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Investment incentives: do they help Ethiopian enterprises?

Investment incentives such as tax exemptions for small and medium-sized enterprises were reintroduced in Ethiopia in the 1990s. The government has promoted the initiative as a success story. However, other factors may be equally, if not more, important for local entrepreneurs seeking to set up enterprises.

Many developing countries have used investment incentives to assist foreign and domestic enterprises. It is thought that incentives such as tax exemptions for small and medium-sized enterprises (SMEs) could ensure local ownership and both create and foster better regional distribution of employment, income, development and industrialisation.

In Ethiopia, the Investment Incentives Scheme (IIS) was reintroduced in the 1990s to assist local industries and influence their location. This scheme consisted in exempting certain industries from paying taxes on some imported goods and also from paying income tax for a set period, if they were to set up in locations approved by the government. An article from the Open University, UK examines the extent to which the IIS influenced entrepreneurial decisions over the choice of industry and location.

Between 1992 and 1998, 4246 indigenous industries were licensed, of which 1163 (27 percent) started up. The government, noting the increased start-up rate and their locations outside the capital Addis Ababa, has claimed success.

Key findings include:

Of the actual start-ups, only 36 percent (419 enterprises, or 10 percent of those licensed) drew on the IIS benefits, and most of these were manufacturing and service sector projects set up in and around Addis Ababa, an area the scheme was meant to assist least.
The civil war ended in 1991, leading to a better environment for the private sector.
Many civil servants were adversely affected by an adjustment programme during this period and were forced to become entrepreneurs, partners or senior workers in the emerging private enterprises.
Most SME founders interviewed said that they preferred to set up enterprises where they live and work and in industries in which they already have experience.
SME entrepreneurs tend to be sole founders and operate with a low level of resources, meaning that unlike large industries they have little access to external financing and goods and cannot afford relocation as they require a central market and infrastructure.

The IIS had significant economic costs for the government in terms of tax revenue lost and the costs of setting up and running IIS offices across the country. Further, less than 36 percent of the licensed start-ups benefited from income tax exemptions because they did not make profits during the exemption period.

The author concludes that there is no direct relation between the IIS programme and the increase in SME set-ups and that the benefits from the programme are too small to override other factors. Further, potentially more effective initiatives could have been implemented with the tax revenues lost through exemptions. The author advises caution in implementing similar programmes where entrepreneurs’ resources and the social and physical infrastructure are limited.

Key recommendations include:

Assist enterprise development by developing infrastructure.
Expand the education system (particularly technical education).
Eliminate bureaucratic barriers to establishing enterprises.
Provide better access to enterprise sites.

Source(s):
‘The Industry and Location Impacts of Investment Incentives on SMEs Start-up in Ethiopia’, Journal of International Development, Vol.18 (1), pages 1-13, by Seife Ayele, 2006 Full document.

id21 Research Highlight: 17 February 2006

Further Information:
Seife Ayele
Development Policy and Practice
Faculty of Technology
The Open University
Walton Hall
Milton Keynes MK7 6AA
United Kingdom

Tel: + 44 (0)1908 655534
Fax: + 44 (0)1908 654825
Contact the contributor: s.ayele@open.ac.uk

The Open University, UK

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