The Case of Hawassa Industrial Park in Ethiopia

BOX 8.4 Fiscal Incentives to Overcome First-Mover Coordination Problems: The Case of Hawassa Industrial Park in Ethiopia

An industrial park in Ethiopia illustrates how a government might overcome first-mover problems by attracting a catalytic large investor—in this case, Phillips-Van Heusen (PVH), the world’s second-largest apparel company. The government worked closely with PVH to identify areas of mutual interest and delivered interventions to create an attractive environment for PVH in the new Hawassa Industrial Park (HIP). They included the following: • Demonstrating government commitment by raising capital, building facilities fast, and delivering world-class factories with high environmental standards as agreed • Delivering strong access to international markets (particularly important for the fashion industry), including the Everything but Arms (EBA) agreement for duty-free and quota-free market access to the European Union; the 10-year extension of the African Growth and

Opportunity Act; streamlined customs procedures; extension of the new Djibouti–Addis Ababa rail line to Hawassa; and improving the Addis Ababa–Kenya highway on which Hawassa lies • Exploiting abundant hydropower to undercut regional competitors in electricity price and reliability (electricity is a major cost in the garment industry) • Complementing the large pool of local labor with employee selection and training programs run jointly by PVH, the government, and donors • Offering tax holidays.

Thanks to PVH’s investment, 18 foreign and 5 domestic supplier companies have already committed to follow it to HIP, and more are expected. HIP was inaugurated in July 2016 and is planned to create 60,000 direct jobs on $1 billion worth of export sales from the park.

Source: Adapted from Duranton and Venables 2018.

targeted improvements in transport, energy, and skills that may lead the firm to put down deep roots and develop linkages. Beyond other support in terms of infrastructure and worker training, tax holidays are also offered, although these were considered “icing on the cake” rather than key elements of the place-based investment decision (Duranton and Venables 2018).

In the United States, South Carolina’s automotive cluster dates to 1992, when BMW chose the state for a $600 million assembly plant and received an incentive package worth $100 million, including nonfinancial incentives. The local airport runway was also extended, and a new employment training program was created. The objective was to create enablers that would ensure the success of BMW’s first plant outside Germany and thereby attract an anchor industry that would further develop the nascent supply capacity of the region. The initiative is thought to have generated between 25,000 and 35,000 jobs in the area (McKinsey 2019).

Both examples point to a strategic use of resources to remove barriers to making the locales viable and to complement the effort with infrastructure and human capital investments. The highest payoffs from business-attraction efforts come from projects that are part of a holistic strategy targeting certain sectors or removing barriers to the emergence of certain sectors (McKinsey 2019). These sectors can then create agglomeration benefits that attract other companies in a supply chain that would benefit from sharing the space. Necessary complements include infrastructure improvements and targeted workforce development programs.

In general, however, there is little conclusive empirical evidence to suggest that fiscal incentives have succeeded in transforming the fortunes of lagging places (Neumark and Simpson 2015; Kline and Moretti 2014; Ehrlich and Overman 2020). Part of the problem is due to the persistence in the local economic geography highlighted throughout this volume. Direct grants have only limited influence on location decisions if they are not large enough to offset localization benefits in existing agglomerations (Devereux, Griffith, and Simpson 2007). Some of the problems are due to poor design without clear targeting. Studies such as Hanson (2009) and Neumark and Kolko (2010) find that tax incentives have little effect on employment in enterprise zones. However, when tax incentives are complemented by traditional supports for economic development (such as technical assistance, location or site analysis, special staffing, and marketing), the intervention can be more effective (Wilder and Rubin 1996; Neumark and Kolko 2010). In their review of the efficacy of place-based policies, Neumark and Simpson (2015) document that discretionary subsidies targeted to businesses in underperforming areas in European countries and location-based subsidies in the United States can spur investment, employment, and productivity spillovers. The discretionary nature of these subsidies—such as the federal New Markets Tax Credit program channeled through banks, as discussed in Freedman (2012)—may help explain their success because applications for subsidies pass through an initial scrutiny, and targeted outcomes can be monitored so that payment of the subsidy is contingent on job or investment targets being met. Nonetheless, correctly calibrating these mechanisms is very challenging. Governments must always be wary of the risks of simply subsidizing uncompetitive, unsustainable industries.

Brazil, for example, has attempted to attract “dynamic” industries to the North and Northeast regions by providing fiscal incentives, fiscal transfers, and direct investments in infrastructure and developed land on the order of $3 billion to $4 billion a year in “constitutional funds.” Evaluations of aggregate outcomes, such as changes in GDP per capita, suggest limited impacts (Ferreira 2004). Carvalho, Lall, and Timmins (2006) find that the allocation of constitutional funds did induce the entry of manufacturing establishments into lagging regions, but that the effect was strongly conditioned on close proximity to firm headquarters: the firms were already important in the North. Further, these funds were dwarfed by industry subsidies that tended to concentrate in the advanced regions.

Between 1970 and 1980, the Mexican government offered firms a 50 percent to 100 percent reduction in import duties and income, sales, and capital gains taxes, as