Manufacturing-Led Growth and Industrial Transformation in Ethiopia: Subsectoral Evidence from Kaldor’s Law and Implications for Industrial Policy

Manufacturing has traditionally served as a powerful escalator for economic growth; however, this growth-inducing role has weakened across many developing economies, including Ethiopia. Despite two decades of robust economic growth and proactive industrial policy, Ethiopia’s manufacturing sector has not evolved into the principal engine of growth and structural transformation. This study empirically examines the manufacturing–growth nexus in Ethiopia by testing Kaldor’s first growth law at both aggregate and subsectoral levels. Using annual data from 1972 to 2024, the analysis employs a novel cointegration framework that integrates an augmented ARDL bounds testing approach with the Toda–Yamamoto Granger causality procedure. The results provide strong empirical support for Kaldor’s hypothesis at the aggregate level, demonstrating that manufacturing output growth exerts a significant positive causal effect on both overall GDP and non-manufacturing output growth. This confirms the strategic importance of industrialization for Ethiopia's long-term development trajectory. However, the lack of consistent evidence under the most stringent model specification suggests manufacturing is not the exclusive engine of growth, highlighting the need for a diversified, multi-sectoral development strategy. Subsectoral analysis reveals pronounced heterogeneity: while large and medium-scale industries function as powerful growth escalators, small-scale and cottage industries, despite their numerical dominance and critical role in employment, do not exhibit a significant “engine of growth” effect. These findings underscore that firm scale and technological capacity are pivotal determinants of manufacturing’s transformative potential. The policy implication is clear: Ethiopia requires a differentiated, dual-track industrial strategy, one that fosters the dynamism and job-creation capacity of large and medium-scale industries while simultaneously addressing the productivity constraints and informality that plague the small-scale segment. Such a strategy is essential for unlocking the country’s full industrial potential. JEL Classification: O14, O32, O47, O25, C22