nominal increase of 28 percent in government spending or 5 percent of GDP, and rising pro-poor expenditure, mostly for infrastructure. However, fiscal outturns showed a significant shortfall relative to projected revenue and grants, which prompted the authorities to reduce total expenditure from the budgeted 36 percent to 25 percent o f GDP, affecting mostly capital expenditure while preserving poverty-targeted recurrent expenditure to a large extent. In particular, some planned investments (particularly in the energy and telecommunications sectors) were scaled back or postponed. 1.51 A sectoral breakdown of public investment expenditure shows that public investmentineducation has been consistently rising over the last few years, while health has increased marginally from very low initial levels (Figure 1.11). A further major boost had been planned, with a new emphasis on rural infrastructure, particularly in telecommunications and electrification. However, these plans were revised in light o f increased fragility o f the macroeconomic situation, increased oil costs, and reduced donor support. 16 Figure 1.11 Trends inPublicInvestment,1981-2006 Source: Own calculations from MOFED data. 1.52 The most notable recent shifts insectoralallocations include the large increases in rural spending in the rollout of the Food Security Program and increased infrastructure investments. Food security comprises about 8 percent of total expenditure, and more than doubled between 2002/03 and 2004/05. Infrastructure investment has grown dramatically, from less than 2 percent of GDP in 1981 to more than 6 percent in 2006, with an uptick in the last two years8 The low point in the decade coincided with the conflict in2000. 3) Regional Differentiation 1.53 So far this chapter has largely abstracted from the size and diversity of Ethiopia. This section attempts to redress this, by focusing on regional differentiation andadopting a characterization of Ethiopiathat helpsto illuminate economic prospects and challenges. Stylizedfacts 1.54 Ethiopia's varied topography and agro-climatic diversity poses huge development challenges. The country's terrain comprises a high central plateauthat ranges from 1,500 to 2,500 meters above sea-level, with several peaks as high as 4,600 meters, and covers some 43 percent o f the country. These highlands are divided by the Great Rift Valley, which runs from southwest to northeast, and are surrounded by semi-arid and arid lowlands. The country is further subdivided by a dozen major river valleys, running down from the highlands, which isolate several regions from the centre of the country and from each other. This geography makes transport and communication difficult and costly, constraining trade and market access and weakening economic integration. The challenges are exacerbatedby landlockedness. 8However, the lack of comprehensive budget data on infrastructure means these figures are indicative only-see Chapter 4. 17 1.55 To some observers, Ethiopia's highlands represent a rapid, self-reinforcing, downward spiral, but this characterization ignores the country's human endowment, prospects for off-farm activities and the potential for urbanization. There i s nonetheless consensus that enabling development in the highlands i s a major national challenge. People historically clustered inpart due to the threat o f malaria and animal diseases inthe lowlands and, although once rich and fertile, much o f this area has been rendered unproductive through over-farming and environmental degradation. Since 1985, the productivity decline due to soil erosion has averaged 2.2 percent a year (Bekele and Holden 2000). Moreover, highland households depend on diminishing plots (now averaging about 0.75 ha) that cannot produce enough annually to meet minimum subsistence needs. The resulting widespread structural food deficits have led to chronic dependence on food aid, with transitory peaks duringdroughts. 1.56 While droughts pose the key source o f risk in some parts o f the country, other areas are prone to flooding. Floods can force farmers to delay planting, wash away top soil, cause landslides, and lead to sediment build up in reservoirs, which negatively affects hydropower generation, irrigation, and drinking water provision. Flooding problems are compounded by some man-made changes to the landscape (i.e. paved areas around towns increase runoff) and environmental degradation due to deforestation and cultivation o f steeply sloped land. 1.57 For decades, the prevalence o f malaria and severe animal diseases inthe lowlands prevented the exploitation o f large parts o f Ethiopia and impeded the absorption o f the surplus labour from the highlands. This poses difficult challenges to policymakers: any effective development o f the lowlands will, at a minimum, require the establishment o f basic human and animal health infrastructure. The toll o f malaria on labour productivity i s high, and without the use o f oxen, farmers have little possibility of cultivating enough landto feed themselves, muchless to produce a surplus. 1.58 Alongside geographic diversity, there is enormous diversity in human development outcomes across the country. This is to a significant extent associated with variance in income levels, and the pattern o f public service access. For example, Figure 1.12 illustrates the wide differentials inprimary enrolment across regions-enrolment i s clearly highest inAddis Ababa, while the pastoral regions o f Afar and Somali have by far the lowest enrolment rates. Figure 1.13 shows the variation inunder-5 mortality, where again Addis Ababa has the best outcomes, while o f the large regions Amhara and SNNPR have the worst. 18 Figure 1.12 Primary (Grades 1-8) Gross Figure 1.13 Under-5 Mortality, 2005 Enrolment Ratio (GER) by Region,2004/05 140 160 I c I20 140 n 120 0 3 100 8F 80 -i loo 2 80 60 k 60 40 40 20 Q 20 0 0 Source: World Bank 2005i. Source: World Bank 2005g. 1.59 Table 1.3 shows the poverty incidence by region (as of the 1999/00 HICES) alongside the per capita transfer from the federal government (Addis i s not included because it is self-sufficient from a revenue standpoint). Benshangul-Gumuz, which has a high poverty incidence of 54 percent, received one of the largest transfers (Br 312 per capita). At the same time, however, the four largest regions (bolded inthe table) received the lowest per capita transfers (along with the Somali region). Table 1.3 RegionalRankings Basedon Selected Indicators (l=poorest; 1l=best) Tigray 61.4 118 Afar 56 181 Amhara 41.8 90 Oromia 39.9 79 Somali 37.9 101 Benshangul-Gumuz 54 312 SNNPR 50.9 84 Gambella 50.5 547 Harari 25.8 441 DireDawa 33.1 254 1.60 The variations in per capita transfers are explained by the block grant allocation formula. Funding i s allocated to regions based on a three-part formula that takes population size, poverty and development level, and an index of revenue effort and sectoral performance into account. However the formula is effectively biased against large regions. Figure 1.14 shows the strong negative correlation betweenpopulationsize and per capita transfers, which explains the high per capita amounts allocated to Gambella and Benishangul-Gumuz (which have a combined population o f less than 1 million). Oromia, with a population over 25 million, received the lowest per capita transfer-Br 79, or less than a fifth of Gambella's. To a certain degree, smaller regions need a larger per person transfer, since there are fixed costs at the regional level 19 regardless o f population size, and the costs o f serving remote populations tend to be higher. The Government has recognized that the current formula does not adequately reflect regional needs, and i s currently considering revisions that would better ground the approach inthe regions' expenditure responsibilitiesand revenue. Figure 1.14 Federal Block Transfer to Regions per capita vs. RegionalPopulation 95 `E 100 - 2 I 0 5 10 15 20 25 30 Population of Region, 2004 (millions) Source: World Bank 2006a. 1.61 Regional human development outcomes, poverty levels, and federal transfers do not always track each other inthe expected way. For example, Gambella has a relatively high poverty rate and very high under-5 mortality rate despite receiving the highest transfer. O f course, there are important historical differences by region that play a key explanatory role-for example, it will take many years to erase the scars left by major droughts or conflict in some areas. Some factors can be changed more quickly than others. An "output" o f development efforts like school enrolment can improve relatively quickly given adequate resources and management, while "outcomes" such as child mortality take much longer to affect-and seen in historical perspective, the intergovernmental transfer system i s relatively new. This suggests that the relatively low school enrolment rates in Amhara and Oromia could be related to the small federal transfers they receive. But many other factors are at play in determining access to services-on the demand as well as the supply sides-and more analysis i s required to assess the relative importance o f the size o f transfers versus other determinants. The "Three Ethiopias'' 1.62 Given the diversity o f Ethiopia, generalizations about climate, environmental status and demography are unlikely to be useful for policy makers, national and local, seeking concrete solutions. On the other hand, it is impossible for national level reports likethe present one, and indeed national level policy makers, to fully differentiate across every sub-region. A simple approach to begin to help addressing this dilemma has been developed by the Ministry o f Agriculture (MOA). This i s based on a comprehensive classification system that recognizes 18 distinct agro-ecological zones (based on precipitation and temperature), and then in turn aggregates these into three broad 20 categories known as the "three Ethiopias" (MOA 2000). These three categories consist Of: EthiopiaOne:the humidmoisture-reliable parts o fthe west andsouthwest; EthiopiaTwo: moist drought-prone areas with inadequate andunreliable rainfall inthe EasternHighlands, central andnortheastern Ethiopia; andfinally Ethiopia Three: the arid pastoral lowlands consisting o f the eastern shelf of the country, including much o f the Afar and Somali regions. Other pastoral areas include the Southern tip o f the country (mainly Borena (Moyale), Kuraz, Hammer Bena, and Teltelie). Figure 1.15 illustrates this classification (a full-color version is also included at the end o fthis report, following the References). 1.63 The next chapter, which focuses on rural development, reviews these categorizations alongside a complementary and richer approach recently developed by IFPRI, which goes beyond agro-climatic factors, since we know inEthiopia that access to markets and infrastructure i s a critical determinant o f growth (for more details on the Ministryof Agriculture classification, see Annex 2.1). The new IFPRI classification of development domains takes account o f market access and i s especially relevant to a strategy focused on growth poles, concentrated in areas where there i s good access to markets over the medium term. 21 Implications 1.64 Ethiopia's economic performance-while strong in recent years-remains highly vulnerable to shocks (particularly rainfall and terms o f trade shocks), and improvements in agricultural productivity have been elusive. In order to put Ethiopia on a path of sustainable growth and poverty reduction, particularly given the rapidly growing population, this report has proposed a two legged strategy to accelerate equitable growth, which was laid out inPart I. 1.65 The core questions explored in subsequent chapters revolve around the set o f policies that could accelerate development in Ethiopia. As Ethiopia's policy makers are now firmly focused on the attainment o f the MDGs, it i s important to ask whether the underlying strategies to promote growth are conducive to that end. The core issues that are addressed inthe balance o f this report are: H o w to accelerate rural productivity growth? I s a different mix o f interventions, or an "ADLI+" strategy, necessary to accelerate productivity growth and structural transformation? To what extent i s it acceptable for inequality to increase from its very low current level to enable growth to accelerate in certain high-potential sectors or areas-and how can the effects o f a possible increase in inequality be mitigated for the poor? H o w does Ethiopia's investment climate help or hinder private investment, and what are priorities for change? What are the key barriers to improving productivity? Does Ethiopia's infrastructure deficit require a "big push"? What i s the optimal sectoral balance for infrastructure development, and how should the strategy be geographically differentiated (by region, and rural vs. urban)? H o w can public investment allocations be efficiently leveraged? To what extent has fiscal decentralizationtransformed local governance realities, and what challenges remain? What kinds o f benchmarking and monitoring mechanisms could further strengthen bottom-up accountability? 23 24 2. AGRICULTURE AND RURALDEVELOPMENT FOR PRO-POOR GROWTH 1) Agricultural Growth Performance:The Needfor New Approaches 2.1 Ethiopia presents one of the most important rural development challenges globally. Among the poorest countries inthe world, the agricultural sector accounts for 40 percent of national GDP, 90 percent of exports, 85 percent o f employment, and 90 percent of the poor (Box 2.1). Agriculture's performance therefore matters immensely for poverty and growth, both directly as well as indirectly through its potential for strong pro-poor growth linkages. The Government's Agriculture Development Led Industrialization (ADLI) accordingly places a very high priority on agricultural growth, which remains the core of the government's poverty reduction strategy (SDPRP for 2002- 2005 and the newly approved PASDEP from 2006). Inthis strategy, agricultural growth i s expectedto stimulate overall economic growth through higher farm incomes, providing a market for non-farm products and inputs, supplying cheaper food and raw materials for agricultural-based manufacturing, andmobilizingsavings to finance investments. Box 2.1 EthiopianAgriculturein a Nutshell Among the rural population, the main source Structure o fMeher Season Annual Crop Production o f income for 87 percent of the households is ((percent o f total grain production) semi-subsistence agriculture which is almost pulses oilseeds entirely rain-fed. Within agriculture, 64 oats 11% 2% wheat percent of value added comes from crops, 23 1 % 7 1 r 12% percent from livestock, and 13 percent from forestry. Exports (where coffee accounts for about half o f value, followed by hides and skins and chat) represent about 20 percent of agricultural GDP. O f the aggregate cropped area, 73 percent is devoted to cereals, 20 percent to pulses, oilseeds and other annual crops, and less than 7 percent to permanent (mostly cash) crops. teff Ethiopia has the second largest livestock 20% NOte shares arn ~ ~ ~ ~ ~ ~ ~ ~ f ~ ~ m 1 9 7 9 1 5 0 . 2 0 0 3 1 0 4 Farm income levels are low and highly variable, and subject to periodic climatic shocks. The primary asset to cushion weather shocks is livestock (72 percent o f households own cattle). The ownership of other physical and financial assets i s extremelv low. Source: World Bank 2006e. 2.2 Inpursuit of ADLI, a series of policies was put inplace inthe 1990s including: (i) supportivemacro-economicframework;(ii) amore liberalized markets for agricultural 25 products; and (iii)strong extension and credit-led push on intensification through use o f a modern inputs, especially seed and fertilizer. After the continuing evidence o f widespread food insecurity in the drought o f 2002/03, the Government also initiated a strong focus on safety nets, programs to build the assets o f food insecure households, resettlement, and soil and water conservation (especially water harvesting). 2.3 These early reforms provided a much needed boost to agricultural production, primarily cereals. Foreign exchange devaluation also helped increased competitiveness o f export products (coffee in particular) and liberalized grain markets led to improved incentives for farmers. The most significant growth took place inthe mid-1 9 9 0 ~ ~ driven largely by area expansion in response to liberalization (although there may be problems with official data on area). At the same time, there is some evidence o f productivity increases from research trials that are beingpromoted (Box 2.2). Box 2.2 Recent Success Stories The White Gold of Ethiopia. The Melkassa centre of the Ethiopian Institute o f Agricultural Research (EIAR) has developed and released 24 food and 5 export haricot bean varieties inthe last 25 years. Using the recommended farm practices and improved varieties tested in farmers' fields, crop yields of 1.9 to 2.3 metric tons per hectare have been obtained by farmers, which is three times more than through conventional practices, though yield at the research station was even higher at more than 2.5 tonsha. Each farmer obtained an average gross income o f over Br 3,600 per hectare- which is 3.5 times the average per capita income inEthiopia. Through the scaling up process, EIARhas forged partnerships with farmers' co- operative unions, the seed industry, importers, and exporters to produce and market the haricot bean. Inthis arrangement, farmers gained access to credit and improved seeds, and were guaranteed a price o f Br 175 per 100 kg for dry beans. Various companies including the Britishcompany Portman purchased the beans fiom the union, and export earnings from beans increased fiom US$20 million in2003 to US$63 million in 2005. All this was achieved through teamwork, a shared vision, market demand and the involvement of key stakeholders inthe process. According to EIAR, similar successes have also occurred in crops such as potatoes, onions, lentils, durum wheat, finger millet, pyrethrum and soybeans. Key to the success is the combination o f technology, marketing and partnerships. However, hrther attention is required in terms of promoting quality, sustaining partnerships, building the capacity o f farmers and cooperative unions, involving marketing agents, and providing marketing informationfor scaling up these successes. Impact of Maize Research and Dissemination in Ethiopia. The Ethiopian Institute o f Agricultural Research (EIAR) conducted a study to assess the socio-economic impact o f maize R&D investments over the period 1986 to 2000 using the economic surplus method. The National Maize Research Programme released 9 composites and 5 hybrids over the period 1970 to 1997. This Programme operates through 25 Programmes and 75 projects o f EIAR and regional research centres, as well as a variety o f actors in the public and private sectors. Over the period 1986 to 2000, the average yield o f maize increased from lt/ha to 1.8t/ha. Based on sample survey estimates, the adoption rates for improved maize in Oromiya, Amhara and Southern Nations were 39 percent, 43 percent and 47 percent, respectively. The internal rate o f return to the investment in research and extension was estimated at 29 percent. The study also concluded that the investment had contributed significantly to institutional development, human capacity building, food security, soil conservation, and establishing linkages with new actors. Despite some data problems, the study clearly demonstrates the social benefito fthis investment. Source: Scaling-uplout conference May 9-11,2006, EIAR, Addis Ababa, Ethiopia Tesfaye 2001. 2.4 The early gains slowed by the late 1990s and the first part o f this decade, with large annual fluctuations in both production and prices. Agriculture value added has risen by only 1.4 percent annually since 1993 with output and price increases contributing 26 equally to this growth. In fact agriculture only contributed 0.3 percentage points on average to annual GDP growth over the decade to 2003 (World Bank 2006e). Thus per capita agricultural GDP and per capita grain productioncontinued their long term decline (Figure 2.1). As a result consumers have yet to benefit from lower food prices that would be stimulated by increased agricultural productivity. With declining per capita incomes and rising real prices of food, rural poverty has stagnated. Rural poverty is compounded by an extreme shortage o f land, with per capita land area falling from 0.5 ha inthe 1960s to only 0.2 ha, and the marginal productivity of labour i s estimated to be close to zero (World Bank 2005b). Figure2.1 RealAgriculture GDP per Capita, 1962-2006 800 1 750 700 Government 650 i 600 L 550 500 450 Haile Selassie's 400 350 +Series1 -T r e n d Source: MOFED. 2.5 Under ADLI, the Government emphasized intensification to increase agricultural productivity, especially a centralized extension push focusing on technological packages combining credit, fertilizers, improved seeds and better management practices to raise productivity. Under this program, fertilizer use almost doubled between 1990 and 2000, to 290,000 tons (Figure 2.2). However, the intensity of fertilizer nutrient use per hectare stagnated inthe latter half o f 1990s and into this decade. Only 37 percent of farmers use inorganic fertilizer and application rates remain low at 16 kgha of nutrients (about 33 kgha of commercial product). 27 Figure2.2 Total Fertilizer Consumption 350 1 300 35 8s .2. 250 30 3 a - 200 25 2 W v 150 20 h .c, .I g CI Q 15 100 L10 5 50 5 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 - Total -+-Intensity Sozirce: World Bank2006e. 2.6 Following the drought of 2002/03, a large-scale food security program was rapidly scaled up in poor and vulnerable areas, amounting to a significant part of total public spending. More recently, weaknesses in the marketing system have been recognized and a new marketing strategy is being developed based on scaling-up cooperatives, and establishing a commodity exchange and its associated institutions. As a result of these various programs, public spending on agriculture, natural resources and food security has risen from 5 percent of the total government budget in 1997/98 to over 10percent in2003/04, above the NEPAD target for sub-Saharan Africa (Figure 2.3). The World Bank's upcoming Rural Public Expenditure Review details these trends. Figure2.3 PublicExpenditureson Agricultureas a Share of Budget I 14I Source: World Bank staff calculations under the RuralPublic Expenditure Review(World Bank 2007), usingdata fiom MOFEDand various World Bank country Public Expenditure Reviews. 2.7 The strong push on intensification has not resulted in a sustained increase in agricultural productivity. According to official data, almost all increased production of 28 the past decade seems to be explained by area expansion, while both land and labour productivity inagriculture showed a generally declining trend. However, the most recent data show an encouraging increase, as shown in Figure 2.4, meaning that the key question is whether this momentum can be sustained. Cereal yields have generally stagnated (Figure 2.5). As a result, land productivity at 1.15 t/ha of cereals is low and labour productivity is very low (agricultural value added per agricultural worker of US$144 vs. US$329 average for Sub-SaharanAfrica). However as indicated above there i s evidence of new varieties of crops being promoted, which could lead to increased productivity inthe future. Figure2.4 Agricultural Land and LabourProductivity(constant 1995 US$) 130 = 120 F 110 Q) F -8 II 100 '0 C .-> 90 CI 80 '0 3 g 70 n 60 Labor -Land Source: World Bank 2006e. 2.8 Agricultural productivity growth has been undermined by serious land degradation. With a heavy concentration of the population inthe highlands, agricultural labour per ha of cultivated landis double the average for Sub-SaharanAfrica. Population pressure has put tremendous stress on the natural resource endowment, particularly soil fertility. Area expansion has increasedpressure to cultivate fragile and marginal lands, resulting in soil loss, mining of soil nutrients, and deforestation. Average estimates of productivity loss due to soil degradation are on the order o f 2-3 percent annually (see below)-along with expansion of cultivationinto more marginal areas, this explains most of the failure to realize the yield gains expectedfrom intensification. 29 Figure2.5 Performanceof CerealCrops (Meher Season Index 88/89 = 100) Performance of Cereal Crops (Meher Season Index (88/89=100) 1 - -Area- Yield - - -ProductionI Source: Central Statistical Authority data. 2.9 Recurrent droughts and highvariability inproduction have compounded the long- term decline in productivity. The growth that has occurred has been erratic, driven largely by rainfall variation (Figure 2.6). This damages the asset base of households, their incentives (especially for the use of modern inputs), andtheir ability to exit poverty. High variability and weak market demand have also resulted in sharp price fluctuations, especially for non-traded staples. The negative impacts o f variability underlinethe need for a greater focus on irrigated agriculture inhighpotential areas. Figure2.6 AgriculturalSector GrowthRates Since 1994 20 L -10- -20 ' wrce: MOFED. 2.10 The overall assessment is that despite more than a decade of focus and significant public support, Ethiopian agriculture remains stubbornly low-input, low-value and 30 subsistence oriented, and subject to frequent climatic shocks. Given this performance, a simple scaling up o f past approaches i s not likely to produce acceptable growth and poverty reduction targets consistent with achieving the MDGs. Recognizing this, the new Plan for Accelerated and Sustained Development to EndPoverty (PASDEP) indicates an evolution o f strategy toward market-driven diversification and commercialization, and increasing exports, with a greater focus on private sector investment. 2.11 Agricultural sector performance over the past two years is indicative o f these new directions in strategy. Following the opening o f incentives for private investment inthe flower industry, a total o f over 100 investors have invested in the industry and flower exports increased to nearly US$13 million in 2005. Other investments in high value products and supply chains are emerging, including the export o f green beans to Europe, the emergence o f a contractual supply chain for the UK baked bean industry, and the supply o f quality milk and poultry to urbancentres. Several of these emerging industries involve out-grower and/or contract arrangements with small farmers, often linked with an emerging indigenous entrepreneurial class of farmers and agribusiness. Although oilseeds and pulses are lower value products per unit, exports o f these products have also experienced impressive growth, increasing their value by a factor o f ten between 1997 and 2006 and demonstrating the increasing competitiveness o f these sectors through area specialization and the uptake o f new technologies (Figure 2.7). These recent experiences demonstrate the potential o f the sector, but at the same time also raise questions about implementation of the new strategy interms of products and locations that can revitalize agricultural growth. Figure 2.7 Agriculture LeadsRecentExport Growth (US$m) 1100 1000 900 800 E3 0 thers [/1 3 700 0 Chat Lo 600 NFruits &vegetables, flowers 8 500 Q Meat & live animals 3 400 El Leather Pulses and oilseeds 300 ElCoffee 200 100 0 1997 2005 2006 Source: National Bank of Ethiopia. 2) The MultipleChallengesto Pro-Poor Growth 2.12 Most analysis indicates that given current technologies, production o f major crops could be doubled (Table 2.1). Why then the long-term stagnation o f agricultural productivity, despite the high priority attached by the Government and donors? This 31 reflects the combination o f six key challenges to promoting rural growth that are especially daunting in Ethiopia: (i) geographical and infrastructural constraints; (ii) land degradation; (iii)frequent exposure to risk and vulnerability; (iv) the challenge o f providing appropriate and profitable technologies for a highly heterogeneous sector; (v) low labour mobility and the very small size of the rural non-farm sector; and (vi) low literacy rates and skill levels inrural areas. Each o f these challenges i s surmountable, but there are no "magic bullets." Appropriate strategies are neededon multiple fronts. Table 2.1 Yields in On-farm FieldTrialsvs. Farmers' Yields (t/ha) a NAEIP is the National Agricultural ExtensionInterventionProgram. SG2000 is SasakawaGlobal 2000 program. Source: World Bank 2006e. The Challenge of Geography, Infrastructure, and Markets 2.13 The burden o f geography-a combination o f isolation, topography, and lack o fpast investments-has left Ethiopian farmers especially poorly connected to roads, transport and other forms o f communication, even relative to other African countries. Farm households are on average 10 km from the nearest road, 18 km from the nearest public transport, and 6 km from the nearest food market. This isolation raises the costs and risks o f market exchange, rendering commercialization strategies unattractive for many households who instead opt to produce their own food. Transaction costs remain a major constraint for smallholder export and market exchange, and account for 30-70 percent o f the final retail price o f food staples (Gabre-Madhin 2001). Better access to food and other markets would improve incentives to produce more profitable cash crops and livestock, and raise farm incomes. Opportunities for economies of scale are missed where markets are thinner or where trade flows are more sporadic, and trading networks suffer from weaknesses infinancing, information, and the inability to assume risk. 2.14 Major improvements in the road network and market infrastructure are necessary to shift agriculture to a more commercial footing, increase productivity, and spur diversification. IFPRI simulations indicate that reducing marketing margins by 10 percent per year between food deficit and food surplus areas would increase overall annual GDP growth by 0.7 percentage points and reduce poverty by an additional 3.1 percentage points by 2015 (Diao and Pratt 2005). 2.15 The main elements o f the Government's approach to improving market connectivity have focused on the crucial areas o f liberalizing markets and improving roads, especially major highways. Liberalization has clearly improved the functioning o f 32 grain markets after the interventionist policies of the Derg, particularly in surplus grain producing regions (World Bank 2006e). The Government has recognized that a dramatically improved road network is a prerequisite for higher rates of growth in agriculture and to foster urban-rural linkages. However, despite a significant effort over the past decade on road construction, transport costs for farmers and for traders remain high, inpart becausemost farmers lack feeder roads to the mainnetworks. And roads are a long term and costly investment that do not improve yields and returns quickly. 2.16 But it is not just roads and topography-supportive policy measures are also neededto get markets `right'. Institution-building and attention to risk, information, and food aid-related distortions are also critical (Gabre-Madhin 2001). The Government's emerging market strategy is to build a central commodity exchange to address problems of market information and transactions costs and risks, and to exploit scale economies though cooperatives (Gabre-Madhin and Goggin, 2006; Bernard, Birhanu, and Gabre- Madhin, 2006). Policy measures inother sectors, such as expansion of mobile phones to rural villages or to subsidize the purchase of radios, could also have substantial impacts on the market's responsiveness and conne~tivity.~At the same time, innovative approaches are neededto help farmers meet the new challenges o f participating inglobal markets-particularly with regardto quality and safety standards. 2.17 Competition i s essential for providing efficient market services to farmers. Input markets require greater participation by the private sector. A dynamic private sector operating from importers to retailers could foster more timely access to inputs and improved quality and services. In several recent surveys, one quarter to one half of farmers complained o f late delivery of fertilizer (World Bank 2006e). A related challenge i s how to facilitate emergence of rural financial markets, which are now crowded out by government guarantees of fertilizer loans. Because of these policy- induced constraints Ethiopia now seriously lags in intensification of smallholder agriculture, relative to other countries such as Kenya that have fully liberalized input markets (Box 2.3). Actions that have been identified to promote fertilizer sales are laid out inTable 2.2. 9World Bank (2005b) estimates that providing the poorest quintile of the population with a radio would increase their incomes by 5 percent and reduce poverty incidence by 11percent. Access to radio broadcasts can promote greater exposure to new ideas andnew opportunities, inaddition to better market connectivity. 33 Table 2.2 Actions to Promote Increased Fertilizer Sales 0bjective Actions Builda sustainable Providetrainingfor fertilizer dealers to enhance their skills and capacities in agriculturalinputsretail fertilizer handlingandmarketingactivities. marketingsystem Buildfarmer cooperatives' capacity in marketingservices throughprovision of trainingto increasetheir share ininput marketing. Relaxcollateralrestrictionson importsand opento domestic andforeign importers. Establisha sustainable 0 Regionalgovernment guaranteesfor input creditto be reducedto 50 percent agricultural inputs by 2008. credit administration 0 Promote cash sales of fertilizers. system Reorganizeandstrengthen farmer cooperatives under the new cooperatives law by providingtraining andtechnical assistancethroughthe cooperative commissionto enhance their capacity to access bank credit andprovide better marketingservices to their members. 0 Strengthenexistingmicro-financeinstitutionsthroughcapacity building for sound financialmanagementandto sustainably expandtheir savings and credit services to more clients. Promotefertilizer use To assist the extension promotionprogram, introducetraining of DA's at a with more responsive diploma level infertilizer use andprofitability. DAs inturn will provide technicaladvice trainingfor farmers. TheDownward Spiral of Land Degradation 2.18 The densely populated highlands are characterized by severe land degradation. Though once rich and fertile, many highland areas have been rendered essentially unproductive over the past few decades and farmers depend on diminishing plots of progressively less productive soils. Farming practices combined with rapid population growth and overgrazing accelerate land degradation and the decline in productivity. In many places landdegradation threatens the collapse of the farming system. 2.19 Massive land degradation arises from deforestation (to meet household needs for fuel wood) and the cultivation of steep slopes to accommodate the expanding population, together with ineffective or inadequate watershed management and uncontrolled grazing of livestock. Increasingly, poor farmers suffer `fodder poverty' that forces them to feed crop residue to their livestock rather than return it to the soil, and "energy poverty" that forces them to use animal dung for fuel rather than fertilizer. Soils become depleted through a lack of fallowing, removal of crop residues, and generally low use of commercial inputs. As a result, soil nutrient removal exceeds the nutrients added by chemical fertilizers. Due to the high rates of erosion, the soil in many areas is less than 20-30 cm deep, which means that it i s reaching the lower limits of productivity and has lost much of its capacity to retain moisture. 34 Box 2.3 Fertilizer Marketing Policy: I t Pays to Liberalize Inthe mid-1990s, both Kenya and Ethiopia liberalized fertilizer policies, encouragingprivate sector participation and in the case of Ethiopia eliminating explicit subsidies. In Kenya, price controls on fertilizer were lifted in 1993, and farmers relied almost exclusively on the private sector and cooperatives for fertilizer. The private sector appears to have responded very rapidly to the new policy environment.Ariga, Jayne and Nyoro (2006) report that by 2004, over 10 major importers, 500 wholesalers, and roughly 8,000 retailers were actively distributing fertilizer in Kenya. Recent studies have revealed that Kenya now has a competitive and dynamic private sector fertilizer distribution system, the average distance of a farmer to a retailer has been halved to 4 km, and inland marketing and distribution margins on fertilizer have fallen by 40 percent.Total fertilizer consumption increased from 281,000 tons in 1995 to 352,000 tons per year in 2005. The number of smallholders using fertilizer has increased from 43 percent to 69 percent from 1995/96 to 2005/06. Farmers who use fertilizer on maize apply approximately 103 kilograms of nutrients per hectare, which is comparable to mean levels in South and East Asia in similar rainfed environments. Efficient fertilizer use has been promoted by a number of participatory extension programs including distribution of small input testingpackages, microdosing, and tailoring fertilizer recommendationsto specific locations. In Ethiopia, fertilizer distribution was liberalized and the subsidy eliminated by 1997. A guaranteed loan programwas implementedto encourage fertilizer consumption. However, after an initial spurt of interest from the private sector, imports and wholesaling became concentrated inthe parastatalsector and a handful of party-affiliated companies, inpart becauseof high collateral requirements for import credit, restrictions on participation by foreign fertilizer suppliers, and a perceived lack of a level playing field for participating in fertilizer imports and distribution. By 2004, about 90 percent of farmers bought fertilizer through EISC, the parastatal for input supply, or the local agricultural office, and another 12 percent through cooperatives.Nearly 90 percent of fertilizer was bought on credit tied to input supply, and only 7 percent of farmers made cash purchases of fertilizer from private dealers (EEA 2006). Fertilizer is applied by only about 40 percent of farmers and the intensity of use has stagnated at about 30 kgha. There are also significant costs inthe system, including late delivery of fertilizer for 25-50 percent of farmers, fiscal costs of non-performing guaranteed loans, and lack of alternatives for farmers in terms of fertilizer types, package size, etc. Although farm gate prices in Ethiopia are comparable to Kenya, the presence of a dense network of small private dealers in Kenya as the vehicle for input supply has resulted in a much more dynamic sector with significant benefitsto farmers. Sources: Ariga, Jayne, andNyoro, 2006; World Bank 2006e. 2.20 The annual cost of soil and nutrient lossesthrough landdegradation, deforestation and loss of livestock carrying capacity averages 2-3 percent of agricultural GDP.lo Although land degradation i s often associated with drier and food insecure areas, it is perhapseven more alarmingthat large areas ofthe traditional "bread basket" zones of the wetter highlands (Le., relatively high potential areas such as Gojjam) are now at highrisk from soil degradation. Their rates of soil loss include some of Ethiopia's highest, reaching 130-170 metric tons per hectareper year. 2.21 Landdegradation leads to a vicious cycle whereby land is progressively degraded because households are too poor to leave land fallow or invest in it. Such processes can result in an irreversible decline in soil fertility, and this has already happened in many 10For a reviewof various estimates and underlyingestimation methods, see Yesuf et al., 2005. 35 areas o f Ethiopia. This may therefore represent not only a self-reinforcing but a progressive deterioration inthe asset base and well-being o f the rural population inmany areas o f Ethiopia (Yesuf et al. 2005). Without major changes in incentives and investments, this circle o f degradation and impoverishment is unlikely to stop. 2.22 Althoughthe Government's Food Security Programprovides significant resources for soil and water conservation for the food insecure area, only about 1 percent of the budget i s allocated to natural resources management for the rest o f the country. Without massive scaling up o f investments for sustainable land management in the wetter areas, there i s a real risk o f increasing areas o f the country sufferingirreversible loss of its most precious natural resource and converting them into food insecure areas. AddressingHigh Risk and Variability 2.23 Economic growth in Ethiopia closely follows performance o f the agricultural sector, which in turn i s heavily influenced by weather shocks, especially droughts. The variability in yields due to weather shocks has a negative impact on farmers' incentives. Producers are less likely, given the risks, to use yield-enhancing inputs (or to use them at 'recommended' levels), as this is unprofitable in poor-rainfall years (Figure 2.8). A generic estimate i s that in a risky rainfall environment a risk averse farmer would reduce fertilizer use by 40 percent (World Bank 2006d). Recent analysis in Ethiopia indicates that fertilizer use i s similarly sensitive to rainfall risk (Dercon and Christiaensen 2005). Inaddition, livestock, often the major store o f wealth o f rural households also suffer in poor rainfall years, and prices o f livestock tend to drop when harvests are poor due to the distress sales for survival. Thus productive asset bases are depleted, leading to classical poverty traps, with long term deleterious impacts o f drought on productivity and wealth." These impacts reduce households' ability to sustain nutritional and health status and to maintain school attendance, particularly for girls (World Bank 2005b). Figure 2.8 Returnswith/ without Fertilizer inNormal and Poor Rainfall Years 900 1 800 0Returnwithout fertiliser 700 normal year 600 Returnwith fertiliser normal year BirrhaI 500 400 Return without fertiliser ba 300 year 200 Return with fertiliser bad 100 year 0 I Source: Dercon and Christiaensen 2006. 'I Survey evidence fiom drought-affected households shows that those who were most affected in 1989 had lower subsequent income growth. Poverty inthe six sampled villages declined by 29 percent between 1989 and 1995, but would have declined by 39 percent inthe absence o frainfall shocks (Dercon 2004). 36 2.24 Yield risk is compounded by volatility anduncertainty inthe price of staple foods. This imposes large welfare losses, especially on net purchasers of grain, who make up the majority of households, even inrural areas and especially among the poor. The principal underlying reason for price variability is, again, climatic shocks, compounded by weak domestic markets and lack of integration with world food markets due to poor infrastructure and a poorly timed influx of foreign food aid (World Bank 2006e).l2With weak domestic demand, high transaction costs of trade, and low tradability for some of Ethiopia's principal crops (teff, millet, sorghum and barley), variability in production results in sharp price movements (i.e., demand i s highly inelastic). Finally, world prices of Ethiopia's major export, Arabica coffee, have been especially volatile, falling from a peak (US$1.85/kg) in the late 1990s to very low levels (US$0.85/kg) in the early 2000s before sharply recovering to US$2.32/kg inlate 2005. 2.25 While risk i s a perennial part of the rural landscape in Ethiopia, it is important to note that neither production risks nor inter-annual price risks are particularly high comparedwith other countries inAfrica, and infact are lower than inseveral countries of southern Africa (Table 2.3). However, high short term (i.e. intra-annual) variability combined with the extreme poverty of many rural households and lack of livelihood diversification in Ethiopia make Ethiopia's rural poor especially vulnerable to shocks. Several studies document the long-term deleterious impacts of shocks on productivity andassets.13 -wmmmmmmmmm Table 2.3 Comparative Statistics on Productionand Price Variability a. Measured by the Cuddy-La Valle Index which closely approximates the coefficient o f variation around the trend. b. Retail prices. Others are wholesale prices. . _. Source: Yields from Computed from FAOSTAT data. Price data were collected from contacts in each country. 2.26 Although the evidence suggests that price risks (both inter-annual and intra- annual) are falling over time (World Bank 2006e), risk mitigationmeasures are neededto facilitate the efficient use of inputs by farmers, and to alleviate the costs to consumers of short runspikes inbasic food prices. Pilot schemes beingpursuedto provide index-based weather insurance to farmers and other risk-mitigation products are promising. Improvements in rural finance and savings would reduce the asset depletion that often accompaniespoor harvest years. 12 In particular, local procurement of food aid aimed at strengthening local markets is often timed just before harvest when prices are highest, rather than post harvest. l3See, for example, Carter et al. (2004) and Dercon and Christiaensen (2005). 37 2.27 Price stability relates largely to capacity and incentives to store, as well as to engage in trade. The private sector i s not currently in a position to take the risks involved, particularly if food aid purchases and deliveries are unpredictable. Thus, a coordinated strategy developed and implementedinpartnership with the private sector to foster greater private storage o f grains in cooperation with food aid agencies i s needed. Inaddition, the planned Commodity Exchange with its associated institutions, suchas the use o f warehouse receipts, should help smooth prices and eventually allow farmers as well as traders to forward contract and lock inharvest prices. 2.28 One major result o f dependence on low productivity agriculture alongside unreliable rainfall has been widespread structural food deficits and chronic dependence on food aid. Ethiopia is the largest food aid consumer inthe world. Food aid deliveries have helped bridge the gap between food supply and needs, averaging about 720,000 metric tons over the past decade, and helping to avert major humanitarian disasters. There are some 5 to 7 million people inneedo f support every year-the chronically food insecure. When rainfall i s untimely or inadequate, this number increases, for example, to 11million inthe 2002/03 drought year. 2.29 While food aid programs have succeeded in avoiding large-scale famine for the past two decades, massive and sometimes poorly timed deliveries have significant negative impacts on producer incentives. Overall effective demand as well as the price volatility i s adversely affected (World Bank 2006e). 2.30 There is a general consensus on the desirabilityof substitution o f cash for food aid and the better management o f any ongoing food aid deliveries. Current safety net and food security programs are also being re-oriented toward productive investments with the aim o f completely phasing out food aid in five years. While this i s an ambitious and probably unrealistic target, these recent policy shifts in food aid should strengthen markets andreduce food dependency. 2.31 Conversion o f food into cash would be expected to raise grain prices-a 100,000 metric ton reduction in food aid i s estimated to increase prices by 10-12 percent (World Bank 2006e). Without complementary measures, higher grain prices increase rural inequality and poverty. Some 2 percent o f mostly wealthier households account for half o f all grain sales and benefit from higher prices, while 70 percent o f rural households who are net purchasers o f grain are worse off. Therefore substitution o f cash for food aid needs to be accompanied by productivity gains that rise faster than the increase inmarket demand, and allow real food prices to fall over the longer term. Technologyfor Heterogeneous Environments 2.32 InADLI-type strategies that characterize many o fthe success stories o f structural transformation in recent development experience, the central driver o f growth has been rapid and sustained increases in agricultural productivity, especially o f cereals. Appropriately, the Government has focused on intensification and launched a technology-based process o f transformation o fthe food production system. This included the basic fertilizer and seedpackage as well as efforts to improve access to a stable water supply* 38 2.33 The successful transformations in Asia were especially pro-poor since land productivity increased faster than labour productivity, ensuring increased employment growth, and total factor productivity increased faster than the decline in food prices, allowing a sharing o f benefits between farmers and consumers, especially the poor (Lipton 2004). However, the growth process in Ethiopia has been qualitatively very different than intended, with area expansion accounting for most o f the growth, although in some areas with assured rainfall, yield increases have occurred. Overall, despite increased fertilizers use, there i s little evident growth in total factor productivity (World Bank 2006e). And without productivity growth, consumers have not benefited through lower food prices. 2.34 The poor performance o f agricultural productivity despite the significant efforts at intensification and use o f modern inputs relates to a number o f factors, but low technical efficiency in the use o f the principal modem input, fertilizer, appears important. Recent analysis indicates that farmers are only achieving on average 60 percent o f their potential production, given current levels o f input use (World Bank 2006e). As a result, use o f fertilizer may be providing negative returns to many farmers resulting in stagnation in further intensification and significant dis-adoption. L o w technical efficiency in turn relates to application o f standard technological packages in very diverse and risky environments, as well as the negative effects o f a state-dominated input supply and credit system, and delayed arrival o f inputswhich results inlate application or plantingor both. 2.35 Extensive data indicate that if better soil and water management were combined with the wider adoption o f existing technologies at better levels o f technical efficiency (seeds and fertilizer), Ethiopia could double cereal yields in food secure areas, and increase yields by half in food insecure areas (Table 2.1). Based upon current seed and fertilizer prices, average profits per hectare could increase by 29 percent over average profits obtained without the use o fthese inputs, representing a potentially important boost to rural growth (Diao and Gabre-Madhin 2005).14 2.36 The challenge i s how to increase the knowledge and access to new technology and to provide incentives for its adoption, within a highly heterogeneous environment with large local differences in soils and climates, and high variability in rainfall across years. Successful adoption o f seed-fertilizer-water technology requires access to the technology itself (research and extension plus input marketing), access to financial resources for purchase o f modern inputs, sufficient incentives to stimulate adoption including acceptable levels o f risk, adequate access to markets and sufficient market demand. Experience suggests that packages of technology are not very appropriate in heterogeneous rain-fed areas, especially when they are tied to credit conditions. In such conditions, farmers require access to flexible and divisible technologies combined with the capacity to select and adapt practices appropriate to their particular field and seasonal conditions. l5 Because o f a standardized package approach, and inflexible input distribution systems (e.g., only two types o f fertilizer both in 50 kg bags), farmers have had little opportunity to experiment, learn and adapt technologies to their own needs. 14Thistakes into accountthe lower grain prices that would result from expandedproduction. 15See for example, Byerlee and Hesse (1986) and Byerlee(1988). 39 And extension agents were pre-occupied with management o f the fertilizer supply-credit program (EEA 2006). Only recently has the need for advisory services been more tailored to the local agro-ecological and economic/market circumstances and to support the whole farm (including livestock and non-staples) been recognized. The decentralization o f advisory services to the woreda level i s an important step, but alternative modes o f delivering services that would make them more responsive to farmers' needs needto be explored. 2.37 Another element o f promoting growth for heterogeneous environments is to encourage regional specialization to fit the particular agro-climatic and market conditions o f specific locations. This also facilitates the provision of specialized infrastructure and services. The Government's agricultural strategy has embraced this approach with its commodity business plans, but this raises the tension betweenthe Government attempting to pick winners (and often failing), versus providing infrastructure and a conducive business environment to stimulate private investment. In practice, public-private partnerships will be needed, but with the private sector playing a lead role. Lack of Livelihood Diversification and Weak Labour Mobility 2.3 8 High population density combined with limitedopportunities for labour mobility and migration have left many households with very small farms that are subject to further fragmentation. Inthe eastern highlands, the average household landholding i s only 0.6 ha and annual per capita food production o f 110 kg does not meet minimum subsistence needs even in normal years. Agricultural production function studies also find zero marginal productivity o f labour in agriculture suggesting surplus labour (World Bank 2005b). At the same time, the livelihoods o f rural households lack diversification. Data from household surveys indicate that non-farm income accounts for only 24 percent o f rural household incomes, the lowest o f any country for which data are available (Table 2.4). Even farm income i s relatively concentrated in cereals and livestock. Related to this lack of diversification is the lack of the development of vibrant rural market towns driven by private sector small and medium enterprises and marketing activities. This was a key theme emerging from the recent Participatory Poverty Assessment. 2.39 Lack o f livelihood diversification and labour mobility in turn relate to several constraints already identified, especially poor infrastructure in rural areas, and insufficient productivity growth in agriculture to drive demand for rural nonfarm enterprises. In addition, surveys repeatedly find that the perception of land tenure insecurity i s an important factor discouraging mobility o f farm labour into non farm jobs, since some rural households apparently perceive that prolonged absence from their village could result inloss o f their land (e.g. MOFED, forthcoming). 2.40 The challenge is to link agricultural growth and rural non-farm growth in ways that are mutually reinforcing. Rural non-farm sectors and small town development depend on faster agricultural growth. At the same time, growth innon-farm incomes will help alleviate the demand constraint on agricultural growth. A longitudinal study o f rural-small town linkages reinforces these conclusions inthe Ethiopian context and finds that investment in both the quantity and quality o f rural roads strongly facilitates these 40 positive synergies.l6 This challenge argues for more holistic and spatial approaches to linkedrural andurbandevelopment that are discussedbelow. Low Literacy Levels and Skills in RuralAreas 2.41 Adoption of technology and access to markets are to a large extent constrained by the level of education inthe rural areas. Levels ofhumancapital inrural Ethiopia are the lowest inthe world, resultinginlow labour productivity, which underlinesthe importance of current efforts to make large inroads on these deficits (see Chapter 1). 3) ContinuingDebatesfor MovingForward 2.42 While there is general agreement on the challenges facing agriculture inEthiopia, there remain a number o f debates on how to overcome these constraints and move forward. Indeedthe weak performance of the sector raises the fundamental question of whether agriculture-led growth remains relevant. Beyond this overarching question, there are debates about: (i) emphasis in development programs betweenhighand low the potential areas; (ii)the role of irrigation; (iii) tenure security and landmarkets; (iv) land continuing emphasis on small farmers versus promoting agricultural business; and (vi) the roles ofthe public andprivate sectorsindrivingthe growth agenda. Table 2.4 Share of RuralNon-farm Income(RNF'I) in RuralHouseholdIncomes CanAgriculture still be an Engine of Growth? 2.43 Given its poor performance over the past decade interms of productivity growth, improvement of natural resources, and poverty reduction, it i s appropriate to question Dercon and Hoddinott, 2005. 41 whether agriculture can still be a lead sector for a growth strategy or whether the problem lies with the specific policies andprograms inEthiopia. 2.44 Fundamentally, the focus o f the Government's development strategy on agricultural growth for poverty reduction i s justified. It i s very hard to find success stories o f structural transformation and sustained rapid growth and poverty reduction in low income countries without achieving productivity-led growth in the agricultural sector. The paradox o f the structural transformation process is that rapid and broad-based growth inagriculture i s needed to promote even higher growth in other sectors and allow resources, especially labour, to shift to these sectors. Rapid productivity growth and a decline in food prices lead to a sharing o f benefits between producers and consumers. Rising farm incomes and real wages o f non farm workers (due to lower food prices) generate strong growth linkages to other sectors, including agro-processing. If agricultural growth i s broad-based and labour intensive, it also stimulates strong employment multipliers, especially in the non-tradable sectors. We recognize that questions have been raised about whether this overwhelming historical evidence in favour o f agriculture-led growth i s relevant today, given growing integration with global markets and the special challenges of African agriculture. However, as confirmed in a recent World Bank review o f pro-poor growth experience, an ADLI-like strategy is still appropriate, at least for low-income countries at an early stage o f transformation (such as Ethiopia), although adjustments are needed (Box 2.4). 2.45 Thus while there i s little debate that rural growth i s essential for poverty reduction inEthiopia, the country's recent experience suggests that modification inthe strategy to accelerate growth across sub-sectors i s required. Simulations conducted using a multi- market model o f the Ethiopian economy by IFPRI (Diao and Pratt, 2005) show that over- emphasis on a single sub-sector (such as cereals) to the exclusion o f other potential sources o f growth will not unleash needed rates of economic growth (Figure 2.9). Growth must be more broad-based across rural sectors, including cereals, livestock, and non-traditional exports, combined with reductions in marketing margins. Nonetheless, the IFPRI results as well as the recent World Bank Poverty Assessment (World Bank 2005b) show that intensification o f cereal production i s essential to raising the real incomes o f the majority o f the population and is especially pro-poor. This i s because cereals remain the main productive sector for the vast majority o f poor people, and most poor households are net grain consumers who would benefit from lower prices. 42 F ure 2.9 Simulations of Alternative Sub-sectoral Growth Strategies,2003-2015 50 In + Base year 7 0 Nontrad.exports ai 40 + +Livestock c1 F? +Staples f 30 + Multi-agriculture a 0 + Multi-agric + Markets 20 I I I 1 2 3 4 5 6 7 Growth rate GDP (%/yr) source: Diao andPratt 2005. Note: The baseyear i s 2003; growth rates are for the period2004-15. Staples only: An additional 1.5 percent annual productivity growth over baseline levels. Livestock only: An additional 3.4 percent annual productivity growth over baseline levels. Non-traditional exports only: An additional 9 percent annual productivity growth over baseline levels. Multi-agriculture: Combination of staples, livestock, and non-traditional exports above. Markets: multi-agriculture plus market improvement (10 percent annualreduction inmarketing margins) 2.46 Another weakness of past efforts relates to demand and markets. Indeed, agricultural growth may not be sustainable unless productivity-enhancing inputs are profitable to farmers, and this requires that demandfor agricultural output rise along with supply. For agricultural growth to be sustainable, the non-agricultural (or non-food) sectors must expand sufficiently quickly to absorb workers (as population rises and workers leave agriculture) and sustainan increaseddemandfor food. Expanding demand in Ethiopia will also require more emphasis on exports, substitution for imported food aid, and a productivity-induced reduction ingrain prices. 2.47 Finally, and related to the foregoing, the private sector and markets will have to play a larger role in driving rural growth than in the past. Recent changes (discussed below) reflect these new approaches with increased emphasis on long-term land leases but still retaining land as the ultimate safety net, privatization of state land, private investment inhorticulture, an emerging policy focus on regional specialization and trade, and increasedinvestment inirrigation and watershed management. 43 Box 2.4 I s Agriculture's Role inPro-Poor Growth now Different? Agriculture's pro-poor role in the structural transformation process was demonstrated by the green revolution. The successful transformation o f many economies in the decades that followed, especially in Asia, saw rapid rural-led growth and poverty reduction, at the same time that agriculture's share innational economies declined. However, the steady fall o f agricultural commodity prices inworld markets, the lack o f obvious technological breakthroughs in agriculture in Africa, the growing importance o f trade in a globalizing economy, and the increasing role o f rural non-farm incomes have all raised questions about agriculture's ability to deliver pro-poor growth intoday's world, and especially inAfrica. I s this "ago-pessimism" justified? A multi-donor group led by the World Bank recently completed a comprehensive study o f pro-poor growth based on 14 country case studies. The evidence from the case studies, inthe context o f the wider development literature, has led to five broad propositions about how and when agriculture and rural development contribute to pro-poor growth: 1. Agriculture continues to play an important and often a lead role in the early stages o f pro-poor growth. Beyond its direct contribution to growth, a number o f features specific to agriculture enhance its contribution to poverty reduction, including the concentration o f the poor inthe sector, its very large growth linkages to other sectors, and thepositive consequences forfood security and lower food prices. 2. The contribution o f agriculture to growth naturally declines as agricultural economies are transformed into urban-based, non-agricultural economies, but even in countries that have attained solid, middle-income status, agriculture continues to "pull beyond its weight," as measured by its contribution to GDP, because o f its unique "externalities," especially its strong backward and forward linkages. 3. The rural non-farm economy increasingly becomes a source o f growth and contributes to rural incomes, initially because o f its linkages to agricultural growth and later because o f increasing ties with urban-industrial development, especially in densely populated areas where infrastructure i s good. 4. Rural development remains critical to reducing poverty and inequality, even as agriculture's role in growth declines during structural transformation. Differences innatural resource endowments, access to markets, and access to assets often promote uneven growth and growing inequality within the sector, between small and large farms and between regions. The widening urban-rural gap leaves the rural poor with few options to escape the poverty trap, unless their plight is addressed explicitly through poverty-oriented rural development strategies, often including support to agriculture. 5. More than ever, local contexts matter. The agro-pessimists have raised important questions that highlight how agriculture's contribution to pro-poor growth varies enormously, not only at different stages o f development in a given country, but also across and within countries. Local contexts must condition the design o f public policy for enhancing the contribution o f agriculture and rural development to pro-poor growth. Finally in this review, high growth rates and significant reduction in poverty was demonstrated by two o f the African case studies-Ghana and Uganda-where agricultural households accounted for half or more o f the rapid decline in poverty in the 1990s-18 percentage points from 1992 to 2002 in Uganda and 14 percentagepoints from 1992 to 1999 inGhana. Source: Byerlee, Diao and Jackson 2005. Low versusHigh Potential Areas 2.48 Various approaches have beenusedto characterize the heterogeneity o f Ethiopia's rural sector with respect to agricultural potential. The Government has defined a simple framework o f three areas: (i) humidareas (reliable moisture); (ii) but drought prone moist areas with unreliable rainfall; (iii)and arid pastoral lowlands. However, agro-climate characteristics are only one dimension o f agricultural potential in Ethiopia. IFPRI/EDRI 44 recently expanded this framework to take account of market access and population density as equally important determinants o f pro-poor growth in Ethiopia (Annex 2.1). Although this leads to a total of 30 possible `development domains,' six domains account for nearly 80 percent of the population and 10 domains for about 90 percent. Aggregating over populationdensity and highland, lowland and pastoral areas, Table 2.5 shows that nearly 30 percent of the population has favourable conditions with respect to both agro-climatic potential and market access (mega-domain A). A larger group (about 40 percent of the population) has good agro-climatic potential with poor market access (B). About one third lives inareas of low agro-climatic potential and mostly with poor market access (C),concentrated inthe highlands, but with significant populations inthe lowlands and pastoral areas. These three areas may be consi ed `mega-domains' in terms of definingthe three legs of a rural growth strategydiscussedbelow. 2.49 Understandably, given Ethiopia's history of recurrent food crises in the densely populated and lower rainfall highlands, many o f the Government's programs of food security, land management, reforestation, and water harvesting have focused on supporting farmers in these areas. Public expenditure for the Food Security Program which targets these areas now accounts for over half of the total spending in the sector. However, many of these areas have inherently low agricultural potential, which is further exacerbated by massive land degradation and very small farm size. This raises fundamental issuesabout the payoffs to these massiveinvestments inlowpotential areas. Table 2.5 SimplisticFrameworkofRuralDiversityinEthiopia (percent ruralhou$ehold$) Droughtpronelowlands Pastoral b11 I 37.6 I 62.4 I 100.0 Source: ChamberlinandPender2006. 2.50 Over the mediumto long term, there is o f course considerablepotentialto convert areas from one domain to another through investments inroad infrastructure (to improve market access) and irrigation, where such investments are efficient. There is also potential to shift people from one domain to another, especially from the drought prone andpastoral areas to higher potential areas with lowpopulation density. 2.51 Moreover, given budget tradeoffs, spending more on low potential areas means less investmentinhighpotential regions. It i s clear that investment i s needed inbothlow and high potential areas, but there is now growing consensus that the challenges of promoting growth as well as reducing poverty and food security in low potential areas couldbe facilitated by shiftingthe balancetoward highpotential areas. This i s evenmore so given the huge challenge o f promoting environmental conservation (e.g., forestation) and arresting growing problems o f land degradation in high potential areas in order to protect future food security. 2.52 But reducing vulnerability of rural people inlow potential areas remains a major priority. The Government and its partners need to be alert for growth opportunities in low potential areas-for example, through promoting livestock fattening and exports in pastoral areas (Box 2.5). However, diversification into non-farm employment and out- migration will be the major priority, giventhe limitedoptions inagriculture. Policies that promote labour mobility, especially better access to vocational skills for non-farm jobs, development o f rural towns and flexible land tenure policies will also be important (see below). 2.53 There are also lowland areas o f the country with high agro-climatic potential but low population density, poor infrastructure, and serious health risks where major investments are needed. With appropriate policies and investments to facilitate resettlement (especially land policies that respect rights o f local communities, supporting agricultural and social services, and control o f human and animal diseases), this would increase land and labour productivity in both the source and the destination areas and thereby raise overall incomes. 2.54 Resettlement is a major activity under the Government's Food Security Program. Since 2003, half a million people (150,000 households) were moved to selected resettlement areas inlowland areas. About half o f these may have obtained food security, according to internal reviews. An external review by the Forum for Social Studies (2006) found significant problems in implementing the programs according to the pre- established guidelines, including land disputes with local communities, unrealistic expectations on the part o f settlers, disease and health problems, and poor access to basic services. For these reasons, there has been significant reverse migration from many o f the settlements. Not withstandingthese problems, voluntary resettlement should continue to be an important part o f the solution to food insecurity and vulnerability. Rain-fed versus Irrigated Agriculture 2.55 Agriculture i s almost entirely rain-fed with only 1.4 percent o f the total cropped area irrigated, less than half o f the African average, and well below the potential in Ethiopia (with estimates ranging from 2.3 to 3.7 million hectares or 20-30 percent o f current cropped area). Dependence on rain-fed agriculture not only reduces productivity but as emphasized throughout this report, it greatly increases growth volatility and the vulnerability o f the poor. According to simulations by IFPRI, hydrological variability costs the economy a massive 38 percent o f its potential growth and causes a 25 percent increase inpoverty rates (World Bank 2005~). 46 Box 2.5 Growth Potentialin PastoralAreas Pastoralism is an important economic and livelihood activity for some 12 percent of Ethiopians residing in the lowlands. Despite the huge natural resource potential, pastoral areas are the least developed, andthe most marginalized and disadvantaged, with infrastructure coverageand access to services beingthe lowest inthe country. As a result, inthe face of the fast growing humanand livestock population, rangelands are being degraded, and resilience and the traditional coping mechanisms are eroding so that even modest natural disasters (drought, flood) can have severe consequences. Many pastoralistshave become food aid dependant. Despite the very low level of development, there is considerable potential in livestock resources. However, the traditional production system is not yet geared towards the market. Livestock are sold to fill immediate cash requirementsfor consumption needs. Absence of appropriate market infrastructure and lack of initiatives to link pastoralists to the market economy are the major stumbling blocks to making efficient use ofthis potential. With appropriateinvestmentsand institutions, pastoralistscould be encouragedto produce for the market and specialize in livestock species and products based on local agro-ecology, pasture/feed availability, and market access. This will require investments in (i)veterinary services, (ii) livestock marketing infrastructures (track roads, feed lots, watering points, quarantine stations, livestock market information), (iii)efforts to raise the quality of marketable livestock, and (iv) linking to livestock markets in the Gulf and Arab states building on traditional niche markets. In the longer run, there i s considerablegrowth potential from commercial livestock inpastoralareas, especially if it is integrated with irrigated agriculture along the river basins in ways that ensure complementarity between livestock and crop production systems (e.g., through fodder production), and commercial livestock and small-scale livestock owners (e.g., through fattening systems prior to sales). 2.56 Perhaps the largest challenge in the country's agricultural (and overall) growth strategy i s the issue o f water resources development. If large-scale investments in this sector could be made successfully, the spur to growth and the reversal o f land and soil degradation could be enormous (World Bank 2005~).Improving the reliability o f access to water through investment inwater management provides farmers with more flexibility in choosing crops, and allows for higher product quality and uniformity to satisfy the requirements o f markets. Increased flexibility also enables them to capture high seasonal prices, and puts a high premium on the use o f productivity enhancing inputs (such as fertilizer and improved seeds). 2.57 Irrigation associated with resettlement could open previously unexploited lands to cultivation and reduce the pressure on currently cultivated lands. Greatly enhanced water security combined with better market connectivity are necessary for the kind o f structural transformation needed to put Ethiopia on a high and sustainable growth path. Thus decisions about water resources development will have a major impact on overall growth strategies and which complementary investments are needed. 2.58 The Government's MDG strategy calls for a rapid scaling up o f existing government plans. According to the MDG Needs Assessment the plan for irrigation development is 717,400 ha, out o f which 381,000 ha i s small scale and the balance medium and large scale. The total cost for study, design and construction was estimated 47 at US$11.5 billion. Recent studies concur on the need for an ambitious push into irrigation over the long run, but how fast and at what scale are not at all resolved (World Bank 2005~). A continuing issue is the relative emphasis on water harvesting through seasonal ponds, small-scale irrigation (e.g., with small pumps from rivers or lakes, or small dams), and large-scale irrigation (above 200 ha). 2.59 Water harvesting has been actively promoted by the Government, with mixed results. Reviews find that in general, the development o f water harvesting and small- scale irrigation has important economic benefits in terms o f improving the food security status o f farm h~useholds,'~in particular in small areas (less than 0.05 ha) growing the vegetables which provide the cash to bridge the `hungry season' in dry areas. Small- scale irrigation, which can be done largely on a cost-recovery basis (average i s about US$1,500 per ha), i s in some cases creating modest wealth for emerging commercial farmers through production o f higher value crops. However, the expected results have not been achieved in many cases, due to poor technology choice, lack o f clear property rights for both land and water, problems o f marketing, weak extension services, and lack o f start-up capital or access to credit to purchase equipment. For small scale schemes, clear rules on land and water property rights will be needed to foster private investment. Much learning and improved implementation capacity i s needed to scale up water harvesting and small scale irrigation, including development o f the legal framework for land and water rights, as well as provision o f advisory and financial services. 2.60 The high cost o f large scale schemes o f US$5-8,000/ha'8 and the disappointing history o f past investments inlarge schemes are major challenges. Economic viability o f such systems could be substantially improved if irrigation is conceived in an overall framework of multi-purpose development incorporating hydropower, fisheries, navigation, water-related tourism, management o f bodies o f water (such as lakes), and other elements. However, while considering these multifaceted benefits makes the case for investment even stronger, many o f the benefits are public in nature. An additional challenge for irrigation i s to generate resources that are at least sufficient to finance its own runningcosts. 2.61 Investments o f this magnitude need to be seen alongside the complementary investments requiredto harness the potential o f higher potential rain-fed areas, especially via roads and technology. Investment inlarge-scale irrigation must be seen as part o f the `S-curve' strategy, requiring not only complementary investments inroad infrastructure and markets, but also strong public-private partnerships to share development costs, as well as to ensure that resulting irrigation infrastructure i s managed along commercial lines. Foreign direct investment is one way o f helping offset the high costs o f large scale schemes. 2.62 Finally, an irrigation strategy must also identify market opportunities. In a demand-constrained domestic market, investment in irrigation may be a zero-sum game and "un-equalizing", unless accompanied by new market outlets, especially abroad. Even l7WorldBankRuralPublicExpenditureReview, 2007. 18EthiopianSocialRehabilitationand DevelopmentFund, Ministry of Water Resources. 48 massive expansion o f water harvesting focused on very small scale vegetable production i s likely to face demand constraints in the near future. Irrigation and links to private sector development are further discussed inChapter 4. Land TenureSecurity versusProtecting the Poor 2.63 A continuing debate is the importance of greater land tenure security and transferability. The Government formally retains ownership and ultimate control o f land and many argue that rural land policy continues to pose an obstacle to growth and development. L o w investment in land improvement to increase productivity (e.g., in perennial crops) and to promote more sustainable land management, as well as low mobility o f labour to higher potential rural areas or towns, have been attributed to a lack o f private land m a r k e t ~ . 'Evidence from many countries shows that land security and ~ transferability enhance investment, improve efficiency o f land use, and promote the potential for structural change o f the economy by allowing marginal farmers to exit agriculture (World Bank 2003). 2.64 InEthiopia, households stillperceive a significant degree o ftenure insecurity, and this insecurity has an adverse impact on their investment in land (Ayalew, Dercon, and Gautam 2005; MOFED, forthcoming). Strategies to correct this perception by the rural population are critical. Strategies could include ensuringthat the rural population i s well- informed about the landlaws and their rights. This would involve a good communication strategy to be imparted by woreda officials. The case o f Vietnam provides an example of effective land administration and markets. As part o f the reform o f collectivized agriculture, the Government allocated land use rights to households that can be transferred, exchanged, leased, inherited, and mortgaged, catalyzing significant investments and the adoption o f higher value agricultural production (World Bank 2005e). 2.65 The Government continues to emphasize the avoidance o f 'distress sales' and the potential for over-concentration o f land ownership. The latter i s supported by global evidence that more equal distribution o f land leads to higher and more broadly based agricultural growth. The Gini coefficient o f land distribution in Ethiopia at 0.45 i s relatively low, and the Gini coefficient o f rural household incomes at 0.28 i s especially low by world standards.20 However, some increase in inequality in land may be inevitable under rapid growth and structural transformation in order to promote efficiency, and will benefitthe poor ifassociated with improved wage opportunities. The very small size o f the vast majority o f farms along with considerable land fragmentation in Ethiopia does not generate the surpluses needed for sustained investment and commercialization.21 Indeed some 20 percent o f farmers with less than 0.1 ha are essentially landless. Even for more commercially viable farmers, the average number o f individual plots per household i s now 11 and there is evidence that very small plot size and land fragmentation is an important cause o f inefficiency in the sector (World Bank '' 19 Deininger and Jin, 2005 estimate that transfer rights would increase investment in tree crops by 30-60 ercent. See also World Bank, 2006c; Gebremedhinand Swinton, 2003; Hagos and Holden, 2006. Devereux, Teshome and Sabates-Wheeler, 2005. 21ibid 49 2006e). But inVietnam where landwas returnedto individuals after liberalization, there has been a trend toward transfers o f land (both rental and sales) to more productive farmers, who tend to be poorer interms o f land endowments, leading to an improvement inbothefficiency andequity (DeiningerandJin 2005). 2.66 Limited measures may be required to ensure that land transactions are not exploitative (such as information dissemination to buyers and sellers about land values) and that landremains accessible to the rural poor. The avoidance o f distress sales can be partially addressed by providing farm households with risk mitigation products (insurance and savings institutions), which would allow them to get through bad years, and by providing irrigation. Moreover, as the rural sector diversifies and connects with markets, other assets, especially skills and capital, become more important to well being thanland.22 2.67 The Government has taken important steps toward improving landtenure security by issuing certificates o f user rights to current land users. This should facilitate transferability through lease or rental, ifnot sales, but it is too early to determine to what extent these certificates will increase the degree o f perceived tenure security, and promote longer-term investments and labour mobility. Much will also depend on whether land certificates are enforced in courts, the Government's scope to expropriate land, and the payment of adequate compensation when it does. Thus, analysis o f the effectiveness o f current policies (which differ to some extent by region) in establishing actual and perceived tenure insecurity and o f the remaining obstacles to a more flexible and efficient allocation o f land and labour will be crucial to ensuring that the country's growth strategy can work. Small-scale Farming versusAgribusiness 2.68 Ethiopia i s a land o f small-scale farmers-the so-called `people of the ox plough'.23 Some argue that with very small farm size and dependence on rain-fed agriculture, the opportunities to generate the needed surplus for wider economic growth are limited. This has been coupled with limited opportunities for private investments, especially foreign direct investment, partly because o f national policies on FDI, and partly due to lack of capital markets in rural areas, and to some extent, access to land. Yet the recent `rose revolution' suggests that there are opportunities for expansion of agribusiness-type investments in rural areas, with significant spin-offs in terms o f employment and foreign exchange earnings. Flowers alone generate at least five times more jobs per hectare than cereals. The planned scaling up o f investment in large scale irrigation also provides an opportunity for private investment in both agricultural production and processing. 2.69 Small-scale farming and agribusiness are not mutually exclusive. There are many examples o f constructive partnerships that allow small-scale farmers to participate in higher value markets, especially for exports (Box 2.6). Some o f these are emerging in Ethiopia, including out-grower schemes for producing fresh beans for the European 22See Byerlee, Diao, and Jackson, 2005. 23See McCann, 1995. 50 market, and contractual arrangements between an export company and farmers to produce haricot beans o f a specified quality for processing inthe UK. 2.70 But the debate about small farmers and agribusiness is in the end a sterile debate-the underlying concern should be the extent to which private investment can be attracted and harnessed to generate jobs. Recent studies o f the Kenyan horticultural industry show considerable poverty reduction, largely through employment generation generated by agri-business type inve~tment.~~ Value addition through processing and packaging has strengthened employment, especially for women (e.g., cleaning and packaging fresh vegetables for the export market).25 2.71 The Government has now recognizedthis potential and is preparing plans to scale up private initiatives to promote high value production and exports. The challenge will be to establish open andtransparent rules that promote competitive relationships (e.g., for allocating land), the role o f "tied" credit lines and guarantees, promotion o f capacity in grades and standards, including sanitary and phytosanitary standards, and development o f business service providers. Privatization o f remaining state farms in a transparent manner, and encouraging both domestic and foreign investment in labour intensive high value crop and livestock production represents a `win-win' opportunity for Ethiopia. Box 2.6 Building Horticultural Exports with SmallFarmers in Mali and Guatemala Inthe 1990s, the Agricultural Trading and Processing Promotion Agency, an autonomous body under the Chamber o f Agriculture undertook to design and implement an export promotion project for Malian mangoes. It specifically sought to restructure supply chains, develop commercialization channels, and promote the application of research and technology. The Agency acts as an intermediary between the producer associations and their trading partners and provides extension services to growers and pack-house employees to increase productivity, reduce costs, and improve quality. Producer associations assist with training and technical assistance, work to pool production, and negotiate contracts. Benefits include: profitability for all partners; access to European markets; reduction by half in transit time to Northern Europe; higher quality products delivered to customers; timely payments to growers; diversified farm incomes; training of the rural labour force; introduction of improved technologies; price increases o f 25 percent to growers; higher pack-house employment (60 percent of employees are women); and improved pack-house working conditions and pay. Sometimes even quite small farmers can participate in such supply chains. In Guatemala, about 20,000 indigenous households succeeded in capturing one-third o f the U S market for snow peas inthe 1990s. Trade and community associations secured funds to establish a distribution system with dozens of intermediaries and over 50 exporters. Through this system, snow peas were Ipacked and shipped within 24 hours of being picked. In 1996, farmers earned an average - US$1,400 from very small plots o f less than 0.25 ha. Source: World Bank 2004d. 24See World Bank, 2005e "SeeDolanandSorby,2003 51 Public versus Private Sector Roles 2.72 Traditionally, the Government has attempted to lead agricultural development through centralized programs o f input distribution and credit lines tied to inputs, supported by targeted extension programs. There are deep seated concerns among officials that a more private sector and market-driven agenda could lead to growing and perhaps unacceptable levels o f inequality. At the same time, some argue that the withdrawal o f government from product markets was not compensated by the needed private sector investments, leading to thin and unstable markets and the need for a more pro-active role by the state (e.g., Donvard et al., 2004). 2.73 Given the limitedimpact o f past strategies however, and the recent success o f the flower industry, the balance may be shifting toward a more private-sector driven approach. But even as the public sector's direct role in markets decreases, the development o f private markets depends on whether the Government can provide an appropriate regulatory environment, including provisions for grades and standards, food safety, bio-safety, and environmental protection. An effective regulatory environment serves to lower transaction costs, reduce the risk o f doing business, and improve the marketability o f products. Moreover, the rise o f supply chains and the application o f more rigid grades and standards will require governments and related agencies to act more as facilitators that develop and enforce the rules by which private sector participants interact withinmarket arenas. 2.74 Clearly there i s a delicate balance between a pro-active state and providing space for market and business formation. Public agencies (national, regional, and local) need to increasingly partner with the private sector and civil society, including producer organizations, community associations, NGOs, and trade associations, in areas such as policy analysis, food safety regulation, and the provision o f infrastructure and irrigation. 2.75 Specialized public-private agencies can help overcome coordination failures along the market chain, through acting as a broker and facilitator in the formation o f trade associations and market chains-for example, the horticultural development boards that have been set up in a number o f countries. The current proposal to establish a modern commodity exchange offers potential to improve market performance but its ultimate success will need to ensure strong ownership and management by private sector traders. 2.76 The Government's marketing strategy also has strongly backed the role o f cooperatives to strengthen not only farmers' bargaining powers but also to improve market efficiency by reducing the number of intermediate steps in the marketing chain. However, international experience strongly suggests that the Government can easily overstep its role inpromoting cooperatives, leading to state-dependent organizations that are not sustainable over the long term (Box 2.7). A recent review of cooperatives in Ethiopia cautions that the type and role o f cooperatives needs to be adjusted to the local context, that partners such as the Government should not impose their own agenda, and 52 that cooperatives may be biased toward the needs o f larger farmers inareas o f lower risks andbetter market access.26 2.77 Another important role for the public sector i s to establish clear rules o f the game for creative public-private partnerships to leverage private investment in high value supply chains and exports (horticulture for export, vegetables for towns and cities, sugar, live animals), development o f "natural" growth corridors to exploit synergies among several types o f public investments and with private investors, and pro-active attraction o f large foreign investors. Ways o f orienting public investments around this "new agenda" are discussed below. 2.78 Matching grants from governments are increasingly used for activities that support private sector and market development, such as training, technology development, access to information, project preparation, investment in local infrastructure, and collective action for mutual benefit. Along the lines o f the `S-curve' approach to development outlined in Part I,the challenge i s to provide time limited public funding to kick start private activities to reach a `critical mass'. In all o f these types o f partnerships, continuing attention must be given to: (1) the fine line between public sector support and public sector interference with market development; (2) the large diversity o f needs among a heterogeneous farm population; (3) the most effective way o f leveragingprivate sector resources; and (4) an effective exit strategy. Box 2.7 Farmer Cooperatives:InternationalExperiences There has been a long history o f promoting farmer cooperatives to allow farmers to capture economies of scale in purchasing inputs and marketing products, and to access finance, either collectively or through their own savings and loans association. Cooperatives have sometimes worked well when there were significant economies of scale from collective action and with good leadership and member ownership. For example, there are many successful cooperatives in the dairy industry, where marketing of milk benefits from collective action in cooling, quality control, and collection (e.g., Operation Flood in India). However, there are many failures in cooperative development. In particular, many cooperatives-especially those closely associated with specific state-led credit programs-became quasi-state agencies, with significant bureaucratic structures, lack of independence from the state, and poor governance subject to political patronage. More recently, there has been a strong push for strengthening o f cooperatives, now usually referred to as producer associations (due to the poor image o f cooperatives), especially since commercialization o f agriculture and emergence o f supply chains has increased benefits of collective action for higher value products in marketing and quality assurance. The roles of farmer associations often extend beyond marketing to contracting o f technical services, such as extension. Lessons from many countries attest to a delicate balance between governments providing the enabling legal framework for successful development of producer associations and support to critical capacity building, while at the same time ensuring that these associations are truly owned and governed bytheir memberswithout state interference. Source: World Bank 2004b; Tanguy et al. 2006. 26Tanguy et al., 2006. 53 2.79 Ethiopia's public agencies at all levels will need greatly increased capacity to identify, target, and implement interventions in partnership with agribusiness, communities and producer organizations inways that are non-distorting, market-oriented, and capable o f generating net benefits to the poor over the long term. They will need to also upgrade capacity for participating in export markets, especially laboratories and other infrastructure to ensure appropriate grades and standards. This poses major challenges to re-orient agricultural officials at all levels-federal to kebele-who have been trained in a system that has emphasized centralized control, state led programs to meet physical targets, and minimal involvement o f the private sector. 4) The Way Forward:StrategiesandImplementation Adjusting Growth StrategiestoAccommodateDiversity and Markets 2.80 A successful rural strategy must address past deficiencies o f ADLI-the focus on staples, on certain technological components, and on technical solutions (increased input use) without adequate attention to profitability. Shifting the focus to markets also brings to the fore the issues o f effective demand, a key constraint to improving the incentives for agricukure. Finally, continuing attention to and increasing use o f market-based ' approaches to risk management remains a core part o f the agenda. 2.81 Givenrecent performance, it is recognizedby boththe GoE andits donor partners that significant adjustments in strategy are needed to accelerate rural growth as outlined inthe recently approved poverty reduction strategy (PASDEP). Even a modest increase in the growth rate o f per capita AgGDP from close to zero currently to 1 percent per annum, can result ina sharp fall inrural poverty, as seen inthe results of a recent review o fpro-poor growth inlow income countries by the World Bank (Figure 2.10). Figure 2.10 Per capita Agricultural Growth and RuralPoverty Reductionin the 1990s -2.5 - Bingladesh .... -3 - .. -3.5 - .......... -4 - Uganda * * Ghana ... , Vietnan e.. P 2.82 Higher and broad-based rural growth must remain at the core o f Ethiopia's development strategy. This must be based on increased productivity in a range o f sub- 54 sectors and diversification within the sector through improved market connectivity and export growth. It must also include the expansion of irrigation and measures to reduce vulnerability and land degradation. Most importantly, it will need to recognize the tremendous diversity withinthe sector and adjust strategies accordingly. 2.83 One advantage o f this strategy is that it captures well the diversity for thinking about three aspects of a rural growth strategy, consistent with the themes introduced in Part I.These would be: i. A continued focus on broad-based (i.e., small farmer led) productivity increases in areas with good agricultural potential. The emphasis would continue to be on food production but with greater efforts to address diversification and markets, including expanded exports, especially of non- perishable products (e.g., legumes and oilseeds). Low population density areas with good agricultural potential require special measures to ensure successful resettlement and immigration, especially investment in infrastructure, health, and services. ii. Inareasofhighagriculturalpotentialandgoodmarketaccess(or areasthat could be economically converted over the medium term to high potential areas through concentrated investments in infrastructure and irrigation), emphasis on promoting higher value products, value adding, and integrated supply chains, especially for exportsbut also for an expanding urbanmarket. iii. Inlowpotentialareascontinuedemphasisonfoodsecurity(bothsafetynets and productive investments) but with greater attention to diversification of livelihoods, promotion of non-farm incomes (to exploit lower wages inthese areas), and out-migration, and where economically feasible, investments in irrigation and landconservation that would raise their agricultural potential. 2.84 There will be many local variations to these broad strategies. For example, even in some lower potential areas with relatively poor market access, there are opportunities for exports of non-perishable products, as recent successes inharicot beans demonstrate. 2.85 The main drivers of growth would clearly be the first two aspects which in turn relate largely to the first two mega development domains highlighted in Table 2.5, while the third would focus but not exclusively so, on reducing food insecurity and vulnerability in the low potential areas, but recognizing that this in itself requires increased growth of rural incomes inthese areas, albeit through diversified farm and non- farm sources. Entry Pointsfor Public Policy 2.86 Public (including donor) support to this broad rural growth agenda can be conceived around five cross cutting thrusts. The first two-(l) an appropriate policy framework for private sector development, and (2) investment in core public goods and institutions-provide the overarching enabling framework for rapid rural growth in all sub-sectors and development domains. The remaining three thrusts are focused on particular segments o f the rural population: (3) promotion o f supply chains for specific 55 products, (4) geographically-focused and holistic rural development approaches (including the rural non-farm sector and towns), and (5) programs specifically oriented to reducingvulnerability andfood insecurity. 2.87 A holistic development strategy will include an appropriate combination of support for all five thrusts but with differentiation with respect to the three domains. In turn, the roles o f public and private sectors and communities in leading each strategic investmentthrust, as well as the roles of federal, regional and local governments varies substantially across the five thrusts (Table 2.6). 2.88 The first two andthe last categories o f support (i.e., the enabling environment and vulnerability and food security) have dominated much o f the agenda to date as would be expected. However, it i s also recognized that there is a substantial unfinished agenda for providing the enabling environment for sustained private sector growth, and for institutionalizing a results-oriented food security program. Table 2.6 Summaryof Five Thrustsfor Supportin! the RuralGrowthAgenda _ _ Trade policies, Public sector Federal and regional Direct budgetary market (MoARD, MTI support regulations, and associated market reforms, Bureaus) financial systems, risk markets, property rights Researchand Public sector extension, WARD, irrigation, roads, BOARDS, the natureof the good general capacity associated and service building, market agencies(e.g., institutions,NRM EARO), and woreda councils Business Private sector National basedaround Technicalassistance development specific productswith and investment services, high growth potential projects matchinggrants, trade associations support to Communities, Woreda, subregional Investment programs develop and business (e.g., growth (may combine implement local associations,and corridors), and severalprojects) and and regionrural public agencies regional block grantsto development woredas strategiesand growth corridors Safety nets, Public sector market-basedrisk (BOARDand investment programs, instruments,small Woreda councils) including micro- scale irrigation, and communities finance and community communitygrants driven development 56 2.89 A revised rural growth strategy would build on and deepen this base through policy reforms and public investments, while giving greater emphasis to the two remaining categories o f support, as follows. 2.90 Deeper and faster policy reforms: The major challenge for improving the enabling environment i s to ensure an appropriate investment climate for private investment, including foreign investment, in the sector (see Chapter 3). Within the agricultural sector, it i s critical to further liberalize the input markets. 2.91 Public investment: The ongoing review o f public expenditures should provide more specific guidance on public investment priorities. However, the evidence to date, and studies from other low income countries suggest that investment in agricultural research and rural roads will provide high payoffs. Given that Ethiopia only invests half the average for Africa inagricultural research (expressed as a percent o f AgGDP) and its extremely diverse agriculture, agricultural research should be a priority. Likewise, a number o f studies have identified rural roads as an important determinant o fproductivity (e.g., Dercon et al., 2006; World Bank, 2005b). At the same time, effectiveness o f investments will need to be carefully evaluated, especially for agricultural extension, where Ethiopia is investing heavily relativeto other countries. 2.92 Promotion of supply chainsfor specific products: Supply chain development has almost by definition to be private-sector led and market driven, working backward from consumer demands. A requirement for majority private sector financing reduces the risks o f the public sector trying to "pick winners." However, the state has a role as a facilitator to overcome coordination failures, co-finance business development services, and support the development o f business and trade associations. And o f course, many o f the core public goods and institutions, such as grades and standards and contract enforcement are needed for effective supply chain development. 2.93 Area-based rural development programs: Unlike the other approaches discussed above, area development programs would have a much broader rural development orientation, including rural towns, and in some versions, small cities. A logical starting point would be the woreda rural development plans. Another level would be a regional development forum (perhaps a federation o f woredas) based on natural and infrastructural boundaries (e.g., the LEADER approach o f the EU or the territorial approaches in Latin America). A "growth corridor" would be a special case with a greater concentration o f national resources in an area, especially for infrastructure, with expectations o f making a significant contribution to national growth. Whatever the definition o f the `area,' distinguishingfeatures o f the approach are participatory planningdrivenby communities and business associations, holism (embracing agriculture, SMEs, ecotourism and environmental services etc.), and strong efforts to exploit synergies among investments in an area, often using matching grants to catalyze community and business initiatives. Given the very low share o f nonfarm income in rural incomes in Ethiopia, a particular focus would be on development o f small towns to expand opportunities for nonfarm employment and to exploit rural-urbansynergies. 57 2.94 The final column o f Table 2.6 shows how donors may align support around these five thrusts according to various instruments (World Bank 2005d). These instruments range from direct budgetary support, to programmatic approaches, standard investment projects, and technical assistance. Moving Forward: An Implementation Agenda 2.95 We have argued that achieving and sustaining higher growth requires a more holistic strategy that provides a broader range o f services, ensures appropriate incentives are in place, and shifts the decision makingto farmers, while enlarging their opportunity sets. For poverty reduction and subsistence smallholders, improving the productivity in staples production remains critically important. Complementary efforts are needed in livestock production, another enterprise inwhich the vast majority o f poor households are engaged. Exports o f high value products hold much promise for longer-term development, but given the small numbers o f people directly involved in this type o f activity, they are not likely to have a significant impact on poverty reduction inthe short- to medium-term. 2.96 In all areas, and especially in highpopulation pressure areas o f low agricultural potential, a key to future growth will be development o f non-farm income sources to supplement farm incomes, including through education, migration, improved communications and infrastructure development. Investment in rural towns and non- agricultural activities will be critical complements to agricultural activities as sources o f growth. Inorder for this to happen, small scale entrepreneurs and traders in rural towns musthave opportunities to establish businesses. 2.97 The recent PASDEP provides the framework and directions that are in many respects consistent with the strategies discussed here. Therefore the major challenge will be to construct programs to effectively implement the strategy. Agricultural programs will need to be led by the private sector and decentralized approaches. Implementation efforts must address the challenges o f sharply increasing productivity and improving the functioning o f markets, while protecting the poorest and most vulnerable. Productivity 2.98 Increased productivity depends on improving the effectiveness and efficiency o f research and extension, making agents more relevant, demand driven, and accountable to farmers for results. The focus should be on building the capacity o f farmers to make decisions on the best use o f available technology rather than to push specific packages or direct output production targets. International experiences suggest that adaptive research efforts to increase the supply o f technologies suited to different environments and farm types provide high payoffs, especially when coupled with improved farmer capacity to experiment. Ethiopia still significantly under-invests in agricultural research even relative to sub-Saharan Africa. For both research and extension, the newly approved Rural Capacity BuildingProject offers an opportunity to test more effective and efficient modes o f delivery, including through non-public providers. 58 2.99 The other side o f increased productivity i s to arrest the negative drag on yields, due to land degradation. Expenditures on natural resources management, outside o f the food security program which targets food insecure areas, i s still only about 1 percent of total rural public expenditures. With broad agreement on integrated and participatory approaches to sustainable landmanagement, the challenge i s to build the capacity at local level to scale up sustainable land management programs, especially in the moisture reliable zones. Markets and Private Sector Investments 2.100 The role o f private sector needs to be enhanced, and public interventions should be designedto "crowd in" private investment. Government has an important role to play inpromoting private investment and competition inproduction and markets. It can use limitedresources to leverage private investment as seen in floriculture. The challenge is to expand to other sectors, but avoiding that the Government picks the winners or takes on tasks better left to the private sector. 2.101 The proposed Ethiopian Commodity Exchange is testimony to a new spirit o f public-private partnerships that promises to make markets more efficient and competitive, and less risky. The challenge i s how to sequence the buildingo f associated market institutions (regulatory framework, information systems, grading and standards, etc.), in ways that lower costs o f entry and provide a level playing field for all market actors. 2.102 The current focus on output markets must be complemented by a real commitment to reform input markets and open space for the private sector. The Government needs to send a strong signal o f commitment to the reform agenda, by immediately reducing the level o f the loan guarantee for fertilizer to 50 percent and relaxing requirements for fertilizer imports. 2.103 Improving the risk environment to invest i s critical. Innovative risk management tools can help better manage weather risks, including warehouse receipts systems and weather index-based crop insurance; and access to savings and credit instruments can help overcome liquidity constraints. Market-based solutions to price stabilization, such as warehouse receipt systems, are more desirable than administrative price stabilization. 2.104 Options for developing rural financial systems, including scaling up successful experiences inmicrofinance and rural savings and loan associations, need to be explored. A special challenge is to find new ways to share risks among commercial banks, cooperatives, risk markets, and farmers for purchase o f modern inputs. 2.105 The transition away from large-scale food aid in kind needs to be managed alongside investing in information and supply chains for high value exports, and developing a viable strategy for growth o f rural towns, including attention to land tenure issues to enhance labour mobility. Demand also requires a balanced growth strategy that builds non-agricultural sources o f income growth. Non-farm economy and rural-urban linkages depend critically on thriving rural towns and urban centres. Creative 59 combinations of demand-pull and supply-push strategies can be used to help build up marketing chains where they do not currently exist. Food Security and Vulnerability 2.106 Safety net mechanisms continue to be important to help vulnerable people absorb catastrophic shocks to their incomes and consumption. To bounce back from a severe shock, a key requirement for a household i s to prevent de-capitalization (of human and physical capital), which would typically result in compromising their long-term growth, income opportunities and overall welfare. 2.107 Above all, continued heavy investment in infrastructure development remains critically important, especially in roads, communication, and irrigation paying particular attention to complementary investments in designated growth corridors. While the emphasis in current growth corridors i s on large scale investments, attention should also be given to investment in rural and feeder roads and small-scale irrigation which can provide high payoff^.^' However, there i s no magic bullet-it will take time, very good policies and lots of resources to lay the foundation for fast rural growth. Public investment will continue to be critical, but the balance must now shift to private investmentandmarket ledgrowth. ''Forevidence on feeder roads see Fanet al. (2004). 60 Annex 2.1, The Three Ethiopias 2.108 The "Three Ethiopias" categorization developed by the Ministry of Agriculture recognizes 18 distinct agro-ecological zones (based on precipitation and temperature), and then inturn aggregates these into three broad categories. To repeat from Chapter 1, these three categories consist of: Ethiopia One: the humidmoisture-reliable parts of the west and southwest; Ethiopia Two: moist drought-prone areas with inadequate and unreliable rainfall in the Eastern Highlands, central and northeastern Ethiopia; and finally Ethiopia Three: the arid pastoral lowlands consisting o f the eastern shelf of the country, includingmuch o fthe Afar and Somali regions. Other pastoral areas includethe Southern tip ofthe country (mainly Borena(Moyale), Kuraz, Hammer Bena, and Teltelie). 2.109 Beyond the regional differences in rainfall, it i s important to review the dimensions of production, development and services that are most relevant to growth potentials. As shown in Table Al, each of these regions can be broadly characterized by distinct growth potentials and risks, which inturn can enable identification of the specific constraints that hinder the emergence of new sources of growth. Basic indicators of human and physical capital endowments, production, and weather and ill-health risks, vary widely among the three regions-population density, for example, is nearly 7 times greater in Ethiopia One than in the pastoral lowlands. Trypanosomiasis affects 52 percent of Ethiopia One, andjust 9 percent of Ethiopia Two, but rainfall i s more variable inEthiopias Two andThree. Table A1 Summary of Key DevelopmentIndicatorsfor `Three Ethiopias' Sources: Compiledftom the CEM 4 Ethiopia's database. Sources includeCSA, Ministries of Agriculture, Water Resources, Healthand Education, EPCO, ERA andETC. Note: I...'= insufficient data; data is aggregated at the zonal level, but for zones falling under multiple AEZs; the predominant AEZ was usedto classifythe zone, inconsultationwith the MOA. 2.110 Growth potential can be assessed in different ways. The approach used here i s based on the following dimensions: the potential for rain-fed agriculture (this combines 61 measures of environmental degradation, the length o f the growing period, the level, and volatility of rainfall); the landholding size per household and livestock assets per capita; public capital stock; the number o f irrigable hectares; and the share o f the active population employed in non-farm activities (a proxy for the intensity of existing rural- urbanlinkages anddiversification). 2.111 The identification o f high potential zones lays the groundwork for strategic geographical differentiation and decision-making about investments. Recent thinking on regional growth strategies suggests that complementary investments to jumpstart growth in such zones via a growth corridor approach could be an effective way to crowd in private investment, generate network effects, and pull labour surpluses out o f surrounding areas. Public investment in the growth corridor is intended to create the conditions needed to enhance market connectivity, and attract investment (Soederbaum and Taylor 2003). Success would imply that broader development would spin-off from these loci o f activity under leg 2, creating virtuous circles of increasing productivity and economic growth. 2.112 At the heart o f such a strategy i s encouraging the creation o f long-term public- private partnerships, innovation and experimentation and facilitating an ongoing dialogue with the grassroots local and national stakeholders. Such a participatory approach would help to ensure a critical condition for success: that a growth corridors strategy creates an enabling environment for growth, but stops short o f central planning. Striking a balance between market-based incentives and the role o f the public sector would be a key challenge. 2.113 Identifying areas with the potential to become growth corridors can play a critical role. Economic growth corridors as defined here are geographical areas that are likely not to follow administrative borders, but are rather shaped by distinct natural or manmade features. A corridor would have an identified potential to optimize economic growth by exploiting opportunities for inter-sectoral complementarities, i.e. between education and technological change, or infrastructure and agriculture-industry linkages. A set of identification criteria would need to be developed that takes into account the potentials/constraints and assetslliabilities in different geographical areas, thus assessing possible synergies. 2.114 Moving toward a growth corridors strategy therefore requires a careful spatial assessment o f existing physical, economic, and human endowments. Table A 2 summarises the three-fold classification interms o fthe degrees o f risk and potential at the zonal level. The classificationtakes account o f the fact that pockets of low potential exist within areas o f overall high potential, and vice versa, and that pockets o f highrisk exist within overall settings o f low risk, and vice versa. 62 Table A2 Risks and Growth Potentialof the Three Ethiopias at Zonal Level Low risk- Gurage & KembataA. Zones Northeastern highlands low mainly Wollo, parts of potential Tigray, andparts of north Shewa 3, EastHararge and some parts of West Harege Low risk- Western highlands, including Parts of SouthGonder, parts medium parts of South Gonder, parts of of East andWest Gojam potential East and West Gojam, West Wellega, West Shewa, North Shewa andArssi High risk- Western highlandof Agew Awi Mirabawi, Mehakelegnaw, Jijiga, Borena, Liben, medium zone; the high-rainfall and Misrakawizones of Shinile, Fiq, and Warder potential southwesternhighlands, Tigray; parts ofNorth Omo includingthe major coffee- insidethe rift valley, and all producingareas of Illubabor of SouthOmo andJimma High risk- East Wellegaand East Shewa, Debubawizone of Tigray, Centre onthe mainlydry, high Metekel, aidthe Western NorthGonder, parts of East pastorallowlandsof the potential lowlandsthat comprise the Shewaandparts of Bale southeast. These zones of the GambellaRegional comprise the Bale zone State and BenchMaji; andparts of OromiyaRegional of the Bale zone inthe Eastern State, andthe Afder, Lowlands. Gode, Korahe, and Deghabur zones ofthe SomaliRegionalState EthiopiaOne: MoistureReliableZones Inthe moisture reliable zones, where nearly 30 million Ethiopians live, there is a diversity of potential. Insome senses the initial conditions are better than inother parts of the country, but in certain areas, adverse environmental conditions seriously constrain potential, as described below. The stylized features of Ethiopia One show that the average size of household landholdings i s almost double that o f the drought prone areas of the eastern and northern highlands and per capita output of temporary crops (mainly food), at 1.92 quintals, is much larger than that of drought prone highlands.The levels of livestock ownership and fertilizer use are also higher. Parts of the moisture reliable zones, with only medium potential, are characterized by substantial under and unemployment o f labour. Environmental degradation is accelerating, however, and sustainable solutions will require more public investment, intensive farming, soil and water conservation, and accelerated urbanization. Inparticular, investment i s needed inwater infrastructure-both for 63 irrigation, to reduce dependency on marginal lands, and for hydroelectric power, as a basis for non-agricultural livelihoods. Off-farm activities are essential to support populations who can no longer survive via subsistence farming on their fast-degrading lands. 0 Other medium potential zones o f the moisture reliable areas have various sources o f potential, including agriculture, livestock, and off farm employment, but also face higher risks. Important sources o f risk include malaria, drought, and tsetse fly insome western zones. Sustainable solutions will require similar interventions to those outlined above, together with risk mitigation investments, including malaria control andtsetse fly eradication. 0 Parts o f Ethiopia One can be classed as high risk-high potential zones in the important river valleys, which are mainly located in the western and southern lowlands that comprise part o f the lowland periphery. Some studies carried out inthe 1980s of the low population density areas inthe lowlands concluded that the tsetse-infected western lowlands offered the best potential for expanded agriculture, provided that the tsetse problem can be overcome. The western lowlands occupy nearly 200,000 sq km, large areas o f which are suitable for rain- fed mechanized farming. There i s also considerable potential for multi-seasonal irrigated crop production in its several river basins. This region offers considerable opportunity for commercial agriculture-based growth. EthiopiaTwo: MoistbutDrought-ProneAreas 0 These zones range from high to low risk, and some offer only limited growth potential, with the most difficult circumstances being faced in the northeastern highlands which face the unenviable combination o f both high risk and low potential. This part o f Ethiopia, which includes Wollo and parts o f Tigray, north Shewa 3, and East and West Hararge, i s critically affected by rough terrain and the environmental and population traps described earlier. Production o f food crops, at 1.1 quintals per capita, is barely at subsistence levels. The vast majority o f households are poor. These zones' most important endowment is their labour force, which is often seriously underemployed. Given the current low levels o f agricultural productivity, incomes would increase through adoption o f modern technology-provided that risk mitigation measures allow farmers to move out o f their low risk-low return strategies. Small-scale irrigation schemes also offer potential to improve agricultural productivity (discussed in Chapter 2). However, this will not be the route out of poverty for many households. The future lies in investments in skills to help enable labour mobility, through non-farm employment and increasing urbanisation. This will involve considerable migration to urban areas, and in particular to lowland regions with much greater resources and development potential. 0 Mediumpotential-high risk zones are suitable for large scale mechanized farming, particularly for such relatively drought-resistant crops as sorghum and sesame. There i s significant drought risk, but also high irrigation potential, as the zones have over 91,000 ha o f potentially irrigable land. The same exists in the fertile south, particularly the parts o f North Omo inside the Rift Valley and the drought 64 prone South Omo,where irrigation potential exits. This demonstrates a potential that needsto bebuilt uponand expanded. Finally, the high potential-high risk zones in Ethiopia Two have tremendous potential for agriculture. These areas include thousands of square kilometers of relatively flat alluvial plains suitable for mechanized agriculture and for irrigated multi-seasonal farming. North Gonder, along with the moisture reliable Metekel and East Wellega zone, contains nearly one million ha of irrigable land, but no significant irrigation infrastructure. These zones could generate considerable economic growth if supported by adequate public goods, irrigation, tsetse fly eradication, and humanand animal healthcontrol measures(see Box Al). Box A1 PotentialReturnsto PublicInvestmentsto Enable Growth in the Lowlands Animal health. Effective, large-scalecontrol of the tsetse fly could offer significant returns. A study of a control program in the upper Didessa valley found that the amount of land cultivated increased by more than 380 percentonce farmers were ableto bring indraft oxen. This experienceis alsorelevantto attempts to resettle highland farmers inthe western lowlands. Most attempts were eventually defeatedby the tsetse fly, emphasizing that resettlement and ox plow based farming in the western lowlands are likely unsustainable without effective control. Infrastructure and connectivity. Sustainable growth in the western lowlands will require significant investment inphysical and human infrastructure, including for hydroelectric power and irrigation. There is a general lack of roads and transport, water resources, energy, and communication infi-astructure, which is fbrther reflected in the lack of urban centers, health, education, commercial, and other infi-astructure,to enable non-farm employment. Irrigation. There i s considerablepotential for irrigated multi-seasonalcultivationof a muchwider range of crops inthe lower river basins of the western lowlands, with an estimated total irrigable area for large and medium scale schemes, of around 1.7mha. This could allow multi-seasonal cropping over large areas, and provide surpluses for both export and development of processing. This development in the western lowlandswould needto be supportedby a goodroad system, and robust markets. Source: World Bank 2004a. See also Chapter 2. EthiopiaThree: (Arid) PastoralAreas The Ethiopian rangelands are home to 10 million people, and cover almost six tenths of the total landmass. There is a dramatic cleavage between rich and poor-about 30 percent of the pastoral households own 60 percent of livestock resources. On a per capita basis the pastoral areas do not produce enough milk and meat to satisfy basic nutritional requirements, and about 70 percent of pastoralists are believed to suffer from nutritional deficits. Natural biomass production, the mainstay of livestock, is slowly declining due to the lack of sustainable range management. Humanitarian relief now covers all the rangelands preventing the worst effects of famine, but has also become chronic and is distributed even in the absence of drought. Pastoralists are generally considered to be more impoverished and disempowered relative to the Ethiopian populationas a whole (World Bank 2005b). Undeveloped infrastructure and services in the pastoral areas constrain activity and compound the pressures created by rapid population growth, environmental degradation and limited access to water. Road networks and access to telecommunications and electricity are extremely limited. Poor veterinary service 65 coverage impedes exports, and herd mortality is estimated to be as high as 8 percent. Inthe absence o f a sound policy framework for developing the pastoral areas, interventions have tended to focus on humanitarian relief, without addressing the structural issues that are threatening pastoralism as a viable livelihoods strategy. The classic approach to livestock policy no longer appears tenable, given pastoralists' declining competitiveness against sedentary breeders andthe obsolescence of meat processing plants. Human capital is especially weak. Less than one-fifth o f children in Somali and Afar regions have access to education, and these regions have among the lowest rates o f health coverage (see Chapter 1). Meeting these challenges i s complicated by very weak administrative capacity at the woreda level. Community-driven development initiatives are underway to fund micro-projects such as construction o f schools, water supply points, andhealthposts, and have shown some success in building local capacity and improving access to services. Still, coordinated efforts are needed to raise access rates to national averages, and also to address demand-side constraints by introducing flexible approaches to education that can accommodate the non-sedentary population. The positive externalities of increasing educational access are well known. For example, awareness about HIV/AIDS in most pastoral areas i s worryingly low, especially given the major highways passing through pastoral areas. There i s nonetheless significant economic potential inpastoral areas for livestock exports and irrigated crop production, even in the face o f substantial risks. Livestock can generate significant growth when approached on a more commercialized basis, and provided with appropriate basic infrastructure and public goods, such as animal health infrastructure, water for forage production, and transport and marketing infrastructure. Moreover, although policymakers tend to focus on livestock in the pastoral areas, this represents just half o f gross income, followed by agriculture (20 percent), gathering o f natural products (10 percent), services (5 percent), remittances (5 percent), and humanitarian aid (5 percent, mainly cereal food). There are increasing numbers o f "agropastoralists," underscoring the need for a development strategy that addresses potential in agriculture as well as livestock. The dry southern and eastern pastoral areas offer the greatest potential in the lowlands, provided supportive public investments are forthcoming. While there i s little opportunity for rain-fed cropping, the region's river basins could be irrigated to enable both crop and commercial livestock production. In the short term, investments are needed to mitigate the ecological impact o f population growth and improve nutritional outcomes in order to protect the sustainability o f pastoral systems. 66 3. ACCELERATING PRIVATE SECTOR-LED ECONOMIC GROWTH 1) The Context of Reform 3.1 The Ethiopian economy has undergone two rounds of reform which have yielded visible results in a transformation from a state-driven system to a mixed public-private economy, and in establishing a foundation for private sector-led growth. The 1991post- Derg reforms established the legal framework for private investment, market-based resource allocation and privatization. A second set of reforms, articulated in the 2001 national poverty reduction strategy (SDPRP), was designed to facilitate the entry of private enterprises through a platform of infrastructure and human capital investments, gradual privatization o f state enterprises, introduction o f domestic private banks, establishment of a Trade Practices Commission, revision of the investment code, fiscal incentives to attract foreign investment, and removal of some key administrative barriers to private sector development. 3.2 Prior to mid-2005, there were signals that the private sector had begun to respond to the second generation of reforms as well as peace with Eritrea. There were very sharp year-on-year increases in registered investment, including increases of 30 percent in 2003, 123 percent in 2004, and 90 percent in 2005. In2005, investment registered with the Ethiopia Investment Commission reached US$693 million. Several sectors, particularly construction andmanufacturing, visibly increasedtheir growth rates. 3.3 The impact o f the 2005 disturbances may have been to disrupt the momentumthat had been built by the 2001/2002 reforms, perhaps forcing the growth "boost" from this generation of reforms to plateau prematurely.28 The rapid growth in registered investments was halted, and in 2006, there was a 36 percent decline in registered investment (to US$456 million), likely to have been at least partially influenced by political instability. In general, only a small share of registered investment has materialized into operations, value added export growth was limited, and urban unemployment remains highby African standards. 3.4 A qualitatively new dimension has emerged because the political climate has become more polarized. In particular, there i s a necessity to ensure that the investment climate-both interms of perceptions as well as reality-is less vulnerable to short-term political pressure through principles o f good economic governance. 3.5 A new generation of reforms is needed that not only enables private investment and competition, but that supports rapid growth of the private sector at a pace and scale that can impact employment and poverty. By late 2006, two factors appeared to at least ** Empirical evidence is not yet available on the impact o f the political environment on investor behaviour. However, accounting and advisory f m s report a substantial decrease in the level o f foreign investor inquiries that they fielded in the second half o f 2005 compared with the first half, which was attributed to politicaluncertainty. 67 signal the broad contours o f the next phase in Ethiopia's growth process. In December 2006, the Government submitted its Memorandum on the Foreign Trade Regime to the World Trade Organization. Second, the Government submitted the PASDEP to Parliament, with an explicit focus on private sector development. The policy emphasis has shifted to growth, through deeper investment climate reforms, and support for the emergence o f growth poles and clusters. The aim i s to raise the trajectory of growth to at least 8 percent from averages o f 4-5 percent. 3.6 For the vision articulated in PASDEP to succeed, the strategy needs to be supported by detailed actions and reforms that are empirically linked to increasing productivity. Such actions may be related to market-supporting institutions, financial sector reforms, sectoral growth strategies building on the experience o f self-discovery o f the rose export sector, and strengthened economic governance. A new Investment Climate Survey (ICs) and several value chain analyses are underway to support identification and articulation o fthis new growth platf~rm.~' Urban Employment and Formalization 3.7 The Ethiopian private sector i s predominantly small scale, informal and service- oriented. Over 99 percent o f all firms are informal. The services sector has been growing (especially in construction, real estate, hotels and trade) as have been small scale, informal manufacturing activities. Informal enterprises extend well beyond small- scale service and retail establishments, and include small manufacturers. The shoe cluster, for example, includes 700 small manufacturers. 3.8 According to the National Labour Force Surveys, the urban employment rate was roughly the same in 1999 and 2005 (Table 3.1), albeit with a small but statistically significant increase infemale employment. Most employment that has been created i s in self-employment and the informal sector. Urban unemployment, particularly among youth, i s high, as shown in Table 3.2 (and young women are more likely to be unemployed than young men). These issues are explored in depth in the urban labour market study (World Bank 2006b). *'Whilethe ICs data are not available at time of writing, preliminary findings of the value chain analysis are incorporated. 68 Table 3.1 Trends in EmploymentRatesby Region, ages 15+ (percent) I Countrv-wide I 55.4 I 56.4 I Tigray 55.1 57.8 Afar 60.9 58.4 Amhara 57.6 59 Oromia 63.O 60* Somali 52.7 47.1 Benishan 63.O 68.5* SNNPR 62.4 61.7 I Gambella I 56.4 I 44.3* I Harari 54.8 51.5 IAddis Ababa 46.2 49.3* DireDawa 49.8 51.6 *Significantly differentfrom 1999 figure at 95 percent, though results should be interpretedwith caution. Table 3.2 High UrbanYouth UnemploymentRates, 2005 (age 15-24) (percent) Country-wide 23.4 19.8 Addis Ababa 38.7 34 DireDawa 34 30.4 Ticrrav 14.5 18.3 Amhara 17.8 13.5 SNNPR 12.6 13.1 3.9 A recent EDRI study revealed exceptionally high turnover in Ethiopia-many businesses are started, suggesting low barriers to entry, but many fail in the first three years o f existence. This suggests that there are investment climate constraints-such as hightransaction costs-that impact firms and projects in their start-up or early stages o f operation, and/or that a very low degree of specialization and a high degree o f competition has relegated many businesses to a very low level of profitability. Investment Performance 3.10 It is clear that in 2003, 2004 and 2005 the anticipated private sector responses were beginning to materialize in light o f improvements inthe investment regime (Figure 3.1,Table 3.3). Industry investment approvals increased rapidly over the last five years, led by domestic investment in manufacturing and foreign investment in agriculture. However, as noted already, many o f the registered investments have failed to materialize inthe form of actual investments. 69 Figure3.1 InvestmentinEthiopia 70,000,0001'Capital (in'000 Birr)] 60,000,000 50,000,000 40,000,000 Implementation 30,000,000 20,000,000 10,000,000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: EthiopianInvestment Commission. Table 3.3 Investmentin Ethiopia 2003104 485 465 2004105 386 545 I2005106 I 46 I 205 I 3.11 Looking more closely at manufacturing, and particularly those investment applications that have been implemented, the largest sub-sectors in terms o f capital investedare pharmaceuticals, plastics (reflecting the privatization o f a state-owned Addis Tire by Matador), and non-metal minerals. Inemployment terms, the largest sub-sectors are plastics, textiles and food. 3.12 It is clear that Ethiopia's investment performance would be far better if a larger share o f registered investments became operational more rapidly. It i s less a question o f entrepreneurship or attracting interest in Ethiopia-ideas and interest in Ethiopia are clearly being generated-but rather a problem o f overcoming barriers to establishment, be they financing constraints, skills and technical capacity, land acquisition processes, or other constraints, as discussed further below. Export Performance 3.13 Ethiopia, following the example o f East Asia, aims to reduce poverty through export-oriented manufacturing to generate employment. As such, the Government's Industrial Development Strategy, prepared in 2002/03, called for (a) elimination o f obstacles to the growth o f investors, both foreign and domestic; (b) providing adequate 70 support to enable entrepreneurs to compete globally; (c) industrial development to leverage abundant factors; and (d) industrial strategy following and supporting agricultural development. The strategy identifies supporting factors including a stable macroeconomic environment, transparency, infrastructure, an efficient financial sector, a strong state role to correct market failures, and focuses on strategic sectors for support. 3.14 Support packages were designed to stimulate investment in export manufacturing through tax privileges, access to long-term capital (seven year project financing from public development banks currently at 7.5 percent per annum), and access to land. While the strategy has contributed to some notable successes, particularly in the cut flower sector, there has not been an overall shift from agriculture to industry, but rather a modest shift fromagriculture to services (Figure 3.2). Figure3.2 N o Shift from Agricultureto Manufacturing Share of GDP Ethiopia:Sectoral Composition of GDP 1 2500 2000 I 1 Services 1500 lnodstry Non-Mfg - 1000 rn Manufacturing 500 0 2000/01 2001/02 2002/03 2003/04 3.15 Ethiopian exports in 2005/06 crossed US$1 billion for the first time, due to favourable crop and price conditions, but Ethiopia has yet to significantly penetrate export markets with processed, value-added commodities. Imports and exports combined were less than 40 percent o f GDP as o f end-2003, which is far below the Sub-Saharan African average, although above Sudan and Uganda (Figure 3.3). Trade-to-GDP ratios for the export-led economies o f East Asia typically exceed 100percent. Figure3.3 Fairly Low Trade Levels 60 - "+Saharan Afrc 40 - Kenya I Uganda 20 - I - 1 I Source; World Bank Global DevelopmentIndicators 2005. 71 3.16 Ethiopia's exports are largely unprocessed. Oilseeds, pulses, coffee, chat and skins, which together comprise 73 percent of Ethiopia's exports, are traded in unprocessed form with most o f the final value acquired by downstream processors who import Ethiopian product. In 2006, a significant increase in meat exports was expected, but again, largely interms o f volume, since live animals are exported rather than fresh or frozen meat. 3.17 The key areas where value i s added locally are textiles, which have increased in value terms, the leather and leather products industry, which consistently export over US$60 million per year, and gold, in which exports typically exceed US$50 million. Exports o f cut flowers were expected to grow from around US$4 million in 2004 to US$20 million in2006. 3.18 Increasing exports requires both access to profitable markets and a response by the domestic private sector to export opportunities. A private sector response depends in part on the quality o f institutions to (a) develop products that can reflect international standards o f product quality and safety; (b) support long-term, predictable relationships with buyers with minimal risk o f commitment failure due to product supply or logistics; (c) enable predictable long-term relationships with a domestic supply chain; and (d) facilitate competitive access to inputs including access to finance and logistics. 3.19 In December 2006, Ethiopia submitted its Memorandum on the Foreign Trade Regime to the WTO, markingthe formal start o f the accession process (Box 3.1). Many question whether accession will be useful to Ethiopia, given its market access as an African least-developed country. A significant part of the accession process i s designed to create the institutional depth required to compete in international markets. In fact Ethiopia has already made substantial gains in reducing average tariffs, and already has access, albeit not permanent, to key markets on favourable terms through such mechanisms as the Africa Growth and Opportunity Act and the European Union's Everything but A r m s initiative. WTO accession will provide a framework for reviewing and improving trade-supporting institutions that impact the private sector, such as sanitary and phyto-sanitary standards, customs valuation, intellectual property rights and commercial laws, as well as liberalizing the service sector (see Box 3.1). 72 Box 3.1 WTO: What's in it for Ethiopia? Ethiopia has recognized that it needs to export more and to attract more investment in order to realize its development ambitions. Ethiopia, as a least-developed country, i s already given preferential marketaccess by a number o f countries, includingthe UnitedStates, through the Afiica Growth and Opportunity Act, the EU(Everything ButArms), and China. So why does it needto accedeto the World Trade Organization? There are a number o f reasons why WTO accession may have a far more significant impact on trade and investment than bilateral agreements: WTO is an institution that derives its strength from the commitment o f its members to managing trade with a common set o f values: openness, transparency, predictability, non-discriminatory treatment, and use o f a rule-based dispute resolution mechanism. These are the same that investors rate favourably in those countries which are considered attractive environments for investment, and that Ethiopia is trying to instil throughout its economic and social development policies. Joining the WTO improves market access, and also sends a strong signal to trade and investment partners about the Government's intent to conduct its policy in a manner that is open, transparent, predictable and fair. WTO accession process is largely not about trade policy, in the sense o f tariff and trade barriers. Rather, WTO accession i s an opportunity to review and strengthen the set o f commercial policies and laws which underpin the economy against best international practices. WTO does not dictate outcomes o f these policies, but the Working Party would need to be satisfied that the laws conform to the basic principles o f the WTO. This review o f policies-particularly to the extent that the domestic private sector participates-would typically result in policy improvements for domestic f m s that would allow domestic f m s a chance to compete. Bilateral agreements may be laborious and can be unilaterally withdrawn by the trading partner (for example, a result o f political pressure fiom its domestic lobbies). Due to the most-favored nation principle, joining the WTO means that Ethiopia will have achieved the best possible bilateral deal with all WTO members-in one process rather than many-and in a manner that cannot be unilaterally withdrawn. This i s a significant increase in the predictability and certainty o fthe commitment. 3.20 Domestic markets can be a more viable source of demand. While export markets may be crucial in the long run, in the mediumterm urban markets may provide a much greater stimulus to growth than at present. Ethiopia's industrial strategy is currently focused on export markets because urban markets are characterized by low aggregate demand, due to a fairly low level of urbanization, low urban salaries, and low levels of discretionary spending. A more efficient wholesale and retail distribution sector with strong supply chains to agribusiness is likely to unlock significant domestic demand, which may also catalyze investment, at the same time raising urbanproductivity levels. 2) Policy Constraints 3.21 Like any developing country, Ethiopia faces a large number of challenges in trying to increase investment, ranging from legal andjudicial reform, to privatization, to improving factor markets like capital and land. However, no country can pursue all fronts simultaneously. Partial reforms ina broad number of areas may not necessarily be welfare promoting. At the same time, reform in any given area may be undermined by adverse interactions with other, less reformed or poorly performing aspects of the economy. Take, for example, the case of privatization, which depends in part on sufficiently deep capital markets to allow domestic investors to purchase firms. Privatization may not yield the desired economic growth if it results in undercapitalized 73 firms. One area in which reform could prove fruitful i s the retail sector; for an exploration ofthese issues see Box 3.2. 3.22 Global benchmarking can help identify constraints. Ethiopia scores poorly on a number of the World Bank's global Doing Business indicators (Table 3.4). The lowest scores for Ethiopia were obtained for registering property (140th out of 151), getting credit (114th), protecting investors (137*) and trading across borders (129th). On the other hand, Ethiopianlabour laws are considered relatively flexible and licensing regimes are not overly burdensome. Table 3.4 Ethiopia's Assessment and GlobalRankinginDoingBusiness I DoingBusiness I I 97" globallv I Starting a Business 7 procedures 95'h Dealing with Licenses 12 procedures, 133 days 59" 3.23 Benchmarking, while helpful, does not prioritize investment climate reforms. Hausmann, Rodrik and Velasco's growth diagnostics model attempts to identify binding constraints to investment entrepreneurship as a subset of either low returns (rates of returnon investments below the cost of capital) or high cost financing. Returns may be suppressed due to either the presence of the state as a competitor, and/or due to microeconomic or macroeconomic risks, low productivity, human capital, high transaction costs, or high cost of financing. Some key factors relevant to Ethiopia are examined inturn. 74 Thailand's emergence as a global horticultural exporter (World Bank 2004h). Specialty wholesale and retail also increases productivity in manufacturing because o f the technology embedded in product supply chains. Modern wholesalers o f industrial inputs and equipment not only sell product but maintain knowledge o f how to deploy the product, thereby increasing the productivity and technologicalcapacity o f the user. Some argue for maintaining retail as a domestic industry on cultural grounds. While clearly the diverse Ethiopian cultural heritage is one o f its most valuable assets, many countries have found that creative entrepreneurs can in fact enhance cultural heritage through their investments when guided by zoning and aesthetic standards. Indeed inabsence o f such policies, and without foreign investment, in Addis Ababa there are frequent instances o f destruction o f cultural assets through unplanned development o f formerly historical areas. International experience suggests that two types o f reforms are needed to unlock the power of modern retailing: lifting restrictions on foreign investment inretail, and efficient land availability. Along withjudicious use o f zoning standards, there i s no doubt that the benefits o f modern retail can accrue to Ethiopian consumers and farmers with positive benefits for employment and cultural heritage. Restrictions on Foreign Investment 3.24 From various articles of the Investment Proclamation (No. 280/2002), and Proclamation No. 375/2003, Table 3.5 indicates twenty-seven investment areas that are restricted to foreign investment. While some of the sectors, such as weapons manufacturing, are often restricted in some way, many of the sectors which are restricted to foreign investors are those that pose the greatest source of investmentclimate obstacles (financial sector, telecommunications, wholesale and retailtrade). Table 3.5 Restrictions on Investment 1. Transmission and supply o f electrical energy through the IntegratedNational Grid System 2. Postal services with the exception o f courier services 1. Manufacturing o f weapons and ammunition 2. Telecommunication services 1. Retail trade and brokerage 2. Wholesale trade (excluding supply o f petroleum and its by-products as well as wholesale by foreign investors o f products locally produced) 3. Importtrade (excluding LPG, bitumen and upon approval from the council o f ministers, material inputs for export products) 4. Export trade o fraw coffee, chat, oil seeds, pulses, hides and skins bought from the market and live sheep, goats and cattle not raised or fattened by the investor 5. Constructioncompanies excluding those designated as grade 1 6. Tanning o f hides and skins up to crust level 7. Hotels (excluding star-designated hotels), motels, pensions, tea rooms, coffee, shops, bars, nightclubs and restaurants excluding internationaland specialised restaurants 8. Travel agency, trade auxiliary and ticket selling services 9. Car-hire and taxi-cabs tranmort services 76 I 10. Commercial roadtransport and inland water transport 11. Bakery products and pastriesfor the domestic market 12. Grinding mills 13. Barber shops, beauty saloons, and provision of smith, workshops andtailoring services except by garment factories 14. Buildingmaintenanceandrepair andmaintenanceof vehicles 15. Saw milling andtimber making 16. Customsclearance services 17. Museums, theatres andcinema hall operations I 18. Printing industries I 1.Banking, insuranceandmicro credit and saving services 2. Forwarding and shipping agency services 3. Broadcastingservices Source: UNDP 2006. Note: A domestic investor is defined as an Ethiopian or a foreign national with permanent residence in Ethiopia who has made an investment; this may include the Government, public enterprises, and foreign nationals who are Ethiopian by birth but prefer to be considered a domestic investor (Article 2.5 of Proclamation 28012002). A foreign investor i s a foreigner or a company owned by foreign nationals who has invested foreign capital in Ethiopia. Also an Ethiopian national permanently residing abroad who prefers to be treatedas a foreign investor falls underthis category. TheRole of State Enterprises 3.25 Fewissues are more salient to the questiono fthe state's credibility with respect to private sector development than the question o f state and party-affiliated enterprises. Investment may be suppressed if entrepreneurs do not believe that they will be able to capture the gains from investment due to unfair competition with the state,or if property rights are insecure (Hausmann, Rodrik, and Velasco 2005). Since 1992, Ethiopia has been undertaking reforms to transform the structure o f the economy from public- to private sector-led. This included the privatization o f a substantial share o f the 212 public enterprises that existed at the time. Between 1992 and 2004, approximately 55 enterprises were privatized, and 157 remained, inaddition to a number o f new enterprises which were financed by foundations controlled by political parties. 3.26 Following a slowdown in effort in 2003, the Government revitalized its framework in 2004 through a Privatization Action Plan which introduced new modes o f divestiture including leasing and management contracts. The reforms included: 0 Use o f market-based valuation methods to guide pricing o f the companies; 0 A deferredpayment scheme to encourage local participation inthe program; 0 Land titles are prepared (were there were none) and made available during the preparationo f the enterprises for sale and are transferred to the buyer; 77 Implementation o f retrenchment using the special provision in the recently proclaimed labour law which allows early retirement for privatized companies32; The Privatization and Public Enterprises Supervising Authority (PPESA) management i s now authorized to negotiate33 with interested buyers after two non-responsive tenders; and Buyers need only pay 35 percent of equity value, with the balance paidover five years. 3.27 A sharp increase in the number of bid documents took place in 2004/05 and 2005/06 following the introduction o f these reforms (Figure 3.4). In FY2004/05, 24 public enterprises were offered for sale, 130 bid documents were purchased, and seven were sold. This included three branches o f hotel chains, a construction materials factory, a food processor, tool factory, a tannery, and garment factory. Some enterprises have been leased, including a textile mill and a metal and hand tools enterprise. Two hotels and a construction materials factory have been returned to previous owners (restituted). Including leases and management contracts, fifteen public enterprises were divested out o f a target o f forty planned divestitures. InFY2005/06, 235 bid documents were sold, 93 bids received, and 10 enterprises sold. While the number o f enterprises sold remains modest at ten, the process has become much more competitive with over three bids received for each enterprise marketed (a complete reverse o f the situation in 2001/02, where out o f four enterprises marketed, only one wouldreceive an offer). 3.28 Leases andjoint ventures, rather than sales, comprise the majority o f the value o f transactions (Figure 3.5). This could result from a number o f reasons, including (a) that the private sector is hesitant to assume the entire commercial risk; (b) that PPESA is unable to close sales transactions and i s resorting more frequently to leases; or (c) that lease terms are more attractive. 3.29 Thus, while privatization has increased its pace, it has not kept pace with new SOE creation. The more important underlying issue is whether the remaining enterprises are an obstacle to private investment. There i s both a "stock" and a "flow" dimension to this question. Due to both privatization and growth o f the private sector, the share o f state enterprises in industrialoutput has declined from 86 percent in 1996 to 53 percent in 2002, but rose again in 2004 to 57 percent due to increased investment in some enterprises (see Table 3.6). In2005, the rapid growth o f private sector output resultedin an important decline o f SOE share downto 51 percent. 32 Early voluntary retrenchment for a 4.5-year old, with 20 years working experience allowed for ''rivatization. PPESA also publishes a notice announcingreceipt of a proposal and asking for any other expressions of interest. 78 Figure3.4 ProgressinPrivatization 250 200 150 100 50 0 2000101 2001102 2002103 2003104 2004105 2005106 Source: PPESA. Figure3.5 Privatizationby Modality Numberof Enterprises Transferred Value of Enterprises Transfered 10 700,000 0 600,000 500,000 6 400,000 4 300,000 2 200,000 100,000 0 0 DirectSales Restitution Leases and Mgmt Direct Sales Restitution Leases and Contracts 3.30 The authorities continue to development new enterprises, even while privatizing others. The net number o f large- to medium-sized enterprises in Ethiopia has actually increased from 119 in2001/02 to 154 in2004/05. However, over the same period, output grew faster inthe private sector, suchthat the SOE share o fthe output o f medium to large manufacturers has declined from 53 percent to 51 percent. Hence, overall, the role of the state remains very large. Table 3.6 PublicandPrivate Shares inMedium-Large IndustrialManufacturing Source; Central Statistical Authority. 3.31 The share of the private sector in manufacturing value added has increased substantially over the past three years, while value added o f state-owned manufacturing 79 enterprises has stabilized and has begun to decline. From 28 percent in 2001/02, the private sector's share in manufacturing value added has now reached 41 percent (Figure 3.6). Figure3.6 Publicvs. Private Shareof Manufacturing Value Added 4,500 4,000 3,500 3,000 5 2,500 2,000 1,500 1,000 500 0 I 2000/01 2001/02 2002103 2003/04 2004/05 3.32 The flow o f new investment is clearly in favour o f private investment except in public utilities, where any potential for private participation has not beentapped. While a large share o f registered investment i s undertaken by public enterprises, the majority is private (Figure 3.7). At the same time, among the top ten registered investments (all pre- implementation), four are from the public sector, including three separate electricity projects and the expansion o f Muger Cement Factory (Table 3.7). Figure 3.7 RegisteredInvestment,by ownership,2001-2005 Domestic iopian by Domestic JV Birth 80 Table 3.7 Top Ten RegisteredInvestmentsby Ownership products 8. Domestic Real Estate Residential Houses Oromia 1,043,478 development 9. Foreign Pharmaceutical Pharmaceuticals Addis Ababa 993,000 products Manufacturing 10. Foreign Non-metallic Mineral Cement Factory DireDawa 936,053 1 Droducts I I I Party-Affiliated Enterprises 3.33 Like several other countries, Ethiopia allows foundations which are controlled by political parties to own enterprises (Box 3.3). Endowment companies became a political issue in the last elections, and there were allegations that depicted party-owned enterprises as a vast economic empire. Because hard evidence does not exist to either support or refute these claims, many inthe private sector assume the worst. More likely to be true i s a picture of a relative decline over time inthe importance o f the endowments. The endowments played a critical role inestablishing key businesses when Ethiopia was not at all attractive to investors. A number of projects would not have received funding without the role of the endowments. However, as the private sector grows and i s in a position to contest all business areas operated by endowments, the early rationale for endowment-owned businesses has disappeared. 81 Box 3.3 Ethiopia's Politically-AffiliatedHolding Companies The phenomenon of business endowments, or holding companies controlled by political parties, is a controversial feature of the Ethiopian investment climate. There are four larger and several small endowments that operate multiple businesses in Ethiopia, each having the objective of regenerating the region to which they belong through income-generatingand employment-creation activities: (1) EFFORT, established in 1995 and by far the largest, focuses on the rehabilitation of Tigray; (2) EndeavorENWEK and Ambasel focus on Amhara Region; (3) Dinsho focuses on rehabilitation of Oromia Region; and (4) Wondo Trading focuses on rehabilitation of SNNPR. These endowments operate with very limited transparency, so there are no published figures on their investments. EFFORT is by far the largest interms of assets, number of subsidiaries, sectoral coverage and its national orientation (as opposed to other endowments which remain regional entities). EFFORT maintains a website with limited information on thirteen wholly-owned enterprises with initialcapital of aroundBr 1.5 billion, but the endowmenthas large equity positions in at least another twelve well-known f m s and has had investments in the past in enterprises which are now closed. Competition with the private sector. The endowments have focused on a number of business areas which are consistent with the Government's ADLI policy direction, includinginput supply to agriculture, storage of agricultural goods, investments in irrigatioddams, agricultural processing facilities such as coffee washing stations, transport, banking and rural microfmance. Several of these areas are ones in which the private sector had limitedaccess, due to their limited ability to achieve collateral requirements. Over time, the private sector has entered, or has been in a position to enter, most business areas where endowment f m s operate. Insome instances, direct competition between endowment and private f m s has resultedinthe closure and exit of the private fm. However, some observershave noted that as the private sector has begun to enter some of the basic business areas, endowments have shifted to newer innovative areas suchas tissue culture. Performance. Some of the endowment f m s have been very successful. In cement, for many years a party-owned fm and an SOE have been the only major domestic suppliers, each enjoying rapid increases indemand. Inthe financial sector, abankaffiliated withanendowmentcurrently hasthe highestreturn on equity among private banks, and the microfmance institution partly owned by an endowment has grown to one of the largest in Africa. However, the endowment-ownedfirms are by no means uniformly profitable. Rather, many of the f m s appear to suffer fiom the types of inefficiencies typically associatedwith state- owned enterprises, including non-commercial objectives that weaken commercial sustainability. It is widely understood that a significant share of the non-performing loan portfolio of state-owned banks representswhat were originally loansto endowment-ownedf m s . Issues. I s the existence of party-affiliated enterprises problematic? There are broadly two types of issues raised by these endowments: issues of economic governance and issues of political governance. The private sector argues that the holding companies affiliated with the rulingparty, EFFORT in particular, is usually managed by a former government official which creates a conflict of interest. Similar linkages exist at the regional level. The private sector argues that these links with the state create advantages which are unavailable to firms owned by private investors, and thus act as a disincentive to domestic and foreign investment. Such advantages include access to information on policies and programs which influence profitability of firms; advantages in raising capital in an environment with no formal equity market; and access to bank credit. Officials argue that the endowment f m s (a) operate with no particular advantage from their affiliation with the state or ruling party; (b) continue to play a crucial role in providing basic goods and services to the xonomy when private investment is limited; and (c) are more usefid as investments for Ethiopia than holdingthe hnds as cash. The question aroundpolitical governancei s related. By being affiliated with the government, the allegation is that endowments gain economic advantage which translates to political idvantage, or can be used by the government not to raise money but to influence voters directly. The nicrofinance holdings alone impact hundredsof thousands of potential voters. At another level, a write-off ifdebt owedbyparty-affiliatedenterprisesto state-ownedbankswould constitute atransfer ofwealth from :he state to the endowments(by eliminating a fmancial obligation of the defaulting enterprises). 82 3.34 There is also a perception that while the number o f enterprises owned by the TPLF or EPRDF i s limited, the firms that exist are in strategic sectors o f the economy, such as transportation or cement. This perception i s magnified in the case o f cement, a commodity which has doubled in price from Br 90 per quintal to Br 180, which i s produced by a duopoly: one state-owned firm and one party-owned. While ex-factory prices are kept below market prices, there is a thriving secondary market incement that i s fuelled by those who have the ability to purchase cement at the ex-factory price (World Bank 2006d). Given that the two producing firms are owned by the ruling party and the state, and because the state i s a large customer o f the two plants and likely to obtain its cement, there i s a perception that the windfall i s more likely to be gained by those who have privileged access to the government. 3.35 Ethiopia i s not the only country in which politically-owned endowments feature strongly in the business environment. The founding and ruling party o f Taiwan, which Ethiopian leadership appears to see as a role model in some respects, for many years has maintained a portfolio that some estimate at over US$1.2 billion. A key difference i s that the KMT has released detailed information on its business holdings, while Ethiopia's endowments are fully opaque. 3.36 This perception i s one o f bad economic governance, and the cost is likely to be one o f a loss o f credibility with potential investors. A program o f gradual divestiture o f party-affiliated enterprises i s likely to have minimal cost to the Government with significant benefits in terms o f policy credibility and investor confidence. Therefore, from a strategic standpoint, the government may eventually revaluate the tradeoff betweenthe benefit of endowments and their cost in terms o f a perception o f an unfair environment for private investment. Short o f such a revaluation, four types o f reforms may help contain the real or perceived distortions caused by party-owned businesses: A fairer financial sector-a fair and level playing field for access to equity capital; 0 Standards of transparency for politically-owned holding companies; Strong secured lending and bankruptcy laws and practices which provide strong disincentives to engage in non-commercial activities with funds ultimately owned by the citizen; and 0 A strong competition secretariat, with the capacity to investigate and remedy the contestability o f key markets and to differentiate between monopoly positions that are related to a commercial advantage vs. monopoly positions relatedto unfair practices. CompetitionPolicy 3.37 As part o f its strategy to foster broad-based and sustainable private sector-led economic growth and poverty reduction, the Government has recognized the need to have 83 an effective competition law-policy framework. The aim o f this policy is to maintain and encourage competition in the domestic economy in order to promote economic efficiency, competitiveness, and consumer welfare. Additionally, the policy aims at ensuring a `level playing field' between State Owned Enterprises (SOEs) engaged in commercial economic activity, `party affiliated' (Foundation) companies, and private sector firms; eliminating or lowering unnecessary regulatory and other policy-based barriers to entry; preventing anticompetitive and monopolistic business practices; and broadening the opportunities for new Ethiopian investors and entrepreneurs to participate in their own economy by increasing accountability and transparency in government- businessrelations. 3.38 In April 2003 the GOE enacted the Trade Practices Proclamation (TPP). It contains articles against collusive behaviour (such as agreements between competing firms to fix prices, allocate markets or customers and bid-rigging), and abuse o f market position by dominant firms (such as predatory pricing and market foreclosure). It also has measures against various types o f other unfair trade practices (such as misleading advertising andtied selling). 3.39 The Proclamation suffers from a number o f gaps, however. It has no provisions relevant for reviewing o f public policy impediments to competition and regulatory reform. It has no specific provisions against mergers and acquisitions that may increase market power o f existing large firms-this i s particularly relevant for the Government's privatization program if creation o f new monopolies i s to be prevented. 3.40 Moreover, SOEs and other government entities are exempted from the purview of the Proclamation. There is a risk that large SOEs and `party-affiliated, firms-some already noted for their anticompetitive business practices-would attempt to further entrench their market position during the transition period, and thus the GOE needs to be particularly active in enforcing the Proclamation, address areas where its provisions may be inadequate, build its institutional capacity and promote competition through a wide information dissemination program inorder to foster compliance with the new law. Access to Finance 3.41 Vibrant domestic investment depends on robustsavings, and on a financial system able to intermediate capital and risk such that savers with various levels of risk tolerance are able to invest in appropriate markets-and conversely, so that projects at various levels o f risk are able to be financed. Building and preserving a stable and efficient financial system for domestic finance to flourish i s a goal on which all are agreed. However, the strategies for doing so, andtheir sequencing, vary. 3.42 The Ethiopian authorities have chosen an activist perspective on financial sector development which i s concerned with achieving results in areas where the private financial sector i s not conspicuously successful: finance for agriculture and the rural economy, for micro-and small enterprises, and for low-income households, as well as long term finance in general. Consequently, the financial sector i s still dominated by large public financial institutions-notably, the nationally-owned Commercial Bank o f 84 Ethiopia (CBE) and the Development Bank o f Ethiopia (DBE). The combined share of the private banks is 23.5 percent o f commercialbankingassets. 3.43 This strategy has had mixed results with respect to financial sector stability, efficiency, and access to finance. In the aggregate, financial sector stability has improved. Efforts have been made to strengthen the corporate governance o f the state- owned banks and non-performing loans have continued to decline and were recently estimated to be at 20 percent and on a declining trend. Efficiency and resource mobilization have improved with domestic credit increasing by 20 percent in 2005/06 over the preceding year. However, access to finance remains limited and i s seen by the private sector as a key obstacle to doing business. In 2004, limited access to finance ranked fourth after land, tax, and business licensing (Figure 3.8). Figure3.8 Rankingof InvestmentClimate Constraints,2004 Gett ng andforconstrxton Overalltax regme B~sinesslicensingand permits Accesability ana pr ce of creaits coilateral Access priceand re1ab Ity of ut lit es Garbagedisposa ana otner m m c palsew ces Receiving construction permits Avai aoi ityof skilled labor Access pnceandreltabiityof commmications Cert ficat on of gooas andservices Lowaemandfor goods CLstomsforimpon Custo ms forexports Labor regJlations BLsiness regstration Non-Tax nspections (f re sanitaryetc) Environmental regLlatlons 0 1 2 3 4 5 6 7 8 9 10 Source: World Bank focus groups, 2005. 3.44 The persistent weaknesses in access to finance have long been attributed to the disappointing performance o f publicly-owned financial institutions, and the overall constrained environment that the financial sector as a whole operated in. The government has responded by opening up the sector to private ownership o f banks, albeit local; selectively allowing foreign entry in leasing, and generally encouraging the transfer o f foreign financial technology and know-how through advisory assistance and consultancy contracts. The National Bank o f Ethiopia i s in the process o f implementing a financial sector project that includes housing finance, leasing, and regulatory and supervisory 85 strengthening. Together with development partners, new initiatives are emerging in the microfinance sector. 3.45 While these reforms have increased resource mobilization, they have not spurned an equivalent rate o f financial sector intermediation nor has it encouraged rapid innovation in the sectors' products and services resulting into a highly liquid financial sector, still offering conventional banking services-which still accounts for about 94 percent o f total financial sector assets. Innovative consumer financial instruments such as credit cards, checking and automobile financing are unavailable. Instead, a large share o f banking system assets are held as cash, real estate or invested in government paper (treasury bills). Loan to deposit ratios are low for the state-owned banks, which have suffered very high non-performing loans in recent years. Term finance i s unavailable from private banks, with much o f the profit o f private banks arising from trade finance. Where the government has made term finance available, for example through the Development Bank o f Ethiopia, it has done so through directed credit requiring 30 percent equity which many local investors cannot raise. 3.46 Overall, while there are stirrings o f change in Ethiopia's financial sector, some of them vigorous, much more needs to be done. The continued shallowness o f finance and the limited access by small firms and households to formal financial services, mean that this financial stirring i s just a turn in the corner. The environment for financial firms remains difficult, and progress can be enhanced substantially. Within PASDEP there i s an opportunity for enhancing the reform process towards a more transparent, well-governed, well-regulated, and competitive financial sector that can allocate resources to the private sector in a more effective and efficient manner, and ensure better access to finance for large segments o f the economy that remainunder-served. 3.47 The accelerated pace of growth envisaged in PASDEP requires a reconsideration o f the basic risk-rewardtradeoff, with consideration given to liberalization particularly in sectors which are currently not well-served, such as mortgage finance, equity finance and consumer finance, as the Government strengthens its supervisory capacity and the asset quality and management o f its large state banks. Property Rights 3.48 Along with capital and labour, secure property rights and efficient land markets are among the most important investment climate variables. Secure property rights- whether through ownership or other long-term tradable rights-are essential to increasing investment as they form a key basis for secured lending. The existence o f land markets and their efficiency substantially defines property values, and the speed at which land finds its highestand best use. 3.49 Ethiopia's Doing Business ranking for property registration is low (146th out o f 151). Landmarkets are inefficient and an impedimentto private sector development due to a number o f factors that are described later inthis section. It i s important first to note that there are two types o f formal land rights co-existing in Ethiopia currently-the old "permit" or "rent" system, and the newer "urban land lease" system. Under the permit 86 system, land itself is not legally tradable, though these rights are automatically transferable when improvements are sold (so, in practice, real estate located on "permit" land is traded frequently); annual payments are not based on market values and are set at very low, fixed rates; and permits have to be renewedannually. When people pay annual "rent," however, indications are that there is massive avoidance of payments, and, accordingly, delays with "permit" updates. In practice, city authorities in charge of payment administration and permit updates in many cases don't have the capacity and systems inplace to administer the processpro-actively. 3.50 An urban land lease system was introduced in 1993 with the express purpose of encouraging the building of housing according to the capacities and needs of people; creating a source of revenue for city administrations; and moving towards market values of land. However, the 1993 landlease law was flawed, and was revised in2002. Inmost Ethiopian cities, a substantially larger proportion of formal landholdings continues to be under the permit system, as compared to the lease system, which has been applied essentially only to new landbeing released by government (inmost cities, currently, less than 10 percent of formal landholdings are leasehold). There continue to be many substantial problems with the 2002 lease law and its implementation in the regions. Evidence o f this i s the fact that permit holders of land were expected to volunteer to transfer to the lease system, but very few have done so. Inaddition, this leasing system is too complex for the current administrative capacity of city governments and not sufficiently market-tuned. 3.5 1 Inaddition, a large numberof landholdings are "illegal" or "informal." In2004, 30 percent of the total housing stock in Addis Ababa was considered illegal. About 20 percent was built to standard but on illegal or unregistered land, and the remaining was "slum" housing (below standard) also on illegal land. Despite their informality, there is an active but poorly understood informalmarket for this landhousing. An important and valuable step currently being undertaken in Addis and in other major cities is the formalization and regularization of the private property holdings that have been built to standard. However, progress hadbeen slow, inAddis particularly. Inmid-2005, out of a total of 200,000 informal and semi-formal parcels, title deeds had beenproduced for only 25,000 parcels and 54,000 cooperative houses. O f these titles produced, only 70 percent had been actually issued to households. In addition, the high transaction cost related to legal transfers limits the size and liquidity of the secondary market, and creates an incentive to trade property informally. The "slum" housing faces its own problems with the general policy being to demolish housing that is not built to standard. Moreover, a similar policy of demolishing housing and involuntary resettlement is promoted by some local regulations incases where legal construction does not conform to the current Master Plan. This policy has a negative impact on urban poverty, which needs to be addressed separately and in its own right. While the above issues are mainly related to housing, rather than businesses, they have important implications on the landmarket generally and on landprices, which impact the general investment climate for business development. 87 3.52 Inaddition to the above, critical factors that cause land markets to be inefficient, and an impedimentto private sector development, include the following:34 High transaction costs. Landtransaction costs are high(sales tax o f 4-7 percent in Amhara for example, which i s very high by international standards, plus capital gains tax which can go up to 15 percent o f the sale price minus construction cost). Transaction processes are lengthy and cumbersome (transactions require no objections from several city administration departments-which can be withheld for any number o f reasons, including if the seller has any unpaid local taxes or fees). Governmental land pricing is inconsistent and deviates from the market. As explained above, the "rent" system o f land still prevails. Payments for rent land were set administratively, with no connection to the market value o f land, and are very low. The lease system was supposed to replace the rent system, with three ways of pricing i)administratively set lease payments; ii)auction-based lease payments; and iii)negotiated lease payments. Auction prices should, in theory, reflect market values, while negotiated prices should be close to auction prices. The prices o f landleases inauctions were perceived by entrepreneurs (in surveys for the Investment Climate Assessment and subsequent Update) as very high, particularly inAddis Ababa, where small numbers o f plots were being released at any given time, encouraging artificially high prices. In response to investors' price concerns, cities now set a floor price for the lease (which is often significantly below prices in the secondary market), around which the final price i s negotiated. However, this prevents a market-driven mechanism for price setting. Further, many new leases (particularly outside Addis Ababa) are allotted at administrative prices that are several times lower than auction prices for similar land. There is no system o f evaluating these indirect land-related subsidies obtained by receivers o f these "administrative-price" leases. Finally, the best lands are often allocated for negotiationsrather than beingplaced on auction (e.g. around Lake Tana in Bahir Dar). Thus, resulting prices o f land within the government land allocation system are substantially distorted and can be prone to corruption. To make matters more complicated, since payments for land under the rent system are typically significantly lower than under the lease system, the lease system i s not popular with buyers-people generally prefer to buy "rent" landrather than lease land, pointing to a needto improve the leasing system. Land leases are not fully tradable. According to the Urban Land Lease Proclamation, "a lease right can be freely transferred." However, owners o f land leases, including developers, cannot sell or trade the lease if the land i s vacant. They can sell the structures on that land, with the land price imputed in the sale price o f the building. One o f the many disadvantages o f this system i s that commercial banks will only accept the actual buildings as collateral for loans and not the value o f land or its use-rights (World Bank 2005j). 34These findings are mainly drawn from Kaganova(2005). 88 Land leases are ofen highly restrictive. Leases often carry restrictions on use, dictating what the plot can be used for according to specific sub-typologies (e.g. a plot can be used either for manufacturing or warehouses or filling stations or depots or workshops), rather than more general typologies that would for instance allow any one of these examples to be established within a certain zone reserved for industrial purposes. Leases also stipulate the speed and quality o f construction on that land. Although these measures are aimed at reducing speculation, they tend to significantly increase the risk of a given investment, for example, by not allowing the investors room to adjust their construction and business plans in response to a changing business environment. Land administration and land information systems are lacking. There is an absence o f a street addressing system in most cities in Ethiopia, creating enormous obstacles to the identification o f properties and the availability and reliability o f information about prices. This lack o f information has important implications: i)it makes land provision by city governments inefficient as the cities themselves have difficulty in identifying which plots are vacant and could be made available for sale and/or which plots are occupied illegally; and ii)it distorts further the allocation o f land under the lease system, since "market" prices cannot be easily estimated and do not necessarily reflect actual prices inthe secondary market. 3.53 In Addis Ababa, attempts have been made to improve the efficiency of land administration by decentralizing the auctionhegotiation process to the ten sub-city administrations. The decentralization i s intended to increase the supply o f land for auctions, reduce the time taken for closing deals and bringthe transaction closer to reality since the sub-city administrations should have a better sense o f the value o f properties within their own jurisdictions. Land is now auctioned twice per month, an increase in frequency. To facilitate lease acquisition, benchmark prices have been reduced by 10 percent and the range for down payments has been reduced from a minimum o f 20 percent to 10percent. 3.54 Cadastres, or similar forms o f land information systems, are recognized as being necessary for land management and administration. Although there has been an attempt to develop cadastres in major cities around Ethiopia, after more than 7 years, most o f these cadastres are not complete and already outdated. A new national Urban Land Information System and cadastre project i s inthe making, promoted through the Ministry o f Works and Urban Development, but it i s not yet clear how it will be implemented and the time itwill take to develop cadastres for major cities inEthiopia. 3.55 International technical assistance has recently been sought by the Ministry o f Works and Urban Development to improve land management and administration in 89 cities.35 The key recommendations from these assessments address the concerns raised above and include(among other recommendations)the need for the following: 0 Improving land information systems through a process of i)street addressing (which is faster and cheaper than cadastres, which would enable identification of land, more information and better planning); ii)establishing cadastres, but in a way that prioritizes the identification of vacant and illegally occupied land; and iii)introducingalandandmarketmonitoringandanalyticalfunctionatthelocal government level, including mapping land transactions, land prices, and construction activity; e Improving the lease system by simplifying and unifying payment schedules, improvingthe management of lease contracts and contract enforcement; 0 Improving and harmonizing land pricing by revising the approach to establishing floor prices for land auctions; differentiating payments for subsidized low-rate leases vs. auction bought leases; reducing the gap between "rent" and lease payments by gradually increasing "rent" payments; 0 Introducing modifications to land allocation mechanisms including establishing "Auction Only Zones" for all most valuable land in cities, and minimizing land allocated through negotiation; 0 Starting regularization and better targeting of subsidized allocation of land for non-residential uses; 0 Substantially relaxinglanduse limitations andplanning requirements, and shifting the power of definingdetails andplanning landuse to local governments; and 0 Promoting an unbiased analysis and discussion regarding the limitations of the current lease system and exploring long-term land tenure options that would be more suitedto the objectives of the government. 3.56 The recommendations from these studies go beyond measures that would impact the investment climate, and address other equallycritical land issues that have an impact on municipal finance, housing policy, and urbanpoverty (which have not been included in the discussion above). A large number of the recommendations provided in these studies have been accepted by the Ministry of Works and UrbanDevelopment and have been included as part o f the Ministry's "Urban Good Governance Package," which is a plan for supporting reforms and capacity building for good governance and management of cities. The federal "package" was developed in 2006/2007, and in early 2007, each region is inthe process of developing an implementation strategy for implementing these reforms. Donors such as GTZ and the World Bank (through the Capacity Building for Decentralized Service Delivery and Public Sector Capacity Building Programs) are ''This TA has been financed through the World Bank-financed Capacity Building for Decentralized Service Delivery Project (Cr. 3698-ET). 90 contributing to the implementation o f these reforms. Given the importance o f property rights, both for the investment climate and economic growth, as well as for the development o f a sustainable city administration that can address the needs o f a business community as well as poorer residents, it will be important to ensure that these planned reforms are indeed being implemented and resulting in the improvements that are urgently required. Administrative Barriers 3.57 The Government has undertaken a number o f reforms to reduce administrative barriers over the last three years, the most significant o f which are highlightedhere. 3.58 A new Customs Law was introduced in 2003, and i s supported by a new organizational structure, recruitment o f new staff, greater transparency in valuation, partnerships with key private institutions, and introduction o f selectivity in inspectiodrisk management and automation. It has resulted in a reduction o f customs clearance times from over 60 days (IMF 2002), to two days today.36 There are now preparations to strengthen risk management capabilities, border enforcement, intermodal transport, and regional harmonization o f cross-border trade regulation. 3.59 Reforms of tax administration at the Federal level started in 2001 and include legislative change, introduction o f a Large Taxpayers' Unit, introduction o f a Value Added Tax, and substantial automation including the Standard Integrated Government Tax Administration System (SIGTAS) which manages VAT, and introduction o f Taxpayer Identification Number (TIN) that can help integrate service delivery to a particular tax payer, such as accelerated refunds o f withholding tax. Tax collection for smaller firms i s executed at the regional level. In mid-2005 the authorities dramatically reduced the estimated profit that makes up the tax base in the presumptive/estimated regime from 23 percent o f revenue (this would be considered a very profitable firm in a more advanced economy). The administrative procedure has not been changed. 3.60 Reforms to attract foreign direct investment (FDO feature streamlining of administrative procedures, in line with international best practice in investment promotion. The Ethiopian Investment Commission (EIC) has implemented a client charter in which most individual processes, including the issuance of a business license, are done within 1 to 4 hours. The EIC has introduced facilitation and "after care" functions to support investors and invested in information collection and dissemination. While its minimumcapital requirements remain high, the improvements are clear. 3) What Explains the Lack of Value Added Exports? Horticulturevs. Leather 3.61 Understandingthe growth progress at the sub-sector level is central to explaining the private sector development process more generally and what may be required to stimulate exports. Contrasting the experience o f leather and horticulture is instructive, as it contrasts two sectors with high potential to create dramatic gains in exports due to 36The DoingBusiness2006 findingof 59 days to clear importsalso considersnon-customsprocesses, includingport handlingandtransportto Addis Ababa. 91 specific advantages conveyed by Ethiopia's geography and resource endowment. Progress, however, has been dramatically different. Floriculture i s a unique and recent growth story in which export value has been increasing at around 100 percent per year. Leather, on the other hand, has stagnated over the past decade, and Ethiopia i s losing marketshare despite the potentially highquality o f its product. 3.62 Floriculture. The diverse agro-ecological conditions, geographic location and low labour costs in Ethiopia create considerable potential to produce a wide range o f tropical and temperate horticulture produce for both domestic and export markets. It was discovered by foreign investors that Ethiopia can support a high quality product (stem length and flower head size) at low cost. The industry's growth has been spectacular (Table 3.8). In2002, there were only four main producers: Golden Roses, Ethio-Dream, Summit and ENYI Roses. By 2005 the industry had attracted around 40 enterprises o f which twenty-two are already exporting to the Dutch flower auction. The number of companies inthe industry is expected to double again by the end of 2006. Table 3.8 Ethiopia'sFlower Exports(US$) 2001 660,038 NIA 2002 1,212,968 84 percent 2003 2,904,000 139 percent 2004 5,050,000 74 percent 2005 (August) 12,645,000 >150 percent 3.63 Incontrast to nearly all other industries inthe country, floriculture has succeeded in overcoming the successive obstacles to growth at each stage of its development through an unusually high level o f trust and cooperation amongst competitors. Initial efforts focused on research to adopt growing practices (hydroponic, greenhouse and field) and varieties to the growing regions to Ethiopia. At a later stage, as outbound logistics became the primary obstacle, the Horticulture Association set up the EthioHorticultureShare Company to negotiate increased cargo space with Ethiopian Airlines and European carriers flying into Addis Ababa, thus helping to alleviate the initially significant barriers posed by the lack o f available transport. This prevented growers from having to negotiate airline space individually at less than economic lot sizes. A third effort was in helping the government design an incentive package that alleviated supply input problems, through: e land being made available and zoned specifically for floriculture: this meant that growers no longer had to negotiate for more than a year with farmers to purchase land; e the government agreeing to fundupto 70 percent of floriculture projects; e inputs such as fertilizers andpesticides were rendered exempt from taxes; and e duty free privileges on all goods and technology. 3.64 According to recent World Bank value chain analysis, logistics accounts for around 74 percent o f the delivered cost o f flowers. The current logistics arrangements- 92 essentially growers self-delivering to EthioHortiShare, which delivers to Ethiopian Airlines cargo services-are no longer sufficient. EthioHortiShare's efforts in booking freight on behalf of the industry are critical, but the company does not offer a range of other services that are necessary along the supply chain. It does not, for example, offer refrigerated transport o f flowers to the airport, nor offer freight insurance, nor handle inbound logistics o f chemical and other inputs, nor ensure that flower handling once in the custody of Ethiopian Airlines is as required to maintain the quality o f the perishable product. There have been instances where mechanical failure caused substantial cargo losses, or temperatures on board were not maintained at required levels. 3.65 A number o f regulatory obstacles have prevented development o f alternatives to the current supply chain monopoly. A third-party logistics company that attempted to offer a full range o f services to the flower sector faced a number o f obstacles to its operation in the airport, ultimately forcing it to abandon its efforts to establish locally. Because Ethiopian Airlines operates on subsidized fuel (at least up through mid 2006), the other airlines that might serve the market refuel (at subsidized rates) in Khartoum, which makes cargo availability in Addis unpredictable. The fuel price itself contributes to freight rates that are some 30 percent lower than other airlines, but prevents the emergence o f viable competition. Because foreign investors are prohibited from wholesale and retail trade, foreign specialized input suppliers do not operate and farms import fertilizers, seeds and farm equipment individually at high cost, albeit often duty free. The impact o f the current logistics arrangements i s to make the chain too unpredictable for farmers to pursue strategies as selling directly to end-users, or through sellingbouquetsrather thanbulk flowers to the auction. 3.66 The industry has grown through factor availability (geography, climate and labour abundance), industry collaboration, incentives, and foreign technology adapted by Ethiopians in collaboration with foreign investors. By addressing the policy and investment obstacles to more efficient logistics services, floriculture can continue its rapid growth and beginto add value. 3.67 Leather. The leather industry has historically been one o f the leading foreign exchange earners for Ethiopia (Table 3.9). Exports o f pickled sheepskins and wet-blue goatskins have often ranked second to coffee as sources o f foreign exchange, and now rank fourth, and generated US$60 million in 2004, about 12 percent o f the foreign currency earnings. It also creates rural and urban employment opportunities with over 800 registered hides and skins traders and about 20 major tanneries; hundreds o f small traditional tannery and leather good factories operate inthe sector. 3.68 Despite its contribution to the economy, the sector is highly constrained by supply, quality, market, skilled manpower, and finance constraints. The leather supply chain i s longer and more complex than that o f roses. It is also characteristic o f a non- integrated chain in which all participants operate independently, and all transactions are arms-length and cash-based (Figure 3.9). Prices fail to reflect premiums for superior quality inputs. N o cross or joint investment exists and participants are having difficulty emerging from their low productivity trap. Technological innovation i s minimal, capital equipment is dated, industry restructuring has not occurred and capacity utilization is low 93 and declining. Additional issues with which the industry must deal in its collective efforts to strengthen the capabilities and competencies which operate within its value chain are discussed next. Table 3.9 Leather Exports inMillion Birr Source: EthiopianLeather Journal (October-December2004). Figure 3.9 Marketingin the Leather Industry Slaughter 102 million off take1 (40% of population) i LiveAnimal Export: 003 million (18% of sheep ppdahon) 3.69 The competitiveness o f the industry has been undermined by the falling quality o f raw material. Supplies are falling below the production capacity o f the industry. Capacity utilization levels for the industry continue to decline secularly, even as demand for quality leather continues to exceed supply. Some enterprises are operating at below break even. Infact, random checking indicated that 100 percent o f sheep and goat skins were infected with Ekek disease, resulting in over 88 percent o f supply being graded in the last two grades IV andV (Table 3.10). 94 Table 3.10 LeatherExport Quality Problems: An Illustrationof DefectsFound 2002 68 99 97 38.7 24 27.3 2003 28 100 96 40 10.7 25.9 2004 81.3 100 94 45.3 18.7 15.1 2005 34 100 89 36 18 11.5 3.70 Development o f shoes will dependon coordination with animal health authorities. In other industries, supply constraints would be solved in part through market signals. However, the domestic supply chain for hides and skins i s unorganized. Supply chains are informal, and there is no traceability back from a skin found to have Ekek to the trader or farmer that produced it. Hence, the price referenced grading system endorsed by the Tanners Association has failed to be consistently enforced. Market signals will needto be supplemented by public sector efforts by the Ministry o f Agriculture. Clearly, the livestock sector's development and evolution through investment in commercial feedlots and abattoirs will play an important role in creating a viable supply chain. A similar problem has occurred in the coffee sector, which relies extensively on informal marketing channels upstream. However, efforts to organize marketing in coffee are relativelymore advanced, particularly including two domestic auctions. 3.71 Untilrecently, the presence o f large state-owned tanneries with different market behaviour contributed to a lack o f consensus within the Association. These tanneries have now been leased or sold to private operators. 3.72 Supplies o f raw hides and skins come primarily from third-party merchandisers who buy small lots o f raw hides from individual slaughter houses and house to house collectors, bulk these up and see them on to tanners. Hence, backward linkages are very weak. Infact, most raw material does not find its way into the value chain, since only 1 percent o f consumed meat is slaughtered at abattoirs. Ancillary veterinary, animal dipping and artificial insemination services which once supported the leather sector have beenretrenched by government andthe collateral benigneffect that they once had on the Ethiopian hides and skins i s beginningto fall off. As inthe case o f floriculture, there are no third-party suppliers o f technical inputs in part due to restrictions on investment in trade. 3.73 The result: a loss o f market share. At one point Ethiopian leather sold for a premium price relative to sources o f tanned leathers coming from SSA. However, Ethiopiantanners' reputation for high quality production is quickly eroding and with it the premiumthat buyers are willing to pay. Indeedsome o f the high quality niches into which Ethiopian tanners once sold (Italian shoe producers) are longer as open as they once were to Ethiopian producers. 95 3.74 The comparison o f the experience o f horticulture and leather sectors indicates some o f the policy dilemmas that must be addressed to increase exports. For a sector which relies on domestic sources o f material, an organized marketing chain supported by mechanisms to hold suppliers accountable for product quality does not exist. Establishing such mechanisms requires social capital and collaboration within the industry, backed by more effective legal and judicial institutions that can effectively resolve disputes. The floriculture sector, which relies more extensively on efficient outbound logistics, has created a solution suitable for bulk exports, and now needs to establish arrangements suitable for value-added exports. In both cases, a lack of competitive input suppliers i s a constraint, and a combination o f public, private and association-level investments is requiredto increase value-added exports. 4) Towards a Renewed Private Sector Strategy 3.75 The reforms o f 1991/92 and 2001/02, while incomplete, have produced real and lasting gains in the form o f a business environment increasingly suited to private investment. Gains from this second generation o f reforms are now being realized, particularly in sectors in which Ethiopia has a unique comparative advantage and which rely less on market-supporting institutions. However, the magnitude of the growth response has been insufficient. The analysis above yields three broad themes that can form the basis o f a renewed private sector strategy: building market-supporting institutions, revitalizing sector-level growth strategies, and strengthening economic governance. 3.76 Consistent with the PASDEP, it i s clear that the private sector will lead growth, and the public sector's role in the economy should be limited to ensuring competition rather than operating inproductive sectors. 3.77 Regulatory and policy obstacles restrict competition in key sectors, such as wholesale and retail trade, logistics, and capital markets. This will require policymakers to reconsider the tradeoff between producers and traders, and to re-examine the rationale behind limited competition in key sectors. Trade and manufacturing can no longer be viewed separately, as the ability o f manufacturers to export has become dependent on efficient services. A carefully-designed opening o f the retail sector can help stimulate the use o f urban retail consumers as a driver o f industrial reform and growth. Limited competition in banking, retail, wholesale, and transportation are taxing the ability o f the private sector to add value inexport markets and needs to be reconsidered. 3.78 Policies that restrict competition from foreign financial institutions, even in such areas as mortgage finance, equity finance, consumer finance or other niche products that do not exist inthe market currently, originate from a particular logic that views the risks o f opening to be greater than the cost to the economy o f remaining closed. However, these are risks that virtually every other country has faced and eventually overcome through a combination o f better targeted controls, regulatory capacity building and gradual opening. The benefits are a more competitive financial sector, better capacity to intermediate, increased skill acquisition and therefore better lending decisions, better capital structures more suited to the operational and risk environment (in particular, a 96 higher proportion o f equity in the aggregate corporate sector balance sheet), and ultimately a far greater capacity to finance growth by leveraging international private sector savings. Given that the PASDEP strategy has emphasised growth as a central pillar, the time has come to reconsider the balance ofrisks. 3.79 Finally, it appears that the policy o f maintaining a single, state-owned operator for delivery o f mobile and fixed line voice and data transmission i s failing to deliver qualitative and quantitative improvements in service delivery commensurate to the magnitude o f public investment. The investment program increases balance o f payments pressure. Both to support prudent macroeconomic policy and service delivery, and to support growth, this policy needs to be considered and replaced with a transparent mechanism for issuing a new mobile license. Such a license would have clear service delivery obligations and monitoring mechanisms, issued to the international consortium willing to pay the highest amount for this license. Market-Supporting Institutions 3.80 To get onto an accelerated path o f growth, and beyond its high degree o f informality, Ethiopia needs an environment that is conducive to the growth o f all firms, including small and informal firms that have limited access to policymakers to protect contractual and property rights. Characteristics o f such an environment include efficient capital markets, contractual and property rights upheld by well-functioning judiciaries, a fair playing field and tolerable levels o f risk (political stability, macro-stability). 3.81 Market-supporting institutions are necessary to reduce transaction costs, reduce commitment failure, and allow firms to network and specialize. For the informal sector, social capital appears to be providing a partial solution to problems o f networking and coordination. To scale up export sectors in particular, the confidence o f firms in exchange must be supported by the formal "rules o f the game" fairly enforced by an independent judiciary, such that formal, arms-length contractual relationships replace interpersonal exchange as the primary transaction mode. Catalyzing Growth: Cluster and Sector-levelInterventions 3.82 Recent value chain analysis yields several lessons. First, it is the importance o f openness to self discovery, as in the flower sector, more than implementing a pre- determined idea o f how the industrial development process will unfold inEthiopia. The empirical evidence shows that investments are not following any single model, and the incentives offered by government appear to have worked most effectively when they offered an additional boost to a cluster that was already emerging through market forces. 3.83 Solving the currently identified problems will be an important first step toward the development of competitive clusters from the current mix o f firms. Further progress should aim toward the development o f competitive clusters. This will require that the firms in the sector begin to develop a higher level o f sector collaboration, moving from dialogue and problem solving, to more complex joint undertakings, including establishing technological institutes, industry-sponsored research, joint identification o f markets and 97 key suppliers, advocacy, and strategic plans. This should be guided first and foremost by the private sector as it engagesinprocesseso fself-discovery. 3.84 Businesses respond to complex incentives, and the problems are far beyond those that can be solved simply through lower-cost land and tax privileges. Each sector will require careful, continuous analysis, experimentation and problem solving. It may be useful to consider vesting the implementation o f industrial policies in a highly-capable public-private institution that has the resources to support innovation in industry, linking to global solutions, evaluating progress, ending support to failures and scaling up success. Strengthening Governance: Creating Space for Dialogue and Participatory Policy- making 3.85 There i s a need to rebuild a constructive, trust-based, relationship between the private sector and government, a process in which development partners might play a role. Various efforts are ongoing and efforts should be re-doubled ifthese are to become meaningfulpolicy-making institutions that both government and the private sector take seriously. The public-private partnership initiative can be further institutionalized through more regular meetings, greater emphasis on fact-based agendas and technical sub-groups that do not require high-level (i.e. minister-level) attendance, but which have clear mandates to report to the minister. This would be constructed at two levels: a bi- annual high-level forum for discussion o f high-priority issues that must be solved at the level o f the Prime Minister or Parliament, supported by a second level o f a number (6-10) o f working groups that address technical issues facing the sector. The Government has shown that it does respond to grievances where there i s a shared interest. To support this, donors should continue to build the capacity o f the private sector bodies, and increase their accessto data andanalysis to support their advocacy role. 3.86 The formal private sector should be encouraged to take a proactive role in the systematic monitoring o f the government's reform progress-positioning accountability within the affected group. A scorecard already exists in the form o f the World Bank's Investment Climate Survey (completed 2002, and the second to be completed in 2007). However, the implementation can be further devolved to the private sector. The results, to be reported regularly every six months for example, on issues such as tariffs, VAT payback time, business license registration, factory to port times, etc., will be important factual inputs into the PPP dialogue and can help build a collaborative platform for joint work. This measure can go some way to resolving the trust deficit that results from polarized, unsubstantiated debate. 3.87 A program o f reform, anchored in public-private dialogue can go a long way toward rebuilding the credibility o f the Government's policy intent, and rebuild the confidence o f the private sector. Such a program would be even more credible if it incorporated consistent sales o f state enterprises, addressed the issue o f party-owned companies, and opened key sectors to foreign investment. 98 4. THE INFRASTRUCTURECHALLENGE Introduction 4.1 It is clear by now that investments in infrastructure are a crucial element in the story o f putting Ethiopia onto a path o f dynamic efficiency and growth. Low capital stocks in infrastructure have translated into underdeveloped markets, high transport and trade costs, market coordination failures, and costly and weak diffusion o f innovation, science, and technology. This chapter brings together recent domestic and international evidence to illustrate strategic choices and options for infrastructure in Ethiopia. We provide a careful review o f Ethiopia's infrastructure challenge, drawing on international lessons learned, but embracing an eclecticism that takes advantage o f existing endowments and recognizes country-specific challenges. 4.2 The chapter begins by reviewing recent trends and the current status; turns to sectoral strategies and programs; and then concludes by highlighting the key challenges in moving forward. It attempts to provide some insights into two overarching questions-how much infrastructure does Ethiopia need, and how much can Ethiopia afford. Given the state o f knowledge and the uncertainties involved, this report can only provide a first step toward answering these critical questions, and further work i s needed, including on the question o f appropriate sequencing o f investments. 1) InitialConditionsandPlans 4.3 Despite impressive recent gains, especially on roads, Ethiopia's level o f access to basic infrastructure i s stunningly low, and among the worst inthe world (Table 4.1). For example, only about a third o f the rural population has access to potable water, and electricity consumption is just over a tenth o f the low-income country average. Ethiopia is o f course not alone in facing a sizeable infrastructure challenge. For example, the household electrification rate o f 6 percent (or 17 percent o f the population living in electrified areas) i s similar to that o f countries such as Rwanda (6 percent), Malawi (5 percent), and Uganda (9 percent) (World Bank, IDA 14 Results Measurement System). 4.4 However, the weakness o f data on infrastructure inAfrica ingeneral places severe limitations on the ability to make cross-country comparisons. Access rates for electricity, for example, tend to come from household surveys, which are not available for all countries. Africa-wide averages reported inthe literature are based on incomplete sets o f information, data collected in different years, and possibly differences in definition. As shown in Table 4.1, for example, the GOE defines access to water as "the percent o f the population with access to potable water inrural areas within 1.5 km," while the definition used by the World Bank (shown inthe top row) i s different. As Estache (2005) suggests, ideally indicators would also capture information about service quality-since 24-hour access to safe water is quite different from sporadic access. For these reasons, our comparisons should be interpreted as broadly indicative of Ethiopia's level o f infrastructure development relative to other countries, rather than precise benchmarking. 99 4.5 Figure 4.1 uses available informationto provide further insight into infrastructure access in Ethiopia. There are sizeable intra-country differentials, notably between rural and urban areas. On urban access to key services, Ethiopia compares fairly well to African averages, but rural access rates are dire. This isolation contributes to low educational participation and access to healthcare (only 9 percent o f births are attended by skilled health technicians; GOE 2006b), and weak (or no) integration in local, regional, and international markets. C Table 4.1 Comparisonof SelectedInfrastructureIndicators (% of population) Access to water (% of population that can obtain 20 54# litres per person per day from improved water source (2004) 1 (2004) (2004) within 1 km of home) Source: World Bank IDA Results Measurement System Access to water (% of population with access to 7 T - p (2004/05) potable water in rural areas within 1.5 km) Source: GOE,PASDEP, 2006 Fixedteledensity (linesper 100 population) Source: Ethiopia data, ETC; Afiica data, ITU (2006) (2006) Mobileteledensity(subscribers per 100 population) Source; Ethiopia data, ETC; Afiica data, ITU 2006) (2006) Fixed line and mobile phone subscribers (per 1,000 52# people) (2003) (2004) (2004) Source: World Bank IDA Results Measurement System Electricity consumption(kwh per capita) 456 Source: Ethiopia data, EEPCO/MME (20061; (2001) International data, GOE, PASDEP, 2006 Percentage of households with an electricity connection (2006) (2000) Source: Ethiopia data, GOE MDG Needs Assessment; International data, World Bank IDA Results MeasurementSystem % of populationliving in electrified areas 17 Source: GOE MDG Needs Assessment (2006) Roadkm/l,OOO sq km 33.2 189 166 Source: Ethiopia data, GOE PASDEP 2006; (2006) (2002) (2002) International data, Estache (2003) Within 2 kmof an all-seasonroad(rural population) 30 Source: Roberts, KC, and Rastogi (2006) ( 2 i i ) (yrsva ) 37ry (yrs vary) ~ Irrigation (percentageof agriculturalarea) 5 Source: FA0 2006 *Defmedeither as "low income" or "IDA onlv" inthe source document. #Sub-SaharanAfrica includesIDA blendas well as IDA-onlycountries. A Accordingto the IDA MeasurementSystem, this figurewas 13 percentin2000. 100 Figure 4.1 Coverage Gaps Between Urban and RuralHouseholds 80% b rA 70% 60% *E 50% c) 4 40% 0 6 30% 20% 10% 0% Electricity Water Sanitation Telephone fZ3 SSA Urban EthiopiaUrban 0 SSA Rural 0 EthiopiaRural Sources: SSA-Estache 2005; Ethiopia-World Bank2005b, WHO 2000, and Estache and Goicoechea 2004. Note: Telephone access defmed as share of households that own phones. 4.6 The infrastructure challenges facing Ethiopia are not unique, inthat nearly all of Africa i s suffering from a sizeable infrastructure deficit (Estache 2005). In the case of Ethiopia, the sparseness of infrastructure canbe attributed to a variety of factors. Clearly, the historically low level of development and investment is important. According to Esfahani and Ramirez (2003), "the steady-stateelasticity of infrastructure with respect to total investment is greater than one.. [meaning] factors that prevent countries from . investing at high rates tend to particularly hinder investment in infrastructure" (p. 445). Infrastructure projects also tend to require lumpy investments (i.e. costs rise in a non- linear manner), making it difficult to expand infrastructure incrementally, which would be more affordable. Yet Ethiopia's capital stock is poor even compared to peers; a country at the same income level and with similar features would be expected (based on our own regressions controlling for population density, share of arable land, and share of irrigated land) to have a road density of 0.11, while Ethiopia has a density of 0.03 km/km. Similar analysis undertaken for electricity consumption, controlling for income per capita, urban and rural population, and country surface, found that Ethiopia's predicted electricity consumption would be 199kwhper capita, while the actual value is 34 kwh. 4.7 Ethiopia's difficult terrain and landlocked nature naturally pose challenges. Conflict and tensions with neighbouring countries have historically dampened prospects for international cooperation over the exploitation of one o f Ethiopia's major endowments, the Nile River (Wichelns et al., 2003). Recent developments under the auspices of the Nile Basin Initiative, however, suggest that unlocking Ethiopia's vast potential inhydrology and irrigationi s now a real possibility (see below). 4.8 The record on public investment effort is much better in Ethiopia than in many developing countries, although this translates into limited amounts given low income- totalling less than US$500 million in2004 for public and donor spending. Ina sample of 101 11 African countries for which data are available, average public infrastructure investment declined precipitously, from about 4.2 percent of GDP in the mid-1980s to about 1.6 percent today, suggesting that this sector bore the brunt of fiscal cutbacks (Estache 2005).37 The pattern of on-budget public infrastructure investment in Ethiopia appears to be the reverse-expanding from 1.8 percent of GDP in 1981 to 4.7 percent in 2005, with an average annual rate of 3.5 percent of GDP over the period 1992-2005.38 This has been complemented by external support, both through infrastructure projects (amounting to about 20 percent of assistance; see below), and via external support to the budget. 4.9 Figure 4.2 compiles available information from the publishedbudget to assess the evolution of infrastructure spending over time, including the federal and regional breakdowns by sector.39 The dramatic increase infederal spending on roads is one of the most striking developments. Total annual spending doubled as a share of GDP between 1997/98 and 2004/05 to 3.4 percent; execution o f the budget for capital spending on roads i s shown inFigure 4.3. Spending on urbandevelopment has ticked upward sharply at both federal and regional levels. This may be partially attributed to a surge inpublic housing construction (spearheaded in Addis Ababa). Breakdowns for federal and regional capital spending on water and sanitation and irrigation are not available (at the time of writing) for the past few years, but from the historical data it is clear that this spending is primarily a regional responsibility, consistent with the ongoing decentralization of service delivery. Irrigation spending has been small as a share of the total. Only limited data are available on recurrent spending (Figure 4.4), and show a fairly constant level o f spending on road maintenance and urban development and housingprograms. 37This figure likely underestimatesactual spendinghowever, since it does not capture public enterpriseor local expenditure. 38 However, these figures should be considered indicative rather than exact, since they do not include significant amounts of off-budget spending by public utilities, and detailed breakdowns o f categories are not availablefor the entire period, meaningsome non-infiastructurespendingis likely included. 39The World Bank is currently undertaking a flagship study on infrastructure financing in Africa, which will include detailed work on better understanding infrastructure spending in Ethiopia. This work is expected to address some o f the data limitations noted here (e.g. the lack of detailed spending data in infiastructure-orientedsectors, and lack of a consolidated data set includingoff-budget spendingby public enterprises), andwill thereforeprovide a more accurate andcomprehensivepicture than is possiblehere. 102 Figure4.2 CapitalExpenditureon Selected InfrastructureSectors (percent of GDP) Federal Capital lkpenditure Regional Capital Expenditure 3% I ~ 3% 1 ,.x 0% 0Yo ----tRoads---+-Irrigation --A- -W&S ..X..Urbr . Roads --t- - -A- Irrigation -W&S ..- ..Urban X ~ Source: MOFED. Note: "Urban" refers to UrbanDevelopment and Housing. Figure4.3 Capital Spending on Road Construction: Actual as percentof Budgeted z00100% 3 m 80% h s2 60% 40% g e 20% 6 0% Source: World Bank2005h. 103 Figure4.4 CurrentExpenditure(percent of GDP) - CurrentExpenditure 0.5% I 1 0.0% 1 I ..-x.. UrbanDev't &Housing ----t Roads* Source: WorldBank2005handRoadFund. *Includes bothon-budgetrecurrentspendingonroads, andmaintenancefrom the RoadFund. 4.10 Public enterprises are responsible for the vast majority o f spending inthe telecom and energy sectors, and are not included in official budget data, but spending by these entities i s a central part of Ethiopia's infrastructure story. Available evidence indicates that public telecoms investment rose from 0.7 percent to 7 percent of GDP from 2000 to 2004. Investment in electricity has also grown in the same period, and investment expenditure by the public Ethiopian Electric Power Corporation (EEPCo) was above US$l billion in 2006. Spending i s projected to expand significantly through 2007, and then to decline through 2010 (Figure 4.5). Figure4.5 Composition of ElectricityFinancingRequirements,2006-2010 12000 10000 3 L ..-e..Generation 8000 LI --t- -Transmission -22 6000 *.-`*... E &Distribution 4000 2000 0 Source: Governmentestimates. 4.11 The financing profile for investment by public enterprises varies markedly by sector. Figure 4.6 presents the expected composition of financing for investment in 2005/06 by the key public enterprises in infrastructure. This has important fiscal implications, since public utility debts are contingent liabilities for the Government. Moreover, the fact that public enterprises are not required to pay corporate income taxes 104 is a "hidden" subsidy (tax expenditure). This situation make full prioritization o f expenditure choices inthe budget difficult (IMF 2004). Figure4.6 CompositionofFinancingfor PublicEnterprises,Budgeted,2005/06 100% - 90% 80% E 70% E360% 50% .240% i20% 30% k 1Ph PA Wh TelecomCorp UhElec PowerCorp EthRoads Authority W BondSales 0 CentralTreasury El O m Income 0 Loans W PuMic Contribution HODA Source: Data from IMFArticle IV Mission, Oct. 2005. Note: Each enterprise does not draw on all sources shown inthe legend. 4.12 That private infrastructure investment has been negligible inEthiopia i s consistent with the overall picture for Africa (with the exception o f South Africa). The average has been 5-10 percent o f total investment (concentrated in the transport, energy, and water sectors), according to the World Bank's Africa Infrastructure Action Plan. 4.13 About 20 percent o f donor support has been directed to infrastructure (average for 2001-2004)' inwhich donors have prioritized roads. Transport accounts for 54 percent o f ODA for infrastructure, followed by 23 percent for water and sanitation. The composition o f donor financing for infrastructure to Ethiopia approximates that of SSA as a whole (Figure 4.7). Figure4.7 Compositionof ODA for Infrastructure,Ethiopiavs. SSA, 2003 Ethiopia SubSaharanAfrica El!lhergy 0TransportHtorage fl lhergy 0 Transpodstorage 0 Communications W Water/Sanitation 0 Communications W Water/Sanitation Source: Staff calculations fiom OECD IDS Online Database. 4.14 The Government's new PASDEP builds on the recent MDGNeeds Assessment to quantify Ethiopia's infrastructure and service delivery deficits, and estimates the associated costs o f rectifying them. It concluded that massive spending will be required 105 to achieve the MDGs-on the order o f US$38 billion by 2010 (of which US$23 billion for infrastructure sectors), as shown in Table 4.2. The estimates were derived based on the UN Millennium Project's costing methodology, which involved bottom-up sectoral needs assessments that were then aggregated and reduced somewhat to eliminate double- counting. Roughly one quarter o f the costs would be covered by community contributions and NGOs, with the rest to be covered by government treasury and external financing (aid and loans). To put the total planned public financing figure inperspective, the projected five-year total for public spending i s roughly 13 times the size o f total public spending in 2004105, thus clearly representing what would be an enormous public sector-driven effort. Table 4.2 ProjectedPASDEPProgramCostRequirementsBasedon MDGNeeds Assessment(millions of Birr) 4.15 The scale o f these needs, as well as the costs, has brought to the fore the debate about whether Ethiopia should pursue a big bang approach to infrastructure development, or opt for a more gradual approach. The justification for a big push on infrastructure i s not conditional upon infrastructure being the sole cause o f and remedy for disappointing growth; it i s more likely to be necessary but not sufficient. 4.16 There have been concerns that an overly ambitious plan could have negative repercussions. The availability o f financial resources i s one consideration. If capital spending increases too rapidly relative to resources available for operation and physical maintenance requirements associated with new investments, the initiatives could prove unsustainable. Similar considerations apply on the human resources side-there must be sufficient space in the budget to meet staffing needs-but there are also constraints in terms o f the amount of human capital currently available. It takes time as well as money to train adequate numbers o f skilled technicians, for example, to maintain ICT infrastructure. Moreover, as the IMF has cautioned (2004), rapidly increasing capital spending can pose problems on the operational side, with limited capacity in contracting andproject management limitingthe speed o fbudgetary execution. 106 4.17 At the same time, there are ways to reduce costs due to synergies between sectors that may not yet have been fully taken into account-for example, it i s less expensive to install water infrastructure where there i s already electricity. More generally, appropriate governance and public financial management (including procurement) mechanisms are critical. Currently, the Government uses a rolling three-year Public Investment Program to plan projects in line with the PASDEP, and plans must be approved by the Council o f Ministers, with priority going to projects that are already underway. The decentralized system o f governance does make project management and reporting more complicated, but according to an IMF assessment "disbursement o f funds from MOFED has been improved and supervision of implementation is regular." MOFED receives project reports on a regular basis, and does on-site inspections (IMF 2004). Public enterprises are legally required to undergo independent audits, though the Audit Services Corporation that performs them i s itself a public enterprise which produces comprehensive reports, but these are not publicly available (IMF 2004). 4.18 The magnitude o f infrastructure spending can have important macro effects, but these need to be evaluated carefully. As debates in Europe and elsewhere have emphasized, it i s important to consider the costs o f infrastructure in terms o f the future growth potential, rather than as "pure consumption". A Br 100 increase in spending which creates infrastructure i s not the same as the same amount spent on salaries, for example. It i s nonetheless true that rapidly growing deficits and rising levels o f public debt to finance infrastructure could have serious consequences for macroeconomic stability. In 2005/06, there were already signs of increasing pressure on Ethiopia's foreign exchange reserves and the balance o f payments, particularly in light o f the international oil price shock and the scale-down in external assistance. As a result, the Government decided to reduce planned infrastructure spending-most significantly in halvingthe plannedrural electrification program to Br 1.25 billion. 4.19 It is important to consider the costs o f infrastructure investments ina longer term perspective which accounts for endogenous effects on growth. There is otherwise a risk o f underinvestment which continues to constrain growth prospects, especially where external assistance i s limited. We turn now to review the case for scaling up. 2) The Case for Scaling Up 4.20 A larger infrastructure stock would be expected to facilitate market linkages and improve rates o f return on investments, thus significantly boosting economic growth. While the precise impact o f infrastructure on growth remains a hotly debated topic, not least because o f the difficulties in determining causality, an increasing volume o f development literature highlights evidence o f strong linkages. For instance, Estache (2005) finds clear positive correlations between growth rates and infrastructure stocks in Africa over the past four decades, alongside social rates o f return to infrastructure projects that are roughly comparable with those in other developing regions. For Ethiopia, he estimates that the same infrastructure endowment as South Korea would have quadrupled its observed growth rate between 1996 and 2000. Similarly, Ndulu (2004) argues that "the effective use o f infrastructure resources explains one quarter o f the growth differential between Africa and East Asia, and more than 40 percent o f the 107 growth differential between low- and high-growth countries." Esfahani and Ramirez (2003) find a significant impact of infrastructure on GDP growth using cross-country evidence, while cautioning that maximizing this potential depends inpart on institutional factors. 4.21 Indeed it can be argued that extremely low levels of infrastructure stock have trapped Ethiopia in a cycle o f low expected returns that deters private investment and inhibits structural transformation. This "trap" hypothesis provides a powerful justification for massive public investmentto overcome these threshold effects and crowd inprivate participation. Many studies estimate economic returns at the sub-sector level. Estache (2004) reports that inrecent literature, average economic returns are about 30-40 percent intelecoms, more than 40 percent for electricity, and about 80 percent for roads. Table 4.3 provides some indications o f the impact Ethiopia's infrastructure deficits may have had historically on the business climate and international competitiveness. Based on a study conducted in 2002, a representative sample o f large firms reported that they lost about 5 percent o f total turnover due to electrical outages, and that it took about 5 months to obtain a telephone connection. However, in the last few years access to and reliability o f electricity have increased considerably, so it i s likely that the 2007 Investment Climate Assessment will show significant improvement on these indicators. Table 4.3 Impactsof UnreliableInfrastructureServiceson Firms Electricity Delay in obtaining electricity connection 57.4 32.2 115.8 (days) Value of lost output due to electrical outages 6.1 4.2 5.4 (percent turnover) Telecom Delay in obtaining telephone line (days) 73.6 37.2 154.9 4.22 Infrastructure plays a major role inhumandevelopment, and not only via positive externalities associated with growth. It has been estimated, using cross-country evidence, that lifting infrastructure access for the poorest quintile to the level of the richest quintile, on average, i s associated with a larger decline in child stunting (14 versus 10 percent) than an analogous improvement in preventative health care access (Fay et al. 2005). Access to paved roads has been correlated with a 5 percentage point lower likelihood o f child labour and a 7-9 percentage point greater likelihood o f school attendance inZambia (Nielsen 1998). Case studies measuringthe benefits o f road network expansion in India, China, and Thailand found that "the healthcare access benefits o f rural transport improvements were among those most highly valued" by the poor and non-poor alike (Cook et al. 2004). 4.23 As the impacts of infrastructure investments feed through the economy, there would be positive effects on poverty and income inequality. Simulations suggest that 108 improving access to infrastructure (defined as giving the poorest quintile access to electricity and sanitation, and ensuring they are no more than 10 km from a budtaxi or 2 km from clean water) would lower poverty in Ethiopia by 11.2 percent (World Bank 2005b). A number of studies also document a negative correlation between infrastructure and income inequality. For example, Calder6n and ServCn (2004) use a panel data set of over 100 countries for the period 1960-2000, and find that inequality (per Gini coefficients or income shares) declines with infrastructure quantity and quality, a finding that holds under a variety o f robustness checks. 4.24 While the general benefits associated with improved infrastructure provision are clear, specific questions about the optimal composition o f spending, sequencing o f investments, financing and delivery modalities are not easily answered. This i s true both internationally, and inthe case of Ethiopia. This requires not only unbundlingthe returns indifferent sub-sectors, but also estimating the interactions across sub-sectors (Box 4.1). The literature on returns reveals no clear consensus, which is not unexpected given the vast differences in crucial variables such as, for example, (i)initial conditions between countries, (ii)types o f projects and how they are designed (e.g. whether benefits disproportionately flow to the rich or the poor), and (iii) specific investments interact how with those inother sectors. 4.25 Indeed, it is notoriously difficult to quantify the impact o f sub-sectoral investments on achievement of desired growth targets and the MDGs, given the importance o f institutional and contextual factors to development outcomes. According to the World Bank's Africa Infrastructure Action Plan, meeting the MDGs would require average investment expenditure o f about 5 percent o f GDP, and another 4 percent o f GDP in recurrent expenditure. Yet this may not be the optimal level for countries like Ethiopia, with very low GDP, which may require higher levels o f investment to stimulate growth and catch-up. Also, within Ethiopia, regional geographical endowments and existinginfrastructure stock affect priorities. 4.26 A logical sequencing of investments in isolated areas that do not yet have significant infrastructure can be outlined. In "virgin" territories a first stage should include construction of a main road artery to link rural communities to the country's transport network, allowing for the flow o f goods and services as well as labour. Development o f basic water and sanitation infrastructure, as well as irrigation investments, would also be necessary as population density increases along the artery. Once communities start to form, development would proceed to a second stage o f electrification-to enable productivity growth and off-farm employment-followed by ICT infrastructure to allow for virtual linkages with larger market towns, thus boosting trade. As the new towns grow, there should be parallel efforts to create an increasingly dense network of feeder roads, integrating the towns with the surrounding rural communities. Eventually, these towns would become hubs that enable an analogous transformation o f outlying areas, thus expanding the frontier o f connectivity. 109 Box4.1 Externalitiesand Complementarities inInfrastructureInvestments Expected rates o f return for infrastructure projects may be underestimated if externalities are not incorporated into cost-benefit analysis (Canning and Bennathan 2000). The example o f rural roads i s illustrative, where the social benefits can be grouped into three categories (Bryceson et al. 2004): boosting economic potential as a route to poverty alleviation; facilitating social service access; and acting as a medium for social capital enhancement. Yet it i s also critical to consider the complements needed to unlock the benefits o f investments in roads-namely adequate financing and capacity for maintenance, access to transport and a conducive environment for the private sector. Similar arguments hold in all sectors; for example, Diao and Gabre-Madhin (2005) note that large scale irrigation in Ethiopia likely requires high- value agriculture to be profitable, which necessitates transport and energy infrastructure. The complexity o f estimating externalities and complementarities, combined with regional socioeconomic and geographical variability, makes it difficult to generate reliable cost-benefit ratios. There are likely enormous regional differentials in returns to investment in feeder roads (Table 4.4). This strengthens the case for a spatially differentiatedinfrastructure strategy. Table 4.4 Returnsto GovernmentInvestment inFeeder Roads inRuralUganda BenefitCost Ratio 6.03 8.74 4.88 9.19 7.16 poorpeopleper million shillings Source: Fan, Zhang, andRao 2004. 4.27 Insome sectors (e.g. roads), initial returns may be low giventhe limitedbase and the need for a certain level o f connectivity before network effects eventuate-which recalls the discussion in Part Iabout S curves. Returns in other sectors (e.g. electricity) also tend to materialize slowly. The package o f services i s likely important-and returns may increase in a non-linear fashion with the number o f services accessed (as found at the household level, by Chong, Hentschel, and Saavedra (2003) for Peru). Moreover, increasing returns to scale can be realized as structural transformation progresses and affects the location o f demand as well firm location choices (Krugman 1991). 4.28 Before proceeding to the next section on policy options, it i s useful to review and compare key dimensions across sub-sectors (Table 4.5). This begins to illustrate the relative costs o f investment and maintenance under a program o f infrastructure expansion, both across sectors as well as compared to current levels o f spending. Further work i s needed to explore the implications in terms o f the balance between capital intensive investments, and those with lower upfront costs but higher maintenance and likely labour content. There are also questions around the supply side and the market structure o fpotential providers o f infrastructure construction and services. 110 . m 3 3 3 $1 3 F I 3) Policy Options 4.29 A series o f cross-cutting policy issues are faced by all infrastructure sub-sectors. These are addressed here before turningto the sectoral programs. 4.30 The potential role o f cost recovery mechanisms is an important consideration. In theory, when public services are rival and excludable (e.g. water, electricity, telecoms), user fees can both improve financial sustainability and make providers more accountable-critical ingredients in facilitating wider and more reliable access to services, especially for the poor (World Bank 2004d). Where consumers are unwilling to pay for a particular service at the set fee, this might indicate that the fee has been set higher thanthe marginal benefit o fthe service (perhaps because the quality o fthe service i s too high) or inability to pay. 4.31 Inpractice in Ethiopia there are several reasons to suggest that subsidies, albeit carefully designed, shouldplay a major role infinancing infrastructure investments: 0 The absolute size o f the investments needed, relative to household incomes and to short term levels o f potential private sector profits; Large up-front public investments are needed in order to reach the level o f service provision where economies o f scale take effect (Fox and Edmiston 2000); and 0 Meeting the MDGs requires increasing infrastructure access for the poor, who have limited capacity to pay for services. 4.32 It is important to distinguish across services. In Ethiopia, public enterprises dominate the telecom and energy sectors (ETC and EEPCO respectively), and cross- subsidize their operations, with revenue from urban (and international, in the case o f ETC) services subsidizing rural provision, in accordance with the Government's overarching development objectives. For telecom, the investments needed could be `self- financed' through cross subsidization since ETC has a monopoly on telecom services. Indeed, in many countries the ICT sector can generate profits and tax revenue that even help subsidize other kinds o f infrastructure. However, these possibilities need to be balanced against the need for liberalization o f the sector (see below). For electricity, prices are undergoing a phased increase that began inJuly 2006, and have so far risen by 22 percent, after having been frozen for several years. To make this increase more pro- poor, a "lifeline tariff" has been protected. Box 4.2 provides the results o f an analysis o f the distributive impact o fchanges to the current tariff structure. 114 Box 4.2 DistributiveAnalysis of Current and SimulatedIncreasein ElectricityTariff Usingthe 1999 Household Income, Consumption, and Expenditure Survey (HICES), Bank staff analyzed the distributive impact of changes to the current electricity tariff structure. At the moment the distribution of electricity consumption is quite narrow, with about 98 percent of customers consuming less than 100 KWh per month.* Looking only at those with access to electricity, in urban areas the top income quintile consumes 2.7 times more electricity than the bottom quintile.In rural areas, the gap is higher, with the top income quintile consuming 4 times more electricity than the bottom quintile (though the most striking feature of consumption patterns in rural areas is the extremely low level of electricity penetration-only the top quintile has an access rate above 1 percent). Electrical consumption charges follow a block structure with tariffs increasing with quantity, and the majority of domestic customers in both urban and rural areas falls in the first block of the tariff-as does the overwhelming bulk of total consumption. Given overall low levels of consumption, the block tariff structure does not discriminate efficiently between poor and non- poor customers. In urban areas 60 percent o f the top quintile consumes less than 50 KWh and therefore faces the same maximum tariff as the first consumption block. Top quintile users spend 5.4 percent o f non-food expenditure on electricity, compared to 7 percent for the bottom quintile. Two simulations were run to estimate the implications of protecting a minimal amount of electricity consumption when increasing tariffs, usingas a baseline the existing tariff. Inthe first simulation the baseline tariff for each consumption block is increased by 1 cent per KWh. In absolute amounts the impact for the whole sample ranges from an increase of Br 1 a year for the bottom quintile to Br 14 for the top quintile.The impact is less negligible when focusing on users inurban areas, where the expenditure increasewill range from Br 25 for the bottom quintileto Br 67 for the top one. The distribution o f the burden of the increase is pro-poor as there are more large consumers inthe highestquintile-66 percent of the additional revenue will be provided by the top quintile, and only 3 percent from the bottomquintile. In a second simulation "lifeline consumption" (defined as the first 50 KWh) is protected, and tariffs on higher consumption blocks are each raised 1 cent/KWh. Here, 74 percent of the additional revenue comes from the top quintileand only 1percent from the bottom quintile. With respect to the pre-reform situation the bottom quintile would be spending Br 6.8 more per year, and the top quintile would be spending Br 52.5 more per year. The results o f the second simulation are even more progressive, though scenario 2 provides only about 68 percent of the revenue of scenario 1. The impact o f the increase could be made more progressive if the consumption of the poor who are large users (likely to be small family run businesses), or of the poor who are small consumers who access electricity by purchasingit from large users (a practice both legal and common) could also be protected. Further work on identifying targeting mechanisms for these customers is needed. *This estimate is based on the best information available for this report (the 1999 HICES), but because of the age of the data-and the fact that the HICES survey was not designed specifically to address these questions-the results should be taken as broadly indicative rather than exact. EEPCo has cited a study finding that about 50-70 percent o f customers consume less than 100 KWh per month, suggesting that the distribution may be wider than indicated here. Source: Staff calculations. 4.33 An alternative form of cross-subsidization4ne that specifically targets the poor in a revenue-neutral way-may be worth considering. By constructing a poverty proxy 115 (e.g., a composite index including elements such as quality o f housing materials, which unlike income measures are unlikely to pose moral hazard problems), poor households could be identified for discounted rates while non-poor households are charged an offsetting amount (Ruggeri Laderchi 2003). The kinds o f questions that should be asked in designing appropriate cost recovery policies are shown in Box 4.3. How subsidies should be designed inEthiopia thus warrants further review. Box 4.3 Determining User Fees for Public Services Isthe service excludable? Possibleto keep peoplewho do Do not charge for service (becauseyou cannot). Pest control forpublic health, not pay from benefiting? surface (non-tollroads), manypolice services. Can poor people be 7 distinguishedfrom non-poor? given money? Cash Administrativelyand politically? transfers or vouchers or food? Charge for service with exemptions for poor Can chargesvary with amounts "Lifeline"price schedule. For water and electricity, charge full marginal costs of used? services for use above specified minimum. Make first few visits for medical care per year free for everyone. Charges are a necessaty evil. Requireshonest appraisal of ability to deliver services along "long route" to accountability (seeVol. I, Chapter 4). If teachers or medical providers cannot be supervised and medical stores not maintained by government,then clients, by default, must bring purchasing power to bear. Will service be adequately Revolvingdrug funds through the Bamako Initiative, irrigation charges, possibly deliveredwithout user fees? manyothers including primary education ifgovernment is not reliable. Chargefees at a level that balancesdistributional effects with efficiency. Water (taps left running), electricity (interrupted service from overuse). Also applies to Will service be overused curative care if staff time availablefor higher-priority public health activities is without user fees? Is waste crowded out or to outpatientclinics at hospitalswhen less expensive to treat the same problems at lower-levelfacilities. Do not charge for service. Best example: primary education. Attendance is limited to one (school year) per child. Social value considered high. Poor people use this more than non-poor. Source: World Bank 2004d, p. 71. 4.34 The topic of subsidies leads to a larger question about the optimal role o f the state in infrastructure development. This has been a subject o f heated debate, and some markedtrends over time, with the pendulumswinging back toward greater emphasis on ensuring appropriate financing and provision. Support for public investment in infrastructure waned in the development literature in the 1990s in part due to the 'white elephant' spectre. However recent evidence on improved rates o f return, associated in part with ensuring adequate maintenance spending and other institutional factors, alongside the renewed emphasis on growth and a disappointing record on private sector 116 take-up of investment opportunities in most sub-sectors, suggests that African governments (and their development partners) have underinvested in infrastructure (Ndulu 2004; Estache 2005). Indeed, the volume o f evidence linking public investment to private capital formation and growth, and crowding in effects on private sector activity, has grown significantly inthe past few years (see for example Milbourne, Otto, and Voss (2003) andBose, Haque, andOsborn (2003)). 4.35 For Ethiopia, World Bank (20040 found a close correlation between public and private investment in infrastructure after the early 1990~.~'Correlation does not prove causation, and other factors may help explain the association (e.g. an improved business climate after the end o f the Derg regime). Yet the results offer some evidence that public investmentmay have a "crowding in" effect on private investment: "if there is sufficient complementarity between the services produced by public capital in infrastructure and private physical capital, an increase in public investment will both increase the flow o f newprivate investment andraise the productivity o f existingprivate investment." 4.36 Given the enormous infrastructure gap and scarcity o f foreign exchange, it i s clear that the Government needs to bring inprivate investment wherever possible. This can be in the form of straight private investment, or public-private partnerships (PPP). The energy and telecom sectors offer a particularly strong rationale for a major private sector role-in energy, due to the enormous up-front capital costs, and in telecoms (especially mobile), where the potential for competition among providers could reduce costs to users and lead to faster network expansion. PPP could be considered for major power generationhydroelectric plants and distribution, which would be legal (for foreign as well as domestic investors) inthe existing framework, but such a scheme has not been tested. Cooperation on investment inrail (where for example improvements inthe Addis Ababa- Djibouti line could significantly reduce the transport costs associated with importing and exporting goods) is ongoing (see below). 4.37 Several steps may be needed to encourage private sector participation, inaddition to general improvements in the investment climate. Political risk guarantees, such as insurance provided by MIGA (see Box 4.4), may be needed to entice foreign investors. 4.38 Important choices have to be made between small and large scale infrastructure, and between major centralized schemes and decentralized development. Achieving the proper mix will be key to ensuring that there i s a critical mass o f infrastructure to attract major private investment, and also to facilitating equitable growth. Access to basic water and sanitation infrastructure and the development o f small-scale irrigation are central to human development and food security, for example, as well as to broad-based productivity growth in rural areas. Expansion o f this kind o f infrastructure requires relatively simple technology and i s best implemented and maintained at the local level. Inthe energy sector, because fixed costs are so large, rates o freturn only become positive after a certain threshold o f investment i s reached-implying the need for major up-front investments to lower unit costs. The complementarities between these kinds of 40This is based on the estimation of a private investment equation, and regression analysis with two variables: the rate of growth of real output, and the ratio of the public capital stock in infrastructure to GDP. 117 investments-for example, feeder roads (low technology and localized management) increase the returns to large, arterial roads (planned centrally)-need to be considered. Now that significant progress has been made on the latter, there can be more focus on strengthening capacity at the local level to improve the network of rural roads. Box 4.4 PoliticalRiskGuarantees The Multilateral Investment Guarantee Agency (MIGA), part of the World Bank Group, aims to promote foreign direct investment in developing countries by providing political risk insurance (PRI) to foreign investors and lenders. MIGA provides coverages for currency inconvertibility and transfer restrictions, expropriationof assets, war andcivil disturbances, andbreachof contract (by the host government). MIGA guarantees alter investors' risk perceptions, thereby making projectsmore attractiveand facilitating access to financing, particularly since MIGA can cover both sovereign and sub-sovereign risk. Other public and privateinsurers oftenwork with MIGA, via reinsuranceand coinsurance, inorder to increasethe amount of coverage available to investors for large projects. MIGA can play a leading role in these cases and mobilizesignificantre-insuranceresourcesfrom bothpublic andprivatere-insurers. In addition to insuring projects, MIGA also provides technical assistance to government agencies. This involves assisting governments to market specific opportunities to the private sector, by disseminating informationon privatizationsor other investment opportunities to a wider network of potentialinvestors or lenders. Relatedly, MIGA can help governments that are attempting to overcome negative perceptions abouttheir country- e.g. that it is an unsafe destination for investment. An increasedfocus on the continent means that projects in Africa now account for 17 percent of MIGA's portfolio, up from 7 percent in 1999. MIGA is involved in many sectors, including extractive industries, agribusiness, manufacturing, andthe financialsector. For example, MIGA has insuredinvestments insheet metal manufacturingin Nigeria and sugar refining in Mozambique. Another area of potential interest to Ethiopiais the tourism sector-MIGA has insuredhotels in various parts of the world. However, the sector where such guarantees may be most important is infrastructure, given the magnitude o f costs involved and the key role of the governance and regulatory environment. Infrastructure comprises the largest sectoral share of MIGA's portfolio in the SSA region, and the provision o f political risk guarantees helps enable public-privatepartnerships for large infrastructure projects, both at the country and regionallevel. Insome cases MIGA's involvement has been necessary to obtain financing, as in the case of the Sasol oil and gas project, a major undertaking which requires building an 865 km pipeline from Mozambique to South Africa. Another example has been MIGA's involvement in the West Africa Gas Pipeline (WAGP), where MIGA providedPRI coverage inorder to mobilize financing for the constructionof a 678 km gas pipeline fiom Nigeria to Ghana through Togo and Benin.MIGA's involvement in projects also ensures that World Bank Group environmentaland socialstandards are maintained. Although Ethiopia is a member country, MIGA currently does not have any exposure in Ethiopia. However, MIGA has provided technical assistance to the Ethiopian Investment Commission (in cooperationwith the ForeignInvestment Advisory Service), at the Commission'srequest. In2005, also at the Government's request, MIGA helped resolve two disputes regarding expropriation o f foreign assets under the Mengisturegime by serving as an impartial partner in mediatingbetween the Government and major claimants. Source: http://www.miga.org andMIGA staff. 4.39 Working collaboratively with neighbouring countries and international organizations to develop East Africa's infrastructure will be key for trade and regional stability. Transport costs are notoriously high in Africa relative to other regions, and a major drain on competitiveness. Strikingly, a model by Limao and Venables (2001) showed that although the distance to markets is important, weak infrastructure accounts for as much as 60 percent o f expected transport costs in landlocked countries (cited by 118 Ndulu 2004). This implies that integrating improved domestic infrastructure with international transport routes with be critical for Ethiopia. Interms o f regional stability, inthe past bothdomestic andinternational tensions (e.g. between SudanandEgypt)have limited the scope for cooperation on development o f the Nile Basin (Wichelns et al. 2003). But the Nile Basin Initiative now offers the potential to buildon the relative peace inthe region, for example for Ethiopia to work toward exporting hydropower-generated electricity to its neighbours. Strengthening economic interdependence in the region would then presumably help build a virtuous cycle that reduces the risk o f future conflict. 4.40 Increasing the use o f local contractors for construction is important, particularly in the roads sector, though project-specific analysis will determine when it i s appropriate to attract international firms. The key will be to foster competition in order to use adapted technologies, thus improving efficiency and capacity for project implementation, and reducing unit costs. Use of local contractors i s also desirable from an employment generation standpoint, and deepens the domestic skill base. The Government's Roads Sector Development Plan considers domestic capacity to be a key factor to enable sustainability in the roads sector, and the Ethiopian Roads Authority (ERA) i s increasingly attempting to contract local firms. Still, the majority o f work i s handled by foreign contractors, and project implementation is capital intensive. Pilot projects by the ERA to use local labour have run into administrative bottlenecks (e.g. late payments to workers). With an increased focus on improving procedures and also developing a skills training strategy, labour-intensive projects using local workers could be a win-win proposition-for infrastructure development as well as job creation (Demeke, Guta, and Ferede, 2005). 4.4 1 Strengthened monitoring and evaluation efforts are needed. Ethiopia has experimented with a range o f approaches, and has begun to incorporate systematic evaluation into programs. This provides a rich base to help inform future decisions about priorities and sequencing across potential choices (see Box 4.5). 119 Box 4.5 Impact EvaluationinEthiopia The World Bank is conducting a program o f impact evaluations to support Ethiopia in monitoring and evaluating progress of the PASDEP and nurturing a culture o f evidence-based policymaking. The program o f evaluations will contribute by: --- building generating sound evidence on what works to achieve the targets inthe PASDEP; capacity inthe country and among implementing institutions; - promotinglonger-term a culture o f dynamic learning and evidence-based programmatic changes; and thus securing effectiveness of programs inachieving PASDEP outcomes. The program has been developed gradually to expand into key areas o fthe PASDEP within the framework o f World Bank and donor-supported operations. Specific evaluations include Social Protection (food security), Infrastructure (energy, roads and ICT), Gender (development initiatives for women, and the gender & law program), and Basic Public Services and Governance (health, malaria, and public expenditures). Infiastructure is a priority area as well as a new area for impact evaluation, specifically inAfrica. Ethiopia i s fast becoming a pilot case for a coordinated approach to evaluating the impact o f infrastructure development. The range o f interventions to be potentially evaluated includes energy, roads and transport, water and sanitation, telecommunications, urban infrastructure, and irrigation. Inmany o f these sectors, the government plans for country-wide coverage to be achieved inthe next 5-15 years. Progress has beenmade inthe areas ofenergy, ICT androads, the first two ofwhich are described below. Proposed Impact Evaluation of the Accelerated Electricity Access ExpansionProgram. The objective o f the impact evaluation would be to measure the impact that the AEAE Program has on the welfare o f the population, namely: - What is the impact o f expanded access and use o f electricity on household welfare and local economic development?; and - What i s the impact o f introducing energy efficient technology on uses o f electricity? The evaluation would also investigate whether specific interventions are more effective than others in achieving positive outcomes and maximizing the use o f available financing. Questions put forth by the government relate to affordability o f household connection charges and factors that affect pick-up rates o f energy-efficient technology: -- What - What i s the impact o f alternative financing mechanisms on household connection rates? is the optimal subsidy to CFLs to maximize CFL usage per dollar spent? What is the impact o f alternative modes o f delivery o f CFLs (public distribution, private, vouchers)? Answers to this last set o f questions will be addressed with a short-term evaluation framework (6-12 months after implementation starts) to provide the government with quick feedback to adjust the roll-out o f the program according to the evidence. Impact Evaluation of Ethiopia Information and Communication Technology. The objective o f the impact evaluation would be to measure the impact that the ICT Program has on the welfare o f the population, and to investigate whether specific interventions are more effective than others in achieving positive outcomes. The main questions for the evaluation would be: - What is the impact ofcapacity and usage of ICT on economic variables (e.g. household income, employment) and institutional development (e.g marketdevelopment)? - What is the impact o f government use of ICT on public services? The evaluation could also experiment with alternative modes o f delivering ICT services to identify the ones that are most cost-effective. Source: Legovini 2006. 120 4) Sectoral Stories 4.42 We now turnto review the status and challenges at the sectoral level, highlighting costs and benefits of investment, implications for growth and key policy issues. Road Transport 4.43 Ethiopia's geography, pattern of settlement, and economic activity mean that transport plays a crucial role in facilitating development. The movement of people, the utilization of natural resources, the improvement of agricultural production and market conditions, access to social facilities, and land utilization and sustainable growth, all require transport as a catalyst. Recognizing the importance of road transport in supporting social and economic growth and inmeeting poverty reduction objectives, the Government has emphasized improving the quality and extent of road infrastructure and formulated a 10-year Road Sector Development Program (RSDP, 1997-2007). 4.44 The program was launched with very significant donor support to increase roads capacity, and to facilitate the economic recovery process through the restoration of the essentialroad network. The first five-year phase, through 2002, focused on rehabilitation and upgrading o f main roads, and necessary regular maintenance. At the same time the program considered major policy and institutional reforms. The second phase aims to consolidate the achievements o f the first phase, and increase network connectivity and provide sustainable road infrastructure to rural areas. By the end of June 2005, a total of 14,53 6 km of roads had been constructed, upgradearehabilitated and maintained (roughly half were federal and half newly constructed regional roads). The program had disbursedabout US$1.7 billion. Table 4.6 shows the allocation of expenditure during the three year period of RSDP I1to date. Table 4.6 Compositionof RoadsProgram(2002-2005) Source: EthiopianRoads Authority. 121 4.45 The overall performance o f the program against the objectives and benchmarks established at the launch o f the RSDP i s satisfactory. Substantial improvements were achieved in reopening much o f the main road system and rehabilitating trunk routes. Table 4.7 indicates the impact o f RSDP investment on the overall road network expansion and its condition. Moreover, planned targets for 2007 based on the revised RSDP I1planare also shown. Table 4.7 Increasein Selected Indicators (year 2005 vs. 1997) and PlannedTargets Proportion of Asphalt roads in Good Condition 17 Yo 54 % 56 % Proportion of Gravel roads inGood Condition 25 % 40 Yo 43 Yo Proportion of Rural roads in Good Condition 21 % 33 % 35 % RoadDensity/1000 sq.km 24 km 33.6km 36.5km RoadDensity/l000 population 0.49 km 0.51 km 0.53 km Proportion of area more than 5 km from all weather road 79 Yo 73 % 69 % Average distance to the roadnetwork 21km 16km 13.5km 4.46 The primary objective o f the road program under PASDEP is to sustain these achievements to restore and expand Ethiopia's road network, and to provide a sustainable level o f essential road infrastructure to the rural population. The program also assists in developing strong management and technical capacity, and in developing the capacity o f the domestic construction industry. The total costs of the PASDEP roads program are estimated at about US$5 billion. The physical targets are ambitious, and include: 0 Reducethe inhabited land area farther than 5 km from a road to 59 percent by the end of 2009/10 (from the current 72 percent); 0 Reducethe inhabited land area farther than 2 km from a road to 81 percent by the end of 2009/10 (from the current 88 percent); Reduce average walking distance from a road to 3 hrs by the end of 2009/10 (from the current 5 hrs); 0 Increase the road density to 54.1 km/l000 km2and 0.72 km/1,000 people by the end of 2009/10, including low class roads (from the current 33.6-km/1000km2 and 0.5 1 km/1,000 people); and 0 Increase the rate of acceptable (good and fair) roads to 84 percent for all road types by the end of2009/10 (fromthe current level of 64 percent). 4.47 The program would consist of a civil works program including rehabilitatiodupgrading o f 5,492 km o f federal roads, new construction o f 3,933 km of federal roads, and improvement o f bridges and structures; a road maintenance program including periodic maintenance on 8,505 kmo f federal roads, and routine maintenance on all types o f roads; a Regional Road constructiodmaintenance program including construction o f 7,500 km o f regional roads, periodic maintenance on 5,300 km o f regional roads, and construction o f 10,500 km o f low class (ERTTP) roads; and institutional support to strengthenroad agencies, and the domestic construction industry. There is also a sub program that focuses on reducing the travel and transport burden o f 122 the rural population, on which experience has beengained through the implementationof pilot activities. 4.48 There has been a gradual shift in the program (Tables 4.6 and 4.8) from rehabilitation o f the existing key trunk roads towards the upgrading and construction of trunk and link roads, as well as the construction o f community roads. The major challenges include: The rise in unit costs of road building as a result of energy costs, and low competition among contractors; 0 The critical shortage of some skills inthe labour market; 0 As the program gradually shifts toward the lower hierarchy of roads in the functional classification, there i s an emergingneed for more decentralized organization; and The need to develop a local contracting industry in line with this gradual shift, and to increase competition among contractors. 4.49 Unitpavedroadconstruction costs inEthiopia are nowmoderately highcompared with the rest o fAfrica. However the ERA'SPASDEP construction costs for major gravel roads are extremely high. High standard gravel roads in Ethiopia cost many times the average quoted costs for similar roads inthe rest o f Africa, as reported inthe World Bank ROCKS database. This i s probably due to the very significant earthworks and drainage needed. In standard road planning models most benefits are derived from reduced road surface roughness, and there is little direct benefit from improved alignment. So it i s difficult to calculate the benefits from major efforts on earthworks unless they are associated with improved surfacing. Table 4.8 PlannedSpending inRoads Sector (2005-2015) (YOof total) Source: EthiopianRoadsAuthority. 123 4.50 Recent staff analysis indicates that in most circumstances upgrading to a high standard gravel road or even upgrading to a surface dressed road would not provide the best solution. A better approachwould be either to keep an earth road, or `lower quality' gravel road, or to opt for a high standard asphalt concrete road. An asphalt concrete road i s more expensive, but deteriorates more slowly than alternative road surfaces and provides a smoother running surface, meaning lower vehicle operating costs. The current cost ratios between a surface dressed road or a high standard gravel road and asphalt concrete roads are too narrow (the former are over 80 percent of the costs of the latter) to make surface dressing or high standard gravel road options viable. Therefore strategies need to be developed for the reduction of unit costs, especially with regard to gravel roads. 4.51 Before concluding this section, the importance of petroleum fuel costs, not only to road transport but also road construction, should be recognized. This has been demonstratedover the past year with the surge ininternational prices. It i s inthis context that Ethiopia's recent experiences with ethanol as an alternative fuel, seeking to emulate the successes in Brazil and elsewhere, are worth highlighting (see Box 4.6). Some regions of Ethiopia also have potential for wind energy. 124 Box 4.6 Prospectsfor Bio-energy in Ethiopia Givencurrent and expected oil price trends and volatility, the ideas of a gradual substitution away from imported petroleum fuels and a diversification of energy supply sources are rapidly gaining macroeconomic and social importance for Ethiopia. Biomass resources such as wood, agricultural crops and residues can be converted into modern forms o f energy such as biofuels (ethanol, methanol and biodiesel) and electricity (cogeneration). The Government recently commissioned a state-of-the-art 8 million litre/year ethanol distillery at the Finchaa Sugar Factory. This initiative-originally intended for gasoline blending for transport-met with resistance from the petroleum sector, forcing the government to look for alternative uses for the ethanol, to build additional ethanol storage tanks, and to operate the Finchaa distillery at below capacity. By 2005, however, Finchaa started exporting most of its output to Europe at a profit. Feasibility studies are now underway for a second larger integrated ethanol plant (distillery and bagasse power co-generation system) and for a 600 ha equivalent jatropha biodieselproduction scheme at the Metahara Sugar Factory. A study, undertaken with World Bank support, to assess the potential to produce and market denatured ethanol and Gelfuel as cooking fuels inEthiopia(2002 and updated in2004) concluded that: (i) puredenaturedethanolandGelfuelwouldbecompetitivefuelsinthedomestichousehold both energy market, and that this market exceeds 50 million litredyear exists for both fuels; (ii)current production capacity at Finchaa would cover less than 20 percent of the potential demand by the urban household sector, but ethanol production could be increased to 34 million litredyear by using the 23,000 tonnes of available molasses at the Metahara and Wonji-Shoa sugar factories; (iii)there are 388,000 hectaresof available idle landwhich couldbe plantedwith sugarcane and/or sweet sorghum to produce more than 2 billion litres/yr of ethanol, plus sugar and electricity; and (iv) there are approximately 10 million hectares of landwhich are available and suitable for both perennial and annual crops inareas below 1500 masl, spread over seven regions. Part of that area could be eventually devoted to ethanol production (sugarcane, sweet sorghum, cassava, cashew apples, etc.) and bio-diesel (jathropha, soy, rape seed, etc.) bearing crops, without creating land conflicts between food and energy production. If, for instance, 20 percent was devoted to a combination of sugarcane and sweet sorghum, more than 10 billion litres of ethanol could be produced annually inEthiopia. In terms of current output, Ethiopia produces about 2 million tons of sugarcane annually, from which an estimated 450,000 tons of bagasse are available and could be converted into competitively-priced electricity using decentralized steam turbine-based CHP systems. Thus at current sugarcane production levels, power generation capacity could be expanded by 215 M W from bagasse cogeneration, equivalent to a quarter of the installed capacity, and up to 263 M W if plans to expand sugarcane production by another 5,000 hectares are realised. Decentralized power generation through integrated ethanol distillery-bagasse co-generation systems could underwriterural electrification efforts, including mini-grids. The development o f decentralized ethanol and co-generation systems in Ethiopia could thus contribute to local employment generation and rural incomes, increase rural access to modern energy services and promote agro-industrial exports, while reducing reliance on imported petroleum and thus supporting macro-economic stability. 125 Railways 4.52 The Djibouti-Ethiopiarailway (CDE) is a single track linking to Addis, managed as a bi-national public ~ndertaking.~~Technical design standards are low (e.g. sharp curves, low-weight rail), but a track upgrade program of 40million, financed by the European Union, is materializing, and should bring the infrastructure to acceptable condition. Reliability is poor, due to inadequatemaintenanceand a lack of spare parts. 4.53 Productivity of the railway i s very low, compared to other African railways, as measuredby traffic density and staff productivity. Despite very low salaries paidto CDE staff, the ratio of staff costs to operating revenue reached 87 percent in2003, comparedto a norm of 35 percent in a financially-sustainable railway operation. CDE presently generates heavy deficits (exceeding 40 percent of its revenue in2003) and faces a serious cash shortage, which precludespurchaseof spare parts, leading to further reduction inrail transport capacity. 4.54 The economic role of the railway is presently marginal. Duringthe last few years, the volume of international freight going by rail has beena mere 5-6 percent share of the total, compared to the early 1960s, when about 60 percent of Ethiopia's international freight was transported by rail. Rail market share experienced a continuous decline after the creation of apaved roadbetweenAddis andthe Eritreanport ofAssab in 1962, which was accelerated by the opening of two roads to Djibouti. Despite the increased role of the port since 1998, the railway has been unable to recapture a significant share of the international freight market. The role of the railway in domestic freight and passenger traffic i s also very limited. 4.55 The present situation of the Djibouti-Ethiopia railway is similar to the situation that most of the railways in Western and Central Africa were facing in the 1980s. Several of these (notably the Abidjan-Ouagadougou, the Dakar-Bamako and the Cameroon railways) have since been revived through concession to the private sector. Encouraged by these successes, it was decided to concession the Djibouti-Ethiopia railway. 4.56 The railway has an important potential economic role. Rail could enjoy a competitive advantage over its road transport competitor on long-distance, regular, massive freight traffic moved in unit trains. Transport of petroleum products represents the main potential market of the railway, since Ethiopia depends entirely on imports, mostly through Djibouti. To a lesser extent, the railway could also play a role in the transport of other bulk commodities imported by Ethiopia, notably grain, fertilizers and building materials. A significant part of this market could be captured if the railway is connectedto the oil terminal to be built inthe new port o f Doralehand adequate,unittrain loading facilities are installed; rail unloading facilities in Addis Ababa (and, possibly in Dire Dawa) are modernised to easily handle unit trains; and the railway operator or petroleummarketers acquire a fleet of modern tanker wagons. 41The Etablissement du Chemin de fer Djibouto-Ethiopien (CDE) was created in 1981 by treaty under a General Transport Agreement o f the same date. Management rules o f CDE are specified inan annex to the Treaty. 126 4.57 Djibouti is already a major container port and its role will be boosted by the new terminal in Doraleh. At present, there is almost no container traffic per se to Ethiopia; containers with freight for Ethiopia are emptied in Djibouti. Creation o f a rail inland container terminal (in the management o f which shipping lines should be involved) in Addis Ababa and adoption by Djiboutian and Ethiopian customs o f adequate facilitation measures (including agreement for shippers to use the Through Bill o f Landing concept) are prerequisites for the railway to enter this market. Determination o f reliable container traffic projections is difficult, and estimates o f potential vary substantially. Experience in other African countries confirms that the railway can be very competitive inthis segment o fthe market. Electricity 4.58 Only about six percent o f Ethiopians have a connection to electricity (17 percent live in electrified areas, which EEPCo defines as access). Everyone else relies on biomass energy, leading to degradation o f rural ecosystems-and this increased deforestation causes erosion and sediment buildup in reservoirs; use of organic materials such as crop residue and dung accelerates soil nutrient depletion, lowering crop yields; and degraded soil lowers rainfall infiltration, slowing groundwater replenishment. Smoke and indoor air pollution created by burning biomass fuels also contribute to morbidity and mortality due to respiratory illnesses. 4.59 Annual per capita electricity consumption, at 34 KWh, is only about a tenth o f the low income country average (317 KWh), and i s far below the African average o f 456 KWh. However, the situation has been improving rapidly. Currently, Ethiopia's total installed electricity-generating capacity i s 791 MW per day, which i s projected to increase to 3,938 MW by 2011. EEPCo supplies the majority o f electricity, which used to be largely limited to Addis Ababa, but coverage has now spread to many towns. The utility is regulated by the Ethiopian Electric Agency. Rates o f electricity coverage are much higher inurbanthan inrural areas. 4.60 Thus far, although EEPCo is a relatively efficient power utility, its strength has been undermined by the tariff structure. However, as mentioned above, a phased increase o f tariffs has begun. If tariffs rise by 50 percent in total, projections show that they would approximate long run marginal costs (they have already risen 22 percent, and continued phased increases are planned over a 5-year period). According to EEPCo, it i s now possible to connect large commercial customers within about two weeks without any difficulty, and new customers sufficiently cover the costs o f associated upgrades and expansion. In the case o f multi-purpose projects (e.g. electricity and irrigation), one option for the future, if determined practical on a project-by-project basis, would be cost- sharing across relevant agencies (so that EEPCo does not bear the entire financial burden). 4.61 The Government has responded and placed rural electrification at the centre o f its poverty reduction strategy, and has a massive program to increase nationwide access to 50 percent over the next five years. The Universal Electrification Access Program (UEAP) will electrify rural towns and villages ranging in size from 200 to 1,500 households through extension o f the grid, reaching both commercial and residential 127 clients. The program will be implemented by EEPCo, which is expected to cover recurrent costs and 20 percent o f capital costs, with the remainder financed by the Government. There appears to be a relatively highwillingness to pay as rural households insome areas servedby private diesel generators pay about US$0.20/kWh (compared to EEPCo's lifeline rate prior to the 2006 increase was US$O.O3/kWh). The role of the private sector i s currently minimal; there are some parties interested in investing in isolated (as opposed to interconnected) systems, but they are concerned about the uncertainty on bulk tariffs they will have to pay once the isolated systems get connected, which i s an issue inother countries as well. 4.62 While most o f Ethiopia's electricity is generated from h y d r ~ p o w e r ,the~ ~ country's vast potential remains largely unexploited. Only about 2 percent o f Ethiopia's hydro-electric potential has been tapped. Particularly in light o f rising oil prices and environmental sustainability concerns, leveraging Ethiopia's water resources for hydropower is an exciting and attractive avenue. The Government's planned investments inhydropower would increase the supply ofelectricity to 4.5 times its current level, for a total cost o f around US$4 billion over 2005- 15. 4.63 Hydropower i s an essential complement to small scale electrification, and can serve a variety o f purposes-including providing affordable pump irrigation in areas beyond the reach o f gravity irrigation, and flood control in areas such as the Dawa- Gennale and Shabelle Basins. This underscores the need for coordinated, multipurpose infrastructure development. For example, the multi-purpose Koka reservoir enabled irrigation o f 50 medium and large-scale farms, totalling 65,000 ha, and generated 110 MW o f hydropower at three different run-of-the-river power stations (although soil erosion now threatens its sustainability). There are tradeoffs between use o f water resources for energy generation and for irrigation, though in some areas (i.e. the rivers that feed Lake Tana), "river regulation and drainage will provide the incremental water requiredfor irrigation" without much loss o f hydropower potential (World Bank 200%). (Irrigation i s covered further below.) 4.64 Affordable hydropower could open the way to agro-processing, and help enable industrial development more generally. Although domestic demand may be insufficient to make rapid expansion in hydropower economically attractive inthe immediate future, energy could be exported to neighbours where power needs and production costs are increasing (Box 4.6). Estimates o f benefit-cost ratios were above 3 for several major hydroelectric proposedprojects on the Blue Nile in an old (1964) Bureauo f Reclamation study (Guariso and Whittington 1987), and returns to providing power to Sudan and Egypt have been estimated at 32 percent (WSDP 2002 from World Bank 2005~). Inthe mediumto long term, assuming robust economic growth in Ethiopia, the country's large population suggests that the domestic market would also be a major driver o f demand. 4.65 Cooperation under the auspices o f the Nile Basin Initiative (NBI), a partnership among the riparian states formally established in 1999, has enormous potential to develop 42See International Energy Agency website for more details: httl,:llwww.iea,or~lTextbaselstatslnoncountrvresults.asp?nonoecd=Ethiopia&SubmitC=Submit. 128 the river's resources in a mutually beneficial way (Box 4.7). Pooling of resources and even co-ownership of large infrastructure assets could bring additional financing, more optimal usage and, through enhanced relationships, advance regional peace and security. This should in turn enable higher rates of return on investments, creating an attractive opportunity for private sector actors. A subcomponent of the NBI partnership is the EasternNile Subsidiary Action Program (ENSAP), through which Ethiopia, Sudan, and Egypt aim to undertake joint projects, has led to the beginning o f development of a shared flood warning system. The NBI is one of the most high-profile regional development undertakings in Africa, as evidenced by its prominent place inthe NEPAD Infrastructure Short-Term Action Plan, which proposes that the NBI be considered a flagship NEPAD project (although the NBI is not governed by NEPAD structures) (NEPAD 2003). 4.66 The NBI also aims to create a regional power grid and power markets, in which Ethiopia has a significant comparative advantage. Untapped thermal energy potential in Sudan and Egypt suggests an opportunity for "thenno-hydro complementarities.. that . could prove cost-effective"--enabling EthioPiaPlans to export hydropower, and also to import it when hydrological conditions are poor.4 are already underway to export to Sudan, Djibouti and Kenya from Ethiopia's electricity supply system, and there is potential to export energy via Egypt's grid to the Middle East and even Europe (World Bank 2005~). 43According to the EasternNile Technical Regional Office; more details at: http:llwww.nilebasin.orp/entro/ethiosudan.htm. 129 Box 4.7 Ethiopia/Sudan-EthiopiarnjiboutiTransmissionInterconnection Reliable provision o f low-cost electricity is critical for industrial development, employment and poverty alleviation. Shortages of electricity are also a severe constraint on economic growth. In some of the Eastern Nile (EN) countries, lack of electricity i s often exacerbated by shortages of imported fuel, woodcharcoal and other forms of energy. One way to increase access to electricity is through power trade and the cooperative development o f hydropower and transmission interconnection investment projects. Significant opportunities for such projects exist in the EN countries. There i s substantial untapped hydropower potential in Ethiopia and Sudan. In view of transmission distances and power markets, the power grids in Ethiopia and Sudan could be interconnected, enabling power trade between these two countries. Future interconnection of the grids inEthiopia, Sudan, and Egypt is also possible. Interconnection of the Ethiopia and Sudanpower systems would thus enable improved economics and increased reliability of supply in the two countries by taking advantage of the hydro-thermal complementarities o f the power systems and some variability inpeak demand. The two countries would be able to trade not only energy but also reserve capacity, thus facilitating a reduction in the total reserve margin on the interconnected system, as well as capital and operating costs. Other benefits derived from the construction of the transmission line would include lower energy costs, ifexpensive diesel-generated electricity is avoided, as well as the resulting environmental benefits due to the lower emission of greenhouse gases. The long-term development objective of the Ethiopia-Sudantransmission interconnection project (currently under preparation) is to promote regional power trade through coordinated planning and development o f power generation and transmission interconnections in the context of multi- purpose water resources development. The proposed project will be developed under the umbrella of the Nile Basin Initiative (NBI). More specifically, the project will pave the road for the development o f an efficient power market inthe Eastern Nile region inorder to foster regional integration, reduce electricity transmission congestion and generation costs, and improve reliability, with tangible benefits in terms o f alleviating poverty and promoting the use of environmentally cleaner fuels for power generation. Inaddition to the benefits of more affordable and reliable power, the project will have a positive externality in terms o f reducing the total emission of C02, as part o f the climate change agenda. The Project was approved by the Eastern Nile Council of Ministers as a fast-track investment project in October 2004 within the Eastern Nile Subsidiary Action Programofthe Nile BasinInitiative. The immediate objective is to facilitate cross-border power trade between Ethiopia and Sudan, andthus optimize utilization o f existing and planned generation capacity. The expected output is a high-voltage transmission line connecting the two countries, which would be the first step in realizing an integrated power system inthe Eastern Nile (and Djibouti). The project components include: (i) construction of a double circuit 321 km long (230 kV transmission interconnection) between Gondar in Ethiopia and Gedaref in Sudan, including terminal substations, a fibre optics telecommunications system and supervisory control and data acquisition (SCADA); and (ii) institutional strengthening and capacity building for power trade and environmental and social issues in the two countries. The cost of the Ethiopia-Sudan transmission line is about US$68 millionand the power expected to be exported to Sudan is 200MW. The cost of the Ethiopia-Djibouti transmission is about Euro 55.57 million (US$62 million) and zxpected power exports to Djibouti are around 40 M W from Ethiopia, to substitute for more zxpensive fossil fuel-based power with low cost hydropower. Source; EasternNile TechnicalRegionalOffice and other documents of the GOE. 130 Box 4.8 The Nile BasinInitiative: Harnessingthe Potentialof the EasternNile There is significant potential (see Annex 4.1, Map 3) in the three Nile sub-basins in Ethiopia for multipurpose water resources development-mainly in hydropower and irrigation, but also with benefits for flood, drought and sediment management, and fisheries, in Ethiopia but also downstream (Sudan and Egypt). Some options have potential for transformational change for economic development in Ethiopia, while conferring regional benefits and facilitating cooperation. Inthe Tekeze-Setit-Atbarasub-basin, opportunities have been identified for hydropower (totalling about 1,000 MW o f installed capacity) and some irrigation (about 70,000 ha). These projects appear to be reasonably significant from an Ethiopian perspective, but may not be significant in a regional context (except possibly for Sudan). Inthe Baro-Akobo-Sobatsub-basin,there have beenmany projects identified (e.g. on the Baro, Birbir, Akobo on small, medium, and large-scale) totalling about 1,000 MW o f installed capacity hydropower and about 100,000 ha o f irrigation (of a total 480,000 ha identified in 14 projects) in addition to significant opportunities for rainfed agriculture improvement. These projects offer significant opportunities for Ethiopia, but may not be easy to implement (given complex social, environmental and health issues) or be significant ina regional context (except possibly for southern Sudan). In the Blue Nile (Abbay) sub-basin, there are very significant opportunities for hydropower (primarily about 6,500 MW o f installed capacity identifiedat Karadobi, Mabil, Mendaia and Border inthe Blue Nile gorge in addition to smaller possibilities inthe tributaries) and about 400,000 ha o f irrigation (primarily in the Lake Tana basin and its tributaries such as Ribb, Megech, Gilgil Abbay and Gumera; Beles; as well as the Blue Nile tributaries such as Anger, Didessa, Dinder, Rahad, etc.). This sub-basin offers multipurpose Opportunities that are significant for Ethiopia as well as for the entire Eastern Nile, providing possible flood management, low-flow augmentation, sediment management, evaporation savings, and hydropower, irrigation and navigation benefits in Sudan and Egypt. All these options are major undertakings and need to be scoped and studied in greater detail, fiom both a project and an Eastern Nile systems viewpoint, to optimize the multipurpose benefits o f these investments and complementary investments (such as watershed management and regional transmission systems). The direct social, environmental and economic benefits o f Eastern Nile Joint Multipurpose investments could also be outweighed by the demonstrative impacts o f regional cooperation and benefit sharing on the Eastern Nile. To facilitate this cooperation, the Eastern Nile Subsidiary Action Program (ENSAP) was launched in 1999 by the Eastern Nile Council o f Ministers (ENCOM) to "ensure efficient water management and optimal use of the Nile's resources through equitable utilization and causing no significant harm" and to "target poverty eradication and promote economic integration." An initial program o f ENSAP projects was presented to the international community in 2001. The Eastern Nile Technical Regional Office (ENTRO), the first international institution o f the three countries, was launched in 2002. To accelerate the progress o f project preparation, ENCOM agreed in 2004 to launch a set o f simple and non-controversial `fast track projects' without delay, to show early results, and to consider the way forward for major, joint, multipurpose development o f the Eastern Nile. This was to be achieved through cooperative investments that conferred tangible benefits, demonstrated joint action, and realized `win-win' gains for all countries. The ENCOM decided in early 2005 to launch the first phase o f identification o f a major program o fjoint multipurpose development on the Eastern Nile. Subsequently, the Ministers asked the ENTRO to identify and prepare a major initial project within a broader Joint Multi-purpose Program (JMP), and ensure good practice in economic, social and environmental analysis and consultation in project preparation. ENTRO has initiated a launch phase o f the JMP to provide the information, analysis, consensus, and institutional zapacity needed to determine the broad outlines o f the first JMP and provide a solid foundation for preparation activities. Source: Eastern Nile Technical Regional Office and other documents o f the GOE. 4.67 While the planned extension of the national electrical grid to a further 1,000 rural towns would support the government's growth and poverty reduction agenda, further economic analysis i s needed. In the international literature, access to energy has been 131 shown to contribute to economic growth and poverty reduction through a variety o f mechanisms. In a comprehensive review of empirical evidence, Brenneman (2002) classifies these impacts as: sustaining economic growth by increasing productivity; lowering costs o f energy to the poor; improving education via improved lighting and school quality, and freeing children's time (especially girls' time); empowering women (by freeing their time); and improving health (e.g. by reducing indoor p ~ l l u t i o n ~ ~For. ) lower income countries,45 Canning (1999) found lower returns, such that electricity generation has roughly the same returns as physical capital as a whole, and that therefore rates o f returns are similar to those emerging from microeconomic evidence. Canning and Bennathan (2001), however, conclude that in a limited number o f countries there i s evidence o f more significant excess returns for electricity generation in low-income countries. Table 4.9 presents rates o f return for selected countries. Table 4.9 Average Ratesof Returnto ElectricalGeneratingCapacity, and Rates of Return to Capital, Selected Countries Source: Canning and Bennathan200 1. 4.68 Ethiopia-specific analysis o f the social and private returns to electrification is limited, but suggests positive returns, as would be anticipated based on the international literature. Estimates o f the benefits o f access to electricity to growth in Ethiopia specifically are not available from macro-modelling. Micro estimates have found that child mortality rates are ten percent lower for rural households with electricity, although this disappears after controlling for community effects, suggesting electricity is likely correlated with access to other community services (World Bank 2005b). EEPCo's feasibility study for the UEAP shows a benefit-cost ratio in the range o f 0.6-1.2, with most substations in the 1.0-1.2 range (and IRRs ranging from 5 to 14 percent). Costs increase at the margin because more robust technology (requiring lumpier and costlier investments) i s necessary to provide sufficient transmission capacity. 4.69 In sum, more analysis and discussion of the tradeoffs and benefits of rapid expansion o f electricity is warranted, especially in light o f financing constraints. 44 Von Schirnding et al. (2002)report that as o fthe early 1990s about 429,000 deaths per year in SSA could be attributed to reliance on solid fuels. 45 Canning uses cross-sectional data for 57 countries, and divides them into two groups-lower- and higher-income countries-based on level o f income per worker in 1960. 132 Questions include whether projected demand justifies the rate of expansion, and how to properly finance and maintainthe expanded system on a sustainable basis, given resource constraints. Improvingthe quality of service deserves more attention, along with pricing structure reforms at EEPCo. It should also be ensured that the expansion proceeds according to appropriate financial and economic criteria, beginning with more robust clusters of towns and villages, and informed by the results o f evaluations (see Box 4.5, above). Irrigation 4.70 Ethiopia's vast water resources have never been effectively managed or tapped, resulting in a generalized lack of water security for both consumption and productive purposes. Dependence on rain-fed farming means that early, late or no rains can significantly reduce output. Much better water management appears among the major changes needed inEthiopia. Recent estimates using a multi-market, spatial model of the Ethiopian economy indicate the devastating impact of a single drought (poverty rate increasesby 12-14 percent), but also that drought shocks represent only athird or a fourth of the total impact of hydrologicalvariability on economic growth. Ifhistorical levels of rainfall variability, drought, and flood are built into the model, projected GDP growth rates rise by 38 percent relative to a version of the model that does not incorporate these factors (World Bank 200%). 4.71 Policies and investments should be designed to smooth overall variability, rather thananexclusive focus on mitigatingthe impact of droughts. The analysis also indicates that cost-benefit analyses o f irrigation and drainage investments that ignore rainfall variability significantly underestimate returns. Incorporating rainfall variability in the projection of an irrigation investment's impact on GDP growth more than doubles the estimated returns relative to assuming either constant rainfall or a single drought event. Greater water storage capacity, bothnatural and man-made, small-scale and large-scale is needed. Presently, Ethiopia's water storage capacity is far below that of other countries in the region (Figure 4.8). Hydrologic infrastructure is needed to regulate flash river flows and to slow sediment transport. Future hydropower development schemes needto be designed as multi-purpose projects, potentially providing benefits such as watershed management, flood control, drought mitigation, drinking water, irrigation, fisheries, local transport, sediment management, and system-wide reduction o f evaporation losses and recreation (World Bank 2005~). 4.72 Investments in irrigation offer Ethiopia enormous potential to boost productivity and reduce vulnerability. Evidence from China, for example, shows a strong positive effect of irrigation on incomes and output, with a disproportionately high welfare benefit to poor farmers (Huang et al., 2006). A recent study by IWMI (2005) of six Asian countries found that irrigation significantly reduces income poverty. Indirect benefits of irrigation at the local and broader economy level are generally much larger than direct (crop production and direct employment) benefits, especially in large-scale canal irrigation systems. Datt and Ravallion(1997) found that higher initial irrigation intensity, higher literacy rates, and lower initial infantmortality all contributed to higher long-term rates of poverty reduction in rural areas. Haggblade and Hazel1 (1989) found that 133 irrigated regions dominated by medium-sized farms and modern input-intensivefarming systems generate the largest multipliersbetweenagricultural productionand income. The multipliers are smaller in rainfed farming systems, and in regions dominated by very small farms or large estates. Figure4.8 Water StorageInfrastructure-International Comparison I 7'000 T ____I____ 6,150 1 6,000 - `B 5,000 - * D 4,729 Source: World Bank 2005c. 4.73 At the same time, recent analytical work on Ethiopia shows that a pro-poor growth strategy focused on either irrigation or seed-fertilizers alone has limited impact. There i s a synergistic effect from a combined strategy (by stimulating both cereal and cash crop production). Achieving this requires complementary investments in markets and transportation for the full impacts to be realized. The study notes that although irrigation has a modest effect at the national-level on poverty, effects in the food deficit area are significant, given that most of the increased irrigated i s targeted there (see Table 4.10). 4.74 Ethiopia has about 3.7 million ha of irrigable land, of which only about 5 percent i s irrigated (GOE 2006b). Irrigatedfarming allows for up to three crops per year, which would among other things helpreduce underemployment inthe highlands. 4.75 Ethiopia's geographical diversity points to the need for a regionally differentiated strategy for irrigation. Large-scale irrigation could boost commercialized farming in the lowlands, whereas small-scale irrigation and microdams are neededinthe highlands. 0 Some river basins (see Annex 2.1) are relatively remote, have little infrastructure (especially in the lower courses), and are not integrated into the national economy, but offer the greatest potential for cost-effective irrigation. These lowlands are characterized by broad, relatively flat areas where major investmentscould create new hubs of economic activity, given complementary risk-mitigation interventions (see Part 11, Chapter 2). 0 In the highlands, which are more densely populated and better served by infrastructure, the topography of the land complicates large-scale irrigation 134 (most major water courses are hundreds o f meters below the level of the plateau). However, there i s significant potential for small-scale irrigation to increase food security and boost productivity until more sustainable solutions can be implemented (Box 4.9). These projects, as Ersado (2005) reports, can have a positive impact on agricultural output, but need to take the health risks posed by standing water into account, suggesting that they are ideally suited for areas "where waterborne diseases pose negligible risk to health or can be cost- effectively controlled." The MDG Needs Assessment calls for 35 percent average annual growth in small-scale irrigation in order to meet targets for 2015 (Diao and Gabre-Madhin 2005). Support for research on suitable technologies for different sites and their cost-effectiveness would usefully complement investments. Table 4.10 Economic Growth and PovertyRates underDifferent InvestmentScenarios Source: World Bank 2006e. 4.76 Table 4.11 compares projected economic growth under three investment scenarios, in irrigation, in"market" infra~tructure,~~and ina combination of both. These projections were made to illuminate tradeoffs in the investment mix; unsurprisingly, the combined investment has the largest impact, but also the highest cost. 4.77 Planning from a macro perspective and attracting private sector partners will be critical for the success of large-scale irrigation projects. Large scale irrigation schemes are costly and development takes years. The Ministry of Water Resources estimates that to meet Ethiopia's cereal requirements by 2016 would require 1.2 million ha of newly irrigated land. Assuming, with the Ministry, that based on a blend o f technologies the average cost of 1 ha of irrigated land is US$6,200, then the overall irrigation investment cost of closing the cereal deficit would be US$7.4 billion (World Bank estimates suggest a per ha cost of US$5,726, for a total of US$6.9 billion). This i s equivalent to 120 percent of today's GDP and to around six times total annual ODA flows. Achieving this would depend on additional foreign aid as well as innovative solutions to reduce costs and bring in the private sector-through concessions; build, operate, and transfer arrangements; risk guarantees; andpartnerships. For success, institutional capacity has to be built up front. Also, if irrigation i s to increase productivity, complementary 46 "Market infrastructure includes roads, transport and storage facilities, communications and other infrastructure investments that will decrease the costs o f transporting and marketing goods" (World Bank 2005c, p. 50). 135 interventions to strengthen watershed management, improve input supply, provide appropriate extension and marketingservices, and bettermarket access will be critical. Table 4.11 GDP Growth Rates Under Different Irrigation Investment Scenarios IBaseline I 1.78 I Irrigation Investment 2.73 53.4 IInfrastructureInvestment Irrigation + Infrastructure 2.53 42.1 3.43 92.7 4.78 The Government's Water Sector Irrigation Development Program has more modest targets-to expand irrigationto 274,000 ha by 2016, which is still an increase of 135 percent above current levels, at a cost of US$1.7 billion. The growth rate inirrigated land is planned to accelerate over the time period, from 4.5 percent in the short term, to 5.5 percent in the medium term, and 6.5 percent in the long term. By 2016 irrigated farmland would total 471,000 ha. The higher agricultural production this would enable would lower the national cereals deficit by 11 percent and the seed cottodsugar crops deficits by 24 percent each (assuming the newly irrigated land is divided 50-50 between (1) cereals and (2) cotton and sugar crops) (World Bank 200%). However, inthe recent reporting in PASDEP the plan for medium and large scale irrigation includes carrying out pre-feasibility studies in 177,998 ha; feasibility and design in464,05 1 ha and carrying out construction in430,061 ha at a total estimated investmentof Br 20.8 million. 4.79 Fortunately, irrigation, drainage and water development projects have a tremendous potential for private sector development. The Tana Beles area, for example, i s suitable for growing horticulture and floriculture crops-crops with considerable export potential (see Chapter 3). There is also a possibility o f groundwater availability in these areas (something which the floriculture private sector i s more inclined to favour due to the associated reliability of supply). Complementary investments in communications and roads, and upgraded international airports, would be important. Because such projects have the potential for significant profits, they are examples o f the types of opportunities for which foreign investors could approach MIGA about political risk guarantees (see Box 4.4 above). Moreover, the developments around Addis Ababa indicate the labour intensive nature of these developments, which is desirable from an employment generation perspective. Another example is the cotton sector, where the recent value chain analysis found that an irrigation investment strategy could reduce the cost of cotton produced by over 45 percent (World Bank 2006d). 136 Box 4.9 Costs and Benefitsof Small-scaleIrrigation A recent evaluation ofthe ongoing water harvestingprogram in Tigray indicates that small-scale irrigation schemes can be profitable and benefit farmers by reducing risks and improving food security, but should be accompanied by enhanced extension services and access to credit (Mills 2004). Their internal ratesof return are high, at between30 and 45 percent dependingon altitude, but take severalyears to materialize. The returns are higher ifthe ponds are used to irrigate cash crops rather than for supplementary irrigation of food crops when rain fails. After five years, farmers who grow cash crops are able to purchase between 30 and 80 percent of their food requirements ifthey sell 80 percent of their cash crops. For micro-dams, Annen (2001) provides the following costs and benefits per hectare of irrigated land in a well-protectedrehabilitated watershed, taking into account crop managemenuinput levels, and altitude zone.* At a development cost of ETB40,000/ha (US$4,706 per ha), assuming a coverage of 60 ha, with average irrigated crop productivity at improved crop managemenuinput levels and average crop price levels, the expectedannual net profitwould be: US$2,812 per hdannuminthe Weyna Dega(medium altitude zone) from three crops; US$3,600 per hdannum inthe Kolla (low altitude zone) from three crops; or US$2,047 per hdannum in the Dega (high altitude zone) where the climate allows for only two crops-one rainy season and one irrigated dry season. In these scenarios, the construction of micro-dams appears to be economically viable with a reasonable return. Obviously this could be improved inareas where the situation allows for small dams able to irrigate a significantly larger area, as well as by focusing on production of higher- value crops wherever feasible. It is however notedthat the development costs of these schemes, at about US$4,700 per ha, appear high relative to other estimates of about half or less. *Depreciation is calculatedat Br 1,333 (US$156.82) per hdannum over 30 years. Source: Excerptedfrom World Bank 2004f. Telecommunications 4.80 The continuing technological transformation o f electronic communications will have a profound impact on the telecommunications and ICT sectors o f developing countries, and thereby the underlying functioning o f their overall economies. A recent UN study concluded that ICT is `...rapidly emerging as a vital factor in economic and social development to facilitate innovative and scalable solutions for achieving major development objectives' (2004). 4.8 1 While low telephone penetration and poor quality have characterized the telecoms sector in Ethiopia, major gains have been made since ICT was established as a development priority in 2003. Ethiopia's teledensity increased from 0.5 lines per 100 persons in 2002 to 1.1 (fixed) lines in 2006-though this still falls short of the African average (see Table 4.12). Internet access now reaches 5,000 kebeles, with plans for expansion to a further 10,000 kebeles. However, a key issue is the availability o f relevant and tailored local content. The number o f mobile subscribers grew from 98,000 in 2003 to 411,000 in2005, and ETC has potential capacity for over 1 million. Although Internet users nationwide can access dial-up service at local call tariffs, nearly all Internet users (94 percent) are located inAddis Ababa. 137 4.82 Globally, there is a substantial shift from analog to digital technologies, from voice to data, from circuit switching to packet switching, and from narrowband to broadband. We are also witnessing the migration o f intelligence from the core o f the network to the edge, and the increasing role of wireless technologies. These developments bring about a dramatic change in the range o f services and applications available to customers, along with falling prices. Just as importantly, they give rise to entirely new businesses and ways o f doing business-their introduction stimulates growth and economic diversification. 4.83 These technological changes are largely driven by competition between network, service and application providers, which are usually privately-owned companies. According to the latest International Telecommunication Union (ITU) report, 61 percent o f all countries in the world have competition in basic fixed line services; the figure for Africa i s 51 percent o f all countries (2006). For mobile communications, 87 percent o f all countries support competition, and the figure rises to 93 percent for Africa. Investors have shown a great willingnessto place their money inmobile licenses inAfrica. 4.84 This is a big opportunity for Ethiopia to make a significant leap forward because it is not constrained by `legacy' investments which are often protected by their owners or the Government. The new context is well understood in Ethiopia but the actions necessary to take advantage o f emerging opportunities have not yet been taken. As a consequence, Ethiopia lags many o f its neighbours and peers by a considerable margin in terms o f access to telecommunications and ICT, especially mobile services, as illustrated inTable 4.12. Table 4.12 Fixedand Mobile Teledensities Africa 3-09 9.14 Cote d'Ivoire 1.43 9.07 Ethiopia 1.10 1.33 Ghana 1.47 7.93 1 Kenva I 0.92 I 7.85 I Lesotho 2.07 8.83 Mauritania 1.13 17.53 Rwanda 0.27 1.64 Senegal 2.37 10.85 Somalia 1.67 4.17 Sudan 2.98 3.04 Uganda 0.27 4.36 Zimbabwe 2.67 3.56 4.85 InEthiopia the structure ofthe sector-effective monopoly and state ownership poses two serious risks. First, the effective monopoly (fixed and mobile) means that funds available for investments to take advantage o f new opportunities are limitedto the 138 resources o f a single entity. In a competitive environment there are multiple sources o f funding. The effective monopoly also means `all the eggs are in one basket'-if you drop the basket all the eggs are broken. Thus, if mistaken decisions that do not serve the interest o f customers are made, there i s no alternative to turn to. Second, decisions taken by the state usingthe money o f tax payers are very often different from decisions taken by the private sector using its own money. This is especially the case inan environment o f rapid change, where there is the risk of state investments in `White Elephants'-a costly beast to feed with no perceivable return. Private ownership means risking your own resources and therefore making wiser decisions. Also, since competition entails sharing the financial burden among different participants, providers are enabled to develop creative solutions (decisions) tailored to the needs o f their clients. 4.86 More broadly, competition and private ownership are not a matter o f ideology but a question o f pragmatism. Encouraging private investment in telecommunications frees scarce public resources for investment in other sectors where there is less scope for private participation. The opportunity cost o f depending solely on public provision o f telecommunications infrastructure would be enormous-according to the MDG Needs Assessment, the sector requires Br 38 billion in spending between 2005/06 and 2009/10. Welcoming private sector investment would mean that a larger resource envelope i s available for other areas, such as health (which according to the Needs Assessment will require Br 35 billion over the period). In addition to the fiscal benefits o f reducing spending needs in the telecommunications sector, private ownership implies creation o f revenue that can be taxed to fund public spending on other development priorities. It therefore benefits both sides o f the balance sheet. 4.87 Figure4.9 and Figure4.10 compare Mauritania (which started its reform program in 1998) and Ethiopia interms of market performance. The Government o f Mauritania introduced competition in mobile services in 2000 and since then the market has exploded. O f course this market growth has brought substantial revenues to the Government o f Mauritania which it has used elsewhere for non-telecommunications purposes. 139 - MDbile Penetrabr't T o M t ~ l e p h c m pne(ntmrate(nXp 110; 1% Fmed Penetratim Begmnmg01WB O r ) D Z a211 0 4.88 The link between competition in 42 African mobile markets and market expansionis also illustrated inFigure 4.11. Figure 4.11 Mobile Teledensity in42 African Countries 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% Comptitbn 4'00% IMonopoty 3.00% 2.00% 1.00% 0.00% 1999 2000 2001 2002 2003* 2004* 4.89 The extent to which Ethiopia lags is neighbours and peers i s further illustrated by Figure 4.12 which shows a regression of GDP (in purchasing power parity) per capita against mobile penetration rates. Ethiopia is substantially below its predicted position and as a consequenceis foregoing a sizeable sum infiscal contribution from the sector. 140 Figure4.12 MobileTeledensityvs. GDP 200 180 + Mauritania 0 160 0 140 rl B 120 100 Pru h 80 t a5: g 60 28 EthiopiaUganda 40 1la 2 20 0 0 100 \ 200 300 400 500 600 700 800 900 1000 Ethibpia 2004 GNIpercapita 4.90 Current ETC Plans call for increasing mobile and fixed penetration to 15 and 8 per 100 people, thus raising network capacity to 12.5 million and 6.9 million users, respectively, by 2010. ETC's financing model assumes the ability to self-fund mobile service expansion andrecoup costs from user fees fairly quickly. 4.91 However, a study produced for the World Bank (2005) on the economic impact of issuing one additional mobile license (over a 15 year period) found that: 0 Its fiscal contribution over the `status quo' would be approximately Br 4 billion 0 Marketpenetration (2 operators) would reachapproximately 9 million subscribers covering 60 percent of the population, as against 3 million with the status quo 0 Mobile retail prices could fall by 40 percent 4.92 The study also anticipated further benefits such as 0 Business opportunities for service distribution (e.g. call centres to re-sellers of pre-paidcards) 0 Stimulation o f other business activities (tourism, trade) 0 Opportunities for small businesses (taxis, courier services) 0 Development of underservedareas (over 150woredas would have coverage) 4.93 Clearly issuing an additional mobile license to the private sector i s an urgent priority which would-substantially benefit the budget of the Government, create jobs, stimulateeconomic growth and assist inthe diversification o fthe economy. 141 4.94 The expansion o f fixed line service i s likely to be more problematic and require partnerships with other private and/or public actors. The challenge is to overcome the problem o f the "final mile" to consumers, which raises a variety o f important policy questions. These include appropriate ways to stimulate private investment and demand, facilitate end-user computer access, design licensinghegulatory policies, and define the role o f public investment incommercializing broadbandaccess inrural areas. 4.95 The current process of "downstream liberalization" is already providing more opportunities for private sector participation in "non-core" activities. The Communications Sector Policy outlines this "open access" strategy, with a single broadband backbone that will be made available to a wide range o f retail service providers who can also extend the network and ensure access to rural areas, increasing the flow o finformation, andfacilitating distance learningprograms. Nowthe issue is one of ensuring rapid and effective implementation o f the policy, and it is expected that the World Bank and other international financial institutions would work with the authorities to operationalize this major policy advance. 4.96 Sales o f SIM cards and voucher cards for mobile services are already handledby private entities, and ETC (in collaboration with ETA) has introduced two modes o f allowing private virtual internet service providers (VISPs) to enter the market. According to the Standard VISP model, companies can sell internet access to customers and inexchange receive a commission from ETC-this i s a revenue-sharing scheme that enables the VISP to operate without infrastructure o f its own. Alternatively, inthe Proxy VISP model, the VISP leases access to the telecommunications backbone from ETC, and purchases its own remote access and application servers with which to reach customers. It therefore offers an extension of ETC services and controls its own customer and revenue base. 4.97 The introduction of a "village phones" program is underway and already producing results, with plans to expand further over the next two years. It has significant potential to facilitate market integration and reduce transaction costs in rural areas, including for transfer o f remittances. It also helps address the final mile problem by relying on wireless technology that does not require that base stations be as closely spaced as those for the mobile phone network. The prospective ICT impact evaluation for Ethiopia contemplated by the Government and World Bank (Box 4.5) would specifically evaluate the returns to the village phones program. A study o f a similar program in Bangladesh financed by the GrameenBank suggests that the impact could be considerable in Ethiopia-the Bangladesh study, as a reference point, found that the "consumer surplus for a single phone call from a village to Dhaka.. . that replaces a trip to the city, ranges from 3 percent to 10 percent o f mean monthly household income" (Richardson, Ramirez, and Haq, 2000). 4.98 ETC has been working to address bottlenecks in international connectivity, and now has terrestrial links to Sudan and Djibouti (as well as satellite communications capacity). Total international gateway capacity is now at 82 Mbps (uplink) and 126 Mbps (downlink). An additional optical link with Sudan has also been commissioned. Capacity limitations and high usage costs o f the `international gateway' have been a 142 substantial obstacle to sector development in the past, and high capacity at low user charges will be vital to stimulating the `leap forward' in Ethiopia. As such, the recent expansion in international connectivity represents an important step forward in linking the Ethiopian economy and society to developments outside the country. 4.99 At the international level, harmonizing ICTpolicy is an important agendaitemfor the Common Market for Eastern and Southern Africa (COMESA), as part of its strategy to facilitate regional integration, investment, and trade (NEPAD 2003). Drinking Water and Sanitation 4.100 In 2004, coverage of water supply was estimated at 24 percent and sanitation at 15 percent, which put Ethiopia nearly at the bottom of Africa (World Bank 2004~). In 2006, the PASDEP reported that access to water in rural areas had reached 35 percent, suggesting a significant improvement, though definitional issues make it difficult to make precise comparisons (see also Table 4.1 above). However, for those who do have access to these services, quality is poor-in rural areas, most people obtain water from unprotected sources and must expend much time and energy to collect water in the dry season. O f those that have an improved water supply, at least 30 percent of systems are non-functional at any given time. Access to safe water is higher in urban (73 percent) than rural (13 percent) areas, but even inurbanareas service is intermittent. 4.101 The gains from water and sanitation access are well known, with substantial positive externalities for health (especially child mortality) and women. According to the Poverty Assessment, Ethiopianchildren in rural households with piped water (including communal taps) are 5 percent less likely to die before the age o f five than those in households using surface or rainfall water (World Bank 2005b). Cases of diarrhea- which cause one in five child deaths in Ethiopia-could be lowered by 50 percent via latrine use, 15 percent via use of safe water, and 32 percent via hand-washing (GOE 2006a). 4.102 Expansion of water and sanitation service delivery has progressed slowly to date, but the Government has outlined ambitious targets for scaling up. The biggest challenge will be raising rural water coverage to achieve the 2015 MDG target of 70 percent (World Bank 2004~). About 15m people in Ethiopia currently have an improved water supply. Some 40m more people will need to be served to achieve the MDG, still leaving 30m unserved. Actually, the Government's targets are more ambitious than the MDGs, andcall for universal drinkingwater access for the mainurbanareas by 2016. 4.103 According to the MDG Needs Assessment, achieving the water and sanitation MDGwill require quintupling the rate of new service provision, and quadrupling annual investment. The objective of the current IDA-financed WSS Project i s to increase access to sustainable water supply and sanitation services, for rural and urban areas, through improved capacity of stakeholders in the sector. It is anticipated that within a few years the constraint will be investment funds rather thanimplementation capacity. The focus is on affordable technologies. This means that hand dug wells will be constructed in rural communities whenever possible, and piped systems in towns will be designed to serve 143 today's population plus five years and expanded as the populations actually grow and customers can afford a higher level o f service. 4.104 The Government's sectoral strategy gives cities, towns, and rural communities the mandate to manage and maintain their water and sanitation facilities. It also promotes a partnershipwith local private service providers to provide the goods, works and services needed to plan, construct and maintain water and sanitation facilities. The strategy provides for the establishment of local oversight bodies (water committees in rural communities and water boards in towns and cities; in urban areas, the government i s already organizing autonomous utilities). Rural communities rely on handpump mechanics for parts and repairs, towns and cities employ utility operators (public or private) to handle operations. Most construction i s done by private contractors. 4.105 To promote sustainability, substantial cost recovery i s expected. Government policy calls for rural communities to pay ten percent o f the capital cost and all maintenance costs. Once urban water systems are initially built via grants, the Government expects towns and cities to cover all recurrent, replacement and expansion costs. Local ownership o f the management and maintenance process i s expected to foster sustainability inthe long run, and some anecdotal evidence suggests this i s the case. In Oromiya, some communities are successfully managing relatively complex water projects, which has been largely attributed to the "active involvement o f the community... [and] flexibility to levy fees and sell extra water to others to generate revenues to pay the staff o f the scheme an attractive salary" (World Bank 2006a). 4.106 Returns on capital investments are too low and risks too high to attract private investors. In an effort to establish their credit worthiness, the federal government has established a Water Resources Development Fund to channel loans from MoFED to towns and cities for system expansion. To date, tariffs in urban areas have been insufficient to ensure quality and continuity o f service, but loan conditions require that water utilities prepare a business plan outlining their expansion plan including the tariff structure needed to achieve full cost recovery, and demonstrate that they efficiently collect revenues. 4.107 For success, investments in water supply need to be combined with a strategy to promote behavioural change in hygiene and sanitation practices. The Ministries o f Water, Health and Educationhave recently signed a tri-partite agreement to collaborate in the development and implementation of a state o fthe art hygiene and sanitationprogram, and AfDB, UNICEF and the World Bank will help finance it. This buildson the hygiene education campaign known as the WASH movement, led by a broad coalition o f government and non-government organizations, begun in 2004 to focus attention on improved hygiene and sanitation practices (GOE 2005). While the Government does not intendto finance on-site sanitation facilities, it will promote a range o f technologies, the simplestof which are affordable to most all households. The Government will, however, finance sewerage inhigh density parts o f cities where on-site excreta disposal systems are not feasible. 144 UrbanDevelopment 4.108 While only 16 percent of the population lives inurbanareas, such that Ethiopia is one of the least urbanized countries in the world, Ethiopia is among the most rapidly urbanising (at 4.3 percent annually).47 The urban population i s expected to total 18 million by 2015. There are about 925 urbancentres intotal, although the size distribution of cities i s highly skewed, with Addis Ababa being a true primate city of between 3-4 million inhabitants, and the next largest city, Dire Dawa, at 300,000. There are only 23 cities with populations over 50,000, accounting for about 45 percent of the urban population (see Annex 4.2). 4.109 Ethiopia's urbancentres are characterizedby a weakly developed economic base, a high level of unemployment and a worrying incidence of poverty and slum dwelling. Urbanunemployment is high and protracted (World Bank 2006b). At least 70 percent of the urban population can be consideredslum dwellers basedon quality of housing, living space, access to infrastructure and services, security of tenure and citizenship rights. Inadequate shelter, combined with poor sanitation, overcrowding, and a high proportion of vulnerable women, youth, children, elderly and destitute with very low incomes and high unemployment result in a high risk of disease and an extreme poverty trap for many urban residents. Urban poverty incidence is high, and though on average less than in rural areas, ranges from 61 percent in Tigray to 27 percent in Afar (GOE 2006a; PASDEP Urban Strategy). 4.110 An "Emerging Urban Agenda" is a key component in the PASDEP, recognizing that "development o f a balanced urban system offers the opportunity to increase market integration by facilitating exchanges and the division of labour, as well as facilitating diversification of the agricultural sector.. .cities offer the opportunity to deliver services more cheaply and can act as poles of growth, thereby playing an important role inpoverty reduction." 4.111 The Ministry of Works and Urban Development has prepared an urban strategy for implementation under PASDEP. The strategy has four pillars: i)support for small and micro-enterprises andjob creation; ii)integrated housing development (through the construction of 100,000 units per annum); iii)improved access to land, infrastructure and services (through provisionof serviced landinthe larger cities); and iv) promotingurban- rural and urban-urban linkages (through a small towns development program, namely provision of serviced land). The pillars will be supported through strengthening the relevant policy, regulatory and institutional frameworks; capacity building and results- oriented performance monitoring and evaluation. 4.112 The Government has set itself ambitious targets interms o f both financing (Br 19 billion over 5 years) and outputs (reduction in unemployment to below 20 percent of economically active population; construction of 100,000 housing units per annum). However with almost three-quarters of urbaninvestment slated for the integrated housing program, bothinvestmentsand targets are highly skewedto housing construction. This is 41All official data on urbanization, rates o f growth, sizes o f cities, etc. are projections based on 1994census data, and some experts regard these as underestimates. 145 perhaps because there i s only one MDG target specifically related to urban development-which i s the reduction in the numbers o f slum dwellers (Goal 9, Target 11). 4.113 To identify how best to support urban areas, where to focus investments,and what kind o f policy or institutional changes or frameworks are required, information and analysis i s required on the nature and characteristics o f the urban landscape in Ethiopia. However, consolidated data and analysis on urban areas are lacking, and i s the subject o f an upcoming World Bank Urbanization Study. For example, international experience indicates that large scale construction o f housing by the public sector is not usually the best solution as there tends to be mistargeting, inefficiencies, and problems with operations and maintenance. Recent studies by the World Bank (2004i) and the Urban Institute and GTZ-IS (draft studies currently being finalized under Capacity Building for Decentralized Service Delivery) also point out issues o f affordability in Ethiopia for the types o f units envisaged (more than 70 percent o f households would be unable to afford even the most subsidized unit). This approach might therefore warrant further consideration. 4.114 The urbaninfrastructure investments requiredgo beyond the provision o f serviced land for housing or industrial development. Municipal investments such as local roads, drainage, street lighting, sewerage, solid waste collection and disposal, markets, abattoirs are all key ingredients for an efficient, habitable and productive city. These are expected to be fully financed through municipal own source revenues. There i s currently little information on how cities are faring with infrastructure and service delivery, differences across regions, or comparisons with international standards. The Woreda City Benchmarking study has made the first steps in recording service delivery and expenditures for capital investments, but further work i s needed. 4.115 Inorder for Ethiopia's cities to "provide efficient and effective public services to residents, complement and facilitate rural development, [be] models o f participatory democracy and build accelerated economic opportunities that create jobs," as envisaged by the national UrbanDevelopment Policy, several institutional issues warrant attention. 4.116 Cities need to be clear about their mandates, powers and revenue generating authority, but there is currently still ambiguity over the division o f roles and responsibilities between regions and Urban Local Government Areas (ULGAs). City proclamations have given powers to urban authorities, but these are weakened by regional laws and regulations. For example, city proclamations allow ULGAs to set tariffs for sales o f livestock in local markets, but regional laws contradict this by stipulating the exact Birr amount o f tariff to be charged for each type o f livestock (often the amounts were set decades ago andneverrevised). 4.117 A peculiarity o f the institutional structure inEthiopia i s the division between state versus municipal functions. Inmost regions, dual administrations and dual budgets exist within each municipality-one for state functions (health, education, agricultural services, financed through regional transfers), one for municipal functions (local roads, drainage, street lighting, solid waste management, abattoirs, etc., fully financed through 146 municipal own source revenues). This can cause duplication of efforts, inefficiencies, and can distort incentives within the municipality, thereby resulting in suboptimal investment choices (e.g. no capital investment in health or education if regional transfers are not sufficient to cover recurrent costs-see IGRBenchmarking Study). 4.118 Access to landaffects the development o f both housing and industry and services. As reflected inthe Ethiopia investment climate surveys, the private sector has identified the availability of land, and the associated time and cost o f land related transactions, as one o f the key constraints to growth (see Chapter 3). Despite the new Urban LandLease proclamation in 2002, recent studies (Capacity Building for Decentralized Service Delivery) indicate, inter alia, that the volume o f informal land transactions i s high; taxation of real estate transactions is high; the allocation of vacant land i s made without auction, for low administratively defined prices or free o f charge; and there are huge differences inthe payments for similar landplots. The desire to attract investors to towns may have overshadowed prudent landmanagement policies. 4.119 One of the key institutional differences between municipalities and rural woredas i s that the former are expected to be fiscally self reliant. At the same time there i s some lack o f clarity regarding the fiscal autonomy of municipalities vis-a-vis regions. There i s no predictable system o f transferring funds to municipalities for municipal functions (unlike the block grant which i s a predictable source o f revenue for woredas). Municipalities rely on their bargaining powers or the largesse o f the regions for support infinancing for infrastructure investments. Since these are often lumpy, lack ofcertainty inhibitsmunicipal ability to planefficiently. 5) The Way Ahead 4.120 This chapter has highlighted the consensus that significant progress across different types o f infrastructure is necessary to unlock the country's growth potential and to reach the MDGs. It i s also accepted that bundling public services can leverage the returns o f each. We found that the case for scaling up infrastructure development i s especially clear in Ethiopia, given specific evidence on positive economic and social returns, and the country's extremely low starting point relative even to other very poor countries. More broadly, development o f regional infrastructure also offers potential to boost peace and stability among Ethiopia and its neighbours by increasing trade and inter-dependency (particularly through exports o f affordable hydropower, and transport to competitive ports). Yet some important questions remain unanswered; some o f the key issues requiring additional analysis and consideration are discussed below. 4.12 1 A geographically differentiated strategy that bundles services around "growth corridors" offers an opportunity to accelerate structural transformation and better absorb rural labour surpluses. Annex 4.1 contains a map that shows existing public capital which provides an indication o f where such poles are already emerging; there is 48The measure o f Public Capital Stock combines 5 variables: the density ofroads per sq km, the percentage of the population with access to telephone lines, the capital stock in health measured by the Potential Health Service Coverage, the percentage of population with access to electricity, and the number of hectares o f land irrigated. 147 also a map that suggests the extent o f infrastructure differentials by region (it shows road density). Such a strategy would aim to crowd in private investment by lifting economic returns, which also requires creating an enabling environment conducive to private investment (see Chapter 3). But determininghow to sequence across sectors is a major challenge, and further work i s needed. The evidence reviewed here points toward a sequence that focuses on roads initially inorder to open trade arteries and foster increased rural productivity, followed by energy and telecoms to foster complementary urban development. There are a number o f related questions, such as how returns at the sector level can be more precisely projected in the Ethiopian context, and differentiated by region and productive sector-uestions which become more complicated when considering "bundles" o f investments. There i s also a need for analysis to quantify and assess the potential impact on the poor.49 4.122 The ongoing decentralization o f some policymaking authority not only to regions, but also to woredas and urban local government administrations, should enable better alignment o f infrastructure planningwith local priorities. Localized decision-making will be integral to the success o fthe envisioned"growth corridors," which will largely depend on identifying the comparative advantage o f specific localities and determining how to exploit them to maximize their economic potential. Localities also need to play an increasingly large role in the management and maintenance o f small-scale infrastructure, as intended by the decentralizationpolicy-particularly inthe water andsanitationsector, and with respect to feeder roads, small scale irrigation, and the use o f productive safety nets. In urban areas, localities need to be clear about their mandates, and have the authority and capacity to not only deliver services efficiently but optimally manage key resources such as land, and provide an enabling environment for the growth o f the cities. There will be difficult decisions. For example, where environmental degradation i s severe, certain investments to prevent further deterioration of conditions may be preferentialto inaction even ifthe projected returns are negligible. Local budgets will be the keypolicy document integratingandprioritizingthe needs across sectors. 4.123 The magnitude o f needs points to the need to review alternative sources o f financing. The Government faces real budget constraints. These can be alleviated, to a significant extent, by donors providing grant and concessional financing. External borrowing on commercial terms would need to be carefully assessed. Debt sustainability i s always a potential concern when considering scaled up public spending, however, and particularly so in Ethiopia (IMF 2005). For example, Aschauer and Lachler (1998) found, based on cross-country evidence, that public capital contributes significantly to productivity growth provided that it is financed by lower current government spending and not by higher public debt. Moreover, households' ability to pay for infrastructure services, andthe appropriateness o f existing tariff structures, warrants a careful review. 4.124 The Government will also need to work inpartnership with private investors, and facilitate private capital formation more generally through improvements inthe business 49 For example, household and community returns could be estimated by using the newly collected HICES data (not available at the time o f writing), with additional modules for health status and other factors as neededas interventionstake place. 148 climate. FDI will be important, especially for the ICT sector, where foreign companies have played a major role in many African countries. Stronger linkages with outside investors would also facilitate technology transfer, boosting project efficiency and leading to innovations that adapt technology to the local context. But the domestic private sector will also be critical. Local companies could be increasingly used as contractors-particularly for road construction-though it may take some time to build the relevant skill base. Moreover, increased competition among contractors should lead to lower unit costs. 4.125 New opportunities for developing infrastructure incooperation with neighbouring countries could strengthen economic growth as well as regional security. Improving road linkages with neighbours to boost trade offers significant potential. Tapping its hydraulic potential could enable Ethiopia to export electricity as well as massively increase the amount o f land under irrigation, and can only be done in collaboration with regional partners (e.g. under the auspices o f the Nile Basin Initiative). Telecom i s another area that could benefit from international cooperation, which has already begun as part o f the East African Submarine Cable System, inwhich ETC has invested. 4.126 To conclude, the likely prevalence o f S-curves, as discussed, suggests that accelerating growth requires scaling up infrastructure efforts. But there are key questions about how to estimate rates o f return in the long term, especially where there are threshold effects; for example, opening a road in a new region may not yield significant benefits until towns form along the road, which could take many years-suggesting flat and then rapidly increasing returns. How should these be accounted for in project analysis and in funding strategies? Moreover, the available evidence reveals large differences in expected costs and returns, as well as financial and institutional capacity constraints (particularly at the local level) that will require tradeoffs at the sectoral level. Finally, what i s the optimal balancing between legs one and two as described earlier in this report: investing in high potential growth corridors, which is more effective from a growth perspective, and spreading infrastructure more evenly, which may be more equitable and pro-poor? What i s the role o f growth poles in finding a middle way? These questions summarize a forward-looking agenda for analysis. 149 Annex 4.1 Maps Map 1 PublicCapital Stock 150 Map2 RoadDensity(Total lengthof road per thousandsof km') Source: World Bank 2004g. The ratio oftotal lengthof roads, irrespective oftheir types, to total area. Computedbased on data from Ethiopian RoadAuthority, 2002/03, & CSA, 2003 Population Projections. 151 Map 3 PotentialProjectson the three Nile-Sub-basinsinEthiopia ""4 TK-4 -...d-- Source. World Bank staff; produced to support work on the EasternNile under the Nile Basin Initiative. River coverage from Environmental Systems Research Institute (www.esri.com). Information on dam locations compiled from multiple sources andplotted using GIS technology. 152 b o o 5. THE GOVERNANCEAGENDA: FOCUS ON DECENTRALIZATION 5.1 A key theme o f this report is the importance o f good governance to the acceleration o f growth and poverty reduction in Ethiopia. Since 1994, the national governance agenda inEthiopia has focused on efforts to restructure what had been a very centralized state. Momentum has been sustained in recent years, following the decision in2002to deependecentralizationto sub-regional tiers ofgovernment. 5.2 This chapter reviews recent progress and prospects, drawing on a rich set of studies conducted by the World Bank and other partners under the umbrella o f the Ethiopia Institutional and Governance Review, which in turn i s part o f the Public Sector Capacity Building Program (PSCAP). We aim to provide a sense o f the extent to which the 2002 reforms have transformed local governance realities, within a longer term perspective, and address the extent to which decentralization has strengthened accountability from the `bottom-up,' and the role o f benchmarking as a tool for monitoring progress. The layout o f the chapter i s as follows: it begins with a review o f recent reform experience against the backdrop o f longstanding patterns, and then proceeds to assess progress and constraints in implementing fiscal decentralization as reflected in budgets and service delivery. Tools for benchmarking and monitoring performance are reviewed, followed by some concluding remarks. 1) Decentralization:FromSubjectto Citizen5' 5.3 Over the long course o f history, until the early 1990s, successive regimes treated Ethiopians more like subjects than citizens-this was the case under the quasi-feudal monarchy and the totalitarian Marxist-Leninist state. The political transformation accompanying the overthrow o f the Derg reflected a desire to reshape the relationship between Ethiopia's people and their government. There are several perspectives on the extent to which this has been realized. While the formal Ethiopian state structure has beentransformed from a highly centralized system to an increasingly decentralized one, challenges remain. Transforming a CentralizedLegacy 5.4 Ethiopia's political history i s unique insub-Saharan Africa inthat the country was never systematically colonized by a European power. The state thus evolved through ongoing local political processes rather than, as in many African countries, in a single defining moment associated with independence. The origins o f the Ethiopian monarchical state can be traced back more than fifteen hundred years, and modern Ethiopia can be dated from a series o f military victories (against Egyptian invaders, the Sudanese dervishes, and Italian would-be colonizers) by King Yohannes inthe nineteenth See Mamdani (1996) on this distinction as a basis for analyzing the dynamics of African states. 155 century. Ethiopia's territory subsequently expanded with political authority heavily centralized in Addis Ababa in the latter part of the monarchy as well as during the Marxist-Leninist Derg regime. 5.5 Consistent with centralized rule, the traditional Ethiopian social order was one of authority and superior-subordinate relationships. A 1972 study described the pattern as follows: Subservience to, and respect for, persons of higher authority i s a fundamental lesson taught to the Ethiopian child.... anyact of initiative on the part of the subordinate is, in a sense, a rejection of his show of dependency demanded by the big man.. ..there does not . appear to be a word in Amharic equal to the notion o f public sewunt in English; the terminology used for government officials i s translated as employee of the government.. . (Korten 1972,cited in Kurey2005) Given Ethiopia's richcultural and regional diversity, it is of course unwiseto makebroad generalizations. Moreover, culture evolves continuously with political and social change. The quote above is no doubt both dated and an oversimplification o f the complexities of modernEthiopia. Nevertheless, it speaks to a certain pattern embedded inthe country's history, the implications of which continue to be felt to some extent today, as discussed further below. 5.6 By 1990, the Ethiopian state was confronted by a variety of separatist rebellions. The Eritrean rebellion was the most widely reported, but rebel movements had also gained strength in Oromo and other outlying regions (e.g. Somali) whose sense of affiliation with the Ethiopian state had always been tenuous. The response of the new political leadershipwhich gained power at this time to the fragility and lack of legitimacy ofthe centralized state was multifaceted-constitutional, political and economic. 5.7 The constitutional response involved the elaboration of a new institutional framework built around formal devolution of hitherto highly centralized authority. The 1994constitution includedthe following features: 0 Participation in the Ethiopian federation was voluntary, with nationalities retaining the right to secede; 0 Except where otherwise provided (as i s done for defence, foreign affairs and macro-economic policy), authority was vested inthe nine regions; 0 Intergovernmental fiscal transfers were to beprovided via block grants; and 0 Ethnic diversity was recognized inthat administrative boundaries were drawn on the basis of ethnic identities, and the use of local languages for state business was permitted, which was a major departurefrom the official dominance of Amharic. 5.8 There was a further round of decentralization reforms in 2002. The use of block grants was extended from the regional to the woreda tier of government (see further below). The role of zones-an intermediate administrative tier between regional and woreda levels-was cut back andthe bulk of their personnel transferred to the woredas. 156 5.9 The political response to state fragility came in two phases. Immediately after coming to power, the EPRDF asserted strong political control in all but the most peripheral regions of Ethiopia by building a network o f party affiliates around the country. The common party platform at both centre and periphery ensured that authorities at all levels co-operated inthe implementation o f the new constitutional order. The result by the late 1990s was "a de facto party-state merger" (Vaughan 2004, p.17). However this was followed by a phase initiated at the Fourth Party Congress in 2001 where the EPRDF announced its intention to radically transform the relationship between government, the rulingpolitical party, and citizens: We need an organizational structure.,.so that government bodies at all levels receive competent professional and political leadership. Our party must be enabled to give a more refined and stronger political leadership than ever before. That, nonetheless, must be done separated from government work and in accordance with government rules and regulations. The conditions necessary for the separation o f the civil service structure from that o f the political leadership must be created.. ..not only at the federal government level, but at all levels...We must also ensure the separation and clearing o f the powers of the legislative and the executive bodies of government and thereby translate into action the democratic principles of checks and balances...at the federal, regional and other levels.. .We must facilitate the conditions necessary for the full participation of all Ethiopians in all discussions to be held on issues pertaining to our development and democratizationefforts. (EPRDF 2001, p. 47) 5.10 Preliminary evidence on the extent to which implementation o f these goals has proceeded at local levels is summarized below. 5.11 As an economic response to the inherited lack o f legitimacy o f the state, the EPRDF designed a development strategy aimed at sustainable and equitable growth. The Agriculture Development-Led Industrialization (ADLI) strategy, as described in Part I and Part 11, Chapter 2, was intended to kick-start growth through broad-based improvements inpeasant agriculture. Progress toDate 5.12 Institutional change. The Government has a broad strategy and programme o f state transformation through decentralization and civil service reform. PSCAP was designed and implemented explicitly to support this reform, and to facilitate a sub- national, demand-driven approach to addressing capacity building priorities. Recent independent studiess1 suggest that this program can be associated with several major institutional achievements. There is strong political will at the highest levels o f the Federal and regional governments to empower the woredas and the `grass-roots' through decentralization. The 2002 decision to decentralize within regions through block grants to woredas has been implemented fully (how budgetingproceeds inpractice is discussed below). The authority o f zones has been scaled back, with most o f their staff re-assigned to woredas. There have been major commitments to invest in the capacity needed to 51Including a review o f trends in intergovernmentalrelations after 2002 (Heymans and Mussa 2004); a CIDA-fundedsynthesis of progress and prospects for grassroots empowerment (P1an:net 2005) and a study of decentralization inTigray (Dom and Mussa2006). 157 make this decentralized system work: the regional affairs units o f MOFED have been strengthened; a Ministry (and regional bureaus) o f Capacity Building established; and intensive training for local staff has been provided by a scaled-up Civil Service College. Notwithstanding these important advances, some major policy challenges remain (Box 5.1). Box 5.1 Getting DecentralizationRight Some Ongoing Challenges - A recent review of intergovernmental relations in Ethiopia (Heymans and Mussa 2004) highlighted a variety of challenges, including the needto: 1. Clarify expenditure assignments. The assignment of responsibilities among regions, zones, woredas, municipalities and kebeles remained unclear. 2. Clarify local revenue sources - especially for urban municipalities that raise the bulk of their revenues locally. Challenges include making revenue authority clearer, streamlining local taxes, building the capacity of local governments to collect revenue, and ensuring that the block grant formula does not discourage localtax effort. 3. Strengthen local governments' budgeting for capital expenditure-in terms of both implementationcapacity and resource availability. 4. Adapt audit systems to decentralizedsystems. 6. Strengthenthe capacityfor sub-nationalfiscal analysis o f both MOFED and regional Bureaus (BOFEDs). 7.Address the special capacity challengesof remote rural woredas. 5.13 A Local-Level Perspective. Recent field studies provide a bottom-up perspective on the extent o f change. These reflect several dimensions, including how the state is experienced in practice by citizens, progress in service provision, the status o f fiscal decentralization and the extent to which the block grant system has altered behaviour at the woreda level. One o fthe critical measures o fthe effectiveness o fthe state at the local level i s better access to, and quality of, basic services. O n this front, aggregate administrative data point to significant and steady improvements for education, health and safe water inrecent years (Table 5.1). 5.14 These official data are usefully complemented by the results o f a pilot Citizens Report Card (CRC) survey fielded in early 2004, which confirms these patterns. The CRC was conducted by the Poverty Action Network o f CSOs in Ethiopia (PANE), and was a pioneering attempt by civil society (with donor support) to engage poor people in an assessment o f service provisioning and quality. Seen inthe larger context o f the need to strengthen empowerment at the local level in Ethiopia, this exercise was an intrinsically important achievement. It also generated valuable information, some of which was incorporated into the government's new Plan for Accelerated and Sustained Development to EndPoverty (PASDEP). 5.15 The CRC surveyed over 3,300 households in Afar, Oromia, SNNPR and Tigray. Across the four regions, for each o f the categories o f water, education, health and agricultural extension, the CRC found both high levels o f satisfaction with the quality of services, and improvements in service quality over the past two years. Table 5.2 shows the percent o f respondents who were completely satisfied with services in each of the areas, and ranks services accordingly. Education scores the highest overall. 158 Table 5.1 Progresson SelectedHumanDevelopmentIndicatorsand Spending onPoverty Sectors, 1995196-2004105 Sector Indicator Years %Change %Change 1995196 1997198 1999100 2004105 200411996 200412000 Education Primary (1-8) Gross Enrolment Rate ("YO) 37.4 52.3 61.1 74.2 98.4 21.4 Literacy Rate (%) 25.8 26.6 29.2 37.9 46.9 29.8 Health U5 Child Immunization Measles ("YO) 39.1 46.9 48.1 56.8 45.3 18.1 BCG (?A) 40.1 50.9 49.1 54.9 49.6 14.4 Water Access to Safe DrinkingWater (%) 19.1 23.7 27.9 35.9 88.0 28.7 Table 5.2 How SectorsMeasureUp (% completely satisfied) Drinking Water 54 4 51 4 38 4 47 4 Health 66 3 56 3 58 2 57 3 Education 72 2 77 1 74 1 75 1 Agricultural Extension 78 1 67 2 52 3 63 2 5.16 The kebele administration played a central role in the lives o f citizens during the time o f the Derg, and recent research confirms that in some respects this continues. The 2005 Participatory Poverty Assessment (PPA) also providesrich insights into governance at the local level (MOFED, forthcoming). While both formal authority and control over authority i s with the woredas, in the lives o f citizens, the kebele administration i s the relevant face o f the state. The PPA asked respondents to rank (by ubiquity, importance, and effectiveness) the relevance o f different local institutions in their lives. O f 70 different institutions that were identified, the kebele consistently rankedinthe top five in both rural and urban settings-and often in the top three-irrespective o f the dimension being considered. In rural settings, woredas did not make the 22 most important institutions inany dimension reported. Inurban settings, municipalities made the top 22 but were consistently near the bottom o f the ranking. Inboth settings, schools generally were rated as the most important local institution. 5.17 For example, kebeles co-ordinate labour contributions to the construction and maintenance o f local infrastructure, summarised inthe PPA as follows: The purpose [of organizing people's social participation] is to harness citizens' energy more effectively towards collective community goals (such as building classrooms, clearing irrigation canals, installingwater pipes etc.). (MOFED, forthcoming, p. 45) 159 5.18 The magnitude o f community contributions through this type o f participation can be large. InAmhara, for example, community contributions of cash, labour and materials amounted to 19 percent o f the total education budget for the region. And in Oromiya, "communities built 2,5 15 new classrooms and rehabilitated another 2,575, constructed 110 new and rehabilitated 1,220 teachers' houses.. . and hired 1,9 17 teachers" (World Bank 2006a, p.79). It has, however, been suggested that some degree o f compulsion underpins participation inthese collective activitie~.'~ 5.19 Another aspect o f control exerted by kebele officials relates to movement: respondents in 8 o f the 31 rural kebele areas surveyed in the PPA reported that kebele officials must be informed o f a journey outside the kebele; in some places permits were provided only if community labour obligations had been met (p.44). In urban areas, registrationwith the kebele i s compulsory and travel out o f the kebele requires an official letter (p.67). 5.20 There has been some significant positive change in terms o f voice and empowerment. Community groups in25 o f the 31rural PPA sites reported that "ordinary citizens were nowadays more able to express their views and opinions freely than was the case five or ten years ago" (p.43). A similar trend was reported for 10 o f the 14 urban sites surveyed. There was little evidence, however, that this increased openness translated into greater responsiveness. Indeed, in 11 rural sites people reported that they feared retribution if they expressed their views too often or too openly (p.44). Similarly, the view in 10 of the 14 urban sites was that responses to complaints were poor or inadequate. "The majority view was summed up by a respondent inDire Dawa: `even a tied dog could be heardbarking'" (p.67). 5.21 As ofthe time o fthe PPA, local politics remainedlargely the domain o fthe ruling party. Respondents inonly 5 o f the 14 urban sites-and only 4 o f the 25 rural sites that provided feedback on the issue-reported that more than one political party was active in their locality. Revealing here is the comment inthe PPA that "the accusation by officials o f beinga member of an opposition political party ifone complained recurred quite often inthe site reports" (p.44). 5.22 The World Bank's 2005 Poverty Assessment noted that rural life in Ethiopia has historically been characterized by remoteness, though this is changing with rapid expansion o f the road network and o f telecommunications (Chapter 4). Nevertheless, most Ethiopians continue to have limited access to information-in particular, only 13 percent o f the rural population owns a radio, which is only a third o f the African average (World Bank 2005b). Severe poverty and vulnerability also tend to disempower, including interms o f limitingpeople's capacity (interms o f time, energy, and resources) to play an active role inthe governance o f their kebele, woreda, and region. 52Thus a January 2006 Ministry o f Capacity Building document, "The Issue of Good Governance inRural Woredu and Kebele" (p.7) asserts that "it is common knowledge that people inthe rural areas are forced to work both on their individual farm plots and on common development undertakings, without being convincedof the necessity and importance ofthe work that should be undertaken.Imposing a penalty is the principal method used in forcing the people to undertake developmental activities." For a review of local power relationshipswhich points to a similar pattern, see Lefort (2005). 160 2) ImplementingFiscalDecentralisation 5.23 A core dimension of the Government's development strategy has been to bring about an equitable distribution of resources and strengthened service delivery via fiscal decentralisation. The key concern i s to reallocate resources to less well off regions and devolve decision-making to the lowest possible levels of government. Funds are transferred to regions in the context of the national Macroeconomic and Fiscal Framework (MEFF), a rolling three-year framework that i s the starting point for determining allocations; the 2006/07-2008/09 MEFF envisioned increasing federal transfers to regions by about 20 percent annually over the period. The Government gives intergovernmental fiscal transfers high priority in the budget, and actual amounts often tend to exceed plans. However, there is a needto better understand the impacts of a fast growing wage bill and the overhead costs of decentralization at the sub-national level, which put pressure on regions' ability to meet pro-poor spendingneeds. 5.24 The devolution o f expenditure responsibilities started in 1993/94 with a big push, when 45 percent of the overall government budget was transferred to the regions. Since then, regional spending has been growing at an annual average of 13 percent. The highpoint of federal spending as a share of total government expenditures (72 percent) was in 1999/00, when the conflict with Eritrea led to cutbacks in regional budgets. Regions are important in implementing pro-poor spending-about half of pro-poor spending that is financed from treasury sources is managed by sub-national administrations. More importantly, regions and woredas are the main service providers and more than 80 percent of recurrentpro-poor spending i s managed at these levels. 5.25 Regional resources come from regional taxes as well as transfers from the federal government, which retains the bulk of the tax base (including foreign trade tax, income tax from incorporated business, and revenuefrom VAT), and currently collects more than 70 percent of total revenue. Regions collect agriculture and urban land use fees, presumptivetaxes on small business, and income tax from the regionalemployees. 5.26 Federal block grants to the regions thus represent the bulk o f regional resources, and are meant to be allocated by the regions themselves based on local priorities. Block grants (mainly from treasury sources) have been growing in importance since 2000, and the total was planned to increase again in 2006/07. Figure 5.1 shows the breakdown of regional resources by origin, excluding Addis Ababa, which is an exception in having substantial own revenue). 161 Figure 5.1 Sourcesof RegionalRevenue: Block Grants vs. Own Revenue-all Regions ExcludingAddis 18,000 16,000 14,000 12,000 a L L 10,000 0 Block Grant Transfer -.-3 8,000 Regional Revenue 6,000 4,000 2,000 0 2004/05 2005/06 2006/07 Source: World Bank 2006g. 5.27 The amount of spending executed by regional administrations increased with the introduction of Specific Purpose Grants (SPGs) in2003 (Figure 5.2), which unlike block grants are tied to certain programs. In the past three years, the size of SPGs increased substantially due to a doubling of spending on food security, and the implementation of the PSCAP andproductive safety net programmes. Figure 5.2 RegionalBudgetswith and without SpecialPurposeGrants (millionsof Birr) 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 2002103 2003104 2004105 2005/06 ERegional Budget DSPG transfer I Source: World Bank 2006g. Additional resources for the regions include community contributions and extra- budgetary sources (such as the Road Fund). Project loans and other forms of external assistance also support capital spending at the regional level. Compositionof Regional Expenditure 5.28 Inline with their functional assignments, the lion's share of regional resources is used for pro-poor sectors including agriculture, natural resources and food security, water, primary and secondary education, and primary health care. However, the 162 overhead costs of decentralization have increased the share of "non-pro-poor" spending inthe past three years, which increasedfrom 30 percentto 40 percent. The composition of spending on basic services versus other sectors is shown inFigure 5.3. 5.29 Trends in regional expenditure depict two important patterns. In the 1990s government emphasized the expansion of facilities and the regions managed about 40 percent of the overall capital budget. Since 2001, regional budgets have focused on running the facilities-recurrent expenditure now accounts for about 80 percent of the regional budget (Table 5.3). The trend has been for regions to manage less capital spending, and regions are now responsible for around 27 percent of total development budgets. Education absorbs the largest share of the regional budget (about 27 percent), and has been growing quickly-capital spending in education, for example, increased more thanfive fold between2002/03 and 2005/06. Figure 5.3 Breakdownof RegionalExpenditure:Basic Servicesvs. Other Sectors- all RegionsExcludingAddis 18,000 16,000 14,000 12,000 L L a 10,000 0 0 Other Sectors .- -$ 8,000 6,000 4,000 2,000 0 2004/05 2005/06 2006/07 Source: MOFED. Table 5.3 The FY 2005/06 Budget Source: MoFED. 163 5-30 Recent analysis shows the continuing efforts to increase sub-national allocations and that the four largest regions have directedthe bulk (about 60 percent) o fthis increase to basic services.53 Moreover, more than three-quarters o f these additional resources were passed down to woredas, where 67 percent o f the extra resources were allocated to basic services. These trends are being reviewed on an ongoing basis under the Joint Budget andAid Review. 5.31 The expansion o f basic services coupled with the devolution o f fiscal powers to lower levels o f government has increased payroll costs. In 2004/05, wages and salaries accounted for a quarter o f government spending, with the regional bill for wages and salaries running four times larger than that o f the federal government. Indeed following the devolution o f fiscal power to the woreda level in2002/03, the wage bill for regional governments jumped 43 percent. Nevertheless, the share o f the wage bill in GDP remains relatively modest at around 6.3 percent in2005/06. Four DecentralizingRegions 5.32 The so-called four decentralizing regions (FDRs) have progressed to the next stage o f decentralization, which involves further devolution o f fiscal powers to the woreda level. The FDRs are home to more than 85 percent o f Ethiopia's population, and each o f them now transfers at least half o f its resources to woredas; so far SNNP transfers the largest share o f regional resources, while Tigray and Oromia have proceeded at a slower pace (Figure 5.4). Intergovernmental fiscal transfers are determined by a formula, which is based on three main variables: population, level o f development, and revenue- raising efforts and sectoral performance. There i s also a revenue sharing mechanism applied to joint revenues, based on a different formula. The FDRs tend to use a formula similar to the federal government's to determine the size o f individual woreda transfers. The SNNP region is more advanced in implementing public finance reforms and i s using a more sophisticated formula which takes into consideration woredas' expenditure obligations and "affordable need." Woredas have full discretion in local sectoral allocations. Inpractice it seems that the actual calculation o f woreda needs i s done at the sectoral level based on selected cost drivers. 53Namely Amhara, Oromiya, SNNPR and Tigray. These regions comprise the bulk of regional spending (86 percentexcludingAddis Ababa) andtheir sectoralspendingdata is morereliable. 164 Tigure 5.4 Block Grants to Woredas (percent of total regional budget) 90 Tigray Amhara Oromia SNNP 1 2 0 0 3 1 2 0 0 4 0 2 0 0 5 Source; MOFED. 5.33 The increased resources in the FDRs have come with much greater power to allocate spending at the woreda level. Prior to 2002, woredas received line-by-line detailed budgets from which they could not deviate to any significant degree. Two studies-one based on field visits to Amhara, Oromia, SNNPR and Tigray in February, 2004 (Heymans and Mussa 2004), the second based on a field visit to four woredas in Tigray (the region which generally has decentralized most rapidly) inlate 2005 (Dom and Mussa 2006)-report on progress on the empowerment o f woredas vis-a-vis regions and zones, and the empowerment o f communities inbudget formulation. 5.34 A recent survey o f Tigray points to progress towards more flexible, bottom-up approaches to budgeting. It found that: The woreda planningprocess gives a key role to the tabia (the Tigrayan name for kebeles). Woreda sector plans are built by disaggregating and re-aggregating sectoral components o f the tabia plans-emphasising the notion o f integrated development o f the woreda as a whole. Communities participate in the planning process via identification o f priorities with tabia sector agents and discussion of the tabia draft plan before it is sent to the woreda. Differences across woredas in their priorities were reflected in relative budget allocations to, for example, agriculture, schools and capital spending. ChallengestoImplementing Fiscal Decentralization 5.35 Rapid progress has been made on fiscal decentralization, and the experience o f SNNP in particular suggests that the block grant transfer system from the region to woredas has made progress both inimprovingequity inresource sharing across woredas, as well as improved efficiency in service delivery. However, given the scale o f change needed to fully implement the vision o f fiscal decentralization, it is unsurprising that significant challenges remain inseveral areas, as discussed below. 165 5.36 First, while a three year indicative planning figure is provided to the Regional Governments in the MEFF, the predictability of transfers from the centre to the regions and from the regional levelto woredas could be strengthened. 5.37 Second, resources-while growing-are limited. Regional spending in nominal terms has been growing at about the pace of inflation, which seems to be inadequate given the regions' responsibility for improving access to and quality of public services. In considering the impact of the 2002 decentralization, it is important to keep in mind quite how small-given Ethiopia's low income levels-are the amounts involved. The 2004 study examined twelve local governments: three municipalities; three peri-urban woredas; and three remote rural woredas. The total (capital plus recurrent, including salaries) 2002/03 budgeted expenditures of each woreda ranged from highs of about US$3 million (inthree o f the woredas), to lows of about US$600,000 (amounting in the rural Boset woreda in Oromia to less than US$5 per capita per annum). Inpractice, the bulk of expenditure allocations go to cover salaries of teachers, health workers and local officials. While there i s some variation, in general, recurrent spending on health and education alone amounts to about 60 percent of the total woreda budget. The obvious risk in this context is of under-spending on development, and on operations and maintenance. 5.38 Third, institutional capacity issues are apparent, including skill shortages (accountancy and management), lack of equipment and inadequate infrastructure. There have been delays in financial reporting by woredas, which are attributed largely to capacity constraints (though recent improvements are noted-see below). The absence of a strong data base and background analysis to estimate the appropriate recurrent to capital ratios and to help determine service delivery standards also make implementation of the decentralization framework more difficult. 5.39 Fourth, while the Ministry of Capacity Building has provided general prescriptions on the basic organizational structures for woredas, these imply a massive expansion in the number of departments, staff and thus wage bills (Srivastava 2005), which in turn imply risk that woreda resources will disproportionately go to overhead- type activities, at the expense of front-line service provision. Salaries are set centrally, although there is evidence of regional variation inresponding to staffing needs. 5.40 The Oromiya Health Bureau illustrates the constraints faced at the regional level. Staffing poses a key challenge-for example, only two out of six positions in the office of the head of the regional health bureau have been filled. While there were staff shortages before decentralization, there are now higher standards, but limited budgets. Providing adequatepay and incentives to compete with the private andNGO/donor sector i s a major challenge vis-a-vis professional staff. The example of the health sector in Boset illustrates some o f the challenges faced (Box 5.2). 166 Box 5.2 Healthcare in Bosat: A Major Service Challenge The Health Office in Bosat has tried various means to meet its challenges, in the face of severe budget constraints. With a population exceeding 135,000 and an area o f over 1,500 square km, there are only 3 nurses; 1health officer; 9 health assistants; 1junior public nurse; 2 junior clinical nurses; and 1 druggist. The organizational structures require a doctor, but the only doctor left for Addis. Its facilities are equally limited. In this context, the local health authority has spent considerable effort on building relations with local and international donors, especially to assist the woreda inobtaining drugs, and has been able to mobilize additional support from the Region, over and above the block grant allocation. Yource: HeymansandMussa2005. 5.41 Infact, humanresource constraints at the regional and woreda levels are part of a larger national issue; according to Mussa (2005): Significantpercentages of civil service positions are vacant at all levels. Staff turnover and lack of institutional memories are serious concerns for the civil service, which adversely affect service delivery, especially at woreda level... Themajor reasons for staffturnover are poor salary scales and non-salary benefitswithin the civil service, and better benefitsinthe market.The parastatals,private sector and NGOs are better employers who are competing for qualified personnel with the civil service. (p.10) 5.42 For example, the private sector pays teachers as much as 8 times more than the public sector. Emigration from Ethiopia is also a factor in brain drain from the civil service among the most highly skilled, who can earn a higher premium elsewhere. The decompression ratio in Ethiopia-i.e. the differential between wages for low versus high skilled workers-is 1:5 in Ethiopia, compared to 1:19 in Uganda (Mussa 2005). On the other hand, while the situation may seem to call for across-the-board decompression and rationalization strategies, such approaches have been increasingly criticized across Africa. The current trend based on international experience i s to disaggregate pay and employment reforms and sequence sectorally (agency-by-agency) and/or by cadre (i.e., creating a senior executive service) (World Bank 2006b). 5.43 The recent labour market study (World Bank 2006b), which provides a more comprehensive review o f brain drain issues inthe civil service, notes that there is intense demand for professionals with a qualification level o f MSc (plus 5-15 years o f experience), who constitute about 5 percent o f the total civil service employment in economics, management, public health and others depending on the specific demand o f the employers. It suggests that civil service reforms, together with new ways o f managing human resources, including performance evaluation and more accurate (and less inflated) definitions o f grades and tasks, will be needed to meet the challenges ahead. 3) Empowerment through Information: Benchmarking Institutional Change and ResourceManagement 5.44 New approaches to the transparent use of information as a tool for strengthening the performance o f local governance systems are directly related to Ethiopia's progress on decentralization and supporting programs such as PSCAP. The section motivates the focus on monitoring governance, highlights some new tools for such monitoring and 167 suggests some specific ways in which such monitoring could help strengthen accountability. 5.45 In recent years, recognition has grown exponentially as to the importance of results-based monitoring for development-including for efforts at institutional reform. Consistent with this, the Government and development partners have given monitoring a high priority in their support for decentralization reforms-indeed, the quality and quantity ofrecent activities puts Ethiopiaat the frontier o fgood practice inthis area. 5.46 Benchmarking and monitoring trends in service provision and the quality o f public institutions can be a powerful tool for furthering the government's objective o f strengthening accountability. In settings where a culture o f bottom-up accountability is well-established, the day-to-day experience o f interactions between citizens and the state can be a strong basis for feedback on performance. Since such processes are not yet well established in Ethiopia, explicit, transparent, formal monitoring i s both an important substitute and a signal to citizens that public officials are held accountable for their performance. Hence a commitment to monitoring has been central to the design and implementation o f Ethiopia's innovative PSCAP, as well as to the Protection o f Basic Services operation, which is supported by several key partners. 5.47 Monitoring can be especially useful for the type o f reforms being attempted in Ethiopia. Since the number o f local authorities i s very large (over 600 woredas, and more than 100 municipalities), benchmarking and monitoring are key to enabling federal and regional authorities to exercise their constitutional oversight responsibilities. Conditional, performance-based grants could be an important part o f the array o f fiscal tools to support good local governance, but can only be used effectively when local- government-specific benchmarks o f performance are available on a regular basis. Publicly available information on comparative performance across localities can also provide a powerful spur for competition to improve services. Each o f these uses o f benchmarking and monitoring information i s considered further below. 5.48 A broader reason for the strong recent focus on monitoring and benchmarking performance-not specific to Ethiopia-relates to the architecture of mutual accountability. As the 2006 Global Monitoring Report spelled out, donors are expected to commit to scaling up resource flows to developing countries while recipient countries commit to ensuring that aid i s used effectively toward reaching the MDGs, and that corruption i s contained. Monitoring helps provide assurance that resources are being well used, not squandered or misappropriated, and that governance systems are improving. Benchmarking institutional performance at the outset o f a reform program, and monitoring trends can signal whether trends are on track-or have stalled or gone into reverse (see Part I). Assessingpublicfinancial management 5.49 Monitoring public financial management i s a highly informative way to benchmark certain aspects o f governance. The budget i s a key instrument of public policy, and how this i s prepared, implemented and monitored can be measured in objective ways that can also be compared across regions and countries, as well as over 168 time. InEthiopia, recent studies offer a rich base of information for analysis, including a local benchmarking survey, a fiduciary assessment of regional (and federal) government, and a Public Finance Review conducted by the World Bank in cooperation with Government and development partners. Some key results are discussedbelow. 5.50 Public financial management issues have become central to the global aid architecture. While improving the quality of financial management was already a stated priority of the Government, it is also highlighted inthe World Bank's new strategy paper entitled"Strengthening Bank Group Engagement on Governance and Anti-Corr~ption."~~ The strategy underlinesthe importance of monitoring results, which inter alia will entail "giving greater emphasis to developing and using specific actionable governance indicators (for example, on public expenditure and financial accountability-PEFA)." It also notes the useful role that public financial management monitoring has played inthe HIPC debt reduction process. 5.51 Assessments in Ethiopia have generally underlined the relative strength of the country's public financial management systems, certainly relative to the level of per capita income. At the same time, recent challenges include ensuring aggregate fiscal discipline, enhancing the realism of the budget as well as strengthening capacity at lower levels in an increasingly decentralized system. Inthe mediumto long term, as discussed in Part I,the tension between the desire to scale-up for the MDGs and increasing uncertainty inthe availability o f resources calls for careful planning and management of the macroeconomic and fiscal framework. 5.52 At the federal level, since 2004, MOFED has conducted its budgeting cycle in compliance with the financial calendar, issuing the Macroeconomic and Fiscal Framework and indicative planning figures to sub-national levels to enable integrated and more transparent medium-term planning. The budget classification system is comprehensive; however there are some extra-budgetary funds and there i s no analysis of contingent liabilities. Some deficiencies in budget monitoring and control persist, particularly in reference to releasing up-to-date figures for sub-national levels, although lags have been significantly reduced. More generally there have been significant improvements in financial reporting at all levels, which has been reviewed inthe context of the JBAR dialogue. 5.53 Recent trends show some in-year variation betweenthe original budget and actual spending, and although overall end-year outturns tend to be close to plan, the record i s worse for capital spending. Spending financed from domestic resources is more predictable than the total budget, which also relies on various external sources. The PEFA found that budget variability at the functional level exceeded 10 percent, and budget volatility is more of an issue at the regional than the federal level. For regional capital spending in particular, the problem of budget predictability i s severe. The gap between budgeted and actual capital spending (from treasury sources) has been slowly declining, but is still a sizeable 60 percent. 54Available at: http://www.worldbank.org/html/extdr/comments/governancefeedbac~gacpaper.pdf 169 5.54 PSCAP requiredthat four rounds of benchmarking of the institutional capacities of woredas and municipalities be completed over the life of the program. After pre- testing, a first round of benchmarking was undertakenin 2005, inwhich 23 woredas and 17 municipalities (all from the four major regions) were benchmarked (GTZ 2005). The benchmarking is organized around 16 measures, listed in Table 5.4, which fall into four broad groups: public finance management, human resource management practices, transparency and community participation and quality of service provision. Table 5.4 Monitoring Ethiopia's Woredas and Municipalities-The Indicators Variations between budgeted and actual expenditure Salary expenditure against total expenditure Own revenue as Dercentane o f actual exDenditure II Increase in own taxedfees and service charges Budnet utilization caDacitv as measured bv actual revenue and exnenditure II Capital budget against total budget Existence, transparency and inclusiveness o f woredas/municipality strategic plan Efficiency and comprehensiveness o f Accounting and Auditingprocedures Enhancement o f existing taxpayer base and efficiency o f tax collection Appropriateness o f staff level (vacancy rate) Compliance with modern human resource approach I Community Consultation and information access level by the public and stakeholders empowerment and participation in local government and service delivery Level o f access to basic services Agricultural services availability to majority o f farmers (woreda only) Cost o f salary against agricultural land use (woreda only) Populationcoverage o f solid waste (municipal only) Cost o f salary against solid waste (municipal only) Source: PSCAP; GTZ (2005) provides detailed scores, andbackground data. 5.55 Highly disaggregated woreda-specific information goes into scoring the five qualitative measures (see Annex 5.1; similar data i s available for municipalities in GTZ (2005)). Emerging patterns include: Almost all woredas and municipalities base their budgets on strategic plans (and two-thirds prepare multi-year revenue and expenditure forecasts), and prepare and distributeannual reports after closing their accounts; Accounting and auditing standards vary widely, with those in Oromia generally weaker (the gap seems larger inruralthanurbansettings); Over half the surveyed woredas and municipalities use modern approaches to human resource management, including written job descriptions with performance indicators, and regular performance appraisals of employees-again Oromia lags inrural, but not urbanlocalities; and A large majority of woredas and municipalities consults with communities in formulating their strategic plans and budgets-most consistently with kebeles, but commonly also with citizens, business associations, women's associations and NGOsKBOs. 170 5.56 Moving from the woreddmunicipal to the regional level, the principal focus o f benchmarking has been on the quality of fiduciary systems-reported in the joint Government/DFID Fiduciary Assessment (August 2005), which is one o f two complementary exercises to benchmark the federal and regional fiduciary systems using the monitoring framework known as the PEFA. The PEFA comprises 28 indicators (scored on an A-C scale55)organized around six facets o f a country's fiduciary system: 1. Policy-based budgeting-the process for translating public policies, including policies that emerge from a PRS process, into specific budgeted expenditures; 2. Arrangements for predictability, control, and stewardship in the use o f public funds (for example, payrollandprocurementsystems); 3. Systems o f accounting and recordkeeping to provide information for proper management and accountability; 4. External audit and other mechanisms that ensure external scrutiny o f the executive (for example, by Parliament); 5. Comprehensiveness o f budget coverage and transparency o f fiscal and budget information, which cut across the above four facets; and 6. Budget credibility-that the budget i s realistic and implemented as intended-a result o f the operation o f the whole cycle. 5.57 The 2005 assessment covered fourteen indicators, focusing principally on the 2nd, 3rd, and 4th facets; noting that the other indicators are to be benchmarked as part o f the JBAR process (a PEFA cycle was currently underway at the time o f writing and i s expected to be completed inspring 2007). 5.58 Table 5.5 details the PEFA results for the Federal government. Several points are worth highlighting: Payroll control emerges as a strength, which i s also true o f the four decentralizing regions (Tigray, SNNP, Amhara, and Oromia also scored A's on payroll controls); The fiduciary system i s strongest at the federal level, but exhibits major weaknesses, and little momentum for continuing improvement since 2002. Tigray and SNNP are exceptions where rapid improvements in fiduciary systems have been achieved since 2002. As o f 2004, Tigray's system was assessed as more or less on a par with that at the Federal level, whereas SNNP still had a way to go; The fiduciary systems inAmhara and Oromia functioned at a level close to that o f their federal counterpart. Amhara's system has witnessed steady improvements since 2002; Oromia's system, though initially the stronger o f the two, showed less momentum; and The systems were substantially weaker in the remaining regions (Addis Ababa, Benishangul-Gumuz, and Somali)-with Somali's the weakest o f all, and showing no signs o f improvement. 55The criteria for scoring the 28 indicators on an A-C scale are available at www.pefa.org. 171 5.59 The overall picture i s one o f diversity: a solid base o f capacity at the federal level and in some regions; more momentum for improvement in some settings than in others; and some regions where capacity remains very weak. As with the woreddcity benchmarking exercise, the richness o f the results-and their value in helping clarify priorities going forward-highlight the importance o f continuing this monitoring on an ongoing basis. Some of this work i s being carried forward through the JBAR, which has already noted improvements in some aspects of financial management as o f October, 2006-for example, in the quality, coverage and timeliness o f fiscal data required under the auspices o f the Protecting Basic Services operation (see Part I,Chapter 6). There have also been improvements in transparency at the woreda level, most o f which have publicly proclaimed their budgets for fiscal year 2006/07. Table 5.5 BenchmarkingEthiopia's PublicFinancialManagementwith PEFA (results for federallevelshown) INDICATOR RATING 2004 Forward INDICATOR RATING Forward (2002 in momentum 2004 momentum brackets) (2002) Publication and tt Clarity & t accessibility o f key enforceability of information and audit procurement rules, reports & the extent to which they promote competition & transparency Legislative scrutiny o f tt Timeliness and tt the annual budget law regularity o f data collection Effectiveness o f cash c) Timeliness, quality tt flow planning, anddissemination o f management and in-year budget reports monitoring Evidence that budgeted tt Timeliness o f the resourcesreach spending presentation o f units in a timely and audited financial transparent manner statements to the legislature Effectiveness o f internal t The scope and nature t controls o f external audit Effectiveness o f internal c) Audit reports are audit acted on by the executive Effectiveness o f payroll c) Legislative scrutiny 1 controls o f external audit reDorts 172 How Performance Monitoring Can Enhance Local Accountability 5.60 While the generation and public provision o f information on local governance performance i s new in Ethiopia, over the past decade there has been substantial experience in other parts o f the world. These experiences point to three distinct ways in which such information mightbe used to strengthen local-level accountability. 5.61 Benchmarking the performance o f local agencies can enable citizens to put pressure on poorer performers to improve: the most direct form o f pressure i s electoral, though reputational concerns might also have an influence. The example o f Bangalore, India illustrates (Box 5.3). The Bangalore example has been widely emulated-in countries ranging from Brazilto the Philippines, Ukraine and Turkey. Indeed, Ethiopia's pilot Citizens Report Card was implemented with the support o f the Bangalore Public Affairs Centre-and one of the social accountability pilots in the Protection o f Basic Services operation aims to complement the production o f the requisite information with its dissemination to groups within civil society. 5.62 A second approach to usingbenchmarking data is more administrative innature- namely to enable upper tiers o f government (regions, for example) to monitor and hold lower tiers accountable for performance (including via future allocations o f performance- linked budgets). Tanzania introduced performance agreements in 2000 which were linked explicitly to public commitments to service delivery standards by individual agencies. It did this via the use of client service charters-ach charter specifies standards o f service delivery ina set o f commitments by the provider andprovides rights o f redress to users if these standards are not met. Each year, the Presidential Office o f Public Service Management undertakes an annual service delivery survey which covers all providers with charters, and makes the results publicly available on its website; the government has encouraged civil society organizations to use the results to pressure for improved performance. It remains too early to tell, though, what impact the initiative i s having on performance. 5.63 Within Ethiopia, there are a number o f initiatives underway which aim to use performance agreements to improve the performance o f public agencies. These include the service provision improvement program which was piloted as part o f the Civil Service Reform Program and now i s part o f PSCAP. A pioneering sub-national example i s the performance agreements between the SNNP government BOFED and its woredas which were reached in 2005. The focus o f each o f these initiatives has been largely on administrative, hierarchical accountability. None has gone as far as Tanzania's, however, in using performance agreements as a spur to civic engagement and bottom-up accountability. 173 Box 5.3 CitizenReportCards inBangalore Frustrated by years of inaction on public services which increasingly were unable to keep up with Bangalore's dynamism andpopulationpressure,in 1994 a group of citizens introduced the ideaof a user survey-based "report card" on public services. Initially, the impact was modest. Althoughas the pioneer o f the initiativeput it (Paul 2002): "It is unrealistic to expect public agencies to respondimmediately and directly to the signals givenby a report card. Agency leadersneedthe time andcapacity to internalize the messages ofthe report card and design interventionsto address the issuesraised.Civil society institutions also needtime andresources to get organizedandplanstrategiesto interact with service providers." The sponsors persisted, establishingan NGO, the Bangalore Public Affairs Centre, to institutionalizethe effort, buildingcoalitions with other NGOs and repeatingthe report card survey in 1999 and 2003. The figure highlightsthe extraordinaryturnaroundinperceptionsofthe qualityof servicedelivery. The Public Affairs Centre describes how this was achieved: `` The first and second report cards had put the city's public agencies under the scanner. The adverse publicity they received, according to many observers, acted as a trigger for corrective action. Inter-agency comparisons seem to have acted as a proxy for competition. Citizen activism and dialogues with the agencies also increased during this early period. These developments prepared the ground for a positive response from the Government. The Chief Ministerprovidedthe framework within which a set of able administratorscould set in motiona series of actions and reforms in the agencies. Many civil society groups and the media have stimulated and supported this momentum. Sustaining this movement is the challenge for the future." O v e r a l l S a t i s f a c t i o n a c r o s s T h r e m R e p o r t C a r d s 0 e n e r a I H o u s e h o I d s 1 0 0 9 4 9 6 8 0 1 60 9 I 4 0 ae 2 0 0 Legend:BMP, BangaloreMunicipalCorporation; BESCOM, electricity; BWSSB, water supply; BSNL, TelecomDepartment;BDA, LandDevelopmentAuthority; BMTC, MetropolitanTransport Corporation; RTO, Motor Vehicle Licensing. 5.64 A third approach to using front-line performance data is to engage citizens directly in the oversight of how public resources are used at the local level. Examples from Uganda, India, the Philippines and Tanzania illustrate (Scott 2006 and World Bank 20060. 5.65 Uganda's Public Expenditure Tracking Study and its aftermath i s a well-known example: following an initial study which showed that only 13 percent of the non-wage funds allocated to schools actually reached their intended destination, the Ministry of Finance began to transfer these funds directly to schools-and publicized figures on the transfer of funds to local authorities in the newspapers and on the radio. Each primary school was obliged to post publicly details of the funds which it had been designated- thereby enabling parents associations to follow up. 174 5.66 InRajasthan, India, building on the passage o f a Right to Information Act inthe state in 2001, the Movement for the Rights of Peasants and Workers (MKSS) organized public hearings inrural areas at which figures from the records o f licensed distributors o f subsidized food rations were compared with figures from the ration books o f recipients. Social audits were also carried out o f hospitals during which data from medical records were compared with patients' actual experience. In both cases, large discrepancies between the two sets o f figures were revealed. This led to further investigation, which in turndisclosed evidence ofcorruption, embezzlement, andmaladmini~tration.~~ 5.67 A Philippines civil society organization (CSO), the Ateneo University Group, set up a citizen monitoring effort, together with government agencies responsible for textbook distribution and highway infrastructure, to make delivery more effective. The project determined that 21 percent o f textbooks were not actually delivered to schools designated to receive them, creating losses o f more than US$3 million, which the Department o f Education promised to rectify. The template developed for this project has been used by many other CSOs. 5.68 InTanzania, the Rural Initiatives and ReliefAgency helped 10 local communities track government program expenditures for health and education. The pilot projects appear to have helped ensure that commitments to deliver funds were indeed followed through. The expenditure tracking tool has been made available to CSOs in other rural areas o f the country. 5.69 Each o f these examples requires data which focus on performance closer to the day-to-day activities o f government than the benchmarking exercises described earlier; the Protection o f Basic Services operation for Ethiopia (see Part I,Chapter 6) includes provisions aimed at making these data (especially vis-a-vis budget transfers to local levels) publicly available. Note also that the effectiveness o f each o f these examples depends on the presence o f civil society organizations (parents groups at schools, other types o f user associations, civil society advocacy organizations, or local community groups) which are both independent o f government and with sufficient confidence as to their rights (and their protection) to make them willing to advocate openly for redress in the face o fnon-performance by public officials. 5.70 Given the critical role o f information in strengthening accountability and improving governance, it follows that benchmarking data and other kinds o f information must not only be produced, but must also be disseminated broadly to the public. To this end a robust and independent media is indispensable. By facilitating a two-way information flow, the media provides a mechanism for performance data to reach citizens, and for citizens' concerns to reach government. Laws providing for the right to information and freedom o f the press, particularly local press in local languages, can provide the enabling environment for the emergence o f informed citizen action and proactive engagement with the state. As more authority is devolved to local government, having access to independently sourced information at the local level becomes more '`For information on the MKSS, visit httr,:llwww.fieedominfo.org/ Press coverage of MKSS activities has beenextensive. 175 important, and enhances the credibility and legitimacy o f government as perceived by the citizenry. Enabling the media to reach its full potential as an agent for development in Ethiopia impliesthe need to strengthenpublic infrastructure (e.g. intelecommunications), continue the strong efforts to increase literacy, and facilitate asset accumulation (e.g. o f radios) at the household level via economic growth. Increasing media capacity and outreach will also be important, including by improvements to the legislative framework and by guaranteeing freedom o fthe press. Conclusions 5.71 Ethiopia's post-1991 embrace of decentralization demonstrates an effort to move toward a more development-friendly set o f institutional arrangements than existedbefore inEthiopia. Ethiopian governance had historically been a top-down matter, an affair of rulers and their subjects. The 1994 constitution sought to transform the relationships around authority and accountability by establishing a broadly legitimate social order characterized by bottom-up democratic accountability o f the state to its citizens. 5.72 A central goal o f this chapter has been to assess-from a local governance and service provision perspective-progress in this transformation from discretionary top- down authority, to an agenda o f broad-based development, underpinned by bottom-up accountability. Unsurprisingly, in the light o f both the deeply-rooted historical pattern and the events around the 2005 elections, the view is somewhat mixed. There have indeed been profound changes in formal institutions, implemented with determined political commitment. And the associated gains over the past decade in service provision have been remarkable. But change takes time, and elements o f a top-down hierarchical political culture seem to persist, with implications for economic and social development. 5.73 Against this backdrop, we have argued that benchmarking and monitoring performance are especially vital inorder to: 0 provide the necessary informational base for bottom-up accountability to be an effective buttress o f broad-based development; 0 signal continuing commitment by the Government to be held accountable for performance; and 0 to strengthen accountability not only to the relationship between government and its citizens, but also to the relationship between government and donors-part o f the `mutual accountability' bargain associated with the new global architecture for aid. 5.74 Following through on the excellent initial work on benchmarking with ongoing monitoring-and assuring widespread, citizen-friendly dissemination o f the results-is thus vital. Inthe short-term, the combination o fthe accountability built into the new aid architecture (Part I,Chapter 6), and a continuing commitment by government to be held accountable for performance plausibly could provide a basis for poverty reduction. But if development i s to be sustainable, the incentives for performance need to be built into a country's domestic institutions: there i s no substitute for bottom-up accountability o f government to its citizens. 176 5.75 The effectiveness of `bottom-up' accountability depends, inturn, on the extent to which the social and political order is perceived broadly to be legitimate. Opening up nationally helps facilitate more engagement locally, which in turn can help deepen a sense of legitimacy o f the political order more broadly. What happens locally and what happens nationally are likely to be mutually reinforcing-and creating a virtuous circle of accountability will, in turn, help accelerate economic growth and poverty reduction writ large. 177 Annex 5.1 Woreda BenchmarkingTables Table A5 LocalSub-indicators of FinancialManagement I1 IHave FM strategic Plan I 100 I 100 I 80 I 83 I 91.3 I 2 Use ICT support for accounting 33 17 20 33 26.1 Regular reconciliation o f fiscal and bank records 83 50 60 67 65.2 4 Do not have bad credits inthe book 67 67 100 67 74.0 5 Use asset demeciation 50 17 20 17 26.1 6 Do not have backlogs larger than one year 17 50 80 33 47.8 1 I I 1 I I 7 Prepare regularly standardized audit reports 50 33 60 67 52.2 Recordprocurement decision making for auditability 83 67 100 83 82.6 9 Completed Internal audit for last fiscal year 83 33 20 50 47.8 10 External audit reDorts not older than two vears 83 50 60 50 60.9 Source: GTZ 2005. Table A6 Sub-indicators of HumanResourceManagement 2 Performance indicators for alljobs 50 50 40 100 61 3 WrittenHRpolicy handed out to staff 67 17 40 50 43 4 Regular performance appraisal o f employees 83 17 100 50 61 178 Table A7 Sub-indicatorsof Transparency and CommunityParticipation 2 Annual Reports 100 83 60 83 81.5 3 Audit Reports 33 83 0 52 42 4 Strategic Plan 100 83 100 96 94.75 5 Tax Assessment 50 67 20 57 48.5 2 PreparingBudgets 50 83 40 50 56 3 Introducing change in service delivery 83 67 40 67 64 Regional Average of Community Cons. (YO) 77.7 83.3 53.3 66.7 70.3 I II Citizens 2 Business Community 67 83 20 33 52 3 Women's Associations 67 100 20 50 61 4 NGOs and CBOs 50 67 60 17 48 5 Disadvantaged People 17 0 0 0 4 6 Kebeles 83 100 80 100 91 I 7 Regional Government Agencies I I 50 I 67 I 60 I 83 I 65 I I 8 IFederal Government Agencies I o I o I o 1 5 0 1 13 I Community participations and decisions I I I 1 I I are written down and made public 67 83 60 67 70 2 Results of community participation is reportedto council members 100 100 60 83 87 I I I I I I Source: GTZ 2005. 179 180 REFERENCES Amen, Chris T. 2001. "Promotion of Small-scale IrrigationinFoodInsecure Woredas of Ethiopia." Sept. 2001 Draft. World Bank. Ariga, Joshua, T. S. Jayne, and J. Nyoro. 2006. "Factors Driving the Growth inFertilizer Consumption in Kenya, 1990-2005: Sustaining the Momentum in Kenya and Lessons for Broader Replicability in Sub-Saharan Africa". Tegemeo Institute of Agricultural Policy and Development, Working Paper 24/2006. 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