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Capital adjustment patterns and uncertainty in African manufacturing

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Author Info
Admasu Shiferaw

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Abstract

Judging by the provisions of its investment code and the apparent stability of the macro-economy, Ethiopia seems to offer a favourable investment climate for the private sector. However, Ethiopian manufacturing has experienced a declining rate of investment since the mid 1990s. Like other Sub-Saharan African countries, more than half of manufacturing firms in Ethiopia have zero investment episodes; episodes that have become more persistent over time. This contrasts badly with high average profit rates in African manufacturing relative to average profit rates in OECD countries. Rather than being smooth and continuous, firm level investment in Africa is less frequent and lumpy. While this pattern of capital adjustment is not unique to Africa, the discontinuity and lumpiness is starker than what is observed in developed countries. The evidence in this paper suggests that such discontinuity and the lacklustre investment performance have more to do with uncertainty and irreversibility. The paper shows that uncertainty, proxied by the volatility of profits, undermines mainly the likelihood rather than the rate of investment. However, the possibility to reverse investment decisions, captured by the scope of the second hand market for machinery, significantly increases the rate of investment.

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Paper provided by Institute of Social Studies in its series Working Papers - General Series with number 435.

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Length: 38 pages
Date of creation: 2006
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Handle: RePEc:iss:wpaper:435

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Keywords: investment irreversibility uncertainty African manufacturing Ethiopia

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  15. Arne Bigsten & Paul Collier & Stefan Dercon & Marcel Fafchamps & Bernard Gauthier & Jan Willem Gunning & Remco Oostendorp & Catherine Pattillo & Måns Söderbom & Francis Teal, 2005. "Adjustment Costs and Irreversibility as Determinants of Investment: Evidence from African Manufacturing," Contributions to Economic Analysis & Policy, Berkeley Electronic Press, vol. 4(1), pages 1228-1228. [Downloadable!] (restricted)
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