DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS

Tittle: The Role Of Export Diversification For Economic Growth In Ethiopia

Prepared by: Jiregna Galana

ID NO- R/2270/09
Advisor:G/Krstos G/Sillase

January,2019
Dire Dawa,Ethiopia
 CHAPTER ONE:
INTRODUCTION
1.1 Background of the Study
Ethiopian economy is dominated by the sector and the country’s economic development is largely
determined by the performance of the sector. The bank of the country’s merchandise export earning
is from the agriculture sector. The sector accounts about 80% of the total export earnings of the
country (NBE, 2010). Rapid growth of export is immediate solution to sustained GDP growth. This
helps the economy of a nation free from permanent dependent on large inflow of foreign aid and
helps to import machinery, equipment that fasten industrialization and continued agricultural
explanation. However, the government strategy and its implementation promote in diversity exports
lack coordination (IMF, 2010).

Ethiopia export portfolio is characterized a highly concentrated on a few group of

commodities(coffee sometimes cold one crop economy) which are highly vulnerable to change in the
price of primary commodities needless to sayEthiopia is a particular in all most all of on the
performance of the major coffee suppliers (like Brazil and Vietnam) to the world market Ethiopia
supply short falls from major coffee supplier (ShewangizawSilesh, 2003).

Since, Ethiopia is heavily dependent on commodity exports and therefore vulnerable to external
shocks, th9is might have retarded the performance of export and the overall economy in general.
To stabilize export earnings and faster growth, the need for accelerating export growth through
diversification is essential. Diversification to nontraditional manufacture product flower shies a new
area of comparative advantage is considered as a primary development strategy in many developing
countries (TeshaleNega, 2005)

In addition to commodity concentration, Ethiopia export flow to few countries such as Switzerland,
china, Germany, Somalia, Netherlands and Saudi Arabia which accounted 11.2%, 10.8%, 9.8%,
8.6%, 8% and 6.1% respectively (NBE,2010).
 1.2 Statement of the Problem
Most developing countries have continued to be very dependence on a few commodities for their
export results in secular and unpredictable declining trends in international prices. Consequently,
such large volatility in export earnings has a significant adverse impact on the macro economy
ofdeveloping countries in order to reduce the extensive dependence on primary commodities, for
generating export earnings, the need to diversify their range of production of primary commodities
(TeshaleNega, 2005).

Similar to other nation, Ethiopia export earning is heavily dependent on a few agricultural primary
commodities whose world market prices have been unsuitable. The export earnings generated from
the export had been remained the same for long period of time in terms of commodities. Thus, there
are still high traditional commodities and geographic concentrations. Consequently, the country
failed to finance its needs (DebeleGemechu, 2002).

As explained above, Ethiopia exports items are largely primary commodities that are in elastic with
regard to price and income. This situation is may lead the country to macroeconomic imbalance. The
increase performance of export sector is attributed to increase trade deficit. Theoretically it is
believed that such imbalance should be finance through foreign exchange obtained from export
sector.

However, the problem of financing such import is worsened because of fluctuation in such
commodities in the international market different policies of both the imperial and the military
government had identified the source of export instability and acknowledged the importance of
export diversification similarly the current government (TGE) together with IMF and WB and also
underlined the significance of export diversification has explicitly stated in its agricultural
development lead industrialization strategy (ADLI) and also different researchers have been done by
different like researchers like, BrhanuLakew(2003), Swangzawsileshi (2003), Teshalenega (2005) in
the hope of diversifying export trade, practically nontraditional export.
 1.3 Objective of the study
1.3.1. General objectives
The general objective of this paper is to see the role of diversification for Ethiopian economic
growth.
1.3.2 The specific objectives
 To identify the major determinants of export diversification
 To assess the role of export diversification on economic growth
 To identify the internal and external constraints on diversification

1.4. Research Question

 What is the importance of export diversification on economic growth?
 What is the role of export diversification on economic growth?
 What are the consequences of export diversification on economic growth in developing
country?
1.5 Significance of the Study
It is believed that export diversification is considered as one of the main solution to the external
instability if export earnings of less developed countries. A number of researcher have been
undertake to investigate the case and consequence of export instability in developing countries.
In Ethiopia also various researcher have been studied the export t trade with emphasizes on export
instability some of the recent works on export diversification include, BrhanuLakew (2003)

Shwangzawsleshi (2003) TeshaleNega (2005). Thus try to recommend that diversification could
reduce the country’s export instability.
But they did not address the means and ways of diversification. Together with this the high
dependence of the country on export earnings of a limited number of products justifies the need or
emphasis is on export diversification. Thus, the outcomes of the study will fill the gap in existing
knowledge by analyzing the appropriate type of diversification for the country.
 1.6 Scope of the Study
The study focused on the contribution of export diversification for economic growth of Ethiopia. It
also tries to identify the determinants of export diversification to give more emphasis on the problem
faced to diversify the export portfolios of the country.

1.7 Limitation of the study

The researcher has been encountered many constraints that hindered for the successful completion of
the investigation. To mention some of the hindrances the researcher faced; lack of adequate and
recent reliable time series data is the biggest problem, lack of reference materials,shortage of time
and finance and in empirical analysis the problems of variables to be stationary and testability and
other related problems that hindered from finding inputs for the investigation.
 CHAPTER TWO
2. Literature review
2.1 Definition and Concept
Export diversification refers to changing the composition of exports, or the relative
contribution of each export product to total export earnings with a view of establishing a
wider variety of export with good market prospects abroad and not subject to in the same
manner by fluctuations of international prices.

This implies changing the composition of export with the purpose of increasing the
country’s foreign exchange earnings (IMF, 1987, cited by semogree and kasekende, 1994).

There are two well known forms of export diversification that are commonly found in tread
literature, namely horizontal and vertical export diversification.
Horizontal diversification entails changing of the primary export mix in order to naturalize
the volatility of international commodity prices.
While vertical diversification involves creating further uses for existing and new
commodities through value added ventures such as processing and marketing (IMF, 1987).

2.2 Theoretical Literature

2.2.1 The traditional argument for export diversification
The traditional argument for export diversification is based on the idea that instability index of export
earning is higher for developing countries that have narrow export base than developed countries
with wider base of exports (bamou, 2003).

According to marshal (1994) and love (1983), concentration on a narrow range of export product is
the source of fluctuation in export earnings.
2.2.2 The new argument for export diversification
The new argument for export diversification can see in two ways. 1 st demand side argument
and 2nd supply side argument.
The new argument on the demand side in that exports facing auto mouse factors such as
rising income and change in test in importing counters have to diversity there exports towards
income elastic ones.

The supply side arguments of production structure adjustment to change in production

technology & input mix, better land utilization, the introduction of new skills, changes in the
availability of imported inputs, in response to potential competitors, etc..

2.2.3 Argument against export diversification

Export pessimism refers to the belief that developing countries cannot successfully penetrate
in to the market of the industrial countries.
The pessimistic views revolve around the decline in the rate of growth of demand for
primary products in the industrial countries and on over supply of manufactured goods if
many LDC’s diversify at the same time (panoutnsopoulos, 1992).

Considering the similarity in terms of factor endowments and the stage of industrial
development, some academicians argued that the scope for market diversification by
penetrating developing countries market is very limited (tecson, 1992).

The other variant of export pessimism, as indict in sodersten Bo et.al (1994), is in terms of
the provoked protagonist vacations by developed market economics if more rapid growth of
LDC exports is going to happen, this proposing import substitution policy.

There are other arguments that consider factor endowments as a limit on export
diversification high ting the possible loss of welfares if production of non-tradition goods is
expanded beyond the limit (derosa, 1992).
2.2.4 Export diversification and economic growth
The idea that responding export benefits is for economic growth is much earlier.
Mercantilist at their time strongly suggested that the necessity of expending and promoting
exports and increasing trade surplus by minimizing import to accumulate precious metal,
Wealth and National mercantilist power.

Being from classical theories introduced by Adam smith (1776) and David |Rica rid (1817),
the common theory was that each country has a, comparative advantage in producing some
goods in exporting some particular products and that specializing in export on this product
will create gain from tread.

During the industrial revolution time when production and export expand must classical
theories follow mill [1848] debated on the source of comparative advantages his chair bad on
line introduced the most debated comparative advantage theory in 1930.the theory focused
on expanding tread exports abed their evaluation by the relative factor or resource
abundance. Both classical and non classical economists argued that countries should
specialize in producing and exporting according to their comparative advantage.

However after the Second World War with the reconstruction of Europe and increasing
independence of many developing countries one of the new ideas in the emerging new
discipline of development economics was diversification, not specializing for economic
growth and development peribisch and singer, 1950 argued that developing countries
dependence on the primary commodity production and exports leaves them vulnerable to
commodity shocks, price fluctuation and declining terms of trade, especially science the
income elasticity of primary commodity is low.

This in turn affects countries foreign exchange reserves and their ability to afforded imported
inputs, become subject to fluctuation and uncertainty. Countries that specialize in a narrow
range of primary commodities are currently faced with declining export earnings and loss in
their share of the international export markets which directly or indirectly affective
negatively affects the countries wellbeing (IMF, 1987).
Compared to primary exportable commodities the volume of selected manufactured exports
may be raised without a compensating fall in prices because they are price elastic (IMF
1987). Moreover, the industrial production environment is easier to control compared with
the un predictable weather changes for agriculture commodities.

Even if income the importing countries are constants changes in the psychological reference
and in different generation of customers. This call for diversification to generate new
exports to think for the changing deceive & needs both incomes & tests have been changing
over time in the European and USA markets, which are the mine customers of African
exports including Ethiopian (IMF 1987).

A diversified national trade portfolio enable a country’s stability by providing a broader

export base and enhance growth by substituting commodities with passive price trends for
this with declining trends in prices, through increasing value added of export commodities,
through additional processing and marketing (ali. et al,1991)

WTD (2007) study pointed out that many developing countries are pursuing export
diversification as an engine of growth to insulate themselves from inspected changes in their
form of trade end, to stabilize domestic incomes and employment.
It shows that developing countries have minimized their reliance on primary commodity
exports and they have made remarkable progress in exporting manufactured or semi-
manufactured goods over the past decades.

Therefore, as all theoretical review indicates that export diversification play a great role to
economic growth decreasing export instability by reducing the dependence on limited
number of commodities.

That is subjects to fluctuation in prices and volume, creating spillover effects and increasing
productivity growth, making countries less vulnerable to sector specific adverse shocks and
making it easier to channel positive terms of trade shock in growth.
 2.2.5 The role of export diversification
When export is concentrated in a few primer commodities, there can be serious economic
risks. Therefore exportdiversification aims at mitigating these economic risks. Economic
risks to be mitigated: -

In short term, volatility and instability in foreign exchange earnings which have adverse
macroeconomic effects on growth, employment, investment planning, import and export
capacity, cash flow, inflation, capital flight on under-supply of investment by risk adverse
investors, debt repayment, and in the long term, Secular & un predictable declining terms of
trade trends which exacerbate short run effect.

Another objectives of diversification is to reduce dependence on one or limited number of

geographical destination for its export.
This because when one country depends on the markets of few developed countries, there
will be occurrence of fluctuation in foreign exchange earnings if that country faces any
economic crises. It also can aim expanding opportunities for export and improvement of
backward and forward linkages to domestic input & services.

Heavy dependence on a small number of primary commodities exposes a country to the

negative effect of unfavorable characteristics of world demand & negative supply side
features of primary products.

On the demand side low income elasticity of world demand for primary commodities can
lead to falling export earnings which can be exacerbated by historically down ward trends in
primary commodities relative to manufactures.

On the supply side, the combined effect of lower skill and technology content of commodity
production & its negligible backward & forward linkages with the rest of the economy
usually lead to little growth spill over’s.
 Hence the need for diversification to minimize volatility in export earnings & boost overall
growth by replacing commodities with positive price trends products & adding value through
additional processing or marketing
.
2.2.6 The major determinants of export diversification
Human capital [HC]: -
Means one of the production elements which can generate added values through in putting it.
In this study it is measured through enrollment rate.
The greater availability of specialized human capital & the consequent lower amount of
human capital for the development of R and D task which implies a larger number of verities
of goods produced and this increase the number of exported commodities and markets.
Foreign direct investment (FDI):-
It is defined as a reflecting interest in and control by resident entity in one economy (foreign direct
investor or parent enterprise) of an enterprise resident in different economy (FDI enterprise or
foreign Affiliate).

ShasheenDileepaJayawee (2009)studied that FDI is deriver of export diversification with emphasis

based on |FDI leading to improve productivity in the hesitation, together with a number spills over
benefits which help local firms to become competitive leading to increase export diversification.

He also suggested that FDI stands as a catalyst for local industry development rants increase
competition effect, i.e. where the foreign enter domestic firms to increase efficiency, & backward
linkage effect where the foreign entrants boost them to grown & generate skill economics. It also
contribute to diversification of export through the market spill over’s where firms learn about foreign
markets & competent of the fixed cost of establishing export market.

Real effective exchange rate (REER):-

It is calculated as a weighted as averages of the bilateral exchange rates that has been adjusted for
relative price level of each economy. In the case of overvalued exchange rate directly reduce export
portfolio or indirectly through an increase uncertainty. However devaluation promote for
diversification through augmenting export by shifting price burden, making the product competitive
in foreign market.
 Openness; -
It is the ratio of export plus important to GDP. It contribute to export diversification through
external effect such as expose to foreign competition, transfer of technology and economics
of scale and also from increased speed of convergence towards richer countries. It also
contributes through reduction in tariff rates, simplification of export licensing.

2.3. Trade Strategy of Ethiopia, Constraints and Prospects of Export

diversifications
2.3.1. Overviews of Ethiopian’s Trade Strategies
 Ethiopia is one of the emerging devolving countries in the world, its economic growth and
development is highly linked with the development of agricultural sector.
 The objective of the chapter is to review and analyze trade strategies with special emphasis
on efforts of export diversification, structure and performance of export during the two
successive regimes.
 This are categorized in to two period based on the life span of each regime.
 The Dergue regimes (1974/75-1991/92) and the EPRDF (post 1991/92).
 The chapter also attempts to identify the major internal and external constraints for export
diversification.
 Finally it assesses the opportunities and prospects of export diversification in Ethiopia.
 To examine the export structure and performance ratios, percentages, tables etc is used.
 Traditionally, there are two trade strategies, i.e. import substitution or inward looking and
export promotion or outward looking strategies.
 If the incentives provided into import substitution rather than to export promotion, then the
strategies characterized by protection, control of imports and anti- export bias, otherwise an
export promotion strategy is public policy measure that actually enhances export activities
(Chantrahunya and Murinde, 1998).
 On the basis of this, the Dergue had adopted inward oriented trade strategies, which had used
high level of protection, overvalued foreign exchange rate and control of import goods
through high tariff imposition. These policies had impact on the profitability and
competitiveness of the export sector. With these frame works, the strategies export structure
 and performance, the constraints, opportunities and prospects for diversification has been be
analyzed in next section.

2.3.1.1. The Dergue Regime (1974/75-1990/91)

 Following the overthrown of the Imperial regime, the country was governed without any
perspective plan for four years (From 1974-1978).
 However, from 1980-1984 there were annual plan the so called “Zemecha” (working
together or a type of collective action), which envisaged economic and social rehabilitation
and inclusion of socialism (PMGSE, 1984). From 1984, however the regime prepared a Ten-
year perspective plan (1984/85-1994) and it was assumed to be implemented through three
medium term plans.
 With regard to the country’s external sector, the main objectives of the plan was to expand
country’s foreign exchange earnings substantially, and also to diversify export market. To
attain these objectives, the government designed different strategies for external sector,
namely, high production for export in terms of equality, quantity, and promotion of export
trade through the provision of favorable tax, transport tariff and exchange rate measures.
 Share of Coffee, Hides and Skins, Oil seeds and Pulses in total Birr 563.64 million, 141.34
million, 9.27 million, 22.47 million respectively, whereas the share of non-traditional
products were planned to go up from 26.5% in 1984/85 to 46.8% in1993/94.
 Overall the plan projected to raise exports by 8.8% per annum and to increase the share
exports as GDP from 13.2-16.3% at the end of the plan period.
 The other incentives for export diversification were export subsidy and preferential interest
rate of 6% on bank loans for exporters while 8% for importers. However, there were
unfavorable taxes on exports and this offset the subsidies provided by the regime (MEDAC,
1997).

2.3.1.1.1. The structure and performance of export during the Dergue regime
(1974/75-1990/91)
 During the Dergue regime, the country’s export commodities mainly depend on few
traditional items.
 Between 1974/75-1991/92 the share of coffee to the total exports was on average constituted
60s percent.
 Hides and Skins between 1974/75-1990/91 accounts on average were 10.8 percent.
  The share of oil seeds and pulses shows declining trend, live animals, sugar, meat products
contribute about 2.3, 1.4, and 0.6 percent respectively.
 Generally during this regime the export sector shows declining trends and export
diversification had not yet realized (see table 2.1 )

Table 2.1: Share and structure of major exports (percent of total)

Products 1974/75-1990/91
Coffee 60.5
Hides and Skins 10.9
Pulses 4.0
Oilseeds 3.2
Sugar 1.4
Live animals 2.3
Meat products 0.6
Others 17.1
Total 100
Source: Calculated from NBE data.

 The Major reason for the poor performance of export of the country was due to irrelevant
trade strategy including overvalued exchange rate which was disincentive for exports, the
marginalization the role of the private sectors and other domestic policies.
 Even though the dergue include some positive policies in its Ten-years perspectives plan such
as preferential interest rate, subsides, and other were offset by unfavorable policies such as
controlling exports, heavy tax, the distorted pricing policy and others for example exporters
were forced to sale their product domestic markets rather than exporting and overvalued
exchange rate.
 Therefore, the dergue regime does not promote export diversification such as infrastructural
facilities, access to world market information, technical assistance to exporters.
2.3.1.1.2. The Economic growth during the dergue regime (1974/75-1990/91)
o The 1974 revolution resulted in the nationalization and restructuring of the Ethiopian
economy. During the dergue regime, the country’s economy deteriorated gradually.
o According to the study by 1990-91 the Ethiopian economy was in a steep decline from which
recovery would be difficult.
o The study denotes that during the last year of the military government, GDP declining by 5
percent in real terms, and inflation soared.
o Defense expenditures accounted for 40 to 60 percent of the national budget. Merchandise
exports fell to their lowest level since 1994, and a collapse in international coffee prices
(during the 1979-89 periods, Coffee accounted for an average of 55 percent of total export)
reduced foreign exchange reserve to an all-time low.
o Recurring cycles of drought and famine again threatened millions of Ethiopians; and ill-
conceived Marxist economic policies further eroded the country’s economic performance. As
a result of these and numerous other problems, the World Bank classified Ethiopia as the
world’s poorest country. Other sources show that the Gross Domestic Product (GDP) of the
country in 1990 was US $6 billion with per capita GDP estimated to be about US $ 120.

2.3.1.2. The EPRDF Regime (1991/92-2017/18)

 The Ethiopia people Revolutionary Democratic Front (EPRDF) overthrown the Military
regime and established Transitional Government of Ethiopia (TGE) in May 1991.
 The TGE in collaboration with the World Bank and IMF under free market economy has
undertaken structural Adjustment Program (SAP) and trade liberalization.
 Both aimed at stabilizing the country’s economic condition especially the trade reform that
was taken to ensure and promote the export sector through diversifying the narrow base of
the nation exports. To implement these, some of the policy package include:-
 Ethiopia birr was devalued from 2.07 birr per US dollar to 5.00 birr per US dollar in October
1992.
  This measure was taken to raise the profitability of export production and to make exports
competitive there by promoting exporters and redirect from UN official to official channel
market, in addition a biweekly foreign exchange auction market induced since May 1993
which was open for licensed importers. In relation to foreign trade, the policy aimed to
eliminate state monopoly, to reduce excessive control over external trade and promote
exports.
 In 1997 the national bank of Ethiopia (NBE) issue directive that allow private non-guaranteed
foreign commercial loans in kind and cash for exports.
 These kinds of loans are exported to promote exports on both traditional and new ones to the
export basket.
 A preferential interest rate scheme is also introduced for exporters, which is less by 3.5
percent compared to the interest rate changed on non-export activities; such allow preferential
interest rate scheme has strengthened the country’s export diversification efforts. In 1998,
EPRDF designed export development strategy for the development of export sector. The
main objective of the study was to maintain the country’s long term economic growth with
macro-economic stability (export development strategy, 1998).
 The overall strategy for export development include that diversification of exports based on
surplus venting by opining un used for agricultural cultivation especially horticulture
products such as vegetables, flowers, cut fruits, chilled meats, emphasis on export of
manufactured products such as clothing, textile, leather product where their world demand is
high.

2.3.1.2.1. The Structure and Performance of export during EPRDF Regime

(1991/92-2017/18)
o The structure of the Ethiopia export is not different from the previous regimes.
o It is dominated by primary products, coffee continuous its domination over the other
export items. Between 1991/92-2017/18 the share of coffee was about 44.2 percent as
well as that of hides and skins constituted 9 percent(ITC).
o The share of Chat constituted on average 8.9 percent. The share of Oil Seeds was 10.7
percent which indicates a very high rate of increasing when we compare it with the
dergue regime that is from 3.2 percent to 10.7 percent. Following this pulse, live
 animals, and meat products shares about 4.5 percent, 3.7 percent, and 1.1 percent
( Daniel Workman,2018).
o The EPRDF regime adopted outward oriented or export promotion trade strategy. This
government tried to pursue permissive and positive policies to promote export
diversification.
o With regard to permissive policies, the state has undertaken policy reforms such as
devolution that makes export market more attractive than domestic market,
rationalization and elimination of export taxes on coffee. (World Trade Map,2018).
o Concerning with positive policies, the EPRDF regime works intensively to improve
infrastructure including roads, power generation, telecommunication and education.
There is also an effort to provide information about world market, training for
business community and other services, especially through Ethiopian export
promotion agency and chambers.
o In general, the regime designed appropriate policy to promote export sector and tried
to improve the quality of export items, encouraging exporter to enter in world market
and free trade zones, and government official tried to create good image of the
county’s export products and attracting investors as a national objectives in order to
achieve the goal of export diversification(WTO,2018).

2.3.1.2.2. The Economic growth during the EPRDF Regime (1991/92-2017/18)

o Ethiopians last weekcelebrated the 23rd anniversary of the May 28, 1991 overthrow of derge
regime through the leadership of the Ethiopians people’s revolutionary and Democratic Front
(EPRDF). After the overthrown of the derge regime the three years in to the era of EPRDF, in
1994, the GDP purchasing power equivalent grew to 20.3 billion US$ with per capital of 200
US$. As early as 1995, the real growth rate of GDP was 4%. The 1994 GDP was broken
down in to 31% service, 3% manufacturing, and 10% Industry, and 56% Agriculture( ).
o Ethiopia shipped US$2.9 billion worth of goods around the globe in 2017, up by 10.5% since
2013. Year over year, that dollar amount also equals a 9.4% improvement in Ethiopian export
sales from 2016 to 2017.( )
o Based on estimates from the Central Intelligence Agency’s World Factbook, Ethiopia’s
exported goods plus services represent 8.1% of total Ethiopian economic output or Gross
Domestic Product. The analysis below focuses on exported products only.
o On a per-continent basis, $1.2 billion or 42.7% of Ethiopian exports by value were delivered
to Asian countries while 29.1% were sold to European nations. Ethiopia shipped another
 16.8% worth of goods to fellow African nations, with 8.5% of Ethiopia’s shipments going to
customers in North America.
o Given Ethiopia’s population of 105.4 million people, its total $2.9 billion in 2017 exports
translates to roughly $27 for every resident in that country.
o Ethiopia’s unemployment rate was forecast to be 16.8% as of October 2017 according to
Trading Economics.(World Factbook,2018)
o The date clearly shows that positive changes in the economy come just a couple of years after
the assumption of power by the EPRDF despite projection that it would take much longer,
with the adoption of the Agricultural Development Led Industrialization (ADLI).

2.3.2. Major Constraints of export diversification

o The performance of export sector suffered stagnation and also observed a declined trend
especially during the dergue regime.
o The share of non-coffee export was still limited and this impedes the profitability and
competitiveness of the export sector.
o The constraints of export diversification directly or indirectly hampered the overall the
country’s economic development and growth. The major constraints in Ethiopian export
sector for its diversification can be seen from internal (supply) and external (demand) sides.

2.3.2.1. The Internal (Supply) Side Constraints

o Irrelevant policy of government especially during the pre- reform period including
overvalued exchange rate, bureaucratic procedures of licensing, high tariff on export, and
imports together with shortage of foreign exchange which as an important contribution in the
process of production for raw materials, intermediate and capital good have essentially
lowered the profitability and competitiveness of the export sector.
o One of the major problems is the type and natures of the exported items are mainly
agricultural products which have less income elasticity.
o These products are unprocessed, low quality standard and there is high reliance on few
commodities. Scarcity of investment, inadequacy of infrastructure, and less technical
 assistance exporters have been significantly inhabited the production capacity of exportable
goods.

2.3.2.2. The External (Demand) Side Constraints

 The external constraints are usually occurred from the nature of the products and the level of
technology that employed in the process of production of the country’s exports.
 These problems summarized as follows: - almost all of the export items are agricultural
commodities with low quality standards which have low income elasticity of world demand
and their demand also decrease as the income of the people increase or they are subject to
large price fluctuations.

2.3.3. Prospects of Export diversification

 Ethiopia has potential in the area of producing and processing agricultural products including
coffee, Tea, Pulses, hides and skins, live animals, horticulture, and fruits, and vegetables etc.
 Taking in to consideration, the current government designed development strategy known as
ADLI the strategy that aimed to bring structural transformation of the economy and
industrialization is the other goal ADLI that aimed to raise the share of industry and service
sector.

2.4 Empirical literatures

 Based on the popularity of the hypothesis diversification led export growth, there has been
remarkably empirical evidence or investigation in to implied linkage between export
diversification and growth.
 Tsega Abraham (2012) used statistical methods such as percentage, ratios and moving
averages to see terms if export trade overtime. In that study he attempt to study many aspects
of export diversification such as, the prospect of export diversification, the problems and
need for diversification.
 The study conducted AlemayehuGeda and Dr. Brhanu entitled the export sector of Ethiopia
employed mainly empirical in its method of analysis. They showed there is casual
relationship between export instability and degree of diversification.
 Al-murabi(2014) using cross country analysis over 91 country’s for the period of 1961 -2014
using export products at the three-digit level and in calculating “the absolute division of the
country commodity shares from the world structured “and Hirschman index of concentration
of commodities. He fined that export diversification indeed associated with higher economic
growth rates.
 Al-murabi (2015) analysis the relationships between export diversification and economic
growth in convectional cross sectional country growth regression through adding various
measure of export concentration to the basic growth equation and he finds that export
diversification promote economic growth.
 Shewangzawshilesi (2013), used data more than 40 years on the role of diversification on
reduce export instability and its impact on Ethiopia economy by employing variable such as
geographic concentration index, commodity concentration index, export market share and
proportion of food export. He concluded that Ethiopia needs encourage both horizontal and
vertical diversification to reduce the export instability impact on its economic growth.
 Hassan and Tada (2014) have investigated the export diversifications and its impact on
economic growth using linear growth model. They specified the model and capture the
notation of export diversification through variable such as the growth of aggregate
manufactured commodities that representing vertical diversification and the growth rate of
aggregate primer commodities reflecting horizontal diversification of the growth rate of total
exports. They estimated for Malaysia, the result obtained in both horizontal and vertical
diversification of export commodity variable has statistical significance impact on export
growth and economic growth.

 HeikoHesse (2016) analysis the relationship between export diversification and growth by
adding other macro variable such as human capital, openness, in dynamic panel growth
models based on the GMM estimators’ developed by Arellano and Bond (1991).
 Finally he finds that a non –linear relationship with developing countries benefiting from
diversifying their export in contrast to the most advanced countries that perform better with
export specialization.
 Solomon Samen (2014) studied the relationship between export diversification and growth in
two stages. In first stage, the link between export diversification (horizontal and vertical) and
export growth using traditional simple econometric regression model. In the second, stage the
 long run impact of export growth on the countries real growth using recent econometric
model (granger standard causality test). Finally his finding shows that export diversification
has significant and positive effect on the overall growth of developing countries.
 Agoisn (2015) found the export diversification, alone and interact with percapita export
growth (measure of diversification weighted export growth rate) are highly significant in
explaining per capital GDP growth in developing countries.
 RerhanuLakew (2013), analyze the prospects for export diversification in Ethiopia by
empirically investigating the main determinants of the country’s exports such variables; real
exchange rate, real private sector credit, real private consumption, and real GDP.
 Finally he finds that real exchange rate, real private sector credit, real private consumptions
are significant determinant of export in the long run, and real GDP, real private sector credit
and real private consumption are in the short run

CHAPTER THREE
3. METHODOLOGY OF THE STUDY
3.1methodology of the study
 This study shows that the technique to collect, analysis and interpreted the data

which will be obtained from different sources.

 The descriptive methodology and econometric analysis will be used to tell the

relevant information about role of export diversification in Ethiopia.

3.2 Source of Data
  Secondary data will be used in the study; the data are mainly to be collected from national
bank of Ethiopia (annual report and bullet), ministry of finance and economic development
(MoFED), central statistical authority (CSA), Ethiopia custom authority (ECA), and ministry
of trade and from various international institutions like IMS, WB and UNCTAD.
 For the purpose of analyzing the countries export diversification and economic growth, the
data over the period between 1974/75-2017/18.
3.3 Descriptive Analysis
To show the determinants of export diversification on Ethiopian economic growth, descriptive
method of data analysis will be used. The trade strategy of Ethiopia, constraints and prospects of
export diversificationis is going to be discussed.

3.4 Econometrics analysis a

 In addition to descriptive analysis, the econometrics analysis will also be used to show the
influence of each explanatory variable on dependent variable by using OLS (ordinary list
square). The OLS model is best linear and unbiased estimation (BLUE).

 This model is developed by subsequent effort of two people .i.e. sir Francis Galton and
Pearson (ask.com).
 The equation attempts to model the relationship between two or more variable and response
variable by fitting a linear equation to observe the data (Pearson, 1930). Every value of
independent variable associates with a value of dependent variable. The model takes the
role of export diversification for Ethiopian economic growth and the variable that determine
the RGDP as dependent variable.
.

3.5 Model Specification

GRGDPt= ao+a1GDIt+a2LFt+a3OPENt+Ui
Where;GRGDPt= growth rate of real domestic product at time t
ao= conistant
GDIt= gross domestic investment at time t
LFt= lobar force at time t
OPENt= opennes at time t
Uit= error terms/disturbance term at time t
3.6 Description of main variable
3.6.1 Independent variables
 Gross capital formation (investment):- It is measured by the total value of gross fixed
capital and changes in inventories and acquisitions less disposal of value for a unit or sector
(IMF, 2011 world economic outlook). Growth and development theories have long regarded
the accumulation of physical capital as an engine of long run sustained economic growth
process.

 Labor force: - it is the total number of people employed or seeking to employment in a

country. Theoretically, labor force is the engine of growth. However, it seems opposition, for
many African countries even for a burden in the economy, because of high rate of
unemployment. But those who are employed formally and informally are playing a crucial
role in economic growth of the country (ILO, 2010).

 Openness: which is the ratio is export plus import to GDP. It contributes to export
diversification through external effects such as expose to foreign competition, transfer of
technology and economies of scale and also from increased speed of convergence towards
richer countries. It also contributes through reduction in tariff rates, simplification of export
licensing requirements procedures and suppression for import licensing.

3.6.2 Dependent variable

 Economic Growth: - the increasing in the amount goods and serious produced by an
economy overtime. It is conventionally measured as the percentage rate of increase in real
gross domestic products or real GDP