Exploring The Economy Of Ethiopia Economics Essay

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Ethiopia is almost five times bigger in the size of the United Kingdom and 27 times in the size of the Netherlands, is geographically located in the east of Africa with border line Somalia(1626 km) from east , Eritrea(912km) on north ,Sudan(1606 km) from the west and Kenya(830 km from the south. Ethiopia has geographically importance due to easy access to reach the Middle East and Europe, increase its importance in international trade. Geographically having an area of approximately 1.12 million square kilometers (444,000 square miles) out of which land is on 1,119 million square kilometers and water is on 7444 square meters.

Ethiopia is high plateau with central mountain ranges almost over the country is divided by Great Rift Valley. The major rivers in Ethiopia are Blue Nile, Awash, Baro, Omo, Tekezie and Wabe Shebele. Ethiopia has also small amount of natural resources with small reserves of platinum, gold, potash, copper, hydropower and natural gas.

1.2 The People

Ethiopia is country with around 80 million people, and in comparison to other country it comes on 14th rank in world. Almost more than 80 percent of the population still lives in the rural areas. The age structure in Ethiopia is 0-14 years are (46.1%),15-64 years are (51.2%) and 65 years and over are (2.7%).Ethiopia has average birth rate of 2.7%.

In Ethiopia is total freedom of religious practice, and the Christianity and Islam are the two main religions in Ethiopia with other religions which are in very number most of them are located in south side.

Almost two-third of the population used the three main languages Amharic, Oromiffa and Tigrigna the official language of the Ethiopian government is Amharic. In schools, colleges and university teaching and medium of instruction are in English, also used mostly in the banking, insurance and business transactions, Arabic and Italian languages are also widely used in Ethiopia.

Almost the 42.7 % of over 15 years old people can read and write mean having basic literacy rate. The Ethiopian government is spending almost 5.5 percent of their GDP in education programs.

1.3 The Government

Ethiopia is conventional short form of name, and conventional long form of name is Federal Democratic Republic of Ethiopia. The first time election was held in 1995 and country adopted a new constitution and the government there is known as the federal republic government. The government involves in the foreign policy and relations, defense system and common interest & benefits.

The Federal State divisions are in nine ethnically based states vested with powers for self administration. The FDRE represent the common peoples interest and peoples of the states, the federal government is structured as a lines of bicameral parliament, with the Council of Peoples' representatives being the highest authority of the Federal Government the representative of Councils Members are elected democratically for six year term.

1.4 Cities and Towns

Addis Ababa, the largest city and capital of the Ethiopia, also is the seat of the Federal Government of Ethiopia. The capital city was founded in 1887 and population of around about 3 million. Addis Ababa is the host city for Organization for African Unity and the United Nations Economic Commission for Africa; also there is more international organization with their headquarters and branch offices. Addis Ababa I also centre point for business, commerce and industries. In Addis can find different manufacturing plants located in and around the city.

There are lots of entertainment and sport facilities in the city, with national parks. The main centre of point are resort centers with hot springs and lake, all of them are easily accessible through road.

The other important and big cities in term of trade and industries having potential of expansion are Awassa, Dire Dawa, Gondar, Dessie, Nazareth, Jimma, Harar, Bahir Dar, Mekele, Debre Markos and Nekemte. All of them are interconnected with Addis through road,most of them have their historical importance with good infrastructure facilities.


The Ethiopian economy is totally dependable on agriculture which has 45% of the Gross Domestic Product (GDP), 65 % of total exports and 85% of employment. Coffee is the main export product and its alone having a share of over 85 % of total agricultural exports. In Ethiopia different crops in different area of the country cultivated but the main crops are cereals, pulses, coffee, cotton, tobacco, fruits, sugarcane and oil seeds.

The industrial sector plays also big role in economy and having almost 11% of share in total GDP, which provides their product to local and global markets. The most important products in term of local market and export are textiles, foodstuffs, tiles, paper, beverages, cement, semi- processed leather, finished leather products and non-metallic products.

In Ethiopia even it is small reserve amount of natural resources and it contribute only 1% to the total GDP, but still there are lots of opportunities in mining to explore and contribute in Ethiopian economy.


There is total monopoly of Ethiopian Telecommunications corporations over the telephonic services open-wire, microwave radio relay; radio communication in the HF, VHF, and UHF frequencies; 2 domestic satellites provide the national trunk service.

Ethiopia has only 1 public TV broadcast station which broadcasting it nationally and only 1 public radio broadcaster with stations in each state, there are some commercial and dozens of community radio stations.


Till 2010 in Ethiopia there 61 airports, out of which 17 airports are with paved runways and 44 airports are unpaved. The railway is under joint control of Ethiopia and Djibouti, but most of it is inoperable and need lots of improvement and expansion to improve the transportation. The conditions of Ethiopian roads are also not in very good conditions out of 36469 km long road only 6980 k are in better conditions other are unpaved around about 29849 km. Ethiopia has 9 merchant marine 8 cargo and 1 roll on/ roll off, they are landlocked and uses the ports Djibouti in Djibouti and Berbera in Somalia. In Ethiopia transportation is a big problem and effects also in the business. Ethiopian government take this problem very seriously and many projects are on progress for improvement and modernization of Ethiopian transportation system.

1 .6 Banking Systems

1.6.1 Introduction

In Ethiopia banking system was introduced in 1905 with the coordination of Bank of Egypt and the first name of bank was Bank of Abyssinia which is controlled by private company in Ethiopia. Later in 1931 it was replaced by the Bank of Ethiopia.

During the Italian invasion period and subsequent British occupation Ethiopia become one of the important places for East Africa Currency Board. Later again it is renamed as State bank of Ethiopia having two active departments involves in the process of separate function of issuing banks and commercial bank. In 1963 the bank is divided into two parts two new bank national Bank of Ethiopia involves in the process of centralizing and issuing bank and the second one the commercial bank of Ethiopia.

In 1974 there was merging of maximum of financial institutes available tat time including state owned also some of them are

The Agricultural and Industrial Development Bank

The Savings and Mortgage Corporation of Ethiopia

The Imperial Savings and Home Ownership Public Association

The Addis Ababa Bank

The Banco di Napoli

The Banco di Roma

In 1975 change in government policy and change into Marxist government bring again lots of changes in banking system like nationalization of private financial institutes and insurance companies. The big and important commercial bank of Ethiopia is now known as Addis Ababa bank and the total control of all banks and financial institutes are under supervision of National Bank of Ethiopia. The Ethiopian Insurances corporation take all power and control for the all insurance companies and for the home loan and renovation loan is provide by the new Housing and savings bank.

1.6.2 Current Conditions

The whole banking system condition is still undeveloped and need lots of improvement and development. In Ethiopia there is also no stock exchange and foreign bank as the banking system is still not globalized, while higher government authorities are afraid of losing control over the economy because of globalizing the banking system. That's why they have full control over the banking system even they decide the interest rate as per the high inflation rate. Below provided table to have a look on the condition of ease of doing business in Ethiopia.

Table 1 Business Climate of Ethiopia

As it's already stated above that National Bank of Ethiopia is Ethiopian central bank and the state owned Commercial Bank is one of the biggest and largest bank in Ethiopia having approx. control of more than 75% of total banking assets in Ethiopia, tables 2 tried to explain the banking system .

Table 2 Value of Ethiopian Bank Assets

Insurance companies and other financial institutions

In Ethiopia the Ethiopia Insurance Corporation controls 10 insurance companies performing business in more than 2oo branches all over the country Below in the table the number of branches and their capital are explained figures available are from 2007 and till then only nine insurance companies are in business the 10th company (Lion Insurance Company) comes after that's why is not mention in table.

Table 3: Branches and Capital of Insurance Companies in Ethiopia (Capital in Millions of Birr)

Stock Market

No stock exchange exists

Other Types of Finance/Financial Market

Micro finance

The formal microfinance industry began in Ethiopia in 1994/1995 with the government's the

Licensing and Supervision of Microfinance Institution Proclamation designed to encourage Microfinance Institutions (MFIs) to extend credit to both the rural and urban poor of the country. By 2005, there were 23 MFIs with almost 1 million clients.

Since the government prohibits any foreign national from providing banking services in

Ethiopia, MFIs in the country must be established as share companies with capital wholly owned by Ethiopian Nationals or by organizations wholly owned and registered under the laws with a head office in Ethiopia. This has led to lack of transparency in the sector since much of the initial capital comes from foreign donors who must enlist "nominal" shareholders to act as fronts. (MFIs are licensed under the central bank). Gobezie (2005) notes,

These shareholders are precluded from selling or transferring their shares and

"voluntarily forsake" their claim on dividends, if any, declared by the MFI. Such

shareholders do not have a real stake in the organization and would be unlikely to lend

it support at a time of financial crisis.

Interest rates charged on loans are not fixed, but a minimum interest rate of 3% to depositors is required by law, which sometimes discourages mobilization in hard‐to‐reach areas (where

administrative costs added to the cost of capital make investment too expensive). Such high

transactions costs mean that most MFIs operate in urban or semi‐urban areas, leaving the rural

poor underserved. On the other hand, MFIs are exempt from Income and Sales Tax on their


Other than the formally‐licensed MFIs, there are NGOs informally involved in the

delivery of microfinance. Their practices include subsidized interest rates, charity and lax

delinquency penalties, which Gobezie notes may undermine the health of the microfinance

industry as a whole.

Top ten reasons to do business in Ethiopia

Political and social stability;

Macro-economic stability and growing economy;

Adequate guarantees and protections;

Transparent laws and streamlined procedures;

Ample investment opportunities;

Abundant and trainable labor force;

Wide domestic, regional and international market opportunity;

Competitive investment incentive packages ;

Welcoming attitude of the people to FDI; and

Pleasant climate and fertile soils.

Opportunities in Ethiopia

As there are lot of business opportunities in Ethiopia in different sectors, as it is not possible to address all of them. But try to concentrate and search opportunities on some of basic and important business sectors for foreign investors

3.1 Business Opportunities in Manufacturing Sector

The manufacturing sector plays an important role in economy of Ethiopia it has almost a share of 5% of GDP and 37.8% to the annual output value of industrial production in 2008/09 (Central Statistical Agency Statistical Abstract 2009). The important manufacturing sectors in Ethiopia are production of food, beverages, tobacco, textiles and garments, leather goods, paper, metallic and non-metallic mineral products, cement and chemicals. The production of textile, leather products and food and beverages are one of the most important industries for investment, because of its geographical advantage of easy and fast access to Middle-East and Europe.

In manufacturing section we discussed on business opportunities in textile and garment industry and leather product.

3.1.1 Textile and garment

In 1939 under the Italian government supervision and technology, the first textile factory was opened. Presently the current textiles industry involves in the process of spinning, weaving and processing. Ethiopia presently having 5 public and indefinite number of privately own small and big factories involves in producing various kind of garments like shirts, kids wear, uniforms etc. for the domestic and international markets.

Presently in Ethiopia textiles industry is major changes are under process regarding development and modernization of technology, with the advantage of very cheap, skilled and work-oriented motivated manpower. This under process development in textile industry improves dramatically and helped also in the country's impressive economic growth in last few years. In Ethiopia the big and successful export potential with lot of possibilities of expansion is only possible because of easily availability of raw material like raw cotton and other natural fibers.

The whole cycle of fast growth and excellent opportunity in Textile industry is depend on the availability main raw material (raw cotton).Ethiopian government is supporting and promoting local production of cotton In the Awash valley the whole production process is carried out, which has approximately around fifty thousand hectares land is under production of cotton. The contribution by the small farmers who produces also a very good quality of raw cotton in total around forty-five thousand hectares . There is lot of opportunities available for the expansion of production in Ethiopia mainly in the areas of Omo-Gibe, Wabi Shebelle, Baro Akobo, Blue Nile and Tekeze River basins. The whole textile industries output is depend on production and timely supply of raw material(raw cotton).

The Ethiopia has all those things which are essential and important for a competitive textile industry for foreign investors to attract like easily availability of raw materials, cheap manpower and energy which make more interest in investment that other African countries, not only this the government also actively supporting the textile industries in term of modernization and producing best skilled manpower and management in keeping mind to attract new investors in textile industry.

Output and Products

Ethiopia's textile industries having all kind of small, medium and large government owned and privately owned enterprises, involves actively in the operations like spinning, fabric formulation, dyeing, finishing and sewing.

In the manufacturing sector the Ethiopian textile industry is one of the most important industry and it is the third largest manufacturing industry, only second to the food, beverages and leather industry. In the financial year 2000-01, textile industry having the total output value of 81.38 million USD (1 USD=8.6 birr) approximately, the total contribution of textile industry towards in the economy was 1.35% in GDP and the total contribution to the manufacturing industry was 8.31%.

The Ethiopian textile industries involves in the action of producing mostly in 100% cotton textiles. Almost all of them involves in the same kind of products manufacturing, such as cotton yarn, cotton fabrics, bed sheets, blanket, knitwear etc. Most of the manufactured the cotton yarn in the Ethiopian textile industry is supplied to the local market. It is approximately estimated that the annual hand-loomed fabric is around 95 million square meters.

Supply of raw material and accessories

Most of the raw material used in textile industry like chemical fiber, wool, dyestuffs, and chemical are depends on the import, the main material cotton is widely produces in Ethiopia and it is easily available in local market.

Export Market

Ethiopian Export Promotion Agency publish that in the financial year 2000-01 it was observes that there was apparent increase against the last year in textile industries in both in the varieties and quantities of textile export. In the category of variety it was increased from 6 kinds, mostly cotton yarn and bleach cloth manufactured from pure cotton, to over 20 kinds including gray cloth pure cotton, bleach cloth, knitwear, bedding products etc. From these mentioned varieties the gray cloth manufactured from pure cotton is the one of the major export item, almost contributing to 75% of the total export quantity.

Ethiopia's textile industries in export targeted mainly at European and African markets. In Europe, the export markets for Ethiopian textiles are Italy, Sweden, and Belgium etc. African major export markets are Djibouti, Kenya, and Swaziland etc.

Ownership and geographical distribution of textile enterprises

Because of new investment and foreign policy by the Ethiopian government in recent years, the lots of changes in textile industries take place such as privatization and the favorable opportunities for the investment of foreign and local private investment in textile industries, ownership of the industry is having totally different kinds of option to invest/run. The types of ownership are mostly in Ethiopian textile industries are privately owned enterprises, public enterprises, partnership enterprise, shareholding Corporation and individual enterprises etc.

The Ethiopian textile industries is classified in two sectors public and private, there are currently 19 public and 16 private industries. Most of the public industries having capacity of producing in very large scale, the play a very important leading roles in textile industry, as counted by the number of public industries it gives a lot of opportunities for employment, total output values, income from sales etc.

Most of the textile industries are situated in highly populated large and medium cities. Out of the total 35 textile industries in Ethiopia, 18 are in Addis Ababa. Rest of the textile industries are located in Amhara and Southern (S.N.N.P) regions.

Marketing System of textile products

Most of the products such as yarn, fabric and blanket manufactured by Ethiopian textile enterprises are usually distributed by private trading companies to the local market. The rest of the product for export is mostly handled by the industries self.

Imported textiles having a maximum market share in Ethiopian local market and almost nearly one thousand small-scale/family-owned trading companies and also a small number of large trading companies are involved in the import business of textiles.

Favorable Conditions for the Development of the Textile Sector in Ethiopia

Abundant Cotton Resources

Ethiopia covering an area of 1.1036 million square kilometers and best conditions for the agriculture such as fertile land, rich geographical and weather conditions, and abundant water resources. Locally cotton production is already developed, and it has made maximum contribution to providing the basic requirement of raw material by the textile sub-industries. Ethiopia has a large area of irrigated land which is very suitable for producing cotton. There is also great possibility and potential for further expansion of the production and increasing the current yield.

Abundant cheap labor resource

Ethiopia having a population of more than 70 million and with having a cheap cost of manpower, Ethiopia has potential of providing sufficient cheap labor force with cost-competitiveness for the development of labor intensive textile sub-industry. The cost of the manpower in the Ethiopian textile industry is cheaper than some Asian countries with developed textile industries, such as China, India, Pakistan and Bangladesh but also than some African countries such as Tunisia, Mauritius, Kenya, etc.

Support through policy and incentives

Ethiopia government defines textile industry as the key industry for the development of industrialization as well as the exploring of local resources to promote export in accordance with the policy of "Agriculture Development led Industrialization (ADLI)". Ethiopian government long term strategy is not only to develop the textile and garment industry and expand market shares in local market, but also to develop a competitive, profitable industry in the export market.

The Ethiopian government strategy in textile industries has been steadily pushing towards market-oriented reform by means of developing more private sectors and making it easier and attractive for foreign investors. As it is clear export promotion is of paramount importance, the government has issued a series of export incentives. The Ethiopian government has developed an friendly environment for the development and modernization of textile industries.

Investment policy and incentives

According to the Ethiopia government newly revised investment policy, the minimum amount of capital required for foreign investors is yet minimized, to create a easy conducive investment environment.

-      The minimum capital amount required for foreign investors on a single investment project has been minimized to 100, 000 USD from 500, 000 USD for totally owned invested projects and for joint venture it has been minimized to 60, 000USD from 300,000USD.

In addition, Ethiopian government provides a series of incentives for foreign investors, such as:

-          Remittance of foreign currency of profit and dividends from investment

-          Exemption from income tax from 1-5 years etc.

In order to promote and increase export, also there are various flexible taxation encouragement measures have been undertaken such as export tax refund, tax coupon and bonded warehouse.

The Ethiopian Ministry of Trade and Industry also provided nowadays textiles and garment export forum to attract local textile and garment exporters to discussed current issues and future development for textile and garment industries in order to promote the export of textiles and garments.

 Increased Domestic Demand

Ethiopia is a highly populated and has a large territory. The average growth rate of the population is 2.7%.

According to the current country economic development program, it is estimated that the average growth rate of GDP in the next coming years will reach the mark of around 7%. Which is possible just because of government right strategy for the development of economy and the progress in reduction of poverty as well as the improvement of people's living standards, it is assumed that not only the present market demand would increase, but also a new market demand will arise in future. Currently the Ethiopian per capita fiber consumption is around about 1kg, which is far below the world's average level of 8.7kg and also Africa average level of 3.2 kg. It is also assumed that domestic fiber demand will increase in future at rate of 5% annually and the large and continuously increasing domestic market will help in the development of the textile sector.

Easy access to international market

The consumption of fiber products all over the world has been almost increased five times, while the world population has increased only 1.4 times in the later 20th century.  The better and improved living standards quality of peoples has increase 75% in fiber production. In recent years, the economic growth of U.S.A, Europe and Japan, the market demand has increased.

Africa Growth Opportunity Act (AGOA)

In May 2000, the United States of America approved Africa Growth Opportunity Act (AGOA) to give sub-Sahara region of Africa, specifically 48 countries, special preferential trade policy. In August 2001, Ethiopia was entitled AGOA qualifications and is one of the 18 beneficiary countries which can export textiles and garments to the United States free of duty and without quota restrictions.

"Everything but Arms" of the European Union

The European Union (EU) has given preferential trade policy to the Lesser Developed Beneficiary Countries (LDBC) including Ethiopia. Accordingly, Ethiopia is a beneficiary of Everything but Arms initiative of the EU in which all Ethiopian export products except arms can enter the EU market free of duty and without quota restrictions.

Common Market for Eastern and Southern Africa (COMESA)

Ethiopia is a member of the Common Market for Eastern and Southern Africa (COMESA) agreement embracing 20 countries in Eastern and Southern Africa with a population of approximately 353 million. Exports and imports with member countries enjoy preferential tariff rates.

Bilateral Agreement

Ethiopia has signed bilateral trade agreements with 16 nations such as Russia, Turkey, Yemen etc which provide legal framework for enjoying most-favoured-nation treatment and removing tariff barriers. According to Generalized System of Preference (GSP), most of the products made in Ethiopia enjoy tariff treatment in the United States, Canada, Switzerland, Norway, Sweden, Finland, Austria, Japan and the majority of EU member nations.

3.1.2 Leather Industry

Ethiopia leather exports involve in the processed and semi-processed skins and hides to the global market. Ethiopian leather product like sheepskin has highly international demand for making gloves because of its natural characteristics and quality. Ethiopian leather export of skin and hides involves the export of pickled sheep skin, wet blue sheep skin, crust sheep skin, wet blue goat skin, crust goat skin, crust cow hides, finished garment leather, finished glove leather, lining/upper leather, suede leather, full grain leather, embossed leather and patent leather. 

Due to lots of investment opportunities and cheap manpower the manufacturing and export potential of finished leather and leather products is really a very attractive option.

Production capacity

Ethiopia has a very large livestock population, stands first in Africa and 10th position in world for having largest livestock production. It is estimated that currently approximately having 35 million cattle's, 21 million sheep and 16.8 million goats, which contributed in production of 8.1 million sheepskin, 7.5 million goatskin and 2.7 million hides, there was a advantage of exporting of raw skins and hides, while it cost only 50-60% of the production of semi-processed leather.

Ethiopia Leather industry is involved in the process from semi-processed in different form to fully processed leathers including leather garments, backpacks, shoe uppers, leather purse, gloves and finished leather.

Most of the product is export and the main markets are in Europe, America, Canada, China and eastern countries.

Leather mnufaturing categories

The leather industries, the CSA distinguishes into the two broad categories. One of them is concerned for the manufacturing of footwear, footwear industries is highly attractive and promising in terms of investment, but not too good in term of employment. The anther category is concerned in the tanning and dressing of leather involves in the process of manufacturing of luggage and handbags.

Raw Material

In leather industry the main role played by the raw sheepskin and goatskin which is also having a highly international demand because of its natural characteristics, thickness, flexibility, strength and quality which are used in various products like sports equipment, gloves and garments.


During the last two decades in leather industry in Ethiopia the finished leather and semi-processed hides and skins plays as the second major export product of the country after export of coffee

The maximum contribution in export comes from the sheepskin and it also assumed that almost all of the sheepskin is produced is export, the other product like wet-blue goatskins hides and other skins have also their contribution in export. The Ethiopian exports in comparison in relative to other African countries in terms of share Ethiopia owning total African skin exports of around 51% for sheepskin and 30% for goatskin. Exported leather products go mainly in UK and Italy.

Development needed In leather sector

The leather industries in Ethiopia have really great potential and opportunities for foreign investors to invest but there are some sectors in this industry which seriously needed development. Below we tried to discuss the condition and development need in leather industries.


A major problem in Ethiopia is regular supply of skin and hides, as goat, cattle's and sheep are used mainly for the purpose of meat. Therefore the raw material for leather industry is available when there is continuous demand for meat is there, which was not in regular term while due to religiously induced fasting seasons. And in fasting period the meat consumption is very less and more in normal days.


The quality of raw material is very big problem in Ethiopia due to which they are facing lot of loss in export. The serious problems which effect badly in quality of raw leather product are flay cuts, putrefaction, dirt , dung , poor pattern.

Because of this problem the exporters are not getting the cost which is required and result is loss in export. The reason for following problem is improper care, knowledge and proper equipment. The Ethiopian government is very serious and some of the projects are under process to overcome from this problem with the active participation of ESALIA, CFC, UNIDO, FAO, UNIC and others.

Berhanu and Kibre (2002) have made an interesting study of competitiveness in the Ethiopian leather sector. For the tanning sector, they have concluded that the main factors affecting competitiveness are:

low capacity utilization;

the poor economic infrastructure: inefficient infrastructure and inefficient bureaucratic structures combined significantly raises the transaction costs of firms, making it difficult to compete nationally or internationally;

the technology employed is not updated (regularly), in particular the lack of learning in production management;

the lack of hard currency to purchase spare parts and inputs;

the relative lack of export support and/or promotion services

For the leather footwear industry, the main factors which make having affection the competitiveness are poor quality, and the high cost of (imported) inputs.

They conclude that the available resources are not enough for competitiveness, and similarly, the availability of cheap manpower also not work sufficiently to compete internationally.

3.1.3 Recommended Modes of Entry in Manufacturing Sector

Recommend mode for Textile and Garment Industry & Leather products

As we discussed above that the Ethiopian government provides lots of incentives and other options for local and foreign investors in Ethiopia as they believed not only foreign investors are getting benefit the country also get knowledge and skill from them, which help them in further development and modernization.

The foreign investors willing to invest in Ethiopia in textile/leather industries can invest in the following three options:

1.       whole- self owned enterprises by themselves.

2.       Setting up enterprises in joint venture with local companies.

3.       Cooperation with public industries which are on their process of. Listed below are the options available for the cooperation with public industries in manufacturing industry

a)       Joint venture

b)      Wholesale ownership

c)       Contract Management

d) Direct investment

Foreign Direct Investment

Foreign direct investment can have positive impacts on poverty by creating

employment, improving technology and human capital, and promoting competition. Not

all kinds of FDI contribute in this way, however, and some can adversely impact certain

dimensions of poverty through unsafe working conditions and environmental

degradation. Nevertheless, if we were to identify the most promising category of capital

flows from the point of view of poverty alleviation, FDI would be it.20

Many developing countries lack access to the technologies available in developed

countries, and hosting MNEs from developed countries is one way to potentially gain

access to that technology. There are limits to technology transfer, however. First, MNEs

will employ the technology that most suits their strategic needs and not the development

needs of host countries. For example, MNEs can employ processes that are much more

capital intensive than would be desired on the basis of host-country employment

considerations.21 Second, there is a strong tendency for MNEs to conduct their research

and development in their home bases rather than in host countries.22

Despite these general limitations, in some important cases, MNEs do transfer

technology and establish significant relationships with host-country suppliers via

backward linkages. If foreign MNE begins to source inputs locally rather than by

importing them, the host country can gain a number of important benefits. First,

employment can increase since the sourced inputs represent new production. Second,

production technologies can be better adapted to local conditions since suppliers are more

likely to employ labor-intensive processes. Third, the MNE can transfer state-of-the-art

business practices and technologies to the local suppliers. Fourth, it is possible that the

local suppliers can coalesce into a spatial cluster that supports innovation and