Greenfield IndustriesManufacturing Systemic Change Pathways
Septmeber 2015 MDF Timor-Leste Version-1
Summary MDF Timor-Leste Country Strategy Poverty Of the approximately 185,000 households in Timor-Leste, nearly half are considered poor.1 In TimorLeste, poverty is:
An overwhelmingly rural and agricultural phenomenon. Majority rural households are either poor or vulnerable to poverty. Commercial agriculture and multiple ways to earn incomes for households are key to achieving resilience and moving out of poverty. The primary cause for malnutrition amongst children under five, and young mothers. Over 58% of children under five are categorized as stunted, with a quarter of young mothers malnourished. Households need to be able to eat more and eat better. A function of large-scale unemployment. There are few jobs in rural or urban areas to absorb the large number of young Timorese joining the workforce annually. Fueled by poor connectivity between different parts of the country. Difficult terrain and poor infrastructure keep producers and markets isolated from each other and entrenches poverty in particular locations.
Economy Growth thus achieved is unsustainable over the long term. New avenues need to be explored and nurtured for a sustainable economic future of the country. The major impediments to growth are:
An over reliance on large capital investments by the public sector as a key driver of economic growth. The economy needs diversification to instil resilience. A small and inexperienced private sector that struggles to grow and manage business models outside of government contracts. Insignificant levels of private sector investment in areas of value addition and processing A disconnect between rural production and urban demand. High unemployment rates compounded by a large annual influx of young Timorese entering the workforce.
1 WB Poverty Head Count (49.9%) considering USD 1.25 a day as the poverty line (2007 updated).
MDF Focus in Timor-Leste
Encouraging investments in diversified businesses outside of oil and gas sector Stimulating establishment of alternate sources of incomes within and outside of agriculture Increasing investments in ventures focusing on adding value to local raw materials through greater processing Improving connectivity between producers and consumers and markets (both domestic and exports)
MDF considers Agribusiness, Processing and Rural Distribution sector and Greenfield Industries such as Tourism and Manufacturing as the most effective vehicles for achieving this focus in Timor-Leste.
Women’s Economic Empowerment (WEE) All sectors are relevant for WEE, integrated in the systemic change pathways (see below).
Alignment with Government of Timor-Leste The Coordinating Ministry for Economic Affairs (MECAE) is particularly interested in improving the operating environment, thus making it easier for Timorese businesses to flourish. The focus of the ministry are the agriculture, tourism and manufacturing sectors as well as topics such SME financing in these sectors. MDF is engaged in conversation with the ministry on all these topics.
Note on Systemic Change Areas Currently the Agribusiness, Processing, and Rural Distribution and Greenfield industries sectors in Timor-Leste have products, services, and actors, but very little structure within which these factors can interact. This constrains the growth around any particular product (agricultural and nonagricultural), service, and activities such as processing, value addition, trading, and manufacturing. Given the amorphous nature of the sectors, MDF’s strategy, and consequent definition of systemic change areas, within these sectors are also broad. But engagement in these broad strategic and systemic change areas are critical first steps towards creating a well-defined, efficient, and effective market system in these sectors (for example, defining specific sub-sectors within the broader Agriculture sector in Timor-Leste). The systemic change areas that has been described in the later sections of this paper are pre-conditional to bringing about more focused changes in the sector. After MDF has laid the foundation for more “formed” market systems, it will seek to redefine and focus the sectors and systemic change areas on which it should focus next. It is expected that achieving the broad systemic change pathways as outlined in this document is a process that should take about 8 years from inception of the country programme, given the required levels of resources are in place from the start. However, the resource environment around
implementing MDF in Timor-Leste has always been constrained, which has limited engagement of MDF Timor-Leste within each systemic change area to half the potential. This has pushed the timeline for achieving systemic change from 8 years as previously expected to 10 years (thus pushing back change horizon to 2023) provided resources are adjusted to the required levels going forward.
The MDF Framework for Defining and Populating Pathways to Systemic Change The systemic change pathway explained Competitiveness and change in sectors do not depend only on the actions of MDF. Sectors are complex and are influenced by a wide variety of factors such as global markets, changes in the policy and regulatory environment, the availability and quality of infrastructure, the cultural context and the environment. Some changes introduced by MDF will catch on quickly; others have faced barriers and moved slowly or not at all. MDF must be able to define which change areas it needs to focus on to make growth more robust and inclusive and then monitor progress towards achieving the quality of change that can be called ‘systemic’. For this purpose MDF developed its Systemic Change Framework as outlined in the figure below. This framework is applied separately to each key strategic change that MDF aims to foster within a sector or market system. The annexes to this Strategic Guidance Note provide a detailed example of how the framework is applied in Fiji.
Application of MDF’s Systemic Change Framework requires a deep understanding of a sector as well as experience working with market players to address constraints to pro-poor growth. The first step in applying the Framework is to develop an inclusive, pro-poor growth strategy for each sector. This sector strategy is typically based in on an Inclusive Analysis of Growth, Poverty and Gender at the sector level combined with a Household Level Analysis of Poverty and Gender Dynamics and defines a vision for inclusive growth as well key constraint areas to inclusive growth. MDF will then proceed to launch partnerships aimed at reducing the constraints identified and unlocking inclusive growth. At the same time, MDF uses the framework outlined above to further define its ‘strategic intent’ for a sector, as accurately as possible given that it will learn more from implementation about what is really needed and realistically feasible. Please refer to MDF’s Strategic Guidance Note on Systemic Change which shows how an inclusive sector growth strategy (for the Horticulture sector in Fiji) feeds into the country strategy, and how systemic change areas support the inclusive sector growth strategy. As mentioned, for each systemic change area, MDF applies the systemic change framework; the introductory section justifies the rationale for identifying the systemic change. Importantly, in time, based on the experience gained from implementing the first partnerships within a sector, it becomes clearer which systemic changes the programme should focus on. As the programme discovers more through implementing its partnerships within the sectors, it becomes clear that some constraint areas appear to be dimensions of, or seem to coalesce around more deepseated problems. MDF then develops a better idea of which changes the market is ready for, and which changes requires more innovative approaches address the problems. Through the interplay between traction gained through partnerships and strategic intent, emerges firmer systemic change areas, which then become the ‘compass’ for programme implementation in the sector. This typically happens around two years into implementation as the first batch of partnerships start to yield results. To help define (and manage, monitor and communicate) the dimensions of change that deserve to be labelled ‘systemic’, MDF asks two fundamental questions: 1) are there appropriate incentives for market players to interact with poor people and to continue, expand and adapt the new business model; and 2) is the adoption and adaptation of the new business model continuing to serve the interests of poor men and women? For each question it has defined three key parameters. The table below reiterates these questions and briefly defines the parameters related to this. It should be noted that the first three parameters refer to the strength of the business case underpinning the change, and other three parameters refer to the beneficiaries of the change. Together they define the quality of change as well as the scale of change, making it truly ‘systemic’.
Parameters with Systemic Change Framework Questions
Parameters
Definitions
Are there appropriate incentives for the market players that interact with poor people to continue, expand and adapt the new business model?
Autonomy
Independent action by businesses or other market players to adopt and/or improve a business model promoted by the programme.
Sustainability
The extent to which the business model promoted by the programme is sustainable and/or profitable.
Resilience
The extent to which the market system supporting the business model can adapt to stay competitive, take advantage of new opportunities and recover from adverse shocks.
Inclusiveness
The extent and depth to which the business model as practiced by market players includes and benefits the target group
Scale
The proportion of the potential target group that gets the goods, services and/or jobs promoted by the programme.
Women’s Economic Empowerment
The extent to which the business model includes and benefits women with respect to income, access to opportunities, access to assets, life chances, jobs, manageable workloads and decision making power.
Is the adoption and adaptation of the new business model continuing to serve the interests of poor people?
Then, by asking these two questions using these six parameters, the framework seeks the programme to define a ‘beginning state’ for each parameter. This is the state of the sector or market system at the start of the implementation process (‘at the beginning of the pathway to systemic change’). Once the programme is being implemented it defines the key market or regulatory gaps it seeks to address to make the market system work better. This is followed by a description of the ‘end state’ for the same parameter. It outlines how the programme wants to see the market system work. If this state is achieved, the work is done. The end
state should be defined as per market needs to work well. Therefore it may occur that the programme defines an end state that it cannot achieve given its current resources and implementation window (contract duration). This makes the Systemic Change Framework a management tool not only for the programme, but also for its investors. It starts to define the ‘total potential’, the ‘total need’ and the ‘total time and resourcing’ required to meet those needs. As mentioned, the space between the beginning state and end state is the gap in the market system that needs to be filled, the pathway to systemic change that needs to be populated. MDF identifies four stages of progression along this pathway, captured for each parameter. These stages are ‘initial’, intermediate, ‘advanced’ and ‘matured’. In time, MDF will make progress against these parameters, but not at an equal pace (there may be very inclusive partnerships that lack scale and to some extent resilience, and partnerships that are strong on autonomy and scale, but less on WEE). Each partnership design needs to be strong and sustainable enough to be considered for co-investment by MDF, but no partnership is perfect. By managing its portfolio MDF will ensure quality of change at scale in a systemic manner. Nevertheless, MDF does not expect that all changes will reach the same level of institutionalisation in the market system within the life of the programme. Some changes may only reach an initial or intermediate level of systemic change, while others may reach an advanced or matured level of change. Using the knowledge and understanding gained from several years of experience, MDF can project the level of systemic change it expects to catalyse two years beyond the life of the programme.2 MDF assesses the progress of systemic change against these projections and analyses why change is happening faster or slower than expected. This helps the programme to better understand market dynamics and adjust its strategies appropriately. Finally, for each parameter, MDF will describe the beginning state and end state of where it is situated in moving forward along the pathway to achieve systemic change. This helps the reader understand how far MDF has progressed in terms of achieving its strategy objective, with whom (which partners), and why. As implementation and insight progresses, MDF periodically updates these stories (as well as, if needed, the desired ‘end state’).
2
The processes of change that MDF catalyses during the programme will continue beyond the end of the programme. MDF uses the DCED recommended two years post programme timescale for its projections.
Greenfield Industries sector Greenfield Industry signifies the infant stage of industry in two ‘non-oil’ sectors- manufacturing and tourism. In many cases the businesses emerging in these areas will be first of its kind ventures in Timor-Leste and represent Timor-Leste’s budding non-agricultural economy. For MDF, Greenfield Industries sector is critical for pursuing economic diversification. Although manufacturing and tourism has been analysed under the auspices of Greenfield Industries, the sectors, and their constraints and opportunities, are inherently different. The same goes for the poverty profiles and WEE implications. Thus, for the sake of clarity, these two areas have been separated out in their systemic change outlooks in the following sections.
Greenfield Industries sector – Manufacturing Scale, constraints and opportunities In Timor-Leste, manufacturing is a very recent phenomenon. There are a few formal and informal manufacturing micro-enterprises in the country. These formal and informal manufacturing businesses make low technology products such as furniture, traditional textiles, concrete blocks and slabs etc. These small-scale enterprises: do not have investable capital, lack the skills, knowledge and ideas about processing, possess obsolete technology, and limited marketing capacity. Given the low quality (and volumes) of locally manufactured products, import dependency is very high among urban and rural populations. Investment in manufacturing goods locally and competitively remains an unchartered territory for most local entrepreneurs. Currently, large businesses focus on supplying to government contracts, provision of services to the oil and gas sector, and investing in retail and wholesale of imported products. There is money in the country, but little or no investnment is being made in the manufacturing sector. The manufacturing prospects in Timor-Leste can be characterised as follows: Given stiff competition from imported products, local manufacturing ventures need to be customised to the Timorese context. Growth in local manufacturing should focus on: products that cater to local tastes or are amenable to customisation; products that are cheaper to be assembled and fabricated locally; products which have raw materials present in country; and designing services to cater to local needs such as plumbing, electrical, sanitation etc. Lack of examples of large scale, or varied, manufacturing enterprises, prevent most local entrepreneurs from seeing these opportunities. If they don’t see it, they don’t invest in it.
Even if an entrepreneur sees an idea in manufacturing, there are many other barriers on the way to establishing a manufacturing operation. There is distinct lack of support services such as: SME credit facilities; skills development; business development services such as financial management, project planning, and logistics; and access to modern technology. Thus, the prospect of handling a novel manufacturing business model without the help of professional support services, is deemed too large a step and increases the perception of risk exponentially, stopping investments from being realised. Any manufacturing opportunity must take into account the fact that Timorese households (urban and rural) do not have high purchasing power. Locally manufactured products must be affordable. Manufacturing is considered as one of the key priority areas for the government as mentioned in the Strategic Development Plan for Timor-Leste 2011-2030. However, a lack of clarity around specific investment benefits and opportunities increases the overall risk for any investment in the sector.
The position of the poor in the sector The poor in the sector are the large, and steadily growing, number of unemployed Timorese youth that are entering the workforce annually. Currently, unemployment rates are rampant especially amongst youth.3 A lack of job opportunities within the private sector, and outside of agriculture, mean that households remain vulnerable to poverty. Finally, vulnerability to poverty impacts the ability of households to act as consumers of manufactured (and household) products. Poor households are open to few choices of products and services at high cost, made worse by low purchasing power.
The position of women in the sector In Timor-Leste, female participation in the formal labour market is lower than that of males. Females also have to deal with lower pay rates for comparable jobs, with respect to their male counterparts. Females are also restricted to engaging in lower income activities in ‘orthodox’ female occupations such as handicrafts. However, given the steady rise in the numbers of females being educated beyond secondary levels, real opportunities exist for increasing incomes within urban manufacturing facilities, such as ready made garments, design and support services to furniture and textiles etc.
3 11% nationally and 21.9% among youth
Such formalised (and contract based) opportunities would also impact significantly on agency aspects empowerment, specifically around control and decision over assets and life choices.
Systemic changes in Greenfield Industries – Manufacturing Manufacturing is an essential pillar of any growing economy. Where there is economic activity, some of that will translate into demand for locally produced items, because that is cheaper, faster, more reliable, more tailored, or simply reduces transaction cost. In the context of Timor-Leste, manufacturing brings along further strategic importance through presenting options for expanding regional presence (more businesses and economic activities outside of DIli), increasing labour engagement (other things to do than work at farms as well as absorbing a greater share of the growing youth bulge) and producing products that provide greater health and nutrition outcomes. MDF sees working in the manufacturing sub-sector as an integral part of addressing diversification and improving resilience of the economy. MDF has identified one pathway for systemic change in Manufacturing subsector: New or existing enterprises invest in novel business models in the manufacturing sub-sector in TimorLeste. Manufacturing is a novel area of economic activity in Timor-Leste. MDF’s work in this area represent the first, and exploratory, steps for establishing examples of manufacturing products and services locally, using locally available raw materials or local skills. As the first examples of manufacturing become established and more mature, it would be possible for MDF to refine the systemic change area for manufacturing with respect to overall competitiveness of Timorese manufacturing, and the best suited products and services that can be manufactured in country. In time, MDF we expect the sector to develop and evolve out of the Greenfield Industries umbrella as its own sector. Although, harder to predict follow up systemic change areas for manufacturing, relative to the other sectors (and sub-sectors) that MDF is active in, some ideas for beyond 2023 are: 1. Investing in, and developing, SMEs involved in manufacturing products, and services, locally which are most competitive (the pattern is yet to be seen as manufacturing is such a new activity in the country) 2. Working with the public sector agencies in clarifying the government’s position around manufacturing and introducing the right kinds of reform and incentives in the environment to influence more investments into this space. 3. Working with financial institutions in developing credit facilities customised to the needs of SMEs who are involved in manufacturing.
Pathway 1: New or existing enterprises invest in novel business models in the manufacturing sector in Timor-Leste. Background (‘before picture’) Existing manufacturing businesses are mostly small scale and informal in nature and offer a very limited range of products to the capital and few municipalities. There is just a handful of large scale manufacturing units in the country. Mainstream financial institutions (private and national banks) do not consider manufacturing as a profitable sector. Large commercial entities are reluctant to invest in manufacturing due to limited understanding of the sector, the range of products that can be manufactured locally, and potential domestic market demand. They are content with wholesaling and retailing imported products and services to the public organizations under government contracts or to urban consumers. Consequently, there are few suppliers of raw materials to existing manufacturing entities. Government through The Ministry of Commerce, Industry and Environment (MCIE) has provided grants to a number of potential entrepreneurs interested in manufacturing, however most of these businesses are no longer functional. The Coordinating Ministry for Economic Affairs, Agriculture, and Fisheries (MECAE) have plans to promote manufacturing, but thinking around that is still fledgling with no clear guidance present to interested entrepreneurs. The government investment promotions agency (AEI) only deals with large FDI ventures such as ports, electricity grid suppliers, beverage companies, and cement factories. This entity does not deal with any local ventures on manufacturing. There are a few other agencies who work on developing skills and providing business development services. However, these services are geared towards the construction industry or very small retail enterprises.
Anticipated ‘end picture’ (when markets work well) As manufacturing is such a novel area of operations, it is too early to conclude how the sector will look like if the environment around manufacturing changes positively. Thus, this section deals with the anticipated picture as investors take the first steps towards establishing a separate manufacturing sector in the country. Over a period of 8 years, Timorese businesses start considering manufacturing as being commercially viable, thus influencing other potential investors to enter. At least 15 manufacturing facilities are established which offer a wider range of products and services at a competitive price to the local market. Of these, at least 2 businesses develop themselves to deal with exports. Industrial policies and initiatives from the government are aligned with private sector and market expectation. Government ministries coordinate their work and provide necessary support to both local and foreign investors interested in manufacturing in Timor-Leste. 2-3 financial institutions offer loan products for businesses supported by at least 2 institution providing business development services. Large-scale manufacturing triggers more suppliers from urban and rural areas
in supplying raw materials. An increase in manufacturing opportunities in country positively impacts the unemployment situation by creating opportunities for female and male members of the population. This is especially true for urban areas where large and labor intensive industries like garments are most likely to be established.
Expected Pathway to Systemic Change (likely number, types and focus of partnerships) To achieve sustainable initial changes in this nascent sector, MDF will enter into a variety of partnerships spanning both products and services. MDF aims to work with at least 9 partners in manufacturing across different products such as: iodised table salt, locally purified water, furniture, mass produced and traditional textiles, commercial and household storage solutions, sanitation products, and cook stoves. Besides products, MDF will with a further 9 partners on introducing services such as: electrical, mechanical and sanitation installations and repair, specialised skills development programmes, and commercial business development services including finance. These partners could be businesses with existing setups or brand new investments in ‘first of its kind’ initiatives. Outside of the private sector partnerships, MDF will engage in 1 partnership with MCIE and MECAE so that industrial policies and initiatives from the government is clarified to stimulate investments in the sector.
Women’s Economic Empowerment Successful manufacturing enterprises will create income opportunities for female beneficiaries, as suppliers to and workers in manufacturing companies. With more enterprises setting up new facilities or expanding/improving existing ones, more female workers will get employment opportunities in specialized or semi-specialized jobs. Female labour-intensive industries like garments and textile will open door for employment opportunity for large number of female workers, especially in urban areas. Female workers will get access to formal or in-house training to improve their skills, which will make them more employable and provide long-term job security. Formalised jobs, with its perks, will also positively impact women’s control over assets and life choices thus strengthening agency. Female suppliers will be able to earn more by supplying more volume of raw materials to the manufacturing enterprises. In addition, there will be a range of products manufactured locally that will reduce workloads and household expenditures (e.g. fuel efficient cooking stoves) as well as address health problems that affect the whole family, especially the women (e.g. iodized salt addressing goiter, hypothyroidism).
Results in time In 10 years (from 2013 till 2023) work in the sector will create 400 FTE jobs within the abovementioned partnerships, out of which 35% are expected to be female. Approximately 650 suppliers will supply raw materials to manufacturing enterprises for increased incomes, out of which 40% will be female. Lastly, through greater availability and access to a range of locally manufactured household products, approximately 15,000 to 20,000 households will benefit in the form of reduced household expenditures, reduced workloads for women, greater nutritional outcomes, and better health.
Feasibility, efficiency and risks MDF is the best placed to take the first steps in Manufacturing because MDF is one of the only organisations in the country who can directly work with enterprises in developing and nurturing new business models on manufacturing. There are a few other public agencies that can offer basic business development services, but given the current situation, more than generic business advice is needed to launch manufacturing enterprises. With its capacity to directly invest in businesses and embed business development services, MDF offers the complete package. Given the nascent stage of the industry, a 10-year time frame is unlikely to see too much in the way of crowding in. Thus, the partnerships MDF will pursue will most likely be the first few examples of successful manufacturing enterprises in the country. Once these first few examples are established, MDF will assess, and if needed, refine its definition of systemic change in the sector and its approach to attain it. As it is a novel economic area for the country, risks are big, and will span issues around managing a manufacturing enterprise (on the part of businesses) to aligning government interest with what is possible/ or should be done, on the ground. Through its partnerships, MDF will continue to monitor closely the evolution of the sector and update the risk profiles.