Chapter One

1.1. Background of the Problem

Foreign Direct Investment (FDI) refers those financial flows invested by Transnational
Corporations (TNCs) with respect to their international production operations (World Investment
Report (WIR), 2006; Dicken, 2001; cited in Yemsirach, 2006; Dupasquier and OSakwe, 2005).
The swift advance in technology in the last few decades have led to tremendous increases in FDI.
In terms of regional distribution, developed countries account for the bulk of global FDI inflows.
Africa has never been a major recipient of FDI flows and so lags behind other regions of the
world. Within the continent itself, the distribution of FDI flow is uneven where the major
recipients are oil producing countries (Dupasquier and Osakwe, 2005).

FDI is not new to Ethiopia in general and Addis Ababa in particular. Rather it was started during
the empirical regime, though it did not last long owing to the paralyzing impact of the military
government (Derg) (Befekadu, 1983). The current government in Ethiopia has taken various
measures to boost FDI in the country. For this effect, the Ethiopian Investment Agency (EIA)
was established in 1992, various proclamations and regulations have been passed and amended
and tremendous promotion works have also been done to attract FDI to the country. Besides
these efforts, yet the country is still unable to fully enjoy the benefits that accrue from FDI. It is
also surprising to learn that even in Addis Ababa, FDI is not in its satisfactory level as it is
expected (Adam, 2007).

Earlier researches on FDI were revolving around the controversies between FDI and economic
development and on the determinant factors for the inflow of FDI in to the host country. The
results obtained from these research works were mixed being dichotomized in favor and against
which invites development practitioners and investment analysts to conduct further research and
investigation. It is evident that investment is one of the many options to development. Thus a
micro-level detailed study on certain aspects such as trends, challenges and prospects of FDI on a
single city like Addis Ababa will provide a paramount importance to understand the nature of
investment and policy formulation for local economic development.
 1.2. Statement of the Problem
In the last few decades, there has been an enormous growth of FDI in the global arena,
stimulated by the ongoing globalization which grew at about 20% per year in between 1986 and
1990 (Dicken, 2001; cited in Yemsrach, 2006). Development economists and financial experts
argue that such investment would accelerate economic growth; initiates transfer of technology,
know how, new management skills and creates access to foreign currency (Todaro, 2003). Other
group of researchers like Chen (2000), however, argues that there is still scarcity of empirical
evidences to validate the assertion whether FDI has an effect on the economic growth of host
countries.
After the overthrew of the military regime, the current Ethiopian government has adopted market
liberalization policies and devaluated its currency (Birr) (Asrat, 2003). Besides, the Ethiopian
Investment Authority (EIA) was established 1992 and a continuous promotion work have been
done by various delegations led by senior government officials to attract foreign investors from
different corner of the world (EIA, 1995).
Despite the above efforts made by the Ethiopian government, yet the number of foreign investors
in the country is not satisfactory as it was expected. In this regard, the United Nations’ Report
(2000), reveals that only 45 foreign investors were operating in Ethiopia. As compared to other
regions in the country, Addis Ababa has relatively better infrastructure service provisions with
large stock of skilled manpower. However, the 2007 statistical report on investment indicated
that, there were only 377 foreign investors in Addis Ababa with a total capital of 5,877, 660.90
us Dollars which is less than the domestic investment.
Among the few research works in the area, Adam (2007) found out that Addis Ababa has a lower
FDI share vis-à-vis other neighboring metropolis like Dar Salaam and Nairobi. The data gathered
and analyzed by Yohannes (1999), from EIA and UNCTAD indicated that the nation’s total
investment is still too low, its investment portfolio is far below other neighboring African
counties. The distribution of FDI in the country is limited to some specific sectors like
agriculture, manufacturing and real estate which show that some sectors such as education and
health which are based for the nation’s economic growth seems to be neglected and are not yet
the focus of FDI (Adam, 2007; Yohannes, 1999).

In spite of the will to attract FDI at policy level, in actual terms, a number of research works in
Ethiopia that were conducted on FDI indicated that, the overall impact of FDI to capital
formation and economic integration of the country is not significant (Yohannes, 1999). Lack of
improved infrastructures, insufficient trained manpower, political instability, lack of good
governance, weak legal institutional framework, improper promotion and inefficient b
However, what makes the Ethiopian economy to remain under developed with chronic poverty
and law FDI inflow is not yet clearly known and crates a knowledge gap which necessitates
specific investigation. In a simple term, what are not yet known are not the particular factors that
affect FDI rather their systematic and integrated effect on the flow of FDI at the time of
implementing interventions that are meshed with these factors. Therefore, detailed assessment on
the trends, opportunities and prospects of FDI in areas like Addis Ababa is worth researching to
bridge the existing knowledge gap ureaucracies were some among the frequently outlined
problems that have been hindering the inflow of FDI to Ethiopia (Yemstrach, 2006; Adam,
2007).
Generally FDI studies in Ethiopia are limited (Yemsrach, 2006). By assessing these few studies,
statistical reports and government proclamations, in the preceding section an attempt has been
made to show the nature and trend of FDI in Ethiopia. Besides, it was made clear that FDI in
Ethiopia is contained in a complex set of problems and situations which are made known by the
above studies.
.1.3. Objectives
1.3.1. General Objective
The main objective of the study is to assess the trends, challenges and prospects of FDI in Addis
Ababa since 1998.
1.3.2. Specific objectives
The specific objectives of the study include:
1. To identify determinants of FDI in Addis Ababa since 1998.
2. To assess the trend of FDI in Addis Ababa since 1992.
3. To access the role of FDI to promote local economic development in Addis Ababa.
4. To assess the existing prospects of FDI in Addis Ababa.
5. To assess sectoral distribution of FDI in Adds Ababa since 1992.
6. To identify challenges of FDI in Addis Ababa.
7. To forward feasible recommendations that would be used as an asset by policy makers
 and foreign investors.
1.4. Research Questions
The study is expected to answer the following questions.
1. Is there any disparity in the sectoral distribution of FDI in the city?
2. What are the main determinant factors that affect the smooth flow of FDI in the city?
3. Is there an increase or decrease in the trend of FDI in the city? And why?
4. What are the major challenges, opportunities and prospects of FDI in the city?
5. What is the nature of foreign investors’ demand to invest in the city?
6. How much of the foreign investors demand is met by the Addis Ababa Investment Agency
1.5. Methodology of the Study
1.5.1. Study Design
The study is mainly aimed to collect data on the FDI operations since 1998 in Addis Ababa. A
mix of both cross-sectional and longitudinal survey methods will be used to assess the trends,
challenges, opportunities and prospects of FDI in the city. Besides, previous studies in the field
have employed either both or one of the methods. Following other researchers’ method
(Yemsrach, 2006; Adam 2007) the study adopted a case study approach which is believed to be
one of the suitable methods used when ever needs arise for an in depth examination of single or
group of variables.
1.5.2. Data Type and Sources
The research will make use of both primary and secondary sources to collect data for the study.
Primary data will be collected through structured and semi structured questionnaires of open
ended and close ended type, key informant and focus group discussion techniques. Secondary
data will be collected from relevant documents such as books, articles, magazines, news papers,
statistical reports and above all from documentary records of EIA and Addis Ababa Investment
Agency(AAIA).
1.5.3. Data Collection Instruments
Data collection techniques such as structured questionnaires, interview, and focus group
discussions will be employed. Structured questionnaires are selected to collect information that
does not need further explanation. Focus group discussion is mainly chosen to be used as a
technique to collect information that are hardly possible to be caught by other methods which
rather necessitates further probing.
1.5.4. Method of Data Analysis
Initially, the data cleaning process will be conducted to identify any missing value and to take
corrective measures by cross-checking the corresponding questionnaires. Analysis of data will be
conducted to show important relationships of variables under the study. To this end a mix of
qualitative and quantitative models will be used. Descriptive statistics such as ratios,
percentages, standard deviations, chi-square and t-test will be used to analyze and describe the
data quantitatively by making use of SPSS-15.0 version (Schematic program for social sciences).
1.5.5. Sample Size and Sampling Techniques
To undertake this study, gathering accurate data will be given a due care. In doing so, a
systematic random and purposive sampling techniques will be used. To select samples among
foreign investors, simple random sampling will be employed since it would enable the researcher
to acquire representative sample with least cost and time. The sample frame of the study will be
262 foreign investors who are licensed by EIA and went fully operational. Thirty percent (78) of
these licensed foreign investors will be selected through systematic random sampling after
preparing the sample frame from EIA’s license registration file. Besides, purposive sampling
technique will be used to select experts from EIA and AAIA for interview.
1.6. Significance of the Study
Currently, the issue of FDI has gained a high concern on the development agenda of developing
counties among which Ethiopia is one. This is because; the flow of funds across borders is one of
the vehicles of development among nations. Cognizant of this fact, this study is expected to offer
the following significances.
 It will provide an insight on the trends, challenges, opportunities and prospects of FDI in
Addis Ababa since 1998.
 It will addresses problems related policy issues and institutional arrangements that would
influence FDI in Addis Ababa
 It will identify gaps for further study and discussion.
1.7. Scope of the Study
The study will be spatially limited to the city of Addis Ababa where most of the country’s
foreign investment activities are concentrated. It will also consider only those operational foreign
investment projects licensed between 1998-2008 excluding projects that are at the pre-
operational and implementation stages.
 1.8. Limitations of the Study
Since the study is spatially limited to Addis Ababa, the results might not be representative of the
whole regions in the country. Besides the study will not include other investment activities such
as portfolio foreign investments and its findings will not be applicable to this sector. In general,
the study will be limited by resources constraints (time and money) and the proposed objectives.
1.9 Organization of the thesis
The thesis will have four main chapters. The first chapter is an introduction, which will provide
overall information while the second chapter will deal with conceptual and empirical literatures.
The main body of the study that is data analysis and interpretation will be presented in the third
chapter. Finally, the summary, conclusion and policy implication part will be presented in fourth
chapter.
 1.10 Literature Review
Todaro (2003) defined FDI as those financial flows invested by Trance National Corporations
(TNCs) with respect to their international operations. As to Krugman and Obstfeld (1998), FDI
refers international capital flows in which a firm in one country creates a subsidiary firm in
another country. World Investment Report (2003) also defined FDI as an investment involving a
long term relationship with lasting interest and control by parent enterprise in one economy over
its affiliate enterprise in another economy.

There are numerous theories on FDI. The theory of FDI and the related multinational firms has
taken roots in the 1970s (Mekonnen, 2005). Since 1970s, the theory and practice of FDI took
several dimensions, and the literature is getting richer and richer (Mekonnen, 2005). These
theories includes market imperfection theory, perfect market theory, theory of propensity to
invest, market disequilibrium theory, Veron’s Product Cycle theory, Dunning’s eclectic theory,
Casson’s internalization theory and theory of “Industrial firm” and Industrial Organization
(Mehari, 2004; Yemsirach, 2006; Alemayehu, 1999; Dunning, 1970; Dunning, 1993; Hill and
Jain, 2009).
1.10.1 FDI and Economic Development Debate
Discussion on the impact of FDI on a host country’s economy is controversial. Research findings
have shown a mixed result (Mehari, 2004). Despite this fact, host countries have been taking
initiatives to liberalize FDI regulation and tried to encourage foreign firms to invest within their
national boundaries (Yemsrach, 2006). Mekonnen (2005), indicated that even if the role of FDI
to promote economic development has long been recognized and debated over years, Sub-
Saharan Africa countries have undertaken policy reforms to attract FDI.
Todaro (2003) indicated that the view in favor of FDI comes from the traditional neoclassical
analysis of economic growth. As per of this view, FDI is highly needed by least developed
countries. On the other hand opponents of FDI argue that it usually caters for managerial and
other key positions for persons in the source country and depresses host country wages. The
existing stock of literature on FDI has three main controversial issues which are repeatedly cited
by researchers. These include improvement or deterioration of the balance of payment, who gets
lion share of benefit and the issue of “Crowding in or crowding out (Mekonnen, 2005).
Writers on FDI have almost come up in to a common base and consensus that FDI is an
important source of capital, employment, technological transfer, competition, economic
development, production, consumption and export of goods and services (Tevelde, 2004;
Yohannes, 1999). In spite of these facts, the pattern of growth for developing countries has been
spiral. Writers on FDI have also given various theoretical explanations on the determinants of
FDI and have a common understanding on the following major determinants such as gwth of
local market, availability of resources, macroeconomic stability, infrastructure, skilled man
power, labor cost, institutional quality, corruption, weak judiciary systems, incentives and
location (Todoro, 2003; Adam, 2007; Demurger, 2000).

FDI and its impacts on development remains hotly debated issue. Supporters argue that FDI is
much needed in poorer countries to finance technological growth and development needs. While
proponents argue that FDI leads to a race to the bottom on social and environmental accounts.
Hence writers are approaching FDI and development from different angles both in the micro and
macro environment focusing particularly on income inequality and poverty (Tevelde, 2004).
While FDI was traditionally seen as an additional source of capital, vital for development of
countries, the view that FDI can bring new package of needed management skills, experiences,
entrepreneurial abilities and technological innovations are also important (Todaro, 1989; Todaro,
2003; Chen, 2000).
On the other hand the argument forwarded by stracturalists against FDI is that, FDI stifles
competitiveness of domestic entrepreneurs and reduce their exchange earning capacity. The
contribution of profit obtained from FDI for long-term capital formation is too little since
investors take the profit of their investment in hard currency. Hence, FDI is blamed by
structuralists for its effects on widening the inequality between urban and rural, large and small-
scale firms and foreign and local companies (Todaro, 1989; UNCTAD, 2002). Various studies
that were conducted in Latin America, Africa and Asia have concluded that while FDI may have
been good for development, more can be done to improve its impact on income distribution and
the poor either through appropriate government policies in the area of education, training and
infrastructure, by working with TNCs through incentives or partnerships (Yemsirach, 2006).
The swift increase in FDI flow on the globe has brought a realization that FDI could affect social
and environmental conditions in the host country macro-economic growth. Even though this was
assumed to be a trickledown effect, countries are encouraged by international institutions to
attract FDI to address social issues such as alleviating poverty. Researchers like Tevelde (2004),
has argued that, the failure of FDI to narrow inequality in most developing counties does not
necessarily imply that FDI was or was not good for development and poverty reduction. Finally,
researchers then argue that governments need to implement policies that will influence the
inflow of FDI to sectors that can generate large externalities and help to reap all benefits from
FDI. This would significantly contribute to reduce poverty and income inequality (Tevalde,
2004).
1.11 FDI in Ethiopia: A Glimpse
History tells us that FDI is not new to Ethiopia; rather it was started during the imperial regime
and end up with a Zero-sum-game due to the paralyzing economic policy of the military
government (Befekadu, 1983). Whereas, in the post 1991, Ethiopia is characterized by
fundamental political and economic reforms which are expected to revive the economy. To this
effect new policies were enacted to facilitate investment and over all development.

In response to the policy changes, foreign firms have started to invest in the country; though it
was not as much satisfactory as it was expected. This made researchers to be keen to identify the
main inhibiting factors to entry, operation, and expansion of FDI in the country. In this regard a
review of research works (Adam, 2007; Yemsirach, 2006; Berhanu 1999; Mehari, 2004)
indicates that resource endowment cost of labor, cost of land, demand conditions, macro
economic conditions, efficiency of bureaucratic and legal systems were the major factors that are
considered by foreign investors to favor or disfavor Ethiopia for their investment. In this regard,
particularly Birhanu’s finding reveals that these factors are negatively affecting FDI in the
country while other researchers remained to be partially optimistic.

Getnet and Hirut(2006) indicated that macroeconomic instability and poor infrastructure have
negative impacts on FDI in the country. Burhanu (1990) also noted that the high degree of
indebtedness of the country vis-a-vis inclined balance of payment makes it difficult to ensure a
repatriation of FDI profits back to home country. Besides, higher privileges to domestic
investor’s shortage of skilled labor force, recurrent draught, prolonged civil war and weak legal
system are other group of factors affecting the inflow of FDI to the country (Worku, 2004; FIAS,
1997).
 1.12 FDI and the Ethiopian Economy
Ethiopia with a total population of 73 million (CSA, 2008) is one of the oldest nation in sub-
Saharan Africa (Yemsirach, 2006). Though the country is rich in natural resource endowment, it
remains one of the poorest countries of the world that badly needs capital for its economic
development (Mehari, 2004). The county’s manufacturing sector is yet at its infancy. Most of the
industries are primarily dependent on imported inputs and they are agro-industry in type
consequently the manufacturing sector contributes less than 20% GDP (Mehari 2004;
Yemsirach, 2006).
As the economy began to liberalize, the basic macroeconomic variables started to change for the
better. Investment proclamation was promulgated and EIA was established to facilitate inflow of
FDI. The data summarized by Yemsirach (2006), indicates that out of the total 1,349 approved
FDI projects only 235 (17.4%) had been operational up to 2004/05. The same report indicates
that most of Ethiopia’s FDI come from the Middle East, European Union and Ethiopian
Diasporas.

Mehair (2004), also analyzed the trend of FDI in Ethiopia and his finding reveals that prior to the
1980s there was low in flaw, where as between 1990-2000, there had been a relatively high
inflow. The inflow was at its peak in 1997. However, later in 2000, the flows of FDI tended to
decline owing to the Ethio-Eirea boarder conflict and slow down of the world economy. After a
rigorous analysis, Yemsirach (2006), indicate the presence of low impact of FDI on the growth
of the Ethiopian economy. She further elaborated that, the impact of FDI on GDP growth is
positive but insignificant.

1.13. Distribution of FDI in Ethiopia

The Ethiopian investment Authority (EIA) and regional investment commissions are established
to facilitate the inflow of FDI to the country in general and to regions in particular. The fact that
Ethiopia is endowed with wide ranging climatic zones and diversified resources, paved the way
for huge number of business opportunities which appear to be available in the country for foreign
investors. In addition, the FDI policy, the five year development plan and the international
agreement Ethiopia is part would welcome investors to participate in various sectors.
EIA (2007) has grouped investment projects in to primary, secondary, and tertiary sectors.
According to the report, the share of primary, secondary, and tertiary sectors was 21.8%, 36.8%
and 41.4% respectively. The primary sector has accounted for small number of projects
compared with the other two rectors though it is given due emphasis by the government as part
of the development policy of the country.

According to the data compiled from investment authority report, some projects are found to be
capital intensive while others are found to be labor intensive. As it is depicted in the report
capital share of the primary, secondary, and tertiary sectors out of the 120,312 million Birr was
25.7%, 45%, and 28.7% respectively. Projects in the secondary sector have got the lion share out
of the total capital invested, because it includes projects like the manufacturing and construction.

The data compiled for employment opportunities for each sector shows that projects in the
primary sector such as agriculture and fishing absorbs more labor (55.8%) than capital (25.7%).
On the other hand the secondary sector (which is relatively capital intensive (28.7%) absorbs
small labor force (12.9%) preceded by the secondary sector with (31.3%) labor force.

Regional distribution of FDI in Ethiopia shows greater disparity among regions. This is
attributed to a number of factors, which includes among others shortage of skilled manpower,
infrastructure problem, sluggish bureaucracy, and inefficient promotion. As the 15 years
compiled data by EIA (1992-2007) shows, FDI is highly concentrated in Addis Ababa, Oromya,
SNNPR, Amhara and Tigray in a descending order. The share of other regions such as Dire
Dawa, Harare, Somali, Gambella and Benishangul Gumz is found to be insignificant.

More specifically, in the last 15 years the lion share of investment goes to two regions such as
Addis Ababa and Oromya where challenges to FDI growth are found to be relatively minimized.
For example, from 1992-2007, Addis Ababa accounts 61.3% of total project, 32.3% of total
capital, and 28.8% of total employment (both permanent and temporary) while Oromya accounts
29.6% of total project, 43.6% of total capital, and 47% of total employment. Generally, based on
the above data one can conclude that Addis Ababa has more number of projects approved and
implemented. Oromya on the other hand accounts the highest proportion of total capital
investment outlay and employment opportunities.

The current regulatory body governing FDI has undergone significant changes as part of the
reform process that was started since 1992. However, Ethiopia does not have separate law
governing FDI. The incentive system in this regard is alike for both foreign and domestic
investors with the only exception that foreign investors are permitted to remit their profits,
dividends and other forms of capital in foreign currency( Adam, 2007; 27). Though a number of
sectors are open to FDI today, there are also few sectors which are exclusively permitted only for
domestic investors (Worku, 2004).
Like any other developing country in sub Saharan Africa, Ethiopia too, saw frequent change of
policies, corruption and in efficient over all service provisions are factors affecting their
investment in the eyes of foreign investors. The unfair competition between VAT and non VAT
registrant, tax system, bank loan and the exorbitant lease price are often criticized and results a
distorted market which ultimately affects foreign investors (Adam, 2007).

1.14. Resource Requirements, Budgeting and Source of Finance

Presented below are material, manpower and facility requirements to be used/consumed starting
from the initial stage till completion of the study. However, it is all subjected to possible revision
and budgeting is provisional.

1.14.1 Resource Requirements

Presented below is material, manpower and facility requirement for the research starting from its
initial stage till completion.

Materials
Stationary Materials and Related Expenses
Duplicating paper for questionnaire, interview guide, and consumption at various levels.
Pens and pencils-for use during data collection and related activities.
Writing pads (middle size) - for field note and use by enumerators.
Bags-for enumerators, the researcher and his assistant.
Markers-for use during one day refreshment training for enumerators.
 Chart paper-for use during one day refreshment training.
Purchases stencils
Payment for duplicating questionnaire
Secretarial service for typing, printing, and binding the final manuscript.

Manpower
Recruit and training of eight enumerators (two for each of the four kebeles).
Hire professionals (on per diem basis) for providing refreshment training for enumerators on
fundamentals of data collection.
Hire an assistant researcher for supervision, edition, and entry of data

Facility Requirements
Arrange bycle/Bajaj for transportation of supervisor and enumerators

1.14.2 Provisional budgeting

.No Description Unit of Unit Q Total Remarks
mt. price.(Br ty price-Br
.
1 Stationary materials and related expenses

Duplicating paper Pads 50.00 2 1000.00

0
Pen (Bic) Packet 50.00 2 100.00

Pencils No 30.00 1 30.00

Writing Pad (Medium Size) No 15.00 1 150.00

0
Bags No 80.00 8 640.00

Chart Paper No 40.00 4 160.001 For the training

00.00
Markers Packet 10.00 1 200.00 For
0 enumerators

Questionnaire Duplication Stencil/p 50.00 4 1000.00

ad 0
Secretarial Service Bulk 1,200.00

Printing and binding the manuscript No 200.00 6 4580.00

 Sub-total 4580.00

2 Per diem and lodging expenses

2.1 Per diem

For the researcher during field work in four Day 100.00 2 3800.00 7 days at each
kebeles 8 kebele
For enumerators during a one day training Day 40.00 8 320.00 2 enumerators
for one kebele
For enumerators during data collection Day 240.00 2 6,720.00
8
For assistant researcher during editing, Month 1000.00 2 2000.00
arranging , entry etc of data
Professional fee trainers Day 100.00 1 100.00

2.3 transportation cost during 28 days field Day 50.00 2 1,400.00

stays 8

Sob total 13,340.0

0
Grand-total 17,920.0
0
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