What’s Ethiopia’s economy lacking?

https://www.thereporterethiopia.com/30453/

ByAshenafi Endale. Feburary 4, 2023

The economist explainsAyele Gelan is a senior research economist with the Economic Public Policy Program of the Kuwait Institute for Scientific Research (KISR). He has widely published in peer-reviewed international journals covering a range of economic policy issues, including macroeconomic, energy, trade, regional, agricultural, and tourism policies. He has authored “Chronicles on the Political Economy of Plunder in Ethiopia, 1991–2018” (2018, Amazon and AAU Press).Aside from academic writing, he is a regular contributor of economic commentary to most English-language weeklies published in Ethiopia. His research and teaching experiences encompass contexts in developed and developing countries. His previous affiliations include Research Economist with the International Livestock Research Institute (ILRI), Kenya; Research Fellow at the Hutton Institute in Aberdeen, UK; and Director of the Tayside Economic Research Centre at the University of Abertay, UK. He holds a PhD in Economics from the University of Strathclyde in Glasgow, UK. The Reporter’s Ashenafi Endale was granted Ayele’s audience. EXCERPTS:The Reporter: From its practices and direction, what kind of political ideology and economic model is the incumbent applying? How do you diagnose the current state of Ethiopia’s political economy?Ayele Gelan: When the popular uprising ended in 2018 and Prime Minister Abiy Ahmed’s (PhD) administration took over, I expected major departures from the two pillars of the Ethiopian Peoples’ Revolutionary Democratic Front’s (EPRDF) ideologies.- Advertisement -The first was the politics of democratic centralism, copied from the principles of proletarian dictatorship in the socialist era. I am not sure if the current administration has made any substantive departures in this regard; perhaps it is still practicing a variant of democratic centralism, stripping it of its socialist flavor.The second pillar was in the economic policy domain: the developmental state model! From the very outset, it was clear that the new administration was not in any mood to abandon the developmental state model. I noticed some inconsistencies in the rhetoric of the new regime during the first few months after Abiy assumed power in April 2018.On the one hand, there was a huge curse of EPRDF politics, which manifested to the point of ditching its name and forming a new party. On the other hand, there was the mantra that “we will continue with the achievements of the economic successes of the previous decades.”I realized the regime was heading down the wrong path because I have never believed miraculous economic growth has ever occurred in Ethiopia, except for the illusions created by high-rise buildings and industrial parks owned and operated by party-affiliated crony businesses.- Advertisement -While expressing commitment to the continuation of the development strategy of the EPRDF era, the authorities were also engaged in a massive campaign discrediting the same economic policies, e.g., the non-achievement of most targets of the Growth and Transformation Program (GTP), the bankruptcies of the giant sugar corporations, the METEC scandal, etc.I have proposed to the authorities that the sooner they disown the so-called miraculous success story, the better. My concern was that there were backlogs of policy blunders whose effects were just simmering underneath and waiting to burst out for everyone to witness. Even if the civil war had not happened, Ethiopia would still be struggling to deal with numerous macroeconomic and structural imbalances; now they are hidden under the rubble.Aside from the rhetoric, there are numerous indicators that the current regime is actively pursuing the developmental state model. These may include the proliferation of megaprojects mostly concentrated in Addis Ababa, aggravating imbalances in center-periphery relationships, worsening inequalities between places and people, etc.In its post-war recovery plans, the government has prepared a three-year roadmap for Homegrown Economic Reform 2.0 and also a reconstruction roadmap. Do you think the reform plans of the past few years are on track?I have three major concerns regarding the Home Grown Economic Reform (HGER). First, why has the government suddenly begun to label its economic policies as “homegrown”?Two things happened soon after the regime change in 2018. The new regime did not take the time to collect and organize evidence, as well as to develop sound economic policy to address existing macro- and structural imbalances.For instance, the agricultural sector was stagnant, and there were dire food security challenges. Similarly, youth unemployment was alarmingly high. So the government was expected to start by addressing these fundamental challenges. It would not have puzzled me if the government went along this path and then labeled its policies as “homegrown.” However, what happened was quite different.The government surprised everyone by unexpectedly announcing a series of privatization initiatives, including even Ethiopian Airlines, in an attempt to fix something that is not broken. This caused widespread uproar among the public, who rightly felt the government was misled by the pressure applied by external multilateral and bilateral agencies.Therefore, “homegrown” was coined to imply that there was no external influence in the privatization drive or other economic reform agenda. However, signs of external influence are still sprinkled all over the major pillars of both HGERs. For instance, devaluation or exchange rate floating have been major elements of both rounds of HGER.It is well known that the International Monetary Fund (IMF) used it as one of the conditions for granting assistance. There is nothing wrong with selectively accepting proposals from multilateral agencies, but labeling such policies “homegrown” was untenable.My second concern was that both versions of the HGER have not been introduced through coherently prepared policy documents. The realistic nature of targets in any development plan is heavily dependent on the quality of the baseline economic statistics used in their formulation. Ethiopia’s official economic statistics are progressively moving away from the reality on the ground.For instance, in a PowerPoint slide I read on HGER 2.0, there is a claim that Ethiopia’s agriculture has experienced steady upward growth during the last five years, starting from 3.5 percent in 2010 and reaching a whopping 6.1 percent in 2014 (both in Ethiopian calendar).The 2014 growth rate provides the baseline for setting targets for the HGER 2.0 three-year plan. It seems the foundation is set to project steady upward growth in the agricultural sector.However, I find it difficult to accept the fact that Ethiopia’s agriculture has grown by that much during 2014. After all, the growth rate during 2010 was low for obvious reasons, instabilities, and popular uprisings! The situation was much worse during the subsequent years, with a shift from ad hoc protests at a few locations to widespread civil war covering many districts and regions of Ethiopia.The third concern is related to the manner in which targets were described for HGER 2.0. Development plans are supposed to be devised in terms of “inputs” and “outputs.” Target accomplishments are outputs, but there should be commitments in terms of setting input provision targets to enable businesses to perform better and progress toward anticipated targets. Policy documents related to both HGERs do not provide information on the relationship between supports (or inputs) and achievements (targets).In these circumstances, distinguishing between normal baseline projections and policy-induced additional growth performance is impossible. For instance, referring back to the questionable 6.1 percent, the authorities were expected to provide evidence of support to farmers to claim the above-normal growth rate—that is, if we accept that the reported growth rate was real in the first place. Otherwise, the growth rate figure could be explained by exogenous factors, such as good rain.What are your recommendations regarding taming inflation, external debt, fiscal deficits, and the forex shortage?At first glance, these questions may sound disparate and unrelated, but they are interrelated in many ways. The art of economic policymaking is in identifying synergies, or policy instruments, that can address and tackle multiple economic challenges concurrently. For instance, at the most fundamental level, the economic problems listed in your question can be explained by supply-side constraints.A huge chunk of Ethiopia’s productive agricultural land is lying idle. Tens of millions of Ethiopia’s labor force are unemployed or underemployed. These problems can be jointly solved by utilizing human and natural resources to produce goods and services. The rest is detail. I will dwell on ways to deal with inflation; policy synergy means solutions for the rest will immediately follow.I often debate with my fellow economists about inflation, which many blame on money printing. I am not surprised that many fellow economists associate the money supply with inflation. After all, that is what we are taught at universities, and that is what we learn from economics textbooks, such as the so-called “quantity theory of money,” in which the amount of money in circulation is directly related to the amount of goods and services produced and marketed.However, there are two implicit assumptions behind that relationship. First, full employment of human and natural resources and/or full capacity utilization by existing businesses Second, the direction of causation is such that the quantity of goods and services in circulation can affect the quantity of money in circulation but not the other way around. But what if the first assumption does not apply?For instance, resources are not fully employed in Ethiopia. There are millions of people in the labor force who are unemployed. A huge chunk of productive agricultural land is yet to be cultivated. A good proportion of Ethiopia’s industries operate at less than full capacity. In that case, additional money supply is required to expand credit, finance investment projects, create jobs, utilize land, and ultimately produce goods and services.This means the direction of causation is reversed, and the authorities can start by expanding the money supply to finance productive investment. Since the new money would ultimately be matched with new products and services on the market, there is no reason whatsoever why additional money would necessarily lead to inflation in the conditions of an economy with sizable idle resources.But it is legitimate to raise a question: why has printing more money evidently been fueling inflation in Ethiopia in recent decades? The answer is simple: the authorities have not utilized the new money to finance productive investments. For instance, the Ethiopian government is the country’s largest borrower from Ethiopia’s banking system.The Commercial Bank of Ethiopia (CBE) is by far the largest lender, and more than three-quarters of its loans go to the government. The funds borrowed by the government are either poured into megaprojects that have no or extremely poor linkages to the production of goods and services. Funds are also used to finance totally unproductive activities such as military expenditure or paying the salaries of the large army of civil servants, who do not directly contribute to the production of any tangible goods and services that would ultimately appear on supermarket shelves.In summary, inflation can be tackled by producing more goods and services. In that process, inevitably more money will need to be printed; therefore, we need to refrain from the temptation to associate inflation with the money supply. A related issue is that government borrowing has effectively crowded out private sector borrowing. This needs to be stopped.Tackling inflation requires a substantial boost in credit to the private sector, particularly those in the productive sectors, such as agriculture and small and medium-sized enterprises.If the logic of tackling inflation is clear, then policy synergy means that the solution for inflation would ultimately contribute to each of the other problems. Enhancing productive capacity is a common denominator for the problems raised by many. We fight against inflation by increasing the production and supply of goods and services for the domestic market. Similarly, by enhancing production of exportable goods, export revenues will finance and reduce foreign debt. Investment and the formation of new businesses would result in an expansion of the tax base. Incidentally, currently, tax base expansion has been somewhat misconstrued; the authorities often interpret it as meaning squeezing existing businesses and collecting more taxes.As far as the forex crisis is concerned, export promotion is the ultimate solution in the medium-to-long run. In the short run, however, the government should employ innovative policy interventions, such as applying dual exchange rates. In short, it means using two exchange rates at the same time. One comes into existence by accepting the existing black market rate for remittances, government intervention, and buying at the same rate as black marketeers.Billions of dollars are sucked into the foreign bank accounts of individuals. Some proportion of that is used by private traders to import goods, taking into account private profits. The country would have additional billions of dollars desperately needed to finance imports according to national priorities, such as medicine, tractors, etc. The other black marketeers are corrupt politicians who may have large sums of birr on hand and are keen to pay any amount of birr per dollar so that they can siphon off the funds and deposit the dollars in foreign banks.If the government bought hard currency at the same rate as on the black market, then dollars would be diverted to official channels and end up in Ethiopian banks.The other component of the dual exchange rate would be the existing official exchange rate, which I propose to keep in place to finance any transaction other than remittance inflows. In any case, the dual exchange rate is a temporary solution that will need to be replaced by a flexible or floating exchange rate when the country’s ability to make exportable goods grows.What is your take on the opening up of the financial sector, devaluation, and gradual floatation?Most countries in the world have opened their banking sectors to competition with foreign banks, and Ethiopia should not be an exception. However, entering any competition requires prior “training.” No country sends its national football team to a match without the coach taking them through rigorous training sessions over a certain period.Ethiopian banking is an infant industry in many ways. Besides, we cannot say there has been competition between existing banks, which have evolved through extreme imbalance. There is one giant, the CBE, in the middle, and numerous private banks dotted around. Government policy has a serious bias in favor of its own banks. There is no level playing field.Private banks charge exorbitantly high interest rates on loans while paying as little as possible for deposits. They retain big margins, make colossal profits, and have continuously declared 30 to 40 percent dividends to their shareholders for three decades. They are partly affiliated with government officials who turn a blind eye to the abnormal banking practices, avoiding desperately needed regulation of the sector.Ethiopian banks will need to learn competition by competing among themselves before they are exposed to competition with foreign banks. The government should reform the domestic banking sector and remove existing imbalances, particularly government giant banks, which should be broken into smaller banks that can compete with the rest of the banking sector, or private banks will need to be consolidated to relatively larger banks, each nearly comparable to the CBE.The performance of the banking sector in any country depends largely on the structure of the sector. The government should undertake reforms that will improve the structure and then the performance of the sector. It is only after undertaking these pre-requisites that the government should contemplate inviting foreign banks to enter and compete with domestic banks.The birr has been devalued umpteen times before, but the only thing Ethiopians got was chronic inflation. It is straightforward why devaluation will wash straight through and translate to inflation. Devaluation is essentially a mechanism that deliberately lowers the value of domestic currency in order to entice foreigners to buy exported goods and services at a lower price.This works only if there is enough to export so that what is lost in value by reducing export prices will be more than compensated by large export quantities. Ethiopia has never been able to produce enough exports. Therefore, in these circumstances, devaluation means loss of export revenue, making an already bad situation worse.On the other hand, devaluation means making imports expensive, with the idea of discouraging imports and saving foreign exchange. However, Ethiopia’s imports are mostly necessities that cannot be avoided: medicine, fertilizer, raw materials for factories, etc. If importing these items is unavoidable, that is, if the imports cannot be discouraged, then what is the point of purposefully making items that must be purchased more expensive for oneself? In other words, for the same quantity of goods, import bills will become larger than before the devaluation.It would amount to shooting oneself in the foot to go ahead with the devaluation of the birr in the immediate future. When the circumstances are right, it is inevitable that the Birr will gradually float.The PM launched an anticorruption taskforce and is also undertaking major reshuffle. Is the government really cleaning house or preparing for grand corruption?I recall Dergue’s anti-corruption taskforce, called the Central Commission for Discipline Inspection (Yequtitir Komite). The joke was that in a short while, members of that commission became among the most affluent folks in town! In Ethiopia, it is customary to form a committee to address any issue that arises. Establishing an anti-corruption taskforce amounts to beating around the bush.A simple two-step procedure of scrutiny would suffice to know whether an official is corrupt or not. First, there are documents that confirm their monthly salary and related benefits. HR units in each department can provide the required information. Second, most officials do not even make any attempt to hide the size of their assets, both fixed and mobile, or the extravagant lifestyles they lead.These two facts are more than sufficient to establish discrepancies and then implicate suspects without the need for the establishment of yet another institution that requires large sums of money to operate.How long do you think it will take for Ethiopia to recover from the two-year war? It will really depend on the authorities’ ability to raise the necessary funds from domestic and international sources, on the one hand, and their commitment to use funds in the least expensive combination of activities, on the other. By the way, I wish HGER 2.0 was more focused and committed to the reconstruction of the war-torn economy.Do you see real fiscal decentralization in Ethiopia’s federal structure? Some argue that the government should resolve the conflict in Oromia peacefully, as it did in Tigray. Why do you think the international community is not vocal about the conflict in Oromia, unlike the Tigray war?Fiscal decentralization goes hand-in-hand with decentralization of politics and governance. Ethiopia has experimented with federalism, but it is untenable to say that the country has so far transformed to a genuinely federalist style of governance. It is just a matter of time, though, and progress towards genuine federalism is inevitable. That is the only way to loosen the simmering tensions.Resolving the war in Tigray alone would not make Ethiopia a peaceful country. For the country to progress toward peace and stability, guns should be silenced in all corners of Ethiopia. The call for peaceful resolution in Oromia is getting louder by the day. I hope and pray that peace talks to end the conflict in Oromia will take place soon.There are two factors that explain why the international community has been vocal about the war in Tigray and less so about the conflict in Oromia. First, the war in Tigray was conventional and intensive, causing massive damage in a relatively short span of time and place. Similarly, the Tigray People’s Liberation Front (TPLF) has built a solid diplomatic capital during its 30-year stay in power.On the other hand, the conflict in Oromia is relatively less visible because it is extensive in its geographical scope; remember, Oromia is about seven times the size of Tigray. Importantly, the nature of the conflict in Oromia is more guerilla-type, and the damages are scattered in many zones and districts. Besides, the conflict in Oromia started long before Tigray, meaning that it slowly built up, as opposed to the sudden flare-up of the war in Tigray.Finally, even after accounting for all these differences, the international community has a tendency to wait until devastations happen on a grand scale.How do you see the role of the World Bank (WB), IMF, United Nations Development Program (UNDP), and western liberals in Ethiopia’s policymaking? Let me begin with the role of multilaterals in Ethiopia. First, many of the multi-lateral institutions were established to serve a specific purpose, particularly to protest the interests of advanced western nations. For instance, not many people recognize that the WB and the IMF are banks owned by a group of powerful countries and governed by boards created by the shareholders. Both act and behave pretty much like any other bank, except that they are given a façade as if they are institutions that were established to serve the interests of all countries to the same extent.The fact is, developing countries are just clients or customers of those banks. The IMF is often labeled as an extension or subsidiary of the US Treasury.The most important thing for Ethiopia’s policymakers and the public is to get rid of the illusion that the multilateral institutions stand for the interests of all countries in the world. It follows that the Ethiopian authorities should bear this in mind and deal with the IMF or WB the same way they deal with any other government institution in the US or Europe. Diplomacy has a big place in this process.It is counter-productive to complain about or curse the conditionalities imposed by the multilateral agencies. It is the job of Ethiopia’s policymakers to articulate issues in the best interest of the country and seek assistance with a clear purpose. The multilateral institutions have a tendency to prescribe more or less similar policy recommendations to all countries.For instance, in all forex crises, it is common for the IMF to recommend devaluation or a floating exchange rate. Countries that have competent policy practitioners can engage IMF staff and convince them of alternative policies. The Ethiopian authorities should be able to convince the IMF that several rounds of devaluation episodes have already crippled the Ethiopian economy, it is premature to float the birr as well, and we choose to pursue the dual exchange option to deal with the country’s forex crisis. The IMF would listen and accept such options.The trouble has been that the authorities have sat around a round table with the IMF without offering any well-thought-out alternatives. In that case, the IMF will get a chance to dictate the terms and the policy options. If that is the case, then it is not the IMF’s fault but that of the Ethiopian authorities.What are the underlying problems in Ethiopia?Ethiopia has multiple chronic imbalances. In “Putting a Spotlight on Ethiopia’s Economic Idiosyncrasies,” in my paper presented at Ethiopia 2050: Grand Challenges and Opportunities, I have outlined a series of peculiar features of economic imbalances in Ethiopia. By “Ethiopia’s economic idiosyncrasies,” I meant the type of economic imbalances that one can rarely find anywhere in the world or development challenges unique to Ethiopia.Among some, one is Ethiopia’s low wage curse. A fresh MSc graduate in Kenya starts with a salary level about five times that of an Addis Ababa University (AAU) professor with a PhD and 30 years of teaching and research experience. An elementary school teacher in Nairobi earns, on average, about seven times more than her counterpart in Addis Ababa. This would not have mattered if the cost of living in Ethiopia were lower than that in Kenya. Data related to cost of living indices for major cities in the world indicate that the cost of living in Addis Ababa is higher than that of Nairobi.Income policy is a forgotten topic in Ethiopia. The authorities are not even aware that the country’s wage level is painfully and embarrassingly low. Low wages hurt the Ethiopian economy a great deal because low wages kill effective demand for goods and services. If the purchasing power of households is crippled to this extent, then business profitability suffers. Low effective demand, low investment, and high unemployment are all features of a low-level equilibrium trap.It is a sad state of affairs that such a big issue is not even recognized; no one even talks about it. Not only policymakers, but the general public, appear to be unaware. In the meantime, low wages are acting like cancer, eating into the Ethiopian economy from the inside out.Another chronic imbalance is related to the extremely lopsided pattern of regional development. Let me illustrate this using a standard indicator in urban economics. This is measured by what is called “city rank and size distribution.” Urban systems evolve and shape up into a similar pattern for most countries in the world. This pattern is measured by what urban economists and geographers call Zipf law. It states that the largest city in a country is mostly about two times the size of the population in the second-largest city, three times the third, four times the fourth, and so on. This is not an exact science, but the ratio may slightly vary, often falling between two and four.According to the 2007 census, Addis Ababa’s population was 2.7 million. The second-largest city was Gonder, and its population was 233,000. This means Addis Ababa’s population is about 12 times that of Gonder. Perhaps the situation has gotten even worse. No country on planet Earth has such an extremely imbalanced urban system. But why does this matter? How does this imbalance affect economic performance?It matters because Ethiopia’s economy is increasingly becoming the economy of Addis Ababa. Most significant economic activities are agglomerated in Addis Ababa and its surroundings. Addis Ababa is congested, hot, and booming. The rest of Ethiopia is frozen and ice cold; nothing is happening on the outskirts. The cost of living for households and the cost of running a business in Ethiopia or Addis Ababa are both escalating because goods are transported over very long distances to reach a large marketplace, with margins adding up and the price of goods rising per km.If there was a healthy urban structure, with large cities scattered all over Ethiopia, it would mean the population would be closer to places of production and goods would be shipped over short distances.If everything is left to the market, then agglomeration always wins through a process called cumulative causation. People choose to live in Addis because that is where they can find jobs. Businesses concentrate in Addis because that is the only place there is a big market for their products. Now we have circular reasoning: people follow jobs, and jobs follow people! Consequently, we have Addis Ababa as we know it.Policymakers must combat the force of agglomeration by encouraging the dispersion of businesses and job opportunities, taking jobs where people are rather than allowing people to flock to a single location where businesses and job opportunities are concentrated.The urban-rural divide is yet another chronic imbalance in the Ethiopian economy, a variant of the troubles in the center-periphery imbalance discussed above.Do you think there is credible data to determine the exact figures for Ethiopia’s GDP?I have no doubt Ethiopia’s GDP accounting is still troubled; official economic statistics have substantially deviated from the reality on the ground. The urge to report miraculous economic growth has been so great that official reports get carelessly prepared and disseminated, purely for propaganda purposes.For instance, Ethiopia’s population might have grown by a maximum of three percent in 2014, but agricultural production is claimed to have grown by 6.1 percent. In that case, why are cereal prices rising in the market?The EU was puzzled by this discrepancy; they expected excess supply would depress prices, but this did not happen in Ethiopia. They sponsored the International Food Policy Research Institute (IFPRI) to undertake an independent agricultural production survey. It came up with a shockingly surprising finding.They found that the official statistics on cereal production were exaggerated by as much as 20 percent to 44 percent. This is specific evidence coming from a sector, but similar discrepancies do exist in most other sectors. In order to paint a rosy picture in terms of the achievements of targets such as the Millennium Development Goals, the authorities fudged the numbers over the years.This week, social media activists have been circulating messages celebrating an “economic success story.” They claimed that “the IMF projected Ethiopia’s GDP growth at 13.5 percent during 2023 and that it is about to overtake Kenya as the biggest economy in East Africa.”I visited the IMF website and found that the actual projection reported was 5.3 percent. Pressed to provide evidence, the activists quoted a Kenyan journalist who used that figure to criticize his government because Ethiopia was about to overtake his country. It is unclear where the novice Kenyan journalist got the 13.5 percent. It is possible that he computed it from the nominal GDP series reported in an IMF publication.The IMF generates two strands of time series data on the GDP of each country. One is at the current price without removing inflationary effects (nominal GDP), and the other is at a constant price after accounting for inflation (real GDP). The IMF mostly reports growth rates computed from real GDP series in national currencies. It does not make sense to report growth rates computed from nominal GDP because the inflationary effect inflates the results.What I found embarrassing is the fact that some Ethiopians are celebrating the fact that Ethiopia’s GDP overtook that of Kenya. The fact is that Ethiopia is twice the size of Kenya in both demography and geography. It follows that Ethiopia’s GDP per capita is half that of Kenya’s.In other words, if the level of Ethiopia’s GDP just overtook that of Kenya, it means that historically, an average Kenyan was twice as rich as an average Ethiopian. Rejoicing in the fact that Ethiopia’s GDP will catch up with Kenya’s GDP in 2023 amounts to celebrating that Ethiopians are about to become half as rich as Kenyans