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 incentivesto assist foreign and domestic enterprises. It is thought that incentives such astax exemptions for small and medium-sized enterprises (SMEs) could ensure localownership and both create and foster better regional distribution ofemployment, income, development and industrialisation.

In Ethiopia, the Investment Incentives Scheme (IIS) was reintroducedin the 1990s to assist local industries and influence their location. Thisscheme consisted in exempting certain industries from paying taxes on someimported goods and also from paying income tax for a set period, if they were toset up in locations approved by the government. An article from the OpenUniversity, UK examines the extent to which the IIS influencedentrepreneurial decisions over the choice of industry and location.

Between 1992 and 1998, 4246 indigenous industries werelicensed, of which 1163 (27 percent) started up. The government, noting theincreased 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 thesewere 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 betterenvironment for the private sector.
• Many civil servants were adversely affected by anadjustment programme during this period and were forced to becomeentrepreneurs, partners or senior workers in the emerging private enterprises.
• Most SME founders interviewed said that they preferred toset up enterprises where they live and work and in industries in which they alreadyhave experience.
• SME entrepreneurs tend to be sole founders and operatewith a low level of resources, meaning that unlike large industries they havelittle access to external financing and goods and cannot afford relocation asthey require a central market and infrastructure.

The IIS had significant economic costs for the governmentin terms of tax revenue lost and the costs of setting up and running IISoffices across the country. Further, less than 36 percent of the licensedstart-ups benefited from income tax exemptions because they did not makeprofits during the exemption period.

The author concludes that there is no direct relation betweenthe IIS programme and the increase in SME set-ups and that the benefits fromthe programme are too small to override other factors. Further, potentiallymore effective initiatives could have been implemented with the tax revenues lostthrough exemptions. The author advises caution in implementing similarprogrammes where entrepreneurs’ resources and the social and physicalinfrastructure are limited.

Key recommendations include:

• Assist enterprise development by developinginfrastructure.
• Expand the education system (particularly technicaleducation).
• Eliminate bureaucratic barriers to establishingenterprises.
• Provide better access to enterprise sites.