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December 30, 2016

2

Eritrea: Go for Value Chain Economic Modeling

by asmaraonline

asmarahutBy Teweldeberhan Gebre

Introduction

Eritrea can be what it wishes to be. Given the extraordinarily resilient Eritrean people, if there is an added value of political will and commitment, Eritrea can be in the rank of upper middle income country category within the next 10 years. According to the World Bank (WB) countries are classified or categorized into four economic groups: low income, lower middle income, upper middle income and high income countries based on their estimates of gross national income per capita (GNI, atlas method) income brackets. The annual per capita GNI annual income brackets are: less than $1,025, $1,026 to $4,035, $4,036 to $12,735, and $12,736 and above, respectively.

Eritrea with estimated GNI per capita (2014, atlas method) of $530 is ranked 186th out of 197 economies. It appears that Eritrea is one of the 31 low income countries of the world of which 27 are African countries. Of the 54 African economies/countries 18 and 9 countries are in their lower middle and upper middle income countries categories, respectively. Sudan and Kenya are the only two East African countries categorized as lower middle income countries.

Poor economic performances are fundamentally associated with poor governance, economic mismanagement, and conflicts and or wars. The presence or absence of abundant natural resources have little thing to do with economic development. Japan is a typical example widely mentioned in economic studies as natural resources poor country but Japan is one of the major economies today. In fact, resources rich countries such as Nigeria in Africa suffer from the paradox of plenty also known as the ‘natural resource curse’. As stated above, out of the 31 world countries in the low income group, 26 are African countries. Africa despite its abundant natural resources is the poorest continent with low economic growth, poor democratic institutions, and worse development outcomes than countries with fewer natural elsewhere.

Eritrea is not poor in natural resources. Eritrea a one-time ‘industrial hub’ and a trading unit in the continent is now troubled to repeat history. Unfortunately, Eritrea today is in a situation of indeterminate state. Eritrean policy-makers appear to miscalculate history and misunderstand the ideology of self-reliance. In principle, I am not against the idea of self-reliance in its original sense. Self-reliance has nothing to do with the ideologies of socialism and or communism as some would like it to be. Self-reliance according to the Merriam-Webster dictionary is “reliance on one’s own efforts and abilities.” It means relying on one’s own power and resource rather than those of others. The principles of self-reliance equally applies to individuals, households, communities, and the different levels of government.

Value chain economic model is responsive to flexible labor markets and prudent macroeconomic policy environments. An increasing proportion of the economically active labor force can be absorbed and turned productive provided there is significant flexibility and expansion of the labor market, enabling macroeconomic environment, encouraging investment climate, and sound domestic financial markets that provide opportunities for people to save and invest.

In the following paragraphs I will discuss value chain economic modelling based on sub-sector and firm level analyses. Sub-sector analysis and value chain analysis against the traditional the traditional economic sectors (agriculture, industry and service) analysis to promote economic development are key for accountable economic governance.

Sub-sector analysis for understanding trade comparative advantages

For Porter (1985) an industry or sector is too broad to be used as point of economic analysis because sector level analysis obscures many crucial activities that makes difficult to analyze an economies trade comparative advantages of nations. Traditionally, countries/governments classify and track their economies and GDP as three sectors: agriculture, industry and service sectors. However, in light of the trade comparative advantage analysis, a country cannot have a complete trade comparative advantage in one or another major economic sector. Every sector has numerous sub-sectors but countries rarely have comparative advantages in all of the sub-sectors of a sector. With scarce resources including financial resources such as the availability of credits for investors it is logical for policy-makers to favor some sub-sectors than another. Let us see the subsectors of the three major economic sectors:

  1. Agriculture

Agriculture includes cereal, cash crops, horticulture, poultry, milk and animal husbandry, aquaculture, fishing, sericulture (production of silk and the rearing of silkworms), aviculture (the breeding and rearing of birds), forestry and related activities. Like many countries, Eritrea cannot have trade comparative advantages in all these sub-sectors of agriculture. But, certainly Eritrea can have trade comparative advantages in one or more of the agricultural activities such as fishing, aquaculture, horticulture, milk and animal husbandry, and poultry. If Eritrea thinks fishing, cash crops, aquaculture, horticulture, milk and animal husbandry, and poultry enhances its competitive advantages over cereals it can use its available financial and arable land for these purposes and import cereal crops to feed its people.

  1. Manufacturing/industry

For sustainable and inclusive economic growth the development of the manufacturing sector is key. The key sub-sectors in this sector are: food products and beverages; textiles; wearing apparel, dressing and dyeing of fur; leather and leather products; wood and wood products; chemicals and chemical products; rubber and plastic products; other non-metallic mineral products; basic metals and fabricated metal products; fabricated metal products other than machinery and equipment; machinery and equipment; electrical and optical equipment; transport equipment; construction and construction equipment; etc. This sector has to be the backbone of Eritrea’s economy. Like in many African countries the Eritrean market is infiltrated by foreign industrial products that worsens trade balance. In this regard, our policy-makers need to wake up and open the manufacturing market both for nationals and foreign investors. This is also the sector for diversification and potentially important for inclusive growth to sustainably eradicate poverty. Not only that but also the idea of global value chain activities are centered on the manufacturing value chain.

  1. Service Sector

The service sector is the second important sector in an economy. The service sector includes wholesale and retail trade; repair of motor vehicles, personal and household goods; hotels, camping sites and other provision of short-stay accommodation, restaurants and bars, and canteens and catering; sea transport, land transport, railways transport, air transport, supporting and auxiliary transport activities; activities of travel agencies, cargo handling and storage, travel agencies and tour operators; tourist assistance activities, post and telecommunications; commercial and specialized banks, insurance and pension funds, and other activities auxiliary to financial intermediation; real estate activities, renting of machinery and equipment without operator, ICT/computer services, research and development, legal, accounting and other economic services, architectural and engineering activities and related technical consultancies, technical testing and analysis, advertising, labour recruitment and provision of personnel, industrial cleaning; and other miscellaneous business activities.

Over time the service and manufacturing sectors should overtake agriculture if the Eritrean economy is required to transform itself. Transforming of the manufacturing and service sectors is fundamental to promote economic development. Opening up the service and manufacturing sectors for investment also speed up the transfer of surplus rural labour into the formal economy. Besides, the development or transformation of the formal economy encourages modernizing and commercializing agriculture as more and more rural households are now transformed into the modern sectors leaving more arable lands for modern commercialized agricultural practices.

Manufacturing Value Chains

The phrase value chain was first introduced in 1985 by Michael E. Porter in his influential book “Competitive Advantage”. According to Porter the idea of a value chain is based on the process view of firms, the idea of seeing an economic firm as a system, made up of subsystems each with inputs, processes and outputs. Inputs, processes, and outputs involve the acquisition and consumption of resources such as money, labour, materials, equipment, buildings, land, administration and management. In that sense, how value chain activities are carried out determines costs and ultimately affects profits in the global and regional value chains.

According to Porter (1985:33-34) a firm’s value chain is disaggregated:

“…into its key strategically relevant activities in order to understand the behavior of costs and the existing and potential sources of differentiation. A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors.”

In other words, a value chain is a set of key strategic activities that a firm carries out in order to create value for its buyers. Porter name the streams of activities the “value system” in which suppliers create upstream values and delivers inputs for firms’ chain.  In the words of Porter (1985: 34) “the ultimate basis for differentiation is a firm and its product’s role in the buyer’s value chain, which determines buyer’s needs.”

Hence, a firm or business unit level economic analysis gives more sense in modelling economic development within the context of value chains. Value-chain analysis appeals to today’s trade comparative advantages of nations than the traditional way of comparative advantage analysis based on value-added (the selling price less the cost of purchased raw materials) because according to Porter (1985: 39) “…value-added fails to highlight the linkages between a firm and its suppliers that can reduce or enhance differentiation.”

Value Chain Example from Eritrea: A typical example of value chain activity from Eritrea is by ZaEr plc. Textile and Garment Factory. ZaEr undertakes a complete textile cycle as indicated below. Here the backward linkage is extremely important. That is the production of cotton while there is no question on the forward linkages because the owner (an Italian) is linked to the world market through Cotonificio Honegger S.p.A, a subsidiary of Zambaiti Copertificio,” based in Albino, Italy.

Figure 1: ZaEr’s- value chain activities-from fibre to manufacturing, transport and sales production cycle

vc

Now, for the textile and garment industry to grow and create more jobs there need to be an intensification of cotton plantations. I would imagine that ZaEr must be constrained by the limited supply of cotton. Thus, in order to expand the textile and garment industry more land and investment is required for cotton production in the low lands. This is clearly a policy issue that need to be addressed by the GoE not just for ZaEr but for other potential investors in the textile and garment industry. ZaEr has trained and employed over 500 citizens and according to reports by the company over 85% of its products are meant for exports to Europe, Middle East, and Africa.

Think about more ZaErs in the sector which means more employment and export earnings for the country provided they follow the footsteps of ZaEr plc. as illustrated above. Also, think about more value chain activities and backward linkages across all sub-sectors-in manufacturing, agriculture and services. A nation state is the product of human being and so does its economy. It is not about natural resources endowments such as oil, labour, capital, and other resources as the classical economists would love to tell us. Economic development is the result of skillfully designed and implemented economic policies.

If global value chain is the focus of economic policy the sub-sector and firm levels of analyses are by far key for performance based economic governance. In my introduction I said that value chain economic model is responsive to flexible labor markets and prudent macroeconomic policy environments. I also said that an increasing proportion of the economically active labor force can be absorbed and turned productive provided there is significant flexibility and expansion of the labor market, enabling macroeconomic environment, encouraging investment climate, and sound domestic financial markets that provide opportunities for people to save and invest. Having said the above, I see the importance of value chain economic modeling as a way forward from the current economic hardships of the people of Eritrea.

The way forward for value chain economic modelling

Eritrean politicians have made strategic mistakes in their tendency in crowding out the private sector from the Eritrean markets. Various reasons were and are still provided by our politicians for the crowding out of the private sectors. However, these various reasons may serve politics but not economics. The end result is a nation troubled in transforming its economy and a nation exposed to extreme poverty. In order to end the current economic deadlock and end extreme poverty Eritrea needs the development of the private sector. To end this deadlock I recommend the following:

  1. End the undeclared state monopoly economic policy and implement the 1994 macro-economic policy:

For Eritrea to catch up the current undeclared anti-private sector economic policy should not be allowed to continue and the GoE should do something about it. Of course, reinstating the private sector will not be without challenges. Even if the government intends to open up the market for private investment the most troubling aspect would be the loss of confidence by the private investor on the unstable government policies. Eritrean nationals do not have confidence on the government’s economic policies. In the short-run this will be a challenge. However, if the government admits its mistaken economic policy confidence of the private sector can be reinstated. The damages can be fixed via initiatives of confidence building campaigns and taking practical steps in improving the regulatory and legal systems. The government can repeat its good experience with the mining investors. If the same treatment goes to other investors there will be reasons to attract more investors across the economy.

  1. Say it and say It yourself clearly

I must mention that there is change going on although the government is reluctant to openly communicate the changes with its citizens. According to the United Nations Development Programme (UNDP) fact sheet its programme for Eritrea has three important pillars: (i) inclusive growth and livelihoods, (ii) sustainable natural resources and disaster risk management, and (iii) accountable institutions, public administration, and service delivery. Had these information been directly told by the government it would have been delighting for all Eritreans. Nevertheless, it gives sense because in dealing with the partners such as the UNDP that the government sees the importance of growth and institutional reforms. According to pillar 1 (inclusive growth and livelihoods) the support mechanisms by the UNDP will be through providing upstream capacity building, supporting livelihoods for vulnerable groups, vocational training, micro-grants and job placement.

  1. Go for a holistic approach as vocational training and skills alone cannot bring change in wellbeing

Inclusiveness of growth has three dimensions-participation (via employment), benefit sharing (reducing poverty) and benefit sharing (reducing income inequality). The implication is clear though. There could be growth but without participation and growth without equitable sharing of benefits of growth. A country can register high economic growth but without equal participation and equitable sharing of the benefits of growth. For people to gainfully participate in the job market skills are by far important. However, vocational training and skills building increases participation and decent pays only under fast economic growth and transformation along the global value chain.

In other words, we can have critical masses of trained people but if the pace of economic growth and transformation don’t match the skilled labour market or vis-versa the impacts on reducing income poverty and inequalities will not be there. While upgrading the skills set of the workforce is by far important sustainable improvements in wellbeing is impossible without structural economic transformation. I illustrated my points in figure 2 below. Thus, nationwide mapping of inclusive growth and economic transformation is critical.

Figure 2: Mapping of inclusive growth and economic transformation

circles

4. Go for Economic Growth Built on Structural Transformation and Value Chain

An economy cannot be transformed before the manufacturing sector is on the lead both in its share of value added to GDP and share of total employment. For the manufacturing sector to play its expected roles in growth and employment, the GoE need to encourage citizens and foreign direct investor including diaspora Eritreans. In this regard, the government can open up investments in the manufacturing sector clustered by sub-sectors agglomerated by industrial zones and workshops. it is understandable that many nationals are constrained by the lack of work spaces to expand their activities due to the lack of investment in buildings and premises.

If Eritrea or its government is ready to organize such a national conference it should prepare its investment menus to share with the potential investors on the spot of the conference. I tried to list the menus for investment alongside each sector above. If it does so, the potential to diversify investment and upgrade the economy will be huge from the start. To organize the said conference should not take the government more than six months because the momentum is crucial to further furbish its partnership with its key development partners such as the above.

  1. Open up the banking sector for private investors

I always tend to favor nationals over foreign investors. But, I must be fair and logical in my economic thoughts gained from my experience and schooling. I don’t deny state involvement in the economy completely. However, the state’s involvement in businesses should be limited to investments where the private sector is reluctant to go for. Having said the above, the state can still have its own development bank/s to back up its strategic investment interests. However, the commercial banking services should be left to national investors while allowing one or two foreign banks to operate in the country is important to entertain foreign and national investors. This measures can encourage diaspora Eritreans to put their savings in their home country and available for investors.

  1. To promote investment organize national business conference in Asmara

The GoE organized an international conference on Eritrean studies in July this year in Amara. In that conference it was reported that more than 130 papers were presented in the presence of around 500 participants. This is huge success in the year 2016. Can this be repeated in 2017 but at this time under national business and investment conference? Of course yes. If there is a will and political commitment everything is possible. If the GoE is genuinely prepared to open up the market for both nationals and foreign investors this is the right time to do so. I say the right time because its partners such as the European Union and its member states as well as the Gulf States are keen to see that and exactly that.

At last, the author emphasize that without political will and commitment nothing will improve and people of this country will continue to suffer.

Reference

Porter, Michael E. (1985). Competitive Advantage: Creating and Sustaining Superior Performance. 1st ed. New York, the Free Press.

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2 Comments
  1. Dec 30 2016

    Dear Tewelde,

    What about the Doing Business PadLock? You have to unlock the the kitchen before you start cooking!

    Your assertion is within scope, but must be clear what steps are needed.

    Regards

    Estifanos

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  2. Dec 31 2016

    Estif,
    You are right ease of doing business is quite important. I don’t overlook the issues of doing business which is extremely difficult in the case of Eritrea. However, ease of doing business as a process cannot be discussed while the market is not opened up for private investments at all. Under closed economy there is no point discussing conditions about the easiness or difficulties of doing business. I must say this though whatever I contribute into this website is to instigate discussions. I don’t intend to cover everything in this short pieces.

    However, I encourage you to contribute into asmara-online.com on the subject.

    TG

    Like

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