When It Comes to Low-cost Labor, Is Ethiopia the New China?

ethiopia

Ethiopia continues to post healthy economic growth, attracting global investments particularly for large-scale, light manufacturing, says Zemedeneh Negatu, the managing partner of EY Ethiopia. The country’s low-cost labor pool could make it the new China – even beating out Vietnam and Bangladesh. Boasting double-digit average GDP growth over the past decade, Negatu says Ethiopia is an oasis of stability in an area with unstable pockets. It is also building the largest hydroelectric power dam in Africa to supply much needed electricity to a region with uneven access. “That’s why I say fundamentals will continue to drive growth,” Negatu notes.

An edited version of the interview follows.

Knowledge@Wharton: We just heard at the Wharton Club of Africa Summit the minister of finance describe Ethiopia as a land in a hurry to attract investment.

Why don’t we start by taking stock of how things stand in Ethiopia in terms of the potential for investment and how this is part of the larger story of Africa as you see it from your perspective.

Zemedeneh Negatu: Ethiopia is a country in a rush and trying to accomplish a lot of things in a very compressed timeframe. There’s good reason. If you go back, say, 12 years, it was an economy that was just muddling along. But since 2002 to 2003, it has almost like it has been supercharged. According to the World Bank, it has grown on average about 10.6%, 10 years in a row. The first few years, we started from a low base. But today, it has the fourth-largest GDP in Africa. Adding 10.6% to a GDP of $70 billion on a nominal basis — or $156 billion on a PPP (purchasing power parity) basis — it starts to become substantial.

I think that gives you a perspective of where it came from. But what’s more important for investors and others is where is it going and how is it going to get there. I think that is probably the more interesting aspect of the discussion. In my view, if it continues to focus on where it has both competitive and comparative advantages (for example, light manufacturing), on transformation of the agricultural sector, and on investment in infrastructure, then the growth forward is sustainable.

“Ethiopia is starting to become the destination of choice for large-scale, light manufacturing, in particular garments and textiles.”

Why manufacturing? This is a country of about 100 million people, a very young population, median age under 20. So you have deployable, available labor. But at the same time affordable. I think that’s the very important component. So, for example, the average monthly cost of manufacturing in Ethiopia is a third of what it is in China. In China, in the coastal areas, it’s up to $600 a month. In Ethiopia, it’s still around $80, maybe $100.

That will give Ethiopia a competitive and comparative advantage. For growth to be sustained, it has to be driven by fundamentals, not piggybacking on the commodity price supercycle because, when commodity prices collapse, what do you do? But if you’re driven by investments in agriculture and manufacturing, you build the infrastructure that is the engine block for the transformation. I’m very confident that the growth can be sustained [even though] there will be bumps along the way.

Knowledge@Wharton: Can I dive a little deeper into a question you just raised about manufacturing? What happened with Tommy Hilfiger setting up a manufacturing facility in Ethiopia?

Negatu: Well, I’d rather not specifically talk about transactions that are underway. But I can tell you for a fact that a number of large, western garment manufacturers are setting up facilities, entire industrial parks actually, dedicated to global brands. I can mention [clothing chain] H&M because the information is already in the public domain. They’re starting to source from Ethiopia. So are many others.

Currently, one of the major Italian brands is building a factory in Ethiopia. The global industrialization transformation which moved large-scale textiles and garments from the U.S. to China in the past 25 to 30 years is now looking for the next China. And Ethiopia is one of them. In southeast Asia you have Vietnam, you have Bangladesh, but Ethiopia is starting to become the destination of choice for large-scale, light manufacturing, in particular garments and textiles, which even the Chinese are offloading, and shoe manufacturing.

This is the trend that we see and this is why we are encouraged, because Ethiopia has positioned itself to take advantage of it. To go back to a point I made earlier about the need for infrastructure for all of these things to happen, you cannot have industrialization in Africa without energy, without power. The Achilles heel of Africa from an industrialization perspective is the lack of power. We can talk about other infrastructure — railways, roads — they’re important. But if the factories don’t have electricity, you can’t industrialize. This is most basic.

In this case, look at what the Ethiopians have done. They’re building the largest hydroelectric power dam in Africa on the Nile river — the Grand [Ethiopian] Renaissance Dam which will contribute 6,000 MW. Investors look at these things. Global investors are looking at our competitive advantages. They see that power is starting to become more available and affordable. Electricity in Ethiopia is the cheapest on earth — four cents per kilowatt hour. Across our border in neighboring countries, electricity costs four times as much. And it’s not as readily available. That’s why I say fundamentals will continue to drive growth. There will be bumps along the way but the fact of the matter is we think this will be sustainable. China is looking for the next China. This is a fact. One of the main countries they’ve identified is Ethiopia.

“Ethiopia has done a very good job of creating a stable environment in a very unstable neighborhood.”

The second part of this whole thing is per capita GDP. To me, that’s a very important measure. You can have a big GDP in aggregate, but is it really being filtered down? In the case of Ethiopia, while its per capita GDP is still low, we’re seeing a 10% to 12% increase per year. Then you can start to see why Unilever is opening a new factory in Ethiopia in July. A lot of these smart investors are starting to come in.

We just did a study in our office. Until three or four years ago, the U.S. relationship with Ethiopia was always looked at through one prism: security. The rest of the Horn of Africa is unstable, they said. There wasn’t much American economic interest. Guess what happened? We just released our study. Between 2013 and 2015, the last two years we have data for, announced American deals in Ethiopia topped $4 billion. And these are blue chip American companies.

The first and only investment [private equity firm] KKR has made in Africa is right here. They spent $200 million, which is a lot of money for a non-resource investment for PE funds in Africa. Two years ago, KKR bought the world’s largest producer of cut roses.

Blackstone is now in the process of building the first-of-its-kind oil pipeline. There are lots of pipelines in Africa, but this is the first one to bring oil into Africa. All the other pipelines are to take oil out of Africa.

GE has announced that it’s going to build a medical equipment manufacturing facility in Ethiopia. We had [private equity firm] Warburg Pincus; a very substantial portion of the $600 million they have committed is for Ethiopia. Coca-Cola has been here for decades, but this is the first time they have put $250 million dollars for expansion. These are not small mom-and-pop lending opportunities.

I’ll put an interesting perspective on it. There seems to be a rivalry now developing between China and the U.S. in Ethiopia. China staked a claim here 10 to 12 years ago. Now you see large infrastructure projects financed by the Chinese. Industrial parks are being opened. China is converting Ethiopia into the China of Africa, the next China. The U.S. was a latecomer, but they’ve caught up fairly quickly. So you have to see this as the battleground.

This would not have happened if Ethiopia hadn’t done its homework. Neither the Americans nor the Chinese would have been interested. Yes, we’re geographically very strategically located. But that would not have mattered if they hadn’t seen the growth, hadn’t seen the stability, which is a very key component for investors. Ethiopia has done a very good job of creating a stable environment in a very unstable neighborhood. To the east of Ethiopia is Somalia. To the west, South Sudan, which is still in the middle of a civil war.

“The early investors in Ethiopia were China, India, Turkey. But now we’re starting to see … Americans; the Europeans are also starting to come in.”

I recently gave a speech to an American audience. I said, “Imagine for a second as a northern neighbor you have Somalia instead of Canada. Instead of Mexico to the south you have South Sudan. Imagine what the American economy would be — in a permanent recession. Here, it’s grown by 10.6%.”

I’m not going to discount the challenges that Ethiopia faces. This is an early-stage emerging economy. Despite the fact that there are huge opportunities, there are still a lot of things that need to be built up. But the trend, I think, is very encouraging, driven by fundamentals.

Knowledge@Wharton: I’m curious to know more. Human capital is a big component of this. Where do you fall on that, balancing between being the China of Africa and supporting human capital development?

Negatu: If we were to fast forward and see where Ethiopia and Africa will reach in the next 10 to 20 years, it will be on the back of investments in human capital. I grew up in the U.S. I went there as a teenager. I always asked myself, how did the U.S. become such a successful country? Because it invested in people; it allowed people to be creative, to express their views and to take risks. Ethiopia is starting to invest significantly in human capital. In 1998, there were only two public universities in this country. Today, there are 32. In the next five years, there’ll be 41. They realized early on that investment in people is extremely important if you’re going to transform.

On top of that they allow private colleges and universities in this country. Today there are half a million people in colleges and universities in Ethiopia. That, I think, shows you the commitment.

The second thing that they’ve done is realize you don’t need MBAs. About six, seven years ago, the government decided that 75% of the graduates from colleges and universities have to be in STEM. You know what STEM is: science, technology, engineering and mathematics. If we’re going to be like South Korea, if we’re going to be like Japan or China, you need engineers and scientists.

The third component which I think is still a work in progress is bringing in the diaspora. Depending on who’s doing the counting, there’s about a million of us in the U.S. Bringing back that knowledge will also help. We’re starting to see the results now.

Knowledge@Wharton: Since we were talking about GDP growth, 46% of Ethiopia’s GDP comes from agriculture. Some 85% of the workforce is engaged in agriculture. If you consider the impact of El Nino on agriculture, it has been devastating. Sticking to the point about human capital, what is Ethiopia doing to protect the country and its people from the adverse impact of climate change?

Negatu: The government’s strategy is a climate-resilient, carbon-neutral economy by 2025. So, for Ethiopia, climate change is not some theoretical debate you have at the Wharton School or somewhere else. It has real life impact.

You mentioned El Nino. El Nino is a very good demonstration of how far Ethiopia has come since 1984, since we last had the great famine for which Bob Geldof and Mick Jagger and all the others put together the great concert Live Aid. There were probably 25 million Ethiopians 35 years ago. Today, there are 100 million of us. The drought today by all accounts is the worst in over 50 years. The one we had in 1984 does not even compare to what we have today. But look at the dramatic change that has taken place. Even though the population has tripled in size, Ethiopia today has been able to sustain the impact of El Nino.

El Nino has affected all of eastern and southern Africa, all the way down to South Africa. It has had a very significant impact on Ethiopia. But not a single person has died from famine. Yes, there are millions facing what is called food insecurity. The bulk of the support has come from the government’s own resources. I think that’s a mark of sustainability. However, that’s one of the reasons why Ethiopia is in a rush; it’s to prevent these kinds of things from having a permanent effect on the country.

One final point I want to make though is on FDI (foreign direct investment). The early investors in Ethiopia were China, India, Turkey. But now we’re starting to see a balance. I mentioned the Americans; the Europeans are also starting to come in. We’re currently working on $3 billion M&A deals, none of them from Asia. I see more balanced FDI sources, not only in terms of diversity of sectors, but also where it’s coming from.

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