10 May 2018

Chinese investments in Ethiopia – win-win or burden?

Outi writes:*

As a part of its attempt to increase its geopolitical power, China has been investing in Africa more and more during the recent years [pdf]. While the Western countries are pickier about their investments in Africa, China cares less about human rights violations and lack of democracy. Attracting investments is often seen as good growth strategy by the developing countries – direct (and indirect) investments can contribute to the training of workers and human capital, employment, infrastructure and technology, and thus create positive spillover effects to the whole society. In the Solow model foreign investments would contribute to both capital growth and the a-component that describes human capital and technology, hence contributing to the economic growth in the long-run.

However, there are also numerous concerns with the direct and indirect investments - they may lead rent-seeking, Dutch disease, and the receiving country becoming indebted and politically depended on the donor country. In many Sub-Saharan African countries, Chinese FDI has been targeted to the natural resources sector, that does not contribute to employment, but instead might lead to Dutch disease ie. overvaluation of the currency that drains the competitiveness of the other sectors. Indeed, the evidence of the implications of FDI on economic growth seems to mixed.

Unlike in the many other African countries, in Ethiopia, the Chinese FDI has been targeted to the manufacturing sector and infrastructure, which could be a foundation for long-run economic growth. Hence, both the Chinese and the Ethiopians have seen this as a win-win situation. However, the sceptics still doubt whether the Chinese involvement in Ethiopia will live up the high expectations. For instance, building infrastructure sure is good for development, but sceptics argue that, in order to win the bid in infrastructural projects, Chinese companies push down the cost by importing low-quality infrastructural materials from China. Additionally, the Chinese strategy of gaining substantial market power by dumping poor quality infrastructural material might prevent the country for developing its own “sustainable and competitive infrastructure market”. Moreover, corruption in the institutions who monitor the quality of infrastructure projects may also lead to bad quality, and if the Chinese are less concerned with bribing the officials than the other investors, it also has an adverse effect on the quality of the projects. Lastly, there is also fear of the high operational costs of the infrastructure projects: for instance, in the telecom network infrastructure, the spare parts come from the Chinese company. If the foreign company has the monopoly on providing spare parts and other such services, it might abuse its monopoly power and engage in rent-seeking behavior.

As an example, the Chinese financed light tramway project in Addis-Abeba seems to be a failing: it is not properly connected to the networks of the rest of the city, its power is constantly failing, and the operation fees are also large. There are also doubts about the functioning of the railroad to Djibouti. Yet, the Ethiopians have their loans to pay back to the Chinese, even if the projects do not bear fruit, leading to the country becoming dependent on China.

Bottom Line: The infrastructure projects in Ethiopia have great potential to bring in long-term economic growth, yet because of the closed-access order and rent-seeking behavior, the projects may not be as profitable as excepted.

* Please help my growth and development economics students by commenting on unclear analysis, other perspectives, data sources, etc. (Or you can just say something nice :)


Tom said...

Hi Outi! Interesting post about FDI in Ethiopia. You mentioned it briefly in the sentence about corruption, but I can imagine most of this FDI resulting in so-called 'white elephant projects'. In the conclusion you mention the closed access order, so are you going to analyse this case along the framework of North et al. ? If you were to do so, I would advise analysing the case per typical limited access order 'characteristic', so you can show that this is the reason why this FDI is still not efficient.

Gabriela said...

Hi Outi! You chose a really interesting topic. In line with Tom's comment, I believe that you could also make an argument that FDI from varied countries (not only China) could open a bit the market, the way how they manage the projects (in an attempt to keep the system closed) might reveal some dynamics of the LAO. In general, I am a bit curious about the magnitude of Ethiopia's manufacturing sector, how are they planning on improving it? who will benefit the most?

David said...

I am slightly in doubt about the comparative here. Although China is not boosting Ethiapia's infrastructure sector, to what extent would it be boosted if China did not invest at all? So although it might be slightly harmed, I am unsure to what extent that leads to significant problems. On the flipside, benefits are very tangible. Increased infrastructure, even if imperfect, can very much benefit economic growth among all other sectors. So even if there is slight harm, isn't this merely the cost of doing business?

With regards to your argument about natural resource management, although interesting once again I wonder what the comparative is. Wouldn't most countries still be likely to invest in their natural resource sector and aim for resource rents? In that case, problems like Dutch Disease etc. would occur anyway. So is it really China's involvement that creates the problems?

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