Ethiopia: The Benefits and Challenges of a Foreign Direct Investment Intensive Economy in Africa Background: During the mid 20th century, China ranked near the lowest in the world in Gross National Income (GNI) per capita. Although the country demonstrated strong ability to attract financial investments, its planned economy system rejected market mechanisms and so lacked the necessary conditions for efficient resource allocation and work incentives. During this planning period, the Chinese economy was almost entirely isolated from the rest of the world economy. From 18-22 December 1978, the eleventh Central Committee of the Communist Party of China (CPC) held a meeting that laid the foundation for reform and opening-up in China through its decision to shift the focus from political movement to economic development. Gradually, China began introducing profit-based incentives for businesses and transforming roles of central and local governments from "direct involvement in economic activities to promoting equity and broadly based development through providing basic public services" (Link). Its opening up to the international economy paired with domestic reform has allowed Chinese enterprises to adopt more competitive and advanced technologies due to new exposure to world-class competition. Through globalization and movement away from the planned economy, China has grown to become one of the largest economies in the world. Modern Ethiopia's economic history can be divided into three parts beginning with the end of Italian occupation in 1941. Under the autocratic rule of Emperor Haile Selassie I (who reigned from 1930-1974), the Ethiopian economy heavily relied on agricultural production which resembled a feudal system as land ownership was highly inequitable. The marginal amounts of industry that did exist were concentrated among foreign owners. Following the 1974 coup by a council of soldiers referred to as the Derg (literally, "the committee"), the country's economy shifted towards a command economy where the private sector's role diminished and the government's role in the economy increased. This regime introduced the nationalization of land in rural and urban areas, extra houses, major enterprises in manufacturing industries, banks, and more amidst a context of heightened violence and civil conflict. Agricultural policy in Ethiopia was directed to state and cooperative farms which thrived with the favorable weather conditions of the 1970s as well as a reduction in civil conflict. The 1980s were defined by severe drought, killing an estimated one million people and necessitating an expensive program of counter-famine spending including a violently imposed forced resettlement campaign. The government's strict control over the economy and prices left the private sector and individuals with no incentive to save or invest, discouraging foreign direct investment, consumer savings and investment, and eventually stagnating the economy. In 1991, a coalition of opposition movements called the Ethiopian People's Revolutionary Democratic Front (EPDRF) brought an end to the Derg regime. The Transition Government of Ethiopia was formed and assumed authority until 2018, moving the country from its previous planned economy towards a more privatized one. The EPDRF emphasized deregulation of the economy, stimulation of private sector development and privatization of public enterprises. Currently, Ethiopia has adopted a labor intensive, export-oriented, agricultural-led industrial development strategy. These reforms have helped attract more FDI that has propelled economic growth in Ethiopia. Sino-Ethiopian relations began in 1988, when the signing of the Sino-Ethiopian Agreement for Economic and Technological Cooperation led to the Chinese extending a loan of $15 million for the construction of a national stadium and ring road in Addis Ababa, the capital of Ethiopia. The China-Ethiopia Joint Commission was formed in 1998 to "review and assess the bilateral relations every two years and recommend measures that would contribute to their further consolidation" (Link). China's presence in Ethiopia became even more prominent as China became their major trading partner in 2005, and Chinese language training centers were established in Ethiopia. Situation: In 1999, the government of the People's Republic of China initiated the Go Out Policy (), a concerted effort to support Chinese companies in emerging international markets. A part of this plan was to expand Chinese Foreign Direct Investment (FDI), with a focus on the manufacturing sectors of countries with cheap labor. As a developing country and a close ally of China, Ethiopia was a clear candidate for Chinese FDI, which in 2000 led to the first of China's investments to Ethiopia. As identified by the World Bank in 2012, the four principle drivers of Chinese FDI in Ethiopia are (link): 1. Taking advantage of existing Chinese entrepreneurial networks that have understood the investment climate for decades 2. Taking advantage of the perceived opportunities provided by the current state of Ethiopian economy including its cheap labor, limited market competition, and market potential 3. Maximizing cross-border investment incentives provided by the Ethiopian and Chinese governments 4. Having the Chinese parent companies of firms in Ethiopia move entirely to Ethiopia to take advantage of its relatively stable political environment By 2019, 1,130 companies from China were registered as operating in Ethiopia. In comparison, the next three foreign countries with the largest presence in Ethiopia were India (325), Sudan (280) and the United States (216). The Chinese firms operated with an estimated investment capital of US $3.7 billion, resulting in 77,187 temporary jobs and 133,843 permanent jobs. The Ethiopian economy has been among the fastest growing in the world with an average of 9.5% annualized growth in real GDP for the 15-year period leading up to 2019. Much of this growth has been attributed to capital accumulation and the variety of public infrastructure projects which comprise much of Chinese FDI, alongn with manufacturing and water well drilling, real estate projects, and more. This period of growth has been marked by a 12.2% increase in manufacturing output, 8.8% increases in service output, and a 3.5% increase in agricultural output. As a result of these increases, the Ethiopian economy can be broken down into the following three sectors: 35.45% agriculture 36.81% services 28.41% industry (which includes manufacturing) Complication: Foreign Direct Investment projects can be challenging for a number of economic factors. As the World Bank outlines, the following six factors challenge China's FDI projects in Ethiopia (link): 1. While Chinese firms in Ethiopia heavily rely on imported supplies and materials, current trade regulations are not efficient enough to facilitate speedy customs clearance, leaving import-reliant Chinese manufacturing companies bottlenecked by limited supply 2. Perceived foreign exchange rate risks deter investment plans and increase worries from manufacturing/labor intensive firms that rely heavily on imported supplies 3. Tax law and administrative inconsistencies muddle perceived future cash flows and present an obstacle to doing business in Ethiopia 4. Lack of quality labor education among Ethiopian employees impedes productivity and skill transfer 5. Insufficient local access to finance 6. Government regulation affects business efficiency, as a significant portion of senior management time is spent on government relations While Ethiopia is one of the fastest growing economies in the world, it is still one of the poorest with a per capita gross national income of USD $890. (Link). The challenge of raising these incomes conflicts with a growing workforce (2 million more participants per year) and an underdeveloped private sector that has a diminished ability to create jobs as a result of the business climate and competitiveness (Link). While Ethiopia's remarkable economic growth over the past 15 years has "resulted in positive trends in poverty reduction in both urban and rural areas," the World Bank reports that "gains [in human development] are modest when compared to other countries that saw fast growth" (Link), reflecting the unequal distribution of these gain; indeed, inequality has only increased in this period. Many studies have outlined that in order for Foreign Direct Investment to translate into economic development for the host country, there are a few prerequisites that the economy must meet. For example: 1. A certain level of development must be achieved to enable host countries to utilize the new technology that investments will bring about-Blomstromet al. (1992) 2. The effects of FDI on the host country's economic growth will be dependent on the size and educational level of its labor force-Borenszten et al. (1998) 3. The quality of a host country's institutions play a sizable role in determining whether the effects of FDI are positive or negative-Slesmanet al. (2015) With this in mind, it is important for Ethiopia to meet all the preliminary thresholds for FDI spillover (absorption) in order to translate the Chinese direct investments into not only GDP growth, but poverty-reducing developments. Currently, the Ethiopian economy is not sustainable. A large part of its economic growth was led by public infrastructure investments. However, many occurrences such as heightened political instability due to conflicts within the country have slowed down the government's plans for reform and constrained access to international financing. As Ethiopia's ability to borrow decreases and its inflation balloons, Ethiopia's potential to attract FDI may stagnate. Moreover, Ethiopia's large reliance on imports have increased its trade deficit over the years, which the government is attempting to control by suppressing imports and implementing macroeconomic policy reforms. The combination of Ethiopia's large trade deficit and the limited ability to convert the currency may put downward pressure on the Ethiopian Birr if it loses its inflow of FDI. As it stands, according to the 2019 Homegrown Economic Reform Agenda, improvements to human capital in Ethiopia were made over the course of a 13-year period (Figure 1), but issues related to poverty and per capita GDP remain a challenge (Figure 2). Decision: In 2019, the Ethiopian Government developed a "Home-Grown Economic Reform Agenda" designed to promote sustainable and inclusive growth in Ethiopia and eliminate macroeconomic imbalances. The IMF has approved a program of nearly $3 billion in support of Ethiopia's transition from a public sector-led model to an economy that is driven by the private sector. As part of their agenda, Ethiopia has goals to reform its financial sector, bring inflation down to single digits, address foreign exchange 'shortages and further improve export competitiveness, reduce debt vulnerabilities, and more. This Home- Grown Economic Reform will target reform in three particular levels (link): 1. Macro-financial reforms Strengthening public finances through privatization of public enterprises and improving efficiency of state-owned enterprises (SOEs) Developing a flexible exchange rate regime to address imbalances Reforming monetary policy framework to stabilize prices in order to promote economic growth Enhancing development of the financial sector 2. Structural reforms Focusing reforms in areas that can ease constraints to doing business Easing barriers to international trade (tariffs, non-tariffs, customs clearances) Improving efficiency of public institutions Improving availability and quality of services such as logistics, electricity, and telecommunications 3.Sectoral reforms Addressing market failures and sectoral regulatory constraints to promote investment in multiple sectors (agriculture, manufacturing) Unleashing new growth potentials in sectors such as tourism, mining, and creative industries While the government's investment in infrastructure and education has provided a good foundation for private sector-led growth in Ethiopia, there are still multiple key obstacles to private investment such as inaccessible credit and insufficient local access to finance. Ethiopia's creation of an economic environment that is increasingly supportive of higher private investment in an attempt to reach sustainable economic growth will need to be accompanied by strong supervision and financial safety nets to guarantee that the financial sector within Ethiopia will remain stable as its reforms occur. Answer all of these questions in a lot of details and use outside sources for further explanations: 1. What types of direct investments is China making? Are they only contracting or investing resources as well? How has that investment pattern changed over time? 2. This case observes that FDI can facilitate rapid economic growth but also the idea that the gains from this growth have been unequally distributed and "unsustainable." Why might this be the case? Comment on how the factors which encourage FDI and the areas where FDI into Ethiopia has been directed may or may not play a role. 3. Evaluate the Home-Grown Economic Reform Agenda: would you advocate for this program? In your response, comment on how this reform affects their relationship with China and how it might affect the nature of FDI in Ethiopia. Do you think it will be successful in achieving its stated goals