Corporate Taxation, Import Competition and Productivity: Evidence from Ethiopian Manufacturing

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Corporate Taxation, Import Competition and ProductivityFirms’ behaviors and performances have crucial implications for any economy in terms of employment creation, foreign exchange generation, resource mobilization, growth acceleration and welfare improvement. Whether firms thrive depends on a multiplicity of factors that characterize the economic environment in which they operate. Varieties of domestic policies as well as shifts in the global economic landscape shape this economic environment. One important domestic policy is a country’s corporate taxation, which can influence firms’ decisions such as exporting, outsourcing, investing on capital and R&D activities. On the other hand, a series of economic partnership agreements have rendered fragmentation of the global value chain and intense import competition to be the essential characteristics of the current economic environment. Under these circumstances, resources and market are reallocated away from the less productive firms into more productive ones. Consequently, low-productivity firms are likely to exit whereas their high-productivity counterparts are likely to survive, experience growth, and integrate their activities to the global market via trade and investment.

Given the importance of any given country’s policy settings and evolving global economic environment, this paper examines the causal effect of corporate taxation and import competition on firms’ export and investment decisions as well as productivity growth at the firm and industry levels. The study uses a firm-level panel data on Ethiopian manufacturing firms over the period 1996-2010. The analysis first describes patterns of firm turnover, export participation, and investment; characterizes features of exporting and investing firms, and summarizes industry- level productivity dispersion. Afterwards, reduced-forms of the export, investment and productivity growth equations are separately estimated to obtain the causal effect of corporate taxation and import competition. Finally, key elements of the investment climate that constrain the business operations of Ethiopian firms are assessed, and this is presented in juxtaposition with firms of selected African countries.

From a simple description of the data, it is shown that there is a positive net entry (2.8%) and significant firm turnover rate (21-24%) annually. Furthermore, almost half of the firms (49%) undertake investment each year. By contrast, the export participation rate is quite low (5%). There is also a marked variation in the prevalence of export participation and capital investment across industries and over time. Relatedly, exporting and investing firms are more productive, larger and employ more inputs per unit of labor compared to firms that are active in only one or none of these activities. At the industry level, the data displays substantial heterogeneity in which high-productivity firms coexist alongside those with a rather low productivity.

In terms of aggregate productivity, the Ethiopian manufacturing has undergone through a rapid growth (21% annually). While there is no effect of taxation, import competition promotes productivity growth. It is also found that firm productivity growth increases when the productivity of the technical frontier firm rises. Moreover, the results imply industry convergence in which low-productivity firms experience faster growth compared to high- productivity firms.

For policy purposes, it is necessary to point out that most firms view the tax rate and tax administration issues to be relatively less restrictive to their business operations compared to shortage of materials, absence of market demand, and access to finance. However, this does not mean that there is no urgent need for tax reforms. The industrial policy making process is also required to embrace the growing integration of the country to the global economy. Such integration can serve as an outlet for firms’ outputs and an alternative source of production inputs. The resulting competition can also foster firm and aggregate productivity growth. To this end, it is desirable to encourage firms to integrate their activities to the global value chain. The relevant policy question is therefore how to provide firms with the necessary support in their effort to become global.

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by: Kaleb Girma Abreha

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