Table of Contents These short articles are my contribution to the Monthly Ethiopian Business Review as a community service work. These articles are based on research that I have conducted on Ethiopian and African economies . I usually take them as a kind of "policy Briefs" which help policy makers to make informed policy decisions. It is also meant to create awareness to the public by simplifying economic jargons to an ordinary readable level.

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Author:

Desalegne Rahmato

Title:

The Peasant and the State

Publisher:

Addis Ababa University Press, 2010, 350 pages; ISBN xxxxx, Birr 50.oo

Reviewer:

Alemayehu Geda, School of Economics Addis Ababa University

In this volume, Desalegne Rahmato brought together more than three decade of his agrarian research on Ethiopia that stretches across three regimes (the Imperial regime ( the Emperor Haile-Selassie regime that ended in 1974), the Derge regime (1974-1991) and the EPRDF regime (1992 – to date)) in a lucid and comprehensive fashion.. In the end he came to the conclusion that despite three regime shifts and various policies, the Ethiopian agriculture has fundamentally remained unchanged. This has left the Ethiopian peasants to remain in abject poverty at which the author is personally outraged. The main message that Desalegne finally wanted to convey is that this is because all regimes and their policy did not take the peasant as ‘an agency’ of change. The peasant is not free to freely does what he/she wants to do. The peasant doesn’t have a limited freedom needed for his development. This consists of the right to the land without any outside imposition, the right to work freely and for oneself not for others, the adequacy of product from the land, and the right to dispose of the product form the land to benefit the producer themselves. To come up to this fundamental conclusion Desalegne has marshaled both analytical and empirical information on agrarian transformation in the world and in Africa in general and the Ethiopian agriculture history in the last half a century in particular. This is superbly done in the book. In particular, the introduction is worth reading by anyone interested in agrarian transformation in Africa/Ethiopian as it brings the major findings of the book in simple and yet rigorous way. For those who do not have the time to go through the entire book, the author has offered them this excellent introductory chapter. This excellent introduction of the book is followed by Chapter one where he discussed ‘Peasants and Rural Policy’. In this chapter he examined state policy across the three regimes in Ethiopia and noted above. In the imperial regime he has examined the successive five year plans and the various package programs used as instruments of agricultural policies of the period. He noted, and amply demonstrated with amazing detail, that all those policies had very limited impact on agricultural development in Ethiopian and part of the blame for this disappointing results lies in the state (and its foreign advisors’) wrong perception of the peasant economy (as well as the class bias of policy makers at that time). For the policy makers the peasants were invincible and irrelevant. The foreign planners were in particular left alone to do or plan whatever they want to do as long as they do not touch the institutions of property right and power relation. In this chapter Desalegne managed to successfully show how ridiculous it is the D. Levine type ‘wax and Gold’ explanation of perceiving the non-western culture as anti-progress to explain the underdevelopment of the Ethiopian

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agriculture. In the process he analytically has shown the wrong basis of policies taken from outside the countryand imposed on Ethiopia – this chapter is just excellent.

In Chapter two he picked ‘commercial farming’ in detail. The argument and details given in this chapter are not only of historical importance but also are of current policy concerns from which policy makers today could learn. In this chapter Desalegne has shown the pros and cons of commercial farming using the then available evidence. The former includes, employment, urbanization, and development of agro-processing while the latter refers to eviction and displacement of peasants. After a careful evaluation, he noted that the commercial farming model is imposed on existing system and was unsustainable model of development for Ethiopian anyway. From the analysis in this chapter he suggested the emergence of ‘Kulak’ peasants as a possibly more sustainable approach to modern agricultural development. I think this chapter is excellent not only in terms of its historic values, as I have said above, but also as an outlet to the current government’s dilemma of how to handle the emerging similar issue related to what is called ‘land-grabbing’ today. In Chapter three Desalegne examined traditional agriculture based social movements and associated conflict by focusing on one of his research locations –North Ethiopia, Wello. The chapter, in a quite amazing detail, shows the problem of the peasant as an agency of change– the running theme in his entire work. He noted that such rural social movements do have a dynamic of their own, invariably including the peasants, even if the latter have not started such uprising. The peasants are usually put in such movement through intimidation by local leaders who are rebelling on the state. He documented the sacrifice these peasants have made both for their local leaders and also at times for their own right. However, whenever the peasants’ managed to secure their right, the new regime/rulers betray them again – placing them in the subjugated position. This vicious cycle make the peasants life a miserable one. The implication of this for agricultural underdevelopment is an obvious one. In fact, this chapter is a reminiscent of the great work of Gebre-Hiwot Baykedagne in earlty 20th century Ethiopia on conflict and underdevelopment in Ethiopia - again an excellent chapter. In Chapters four to six (4 to 6) he devoted a good part of his writings to agrarian issues that prevailed in third (EPRDF) regime. In Chapter 4 he examined the current (EPRDF) government’s policy of ‘land registration’ as one of the policies to ensure tenure security. To come up with a balanced view about the issue, he has examined case studies both from the North and South of the country. In that chapter he addressed the endemic problems of land disputed in rural Ethiopia, and how insecure the peasant had been and still are about the land on which they work. After a through examination of the evidence he managed to collect, he came up to the conclusion that the current government’s policy of land registration did not bring fundamental change in tenure security because it failed to change the fundamental relationship between the peasants and state, in which releationshipe the latter is dominant. Chapter 5 is an excellent chapter for anyone interested to have an overall picture of rural Ethiopia and its governance as it exists today. In this chapter Desalegne has outlined various roadblocks to empower the Ethiopian peasant. He noted that empowering the peasant could be done primarily by the peasants. However it can be greatly assisted by all concerned with condition of the peasants. The importance of this chapter lies in the great emphasis that Desalegne has put on the issue of focusing on the peasant as an agency of change, which he was arguing throughout as a missing angle in agrarian policy making in this country.

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Chapter 6 and the conclusion that followed is an attempt by the author to rap-up the book with excellent pointers to future policy direction. In this part of the book Desalegne has pointed out to an interesting aspect of Ethiopian agrarian history and policy where a policy to address one issue (such as the 1975 land reform that is meant to address land inequality) leads to another problem (fragmentation of land and insecurity as an enduring aspect of Ethiopian agriculture). The author also shows how landlordishp is replaced by state-landlordsip and in the processes the hegemony of others on the peasants, which is mediated by property ownership, became an enduring aspect of the country’s rural life. This part of the books shows how these enduring aspect of Ethiopian agriculture has led to undermine the peasant as an agency of change and led to underdevelopment of the sector and the country. He concluded this chapter by outlining about five policy directions that any expert concerned with the development of Ethiopia in general and the Ethiopian agriculture in particular need to take as a must reading. These policy directions are tied together to the author’s belief that development should be a joint venture, including in particular the peasant as an agency of change. He also noted that development should also be pluralistic. I strongly recommend this final part of the book for our policy makers today which are confronted with identical problems that Desalegne has examined thoroughly for decades. The contribution of the book relates to historical documentation of agrarian policy, as well as state peasant relation and rural conflict in the last five decades in Ethiopia. The book also could be taken as a work of critical evaluation of past agrarian polices and the implication of that for current policy. It does these things in an excellent manner and I am sure the audience of it welcome it highly. The scholarship went into this work is superior. I know of no competing work on this area and it is the best around. I feel I might have not made justice to Desalegne’s excellent book of over 350 pages about peasants and State in Ethiopia by summarizing and reviewing it in the few pages above. Be that as it may, I am of the opinion that like that of his previous classic work on ‘Agrarian Reform in Ethiopia’ this book will also be a classic book which will be a must reading for students of Agrarian change and development in Ethiopia – it is just excellent. Alemayehu Geda School of Economics, Addis Ababa University Research Associate/Fellow: University of London, SOAS/CDPR (London, UK), African Economic Research Consortium (Nairobi, Kenya). The Kenyan Institute for Public Policy Research, Nairobi, Kenya Central Bank of Kenya, Nairobi, Kenya Center for Economic Policy Research, Kampala, Uganda African Development Bank, Tunis, Tunisia. Economic Commission for Africa (Addis Ababa, Ethiopia) Director, Institute of African Economic Studies, Addis Ababa [email protected] Web: www.Alemayehu.com

Discovering Oil in Ethiopia, a Curse or a Blessing:

The

Macroeconomics of a Commodity Boom (part II) Alemayehu Geda In the first part of this article I have noted potential economic problems that may arise from discovery of oil in Ethiopia. I have also highlighted the fiscal policy direction that must be pursued to tackle such potential problems. In this and final part of the article I will highlight the monetary and exchange rate policy direction as well as the direction for institutional building. The fiscal policy direction needs to be combined with an exchange rate and monetary policy that would avoid the possibility of real exchange rate appreciation and an increase in money supply. An important policy objective in this regard could be inflation targeting that requires deploying relevant policy instruments such as tighter monetary policy. Such monetary policy could be combined with a managed floating exchange rate regime. The exchange rate policy need, however, to follow a more gradualist path to exchange-rate flexibility. In addition, counter-cyclical fiscal policy will provide a degree of automatic sterilization. Successful booming sector-driven economic transformation requires macroeconomic and financial frameworks for promoting national savings, fiscal stability, diversification and a political and social contract for managing booming sector revenues, based on democratic participation and transparent economic governance. In this regard, one can take lessons from African success stories such as Botswana. A number of studies ascribe Botswana’s success to prudent fiscal and macroeconomic policies. Botswana's high growth has reflected good governance & institutions, including democracy, political stability and low corruption, prudent financial management and macroeconomic stability. It also held successful initial negotiations with the diamond company, resulting in high levels of royalties. The government avoided 'Dutch-Disease' by not engaging in excessive spending of the export windfalls, which would have hurt both agricultural and non-mining industrial growth. Botswana also created a Revenue Stabilization Fund, treated the boom as temporary, had legally enforceable maximum expenditure limits, and invested diamond revenues predominantly into infrastructure, education and health. Nevertheless, the country has seen little diversification into manufacturing, high level of unemployment and poverty was not sufficiently reduced. Thus, Botswana was able only to minimize but not escape the resource curse. From this we may conclude that prudent macro management is a necessary but not sufficient condition to make the best out of a booming natural resource sector and hence the need to have long term strategic policy direction is crucial. The study from which this brief article is extracted has also shown that the dependence on primary commodity production and export has detrimental implications for the long-run growth and industrialization aspiration of African countries. Thus, the majority of countries, like that of Ethiopia, in the continent are characterized by a lack of diversification owing to deficiencies in human and physical capital and inappropriate policy. An increase in investment with appropriate sectoral allocations for diversification is highly recommended. Thus, there is a need to design incentive mechanisms, and create an enabling environment to diversify the Ethiopian economy. The macro policy options discussed so far are summarized in the Diagram below. Macro Policy Options to Deal with the Challenge of A Booming Primary Commodity Sector

It is imperative to learn from the experience of both African and Asian economies, which managed to diversify their economies in the last four decades. As has been noted by the famous Asian expert named Amsden, the state in East Asia was crucial for its industrialization and export expansion. The state set four functions for itself including: development banking and efficient bureaucracy, localcontent management, selective seclusion (opening some markets for foreign transactions and closing others), and national firms creation that includes the emergence of a managerial class and cadre of entrepreneurs. Two principles guided this effort. The states decide to make manufacturing profitable enough to attract private entrepreneurs, and induce enterprises to be result-oriented and to redistribute their monopoly profit to the population at large. Similarly, judicious targeting and organization to ensure the efficacy of public policy to encourage primary product diversification and processing, exportation and domestic capacity creation through training, infrastructure provision including research, subsidies and credit provision was made by governments of Southeast Asian countries that were commodity dependent. Ethiopians need to move along similar lines by tailoring such lesson to their condition and the prevailing global environment. In particular, the current global environment shows the increasing engagement of Africa with newly emerging economies that are demanding natural resources from Africa. This has the danger of locking African countries into primary commodity sector. Two strategic policy directions in this regard could be pointed out. One is the possibility of establishing an industrial fund, financed from the booming resource export sector and use it for industrialization. A second possible avenue is to negotiate with emerging partners such as China to have ‘a commodity-induced industrialization’ model’ – that will ensure that emerging economies' commodity demand is not realized at the expense of the future industrialization and development aspiration of African countries. For this to happen, sound quality of government policies and institutions that are equipped enough to deal with emerging countries counterparts are needed. All policy directions outlined thus far have implications for capacity building. Capacity building in the form of achieving better economic governance so as to make informed policies that are based on evidence; building institutions that will effectively negotiate on natural resource exploitation and its

use with foreign firms; and managing the rent from the booming sector in a socially optimal fashion is extremely important. Technocrats at the relevant ministries and offices such as the ministries of finance, the central bank and government advisory bureaus also need to have the capacity to use commodity and macroeconomic models as well as financial and legal management capacity for making technical analyses, forecasting and policy simulations to inform policy makers. It is also important to make the best use of international and regional initiatives that have recently been under taken to encourage increased transparency in the use of natural resource revenues. The “Extractive Industries Transparency Initiative” which aims to set a global standard for transparency in oil, gas, and mining being a case in point. According economists named Weinthal and Luong the lesson from Botswana's example is that it managed to have an insulated and autonomous technocracy committed to long-term developmental goals. This, although important, is not sufficient for it overlooks the institutional capacity that carrying out and sustaining such polices requires. In particular, these researchers noted, institutionalized mechanisms for accountability and transparency that can curb rent-seeking and corruption are crucial. Thus, there is a need for strong budgetary institutions and procedures that can constrain legislatures and ministries from expanding the budget. Botswana was able to maintain an unyielding budget and prevent overspending because of a legislative procedure requiring parliamentary approval for any new public project after its National Development Plan was passed, thus preventing the executive branch from altering the budget on whim. This is something we lack in Ethiopia. The challenges of resource flows from the booming primary commodity sector in Ethiopia may not be dealt with by addressing constraints that are specific to the export sector alone. Rather these challenges are challenges of a development strategy in general and industrialization and institutional building strategy in particular. We hope that Ethiopian policy makers are aware of these challenges ahead of them, as time is of the essence in such issues.

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Commentary

Catching Up With the World: Ten Things that Ethiopian Banks Should Do to Improve their Global Standing

L Alemayehu Geda (PhD) is Professor of Economics at Addis Ababa University. He can be reached at [email protected]

iving aside the long history of the use of money in Ethiopia that can be traced back more than 2000 years. It is following the demise of the Dergue, that the post-1991 economic policy witnessed a marked departure from the previous Socialist system. This new change in policy brought about a significant change in the functioning of the financial sector. Not only was the financial sector going to serve the private sector, which had hitherto been demonized, but new private financial institutions, also emerged. At the same time the role of the Ethiopia’s central bank, the National Bank of Ethiopia (NBE), was also reformulated. Thus, financial sector reconstruction was at the top of the EPRDF’s government agenda some two decades ago. In undertaking this task the Ethiopian government adopted a strategy of gradualism: gradual opening up of private banks and insurance companies alongside public ones, gradual liberalization of the foreign exchange market, and so on, and a policy of, at least in intent, strengthening domestic competitive capacity before full liberalization. This is, restricting the sector to domestic investors, strengthening the regulatory and supervision capacity of the NBE, giving the banks autonomy, and opening up the interbank money market. In line with this strategy various proclamations and regulations have been passed since 1992. Despite the proliferation of privately owned companies, following the financial sector liberalization, their relative market share is still small. This is true in terms of deposit mobilization (and loan disbursement). The dominant position is held by the public sector in general and the Commercial Bank of Ethiopia (CBE)

41 Ethiopian Business Review | December, 2013 Edition

in particular. The public sector’s share in the industry did, was falling continuously since 1996/97 while the share of the private banks rising, though the trend seems reversing following aggressive deposit mobilization by CBE, from private and public sources, in the last couple of years. A similar pattern is observed in terms of disbursement of loans, loans outstanding, and loan collection. Yet the trend of the existing data shows that the share of the private banks – both in terms of deposit mobilization and lending – has increased significantly over the years. In general, given the nascent level of development in using market mechanisms in Ethiopia, the challenge of transition from the pre-reform period to the post-reform period, the relatively good shape in which the existing financial institutions find themselves despite the weak supervision and regulation department of the NBE (which lacks skilled human resources), the government’s strategy of gradualism and its overall reform direction at early phase of liberalization need to be appreciated. However, after more than two decade on this road, one would expect a concession that it should declare when will be the end of that gradual liberalization period; it was supposed to clearly chart out a time schedule/frame for its full or partial financial sector liberalization programme. This is badly needed as our banks are far behind the global banking practice. This could begin first by exploring the possibility of joint venture schemes with foreign banks. Obviously the government cannot rationally protect the sector forever, and it is time to recognize this and act accordingly. Both the public and private banks need also to consider the following 10 points that I think are

The current banking service in Ethiopia is way behind the customer service internationally offered, the financial product variety available; the efficient IT based service globally available and the aggressive marketing practice of international banking. It is even way below the level of private banks in neighboring countries. This needs to be changed dramatically and in a very short period of time. Separate the Power of Bank Managers and Bank Board of Directors in Practice International banking practice dictates that the board is concerned with strategic direction while mangers in managing the business. The managers need to have an incentive structure which encourages them to excel in their trade and, hopefully, graduate to a privileged managerial class. In our banking sector the boards micro mange banks (in particular in credit provision, foreign exchange allocation) and engaging in conflict with managers leading to inefficiency and in-fight in the bank. This needs to be tackled in a decisive manner. Invest on IT and New Technology (If Possible Collectively) This awareness seems to sink in Ethiopian banks today, however the depth of IT and Technology use is way behind the global standard, even compared with our neighbors such as Kenya (its success in mobile banking through what the Kenyan call M-Pesa being a world level success story). SMS banking doesn’t mean we are using IT in banking; it is

just the tip of the iceberg. Banks need to share technology with other banks since that is less costly – for instance every bank in Ethiopia need not to have its own ATM machine for it can share all ATMS in the country and share the cost accordingly (the NBE was supposed to help in that through regulation). Engage In and Influence Macroeconomic& Financial Policy Making Collectively Macroeconomic stability is crucial for the operation of banks. A wrong macro policy such as unpredictable exchange rate policy or monetary and fiscal policy that leads to inflation will lead banks to loss and eventually collapse, since it unduly raise their expenditure (vis-à-vis their planned revenue). Thus, banks need not sit in fold arms for the government to do good since it does make mistakes. They need to monitor and influence policy making with a collective say through bankers’ association or chamber of commerce. This can be achieved by having representative in such policy making committee or conducting research and showing that to the government. They need also to fight collectively discriminatory policies that benefit some banks (say the public ones) and hurt other (eg. the saving policy for government condominium housing project). If the formal channel is not working banks may need to lobby officials too. Measure Your Performance in a Competitive Framework There is a tendency to measure success by the total profit of banks only. If Ethiopian banks use the real interest rate (lending rate less inflation) for instance, at times they are actually lending at negative interest rate. The Ethiopian banks survive this because they pay negative real interest to depositors. If depositors

knew this and have an alternative and better way of depositing, the Ethiopian banks will be out of business immediately. Moreover, profit per capital invested, earning per share, profit computed in dollar/Euro terms, the relative positions of each bank [relative to domestic and regional banks] is a good indicator of the banks’ performance and future direction. This needs to be adopted by Ethiopian banks. Target Remittance The income from handling foreign exchange is becoming an important source of income for Ethiopian banks. It is imperative in this regard to focus not only on exports which is the traditional source of foreign exchange but most importantly on remittance. The country’s export revenue is still small, USD 3.08 billion for the 2012/13 fiscal year, less than my estimate of remittance (both formal and informal), which is above 3.5 billion USD. This should encourage our banks to be creative in getting their hand on it. Look Regionally The horizon of our banks is very narrow and limited. However, there are a number of opportunities around our neighbors: a case in point here is Djibouti, Southern Sudan etc. Thus, our private banks need to see beyond the horizon, at least regionally and hopefully in the future globally. They shouldn’t tell themselves that there is already a lot to be done at home as working outside doesn’t contradict with working at home as long as it is more profitable and strategic. Diversify Your Services and Products The current level of banking service and banking products in Ethiopia is way behind the international practice. This

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important to bridge the gap between our banking practice and the advances in global banking practice, including the banks of our neighbors such as Kenya. Provide International Level Customer Service

Point No 8: Diversify your Services and Products: The current level of banking service and banking products in Ethiopia is way behind the international practice. This is an opportunity for banks in Ethiopia because it shows the potential for their expansion. Thus, they need to see the possibility of exploring, investment banking, credit provision for consumer durables, corporate banking service, home banking, electronic purse, clearing system, corporate bond issuing, committed and uncommitted facilities to name but few lucrative businesses. Point No 9: Have a Strong Marketing and Research Department: In order to realize the possibilities noted in point 8 above and also to actively participate in policy circles as noted in point 4 above, banks need to have a strong marketing and research department. This need not be a department with a huge staff. A well paid and well-motivated skilled staff of 5 to 6 person can do the trick at initial stage of its operation. Think that allocating huge money in building a headquarter office building is less impressive than spending on such human capital from a strategic point of view especially if the sector is to be liberalized.. Point No 10: Have a 5 to 10 year Strategic Planning and Monitor it each Year: I am sure all our banks have some sort of strategic planning. In most cases these are generally simple paper works. What I am thinking here is serious strategic plans that will be drawn by the staff noted under point No 9 above and can beused to advise the board of directors. This could be complemented by external consultants work. This needs to be gauged and monitored periodically. I highly doubt that existing (if any) strategic plan of our banks has been revised, say, owing to the effect of the global crisis, the rampant inflation in Ethiopia and the unprecedented devaluation of recent past. The answer is most likely in the negative and this is because the strategic documents of our banks are not serious plans and are usually drawn for the sake of having them on paper. Our banks need to get out of such quagmires and draw realistic strategic plan which will be based on key success factors in the industry. This includes: (a) knowledge of market, risks, opportunities, technology and ability to manage them; (b) local presence and extensive network locally, regionally and eventually globally; (c) ability to tackle obstacles that may come from officials, problems of credit concentration, competition and (d) links with high credit quality companies, patience to close lucrative deals and integrity and transparency. I hope these are helpful direction to direct us towards the global and completive banking practice. NB. This is a shortened and updated version of a paper presented for Dashen Banks 15 years Celebration and interested readers can get the longer and original version there.Dashen is greatly acknowledged.

View Point

Ethiopia, Kenya: A Beneficial Interdependence

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n March 10, 2014, Kenyan President Uhuru Kenyatta accompanied by high level government officials and some of Kenya’s prominent private sector figures came to Ethiopia on a four day official visit. During the occasion, both nations vowed to strengthen cordial relations that started to flourish between Ethiopia and Kenya. They also agreed to deepen and expand the scope of their collaboration. Indeed, Ethiopia and Kenya have quite an admirable peaceful political and ecoAlemayehu Geda (PhD) is nomic partnership, unlike most counties Professor of Economics at in the Horn of Africa, where conflict and Addis Ababa University. violence are common. Perhaps Kenya is He can be reached at the only country in the world that has a [email protected] better level of development than Ethiopia and allows Ethiopians to come to their country without a visa. Notwithstanding this aspect, the two countries have their own unique economic potential that has not been exploited thus far although many bilateral agreements were signed by both countries. I would argue that in terms of growth and development, Kenya and Ethiopia could fly together instead of jumping separately. Although this issue needs in-depth and detailed studies and implementation strategies, I will attempt to outline this potential in five thematic areas of potential synergy. There is a vast market for both nations. Ethiopia is the second most populous nation in Africa with an estimated 90 million people. Kenyan’s population is also half the size of Ethiopia. Given, the sustained and strong economic growth registered by Ethiopia in the last decade (which the Ethiopian official sources claim to be above

49 Ethiopian Business Review | April 16 - May 15 2014 Edition

10Pct) there is a huge market for Kenyan firms, which are more efficient compared to Ethiopian firms. Thus, the Kenyan firms demand constraint could be alleviated by strong economic cooperation of the two countries that will create a combined market size of over 140 million people. Synergy in power and port use is another huge potential. Ethiopia has an enormous potential of cheap and renewable energy production. In hydro-power alone, the country has a potential to produce over 45,000MW. The country is also on the right track in the actual production of this energy in which its production will go to about 8,000MW (form the current level about 2,100MW) in the coming 3 to 4 years. Sourcing such cheap and clean energy from Ethiopia can reduce its cost for Kenyan firms by more than half. It is encouraging to see that the two governments have already reached an agreement for the supply of 500MW of electricity from Ethiopia to Kenya. In addition to this, landlocked Ethiopia can benefit from accessing the sea through the port of Mombasa and Lamu, in particular for the Southern part of the country. Although the government of Ethiopia doesn’t seem to be aware, studies in Africa show that a landlocked country can lag behind in terms of growth by at least 2Pct compared to a country with direct access to the sea. Thus, economic cooperation with Kenya and an optimal access to the sea can significantly reduce this growth handicap of Ethiopia as well as its strategic vulnerability. Trade, in areas like industrialization, finance, Information and Communication Technology (ICT) is another way the two

Tourism, air-transport and human capital is another potential area of benefit. Kenya has a welldeveloped tourism sector. Mombasa marine resource and Masai-Mara parks are among world class tourist destinations that attract over a million visitors each year. Ethiopia, on the other hand, has enormous potential in tourism (the historic routes, the Ertale live volcano in the lowest place on Earth being a case in point). However, it has not exploited this potential as can be inferred form the number of visitors that come to Ethiopia each year, which in 2006 was 290,000. This is more than five times smaller than the number in Kenya, 1,644,000 in the same year. A joint effort of attracting tourists to both places through conscious joint planning by their respective airlines could bring about a winwin outcome for both. In addition, the Ethiopian Airlines with its state of the art facilities, workshops, and training center, can help the Kenyan Airways to build its capacity within the existing strategic and cooperative framework. Finally, the two can bring about synergy in regional peace, stability and democracy. A deeper engagement of the two countries in economic cooperation not only requires working together on regional peace and political stability as they are currently doing (in South Sudan and Somalia), it can also help to establish a vibrant media in Ethiopia, which is dearly missing in Ethiopia’s context but common in Kenya.

Side by Side, the pictures below depict the solid relationship of Ethiopia and Kenya, with the Ethiopian leaders consistently at the right and Kenya’s to the left.

Considering the long and rich experience of the Ethiopian government in bargaining hard for what it believes in terms of policy with its development partners, Kenya can learn a lot working with Ethiopia to challenge policies imposed by international institutions such as the World Bank, IMF and WTO as well as by influential partners with strong national interest at heart (such as the West and China). In short, Ethiopia can bring market size, a cheap source of clean energy and perhaps skill in ownership of policy and negotiation power with development partners to the table. In the same manner, Kenya can bring efficiency in commerce, finance and communication, skilled human capital, vibrant, democratic and independent culture of media and water access to the table. There are also other synergies that may come with a joint operation of the two countries such as regional political security and stability and informed bargaining power with development partners. Thus, it is imperative to consider that economic cooperation and a special status of Ethiopia in Kenya and Kenya in Ethiopia, informed by in-depth study, is a win-win outcome for both countries. It will allow both countries to reach a higher and steadier state growth and development than is currently possible for both. In addition, this approach, on top of expanding regional infrastructure, might also provide a pragmatic approach to regional integration in the region and Africa at large. g

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nations can work together. A comparative analysis of the level of development in commerce that includes trade and finance between the two countries shows that, the level of development in Ethiopia is way below that of Kenya. Thus, Kenyans have much to offer to Ethiopians and can benefit from it in the process. Similarly, the level of development in ICT in Kenya is something that the inefficient and non-accountable Ethio - telecom can learn by working with the Kenyan Safaricom, one of the big telecom providers in Kenya. The latter’s world class service of mobile banking (the MPesa) can be a case in point here. The Commercial Bank of Ethiopia can also learn a lot by working with its counterparts in Kenya. Ethiopia can also learn from Nakumat and Uchumi, two of the biggest retail companies in Kenya, to stabilize the price of basic goods offered by local retail companies that are protected from foreign competition. Not only should Ethiopia learn from the working of Kenyan firms (such as Safaricom) but also, perhaps more importantly, how Kenyans mange to create a competitive environment, which allows Kenyan companies to work in a joint-venture with world class firms. Kenyan firms are performing well because they have a creative, well rewarded managerial group and efficient staff. These points are equally enjoyed by Kenyan firms operating in banking, trade and industry and Ethiopia can benefit a lot by learning and working with such entities in Kenya.

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World Bank’s Advice on Devaluation: Why It Doesn’t Boost Export?

L

Alemayehu Geda (PhD) is Professor of Economics at Addis Ababa University. He can be reached at [email protected]

ast month, in its latest Ethiopia Economic Update entitled ‘Strengthening Export Performance through Improved Competitiveness” the World Bank has advised the Ethiopian government to devalue its currency to speed up the growth of exports. Empirical evidence presented in this report suggests that a 10Pct lower real exchange rate could increase export growth in Ethiopia by more than five percentage points per year and increase economic growth by more than two percentage points.

The World Bank argues that the Ethiopian currency is unduly expensive in terms of foreign currency such as the USD. In the economic jargon we call that over-valuation of exchange rate. In lay man terms, the World Bank advice says that ETB19.60 Ethiopians are giving when somebody comes with USD1 is too small. So, it means giving them ETB22 (10Pct increase) or ETB24 (20Pct increase), instead for the same dollar. If that is the case, the World Bank argues that Ethiopian importers will be discouraged because it will be expensive to them in terms of the local currency. In addition, the World Bank says, exporters will be encouraged because they will get more money in terms Birr for the same USD1 export item they send abroad. Not only that, the Bank continues narrating, investors and those who send money to Ethiopia will be attracted by this and will send more mon-

ey and invest a lot. When that happens, the country will be able to narrow down the gap between imports (which is close to 11 Billion USD) and exports (which is just under USD3 billion). No question this is a huge foreign exchange deficit; however, despite this pressure from the World Bank, the Ethiopian government is moving with its exchange rate policy (referred by economist as managed floating). This policy allows the government not to completely leave the exchange rate to be determined by the ‘free’ market. With these in mind, I argue that the current government policy towards exchange rate is right and the World Bank policy or pressure is wrong for the following basic reasons. First, Ethiopian imports are what can be described as strategic imports which are not amenable for reduction because they will be expensive in local currency following the advised devaluation. The breakdown of our imports shows that about 70Pct of our imports are capital & intermediate goods, fuels and related imports which Ethiopia will be importing whether they are expensive. This demonstrates the wrong presumption of the World Bank. In fact if imports came to be expensive in local currency they will lead to inflation which the government has tried its best to abate it in the last two years. Moreover, since the government is a major actor in the economy its own import

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price will be very high and will enter into budget deficit which invariably leads to inflation in Ethiopia. The second consequence of devaluation in today’s Ethiopia is its inflationary effect. Myself and my former student’s empirical research and forecast on Ethiopian inflation shows (and actually proved right in the last devaluation) that a 20Pct devaluation in Ethiopia will have an effect of about 40Pct increase in inflation. Given the Ethiopian traders capacity of passing such an increase in price to consumers which is found in the same study, this will have a detrimental impact on the welfare of the population, especially the poor. In addition, given the low level of foreign inflation this might even lead to appreciation of the Ethiopian currency and possibly contraction of business activity due to rise of cost of inputs and low real demand that may emanate from this policy. This is what critical economist call “contractionary effect of devaluation” which was very common in Latin American countries in the 1980s and 1990s. My other argument against the devaluation advice relates to the fact that Ethiopian exports will not dramatically increase or may not increase at all because of devaluation, as the World Bank presumes. This is because the fundamental problems behind Ethiopian exports is not a need for a rise in price (not that devaluation here acts as a rise in price because exporters get more money in terms of birr for the same export) but rather major hindrances to supply and production and exporting. Based on the survey based research conducted by me and my colleagues on problems of Ethiopian exporters by looking the cases of 100 exporters, we

found that their fundamental problems are access to land, customs, tax regulations, tax rates and administration as well as corruption. More than 70Pct of the exporting firms rated access to land as the major obstacle for their operation. In addition, a more structural problem to Ethiopian exporting firms is the lack as well as inadequacy of infrastructure. Though encouraging improvements are reported in road, air transport and telecommunication services, about 70Pct of the exporting firms reported such infrastructure as well as telephone and communication deterioration as major problems. The other important factor is access to finance, which is constraining firms from operating at full capacity. Exporting firms exhibit considerable level of inefficiency with an average capacity utilization rate of around 55Pct. These show that Ethiopia’s balance of payment problem is more of structural than financial. I think addressing these, not devaluation, is the key to leapfrog on Ethiopia’s exports. Similarly, the World Bank suggestion seems to send a signal that the Ethiopian government could wake up just one day in bright morning and change the exchange rate. This perception incredibly damages the policy credibility of the government. Thus, if needed the government need to stick to its managed floating policy stance and make changes in piecemeal and predictable manner as it is currently doing; otherwise, inter alia, business people may began planning in USD instead. The government could also lose some policy power –Zimbabwe being a case in point that lost total monetary policy control today. t


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Commentary

Why is There a Big Gap Between Targets and Outcomes in Ethiopia?

T

he following opinion piece is the first of a two-part series on budget planning in the Ethiopian government: Planning and budgeting are the principal government instruments that translate national development goals into public expenditure programs. They are the tools to estimate potential resources and matching limited resources with unlimited needs. The process is more challenging in developing counAlemayehu Geda (PhD) tries where, in addition to the lack of strong private is Professor of Economics at sector, the resources are very limited on one hand Addis Ababa University. and the expenditure need is enormous. He can be reached at Notwithstanding the government’s ambition to [email protected] grow fast and hence to “plan big.” the reality shows that it is marked by a history of missed targets. What seems evident is that the Ethiopia’s planning and budgetary system is in the initial stages of much-needed reform since it may not accommodate sustained growth by maximizing public spending. The annual budget cycle involves planning, budget formulation, approval and implementation and control. In recognition of the need to look at medium term perspectives (i.e. at least 3 years ahead), the budget process in Ethiopia starts with the construction of a medium term Macroeconomic and Fiscal Framework (MEFE). MEFF is a three year, rolling financial plan of the government to envisage the resource envelop in the coming three years and to broadly indicate the resource allocation among the major categories of expenditure, such as recurrent capital and block grants to regional states. Upon approval by the Council of Ministers, MEFF is to be used to trigger the preparation of the next year’s detailed annual budget, with the framework provided by the ceiling for each expenditure categories. Priority sectors, such as education, health, road and water, have their respective programs.

The preparation of MEFF involves projection of macroeconomic aggregates, such as the Gross Domestic Product (GDP) of the country, as well as monetary and Balance of Payment (BoP) to be used as a basis for domestic revenue (tax and non-tax revenues) and foreign resource projections. In addition, it also oversees the designing of the Public Investment Program (PIP) by line ministries. Another important ingredient of the MEFF is determining the level of fiscal deficit to decide on the level of domestic borrowing. The latter’s adverse effects on macroeconomic stability notwithstanding; it allows the government to finance its deficit. The planning stage, in principle, mainly encompasses economic and budget review of previous years, the setting of future policy directions, determination of available resources, setting program priorities and allocation of the corresponding resources. Hence, this stage is the most challenging step of the budgetary process. In other words, linking the annual budgetary process to medium-(MEFF) and long-term development objectives of the county (like the Growth and Transformation Plan) and developing feasible and credible budget is an important task that needs to be done by the government. However, significant improvements in MEFF formulation remain to be seen, particularly in the areas of mechanisms by which priorities can be set in the process of making broader resource allocation, weak coordination in the preparation and implementation of MEFF and in making budget process efficient and effective. One of my studies on the issue of planning and budgeting revealed the following challenges, which can be classified as macro and sectorial challenges: At macro level, annual budget formulation is dependent on the MEFF, which is based on a five-year

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plan of the government. The legislation and planning process show the centrality of MEFF in planning, policy making as well as implementation. This raises the question of the level of experts that prepare MEFF and hence the quality of MEFF, the gap between targets and actual, and whether the MEFF is measurably linked with the five-year plan. The bulk of this job rests on the Ministry of Finance and Economic Development (MOFED) with limited help from the National Bank of Ethiopia (NBE). In this regard the country has an

enormous shortage of skilled experts and tools such as macroeconomic models that could do the demanding technical work of sensibly designing MEFF and linking the MEFF with longer term plans, as well as across sectors or line ministries. Whatever the result, the implementation of the MEFF is besieged by unpredictability of donor financing, implementation limitation and lack of realism in its initial formulation. Consequently, the planning process in Ethiopia is pretty much topdown. Here the federal capital budget (investment), which is central in the growth process invariably is computed as residual directed to lower echelons, where accurate information is missing. In addition, there is no technically competent way of either setting up the budget ceiling for each spending units, making a comparison across sector when request for budget increment or cutting is made to align resources with spending needs. In short, there is no way of knowing technically expected impact of the spending units

in question. Problems also emanate from sectorial and ministerial programs that are not technically linked across sectors. Their formulation is not integrated in the planning process explicitly. On top of these, in the agricultural sector which is taken as important by the government, the most important programs (like the food security and public safety net) that constitutes nearly 90Pct of to P. 46


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the resources is focused on vulnerability (crisis management) with minimal growth and development. Last but not least, there is no strong, technically competent monitoring and evaluation system established by the government. The government pretty much relies on the reports of spending agencies, which may not always be the best metric. Given such flaws in the policy and planning process, it may not be difficult to see a significant gap between targets and actual performance as well as inefficiency of public spending in the country. In addition to these problems, the activities of ministries depend on the preparation of PIP, whose process is weak. Thus, the quality of the PIP preparation determines the planning and budgeting quality of the line ministries. Once a ministry has prepared its budget using PIP, revision

dictated by MoFED is minimal – showing the importance of what the ministry does for national and sectorial development. However, most ministries do this planning and budgeting, including primarily PIP preparation, with no skill base to speak of and without proper technical evaluation and prioritization, paying little heed to how its activity is linked with the rest of the economy and evolves over time. Thus, if PIP is bad so is the ministries’ plans and hence the national plan. After the decision to cut the budget of a particular ministry is made by MoFED, the ministry in question doesn’t have a technical way or formula to pick one project or program and leaving another based on technically measured impacts. Most projects within a ministry, except perhaps some donor related ones that constitute significant percent of projects are not technically analyzed and evaluated owing to lack of skill and capacity, and the sheer large number of projects. This underscores not only the importance of planning and budgeting at the level of the line ministries but also the need to integrate planning at line ministries with the rest of the economy with the aim of obtaining synergy and efficiency. These fundamental challenges in the efficiency of public spending at line ministries combined with macro or national level planning and policy formulation problems alluded before, substantiated the argument that there is spending without proper planning in the country and hence the disappointing performance. This and related problems in the rest of the economy has reflected itself in a big gap between targets and outcomes. It is imperative to conclude the first part of my article by asking what needs to be done to improve the situation. Policy actions that would aid the planning, policy making and budget process in the country will be presented in the next issue of EBR. g


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Commentary

Why is There a Big Gap Between Targets and Outcomes in Ethiopia? Part 2: Solutions

I


n the previous issue of EBR, I tried to examine the problems of economic policy-making, planning, and its implementation in Ethiopia. In the final part of this series, I will attempt to offer a direction for improving the planning and policy-making process in the country. The first step should be improving the process of formulating the medium-term Macroeconomic and Fiscal Framework (MEFF). Linking policy, planning and budgeting is essential in the creation of an efficient and effective budgetary system. Incidentally, the sole institution responsible for planning and budgeting is the Ministry of Finance and Economic Development (MoFED). However, merging the two institutions that used carry out the two tasks separately, the Ministry of Economic Development and Cooperation (MEDaC) and the Ministry of Finance (MoF), resulted in long-term policy issues being sidelined, which creates problems with future planning. The decision to merge the two institutions has effectively undermined the role of long-term planning and project appraisal and may have impacted the formulation of the MEFF. I hope the new planning commission will help in this process. In any case, government should give attention to the formulation and coordination of long-term planning and engage the relevant stakeholders in the formulation of MEFF and its linkage with five year plans such as the Growth and Transformation Plan (GTP) that is currently lacking. That would, in effect, allow the preparation of a feasible and credible budget on the basis of accurate forecasts of the available resources. Having a politically impartial national ‘Economic Council’ made up of high caliber professionals that advise the government in policy making is also an essential institution that is needed and currently missing in Ethiopia. It is also imperative that additional focus be devoted to aid coordination and harmonization in budget design, since the volatility of donor pledges has proved extremely difficult in determining the resource envelope and hence coming up with a realistic MEFF. In general, the introduction of full a Medium-Term Expenditure Framework (MTEF), which

bridges the gap of the current MEFF, along with appropriate analytical tools (such as planning and macro models), would enable the facilitation of prioritizing expenditures based upon their outcome and impact on the productivity of the economy. This would also enable an effective monitoring and evaluation of the implementation of projects and use the feedback for future decision making about budget allocations. This, however, cannot be done without high-quality experts, which requires providing a competitive incentive package at MoFED and core ministries. This needs immediate action. For instance, the Kenyan Treasury (the equivalent of MoFED) is currently engaged in training more than 200 economists at the MSc and PhD levels for a similar task, which is not the case at MoFED. Improving inter-sectorial linkages and establishing appropriate planning and budgeting at line ministries will also help remedy the situation. It is apparent from the current practice that inter-sectorial linkages are not evaluated and analyzed in allocation of resources at the macro level. Neither the line ministries, such as the Ministry of Agriculture and Rural Development (MoRAD), carry appropriate economic and social appraisal or prioritization of sectorial projects and programs using proper economic tools, such as project analysis and appraisal. There is no national entity responsible for national- and ministerial-level project analysis and evaluation either. This not only undermines the efficiency of resource use but also precludes seeing the direction to which sectors and the national economy trajectories are heading. The need to immediately address these problems cannot be overemphasized. The link between capital and recurrent expenditure as well as long-term (GTP) and medium-term plans (MEFF) should also be improved in order to advance the planning and policy making process in Ethiopia. Capital expenditure has a direct effect on future levels of recurrent expenditure. The current rise in capital budget in the country is worrisome in view of accumulating massive future recurrent costs. Thus, during the formulation of the capital budget, a careful analysis should be done to consider

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the sustainability of recurrent costs. Again, this cannot be done without a number of high-quality experts who are incentivized to work at MoFED and other core ministries. It is evident that wider participation in the budgetary process considerably improves the quality of decisions and ultimately provides checks and balances in the budgetary process. Budget preparation is not only the responsibility of the MoFED. Other spending organizations have an important part to play in the process as well. Concerted efforts at organizing stakeholders in the planning phases should entail alerting them to focus on government development objectives and the alignment of institutional interests to national priorities. Revenue administration is the duty of the Ethiopian Revenue and Customs Authority; they should be consulted in the construction of the overall resource envelope. In some countries the role of civil society organizations (CSO’s) in governance has grown. In Ethiopia, however, the involvement of CSOs in public finance management is limited. Engaging some of the CSOs in budget preparation would prove to be enormously useful. Participation needs also to be extended to research institutions and universities, without whose input the planning process will most likely be ineffective. Focusing on performance will be useful to narrow the gap between planning and achievements. Currently, the use of line item budgeting provides the advantage of listing expenditures according to their objectives. It helps in specifying how much money a particular spending agency or unit will be permitted to spend on personnel, benefits, travel, equipment and so forth. It has the advantage of putting ceilings on these items in the budget allocation process and ensures that agencies don’t spend in excess of their allocations. Yet, it’s not a foolproof method: it doesn’t give information about why money was spent or on the efficiency and effectiveness of projects. It is also associated with the short-term horizon and has no long-term cost implications. It doesn’t indicate the output and outcomes gained through the allocated budget. Hence, it is important to re-orient the incremental input based budgeting towards target-based budgeting. This approach will improve the budget performance as measured by output indicators, unit costs and measurable deliverables, or the quality of services for a given allocation of the budget process. It is imperative to introduce performance budgeting. The government of Ethiopia has been rolling out a pilot program of budgeting that is currently being used in selected federal ministries. However, one cautionary note is that imposing a new system should not exceed the capacity to absorb it. Bringing

the existing system up-to-date before introducing new systems is critical. Thus, to have successful implementation of the reform, the following measures are essential prerequisites. First, there should be firm commitment from the executive and legislative bodies. Second, there should be skilled manpower both at MoFED and spending institutions to carry out the implementation and initial planning. Finally, the use of unit cost in the budgeting process is essential. The government needs to improve problems in stretching resources, top-down planning, as well as delays in reporting in order to have an effective plan. From a resource and planning perspective, the current woreda level decentralization is costly, unmanageable, stretches limited public resources and needs improvement. Moreover, woreda level information shows the dominance of top-down planning, high expectations in outcome with inadequate inputs, and is dominated by recurrent expenditure which invariably is over 90%. The government’s discipline in executing budget and compliance with the existing legal framework are the major issues that are central in public sector financial management system. However, delays in producing accurate and timely financial reports are common problems in Ethiopia. Decentralization in administrative systems may have come at the cost of stretching capacity in terms of trained professionals in this regard, too. Thus, more should be done in terms of training personnel at the local level with the necessary skills to produce timely financial and audit reports, at least in the short term. The use of information and communications technology and e-government for planning and budgeting is an area worth exploring. Finally, the analysis of the planning and budgeting approach in Ethiopia shows the aforementioned problems associated with planning, budget formulation and execution. At the level of line ministries, in general, there seems to be no effective planning, budgeting and policy implementation framework that links each line ministry (sector) with other sectors. This challenge may be related to lack of skilled experts and high staff turnover owing to bad incentive structure as well as weak relationship between MoFED and line ministries (such as MoARD) on a technical level and between federal ministries and the regional bureaus, down to the woreda level. In addition, not enough attention is given to planning and programming sections at ministerial levels. Urgent action in all these areas are required to bring about meaningful change in the planning, budgeting and policy formulation process in the country. g


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Commentary

Capital in the 21st Century:

A Must-Read Book About Income Inequality in the World Today

T


his year, 147 years after Marx wrote his path-breaking book Capital, a French economist named Thomas Piketty wrote a sensational book with the same title. This book has sent a shockwave through the field known as neoclassical economics (or, using the Ethiopian government’s terminology, ‘neoliberal’ economics; or, in plain English, the economics that worships a free-market economy [in Amahirc, it’s known as “Ye netsa gebya economy”]). This branch of economics dominates modern economic discourse and offers justification for the neoliberal ideology, which says markets are nearly perfect and hence government need not intervene in the economy. This kind of economic thought is taught at many top-notch universities in the United States and Europe. The World Bank, International Monetary Fund and the World Trade Organisation, backed by these neoclassical and neoliberal economists and their governments, have pushed the policy prescription of such free market economics onto Africa. This is done through what is known as ‘Structural Adjustment Programs’ (SAPs) and, more recently, the ‘Poverty Reduction Programs and Papers’ (PRSPS). I put the latter in the same category as the former because in terms of macro policy, the prescription between SAPs and PRSPs are the same in that both subscribe to the idea of the liberalization of finance, trade, labour markets; privatization, devaluation, minimal government intervention; as well as conservative fiscal and monetary policies. The impact of these policies in Africa since the 1980s has

been disastrous. In fact, it’s been so problematic that the famous Western magazine The Economist declared one of those decades of Africa as “the lost decade,” before describing the ambitious, modernizing ‘Rising Africa’ that exists today. What is striking about neoliberal economics is that it doesn’t talk about distribution of income or inequality at all, thus endorsing the existing distribution of income as justifiable. Thus, many economists teach economics with the assumption that the economy is efficient when the labourer gets wages, and the entrepreneur profits. However, Thomas Piketty’s book, contrary to conventional wisdom, has squarely focused on the nature of inequality and the distribution of income between capital and wages in the last 300 years. It is important to note that progressive economists have always been concerned about the distribution of income. However, since neoclassical economists dominate research funding and publications, their calls have largely fallen on deaf ears. Ironically, when the West was hit by the global financial crisis in 2008, it was the policy prescription of progressive economists that was used to offer a remedy to and explanation of the crisis. Given Piketty’s important contribution to the field of modern economics, I’d like to offer a few highlights from the book that I think are noteworthy. The first important point that impressed me is that Piketty knows his audience and how to skillfully navigate through a profession that is dominated by neoliberal economists. First, he and his colleagues

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did meticulous research about the distribution of income (inequality) for the last 15 years. They then presented the basic findings in top-rated professional journals using sophisticated mathematical techniques so that the findings would be legible to the most discerning economists in the profession. After acceptance by many economists, Piketty was sure to write the same basic ideas in plain English in an attempt to help popularize the ideas for the general reading public. The second important point is the main message of the book: the world is characterized by a shocking level of inequality and in the last 300 years, the rich are getting richer and the poor are getting poorer. As you can see in the figure above, which is taken from Piketty’s book, the richest 10Pct of Americans control about 50Pct of the US national income as of 2010 (roughly the same as the 1930s). That share dropped to about 33% during the period of 1940 to 1980, when it was the lowest. We can clearly see that inequality has been rising sharply since 1980. Another point I’d like to raise relates to the role of “technological diffusion,” and the “expansion of quality education for all” to address the problem of inequality, which is discussed at length in the book. For this to happen, however, the role of

well-informed policy (ie. policy informed by rigorous research) through conscious government intervention to abate inequality is important. This is the opposite of the policy recommendations of neoclassical economists and their backers, who are largely against the role of state in development. However, we need to be cautious here; if the government is not well-informed, the government failure could be worse than market failure. Recent studies show that the urban poor in Ethiopia, who spend over 70% of its income on food, are unable to properly feed themselves because of rent, food and energy price hikes. This usually means those who are living in poverty in an urban context usually cope through cutting meals or the generosity of others. The implication is that growth by itself is not enough for poverty reduction. It could be anti-poor, especially when it is accompanied by inflation, as was the story in Ethiopia between 2004-2009, as household-level data shows. This needs to be addressed squarely because such inequality invariably leads to increased poverty among the masses, the escalation of crime, as well as political violence and instability with dire consequences for the economy and the country at large. g


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Commentary

‘Competitive’ Vs. ‘Comparative’ Advantage A Brief Lesson from Michael Porter’s (1990) book

Competitive advantage: creating and sustaining superior performance

R

ecently the leading role of the agricultural sector to growth in Ethiopia has been challenged by the service and manufacturing sectors. This is partly due to the government’s policy that focuses on the development of the industrial sector, as stipulated in the Growth and Transformation Plan (GTP).

In the last 10 years, the average growth of the agriculture sector was roughly 8Pct, while the industrial Alemayehu Geda (PhD) and service sectors grew at average annual growth is Professor of Economics rate of 14 and 13Pct, respectively. Thus, the contribuat Addis Ababa University. tion of the agricultural sector to the official growth He can be reached at of the country in the last ten years has been 50Pct, [email protected] leaving the rest to the service (36Pct) and industrial (14Pct) sectors. Yet the bulk of Ethiopia’s population, more than 80Pct, works in the agricultural sector. The disparity between the contribution of the agricultural sector to the gross domestic product (GDP) and the amount of people working in the field shows how low the productivity (output per person or per land) in agriculture is. Notwithstanding this growth and focus on the industrial sector, there is a marked absence of structural transformation in the economy because the industrial sector is just about 13Pct of the GDP, of which the manufacturing sector is about half of this figure. This has been the case for the last 40 years. The absence of structural transformation means the country is still primarily agrarian (46Pct of GDP), but recently the service sector (43Pct of GDP) has begun to contribute significantly to the country’s development. This shows that the government’s focus on industrialization or manufacturing is legitimate. However, the important question is what should be the nature of such focus. I think Michael Porter’s work on ‘competitive advantage of nations’ is crucial in this respect. Porter’s work has influenced the strategies of a diverse group of countries, such as Japan, Finland, Estonia, Portugal, Singapore, Costa Rica, Nicaragua, Mexico and Rwanda as well as the state of South Carolina and various councils and regions in the United States.

It is also interesting to note Porter’s idea in the context of the dominant neoliberal or neoclassical ‘comparative advantage’ theory that the media and many economists love to discuss. If one follows this theory, Ethiopia is good in coffee, hides and skins, among other products, which indicate that the country has comparative advantage in these items and should focus on that rather than manufacturing as the government is currently doing. Yet, one cannot bring about structural transformation by focusing on coffee and hides and skins. Michael Porter’s theory is thus important. Porter begins by asking: why do some nations succeed and others fail in international competition? How can we explain why Germany is the home base for world leading makers of printing presses and luxury cars? Why is the tiny country of Switzerland the home base many companies in pharmaceuticals, chocolate and trading? There are no convincing explanations of this from standard neoclassical comparative advantage theories. Today international goods are increasingly skill-intensive. Factor comparative advantage is an incomplete explanation of trade in particular in industries involving sophisticated technologies and highly skilled employees–precisely those factors most important for a national productivity and structural transformation and hence competitiveness in global market. However, there were also conflicting explanations for national competitiveness. Some see it as macroeconomic phenomena, yet nations enjoyed rapidly rising living standards despite budget deficits (Japan, Italy and Korea), appreciating currency (Germany and Switzerland) and high interest rates (Italy and Korea). Others argue that competitiveness is a function of cheap and abundant labour. Yet, nations such as Germany, Switzerland and Sweden have prospered despite high wages and long periods of labour shortages. The most successful trading nations such as Germany, Japan, Switzerland, Italy and Korea have

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Angola

Botswana

Egypt

Ethiopia

Mauritius

Rwanda

South Africa

Cost of starting a business (% of income per capita)

143.10

1.10

10.40

135.30

3.30

21.60

0.30

Paid-in min. capital (% of income per capita)

24.60

na

na

249.10

na

na

24.60

Total tax rate (% profit)

52.1

25.4

43.2

32.5

27.5

35.

na.

Cost to export (USD per container)

2050

2945

625

2180

660

3245

1620

Cost to import (USD per container)

2715

3445

755

2660

695

4990

1940

Source: World Bank, Doing Business Ranking Data, 2013.

been countries with limited resources. Other explanations such as government intervention and management practice are not robust enough to explain contrasting realities. Porter contends that regarding the source of national and firm competitiveness, we never asked the right question. The right question, according to him, is not to ask about ‘competitive nations’ as opposed to the right question of ‘national productivity’. Productivity is the source of prosperity (or higher living standards). It is related to the productivity of how resources are combined, the quality and features of products and how they are efficiently produced. The challenge is then to know how high levels of productivity could be attained continuously. Sustained productivity growth requires that an economy continuously upgrade itself (by raising product quality, improving product technology or boosting productive efficiency). Trade is essential to bolster productivity. Japan, which exports manufactured goods because it has high productivity and imports raw material and components involving less skilled labour and lower level of technology, illustrates a nation where the mix of trade can bolster productivity. If we take a recent Ethiopian example, the giant Chinese shoe maker, Hujian Group, that came to Ethiopia and setup its factory in Dukem, could have increased its profit by 22Pct because compared to China, labor is cheaper in Ethiopia by 22 Pct. However, it can’t attain this level of rise in its profit because working in Ethiopia has raised its logistic cost (port, customs, power, management time, etc) eight-fold. Thus, as a country we need to work on our competitiveness (productivity) not only for making our manufacturing policy successful and hence bring about structural transformation, but also to attract investment to the country.

Our competitiveness and hence productive record so far is not impressive because we have not focused our policies on improvement. Thus, seeking the explanation for competitiveness at the national level is to answer the wrong questions. What we must understand instead is the determination of productivity and the rate of productivity growth. To find answers, we must focus not on the economy as a whole but on specific industries and industry segments. Competing internationally may involve exports or locating some company activities abroad. To achieve competitive success, firms must possess a competitive advantage in the form of lower cost or differentiated (or unique) products that command premium prices. As the famous late Austrian economist Joseph Schumpeter recognized many decades ago, there is no ‘equilibrium’ in competition. Competition is a constantly changing landscape in which new products, new ways of marketing, new production processes and whole new market segments emerge. This means improvement and innovation in methods and technology are central elements of competitiveness and productivity where firms play a central role in the process of creating competitive advantage. If we meet this challenge, then our firms will engage in the global market through exporting to amplify their homebased advantages and offset home-based disadvantages through global strategy that tap selectively into advantages available in other nations that includes big markets, economies of scale, costly domestic policies, global network that add to and sustain home-base advantages, among others. As policymakers, the government needs to focus on that and measure its success by the level of competitive advantage (productivity) our firms have attained. g

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Commentary

Do not Throw Out the Baby with the Bathwater Michael Kalecki’s Advice on Financing Development

M

ichael Kalecki (1899-1970) was a rare economist of Polish origin who could be referred as the unknown prophet in economics. He actually developed his theories before or at the same time as the famous British economist J.M. Keynes’ ideas that revolutionized economics and economic policy from 1930s to 1970. Alemayehu Geda (PhD) These Keynesian policy ideas were viewed as is Professor of Economics outdated until the recent 2008/09 global economic at Addis Ababa University. crisis, when the United States government started He can be reached at to use exactly his policy recommendations (“the [email protected] Stimulus Package”) to help remedy the economic downturn. Among Kalecki’s corpus of economic work was his famous idea about “the problem of financing development,” especially for developing economies. Kalecki came from a relatively poor country (Poland), and, in the 1960s, his ideas were helpful in advising poor countries such as India, Cuba, Bolivia and Israel on financing development. Thus, his insight about developing countries’ problems is quite relevant for many countries in Africa, including Ethiopia, which seems to confront similar challenges today. One of the major points in Kalecki’s problems of development finance is the notion that in the course of development “there is no financial limit, in the formal sense, to the volume of investment [as they can be financed by credit creation or money printing]. The real problem is whether this financing of investment does or doesn’t create inflationary pressure.” This seems to be the case in Ethiopia, because today investment as a share of gross domestic product (GDP) is 40Pct, while gross domestic saving is about 10 to 22Pct (the range 10-22Pct is big, because since 2010, the official saving fig-

ure is problematic, as it doubles in just one year; moreover, saving in the banking sector today is just 10Pct of GDP). In any case, this reality establishes Kalecki’s first point: if your investment is more than double your saving, it is in line with Kalecki’s notion that investment financing is not a problem; rather, the inflationary pressure is. When a country fails to live by its means, debt accumulation and policy surrendering pressure could follow, like what happened to Greece recently. The second important point about problems of financing development for Kalecki is whether a certain level of investment will bring about inflationary pressure or not depends on the expansion of the supply of the consumer goods (especially food) in response to the demand. The implication for the current government here is twofold. First, in the second phase of the Growth and Transformation Plan (GTP II), the government doesn’t need to ‘throw out the baby with the bathwater’ by shifting its focus significantly from agriculture in general and food supply in particular. If this is not the case, all the industrial investment in the GTP II will lead to inflation and foreign exchange shortage and a fall in the value of the birr. In fact, the government may need to recognize analytically that the first phase of the GTP is Kaleckian, as its investment was accompanied by significant wheat, edible oil and sugar imports in the face of inflationary pressure and shortages. The second Kaleckian point to note is that it doesn’t matter for the Ethiopian mass – the poor – if the economy is growing by 10Pct if food prices are increasing by 15Pct, because their standard of living will decline by 5Pct, assuming very generously that the income of the poor increases by the growth of the economy, no distributional income

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problems exist, and population growth is not an issue. Finally, Kalecki emphasized the limitation of the view that the high rate of growth of food supply can be developed by mobilizing the supply of labour in rural areas to urban or industrial centres, thereby allowing more land and more output per household in rural areas following this migration of labour from rural to urban areas. Kalecki argues that the notion that migration from the countryside will leave behind an extra surplus of food that will find its way to urban markets is not correct. This is because a large proportion of this extra surplus will be used to increase the food consumption of the peasants. In addition, the standard of living of an industrial worker will frequently be higher than that of a poor peasant. Thus, the demand that could be generated by higher investment as envisaged in the GTP II and the high employment that will accompany it will only in part be met by the extra surplus to be created in the course of migration. It follows that the rise in investment may create strong pressure on the available supply of goods, while at the same making it possible to increase the production of industrial consumption goods in line with the demand. It may be shown that in some instance the rigidity of the supply of food (farm size, low productivity, low irrigation, and dependence on rain-fed agriculture, among others) may lead to underutilization of productive facilities both in food and in non-food consumption goods. In particular, if the resulting rise in food prices doesn’t accrue to the peasants and instead to big merchants and land owners, the

reduction in real wages due to the increase in food prices will not have as a counterpart increased demand for mass consumption goods on the part of the countryside, for increased profits are not spent at all or are spent on luxuries - bringing about stress on the limited foreign exchange supply of the country instead. So what should be done? One angle that Kalecki examined relates to how this could bring about challenges in foreign trade, balance of payment and aid as well as its implications for policy that we may address in a future issue of EBR. In relation to the issues above, Kalecki’s advice is “…the expansion of food production, paralleling industrial development, is of paramount importance in avoiding inflation pressure. Investment in industry, transportation, public utilities, even long-run development projects in agriculture itself should be accompanied by measures which will expand agricultural production in general and food production in particular in the short term.” Thus, Kalecki’s advice is important not only to avoid inflation and the misery of the poor but also to maintain Ethiopia’s attractiveness for foreign investment, which is partly related to low-wage workers. This can’t be sustained if food prices continually increase. These measures range from land reform and cheap bank credit for peasants to improvements in the methods of cultivation, smallscale agriculture, and cheap fertilizer. It should be noted that after the problem of the rigidity of the supply of food has been overcome, the problem of supply of industrial consumer goods usually becomes more acute –but this is, again, for another issue of EBR.


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Commentary

A Striking Similarity The 1997 Asian Financial Crisis vs. Ethiopia’s Current Foreign Exchange Problem


The 1997 financial crisis in Asia occurred after several decades of outstanding economic performance. Annual gross domestic product (GDP) growth in the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) averaged close to 8Pct over the decade before 1997. This is similar to the official growth rate registered by Ethiopia in the past decade. Then, in 1997, these economies witnessed a major financial crisis. In general, economic growth in the region suffered dramatic decline. Equity prices fell by 10 to 45Pct, while exchange rates declined by 12 to 68Pct. Exports suffered as well: the median annual growth of exports, which was about 23Pct before the crisis, had declined to 4Pct.

Secondly, it was the maintenance of prolonged fixed exchange rate regimes that encouraged external borrowing and led to excessive exposure to foreign exchange risk. Thirdly, Fisher and Krugman argued that the crisis was due to lax prudential rules and financial oversight, which led to a sharp deterioration in the quality of banks’ loan portfolios. As the crises unfolded, political uncertainties and doubts about the authorities’ commitment and ability to implement the necessary adjustments and reforms exacerbated pressures on currencies and stock markets. Reluctance to tighten monetary conditions and to close insolvent financial institutions also added to the turbulence in financial markets. A good number of these signs are apparent in Ethiopia today, as described in the table below. In contrast to this view, another Nobel laureate, American economist Joseph Stieglitz, who at the time was vice president and chief economist of the World Bank, noted that the aforementioned opinions went further than is justified by the fundamentals. In his view, no other economic system had delivered so much in such a short span of

The Origins of the Crisis The origins of the 1997 Asian financial crisis were a heated debate on a world scale. For instance the famous American economist Stanley Fisher and the Nobel laureate Paul Krugman argued that the key domestic factors that led to the crisis were the failure to dampen the overheating of the economies, which resulted in large external deficits as well as property and stock market bubbles. 2009/10 Gross Domestic Investment (% GDP)

2010/11

2011/12

2012/13

2013/14

27.0

32.1

37.1

35.8

40.3

9.3

17.2

19.2

19.2

22.5

-17.7

-14.9

-17.9

-16.6

-17.8

5,097

8220.2

8,758.2

16,736.2

27,395.3

Net External Borrowing (% of total financing)

81.0

94.9

74.6

100.7

74.8

Net Domestic Borrowing (% of total financing)

34.5

1.4

43.3

10.5

49.3

-29.2

-13.9

-49.4

-18.4

-32.1

Gross Domestic Saving (%GDP) Resource Balance (Saving less Investment) Total Financing of Public deficit (In millions of Birr)

Others and Residual(% of total financing) Source:

Alemayehu Geda (2015) Profile of Ethiopian Macro economy ( Department of Economics, AAU) Based on NBE Annual Report, 2012, 2013 and 2014

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2009/10

TOTAL Debt Disbursement China’s Share

2010/11

2011/12

2012/13

2013/14

USD

%

USD

%

USD

%

USD

%

USD

%

1,564.5

100.0

2,081.5

100.0

1,650.4

100.0

2,706.7

100.0

3,150.0

100

168.8

10.8

299.4

14.4

371.6

22.5

743.1

27.5

1,322.5

41.98

Total Public Debt (stock)

11,496.7

100

14,633.7

100

17,600.6

100

22,085.4

100

25,703.3

100.0

External Debt Stock

5,633.3

49.0

7,807.6

53.4

8,888.7

50.5

11,222.8

50.8

14,007.0

54.5

Domestic Debt Stock

5,863.4

51.00

6,826.1

46.7

8,712.0

49.5

10,862.7

49.2

11,696.2

Extern Debt/GDP Ratio

27.5

26.8

25.7

27.4

45.5 28.6

External Debt Disbursement by Creditor & Debt Stock (in Millions of USD)

Source: Alemayehu Geda (2015) Profile of Ethiopian Macroeconomy ( Department of Economics, AAU) Based on MOFED, 2013

and 2014 Public Debt Bulletin.

time. He further noted that financial and currency crises have occurred elsewhere in the world. Although the lack of transparency in the East Asian economies contributed to the problems, it is probably not responsible for the crisis itself. East Asian countries have high national saving rates The East Asian governments had all run budget surpluses or minimal budget deficits at the time. Also, macroeconomic policy has been relatively stable, as evidenced by their low inflation rates. Thus, he argued, the financial crisis in East Asia can be understood as the result of a number of factors that have made these economies especially vulnerable to a sudden withdrawal of confidence. The problems – including misallocation of investments, unhedged short-term borrowing and, in Korea, very high debt-to-equity ratios – were rooted in private-sector financial decisions. This is not to absolve governments of responsibility, Stieglitz argued. Insufficient financial regulation and implicit or explicit government guarantees, as well as misguided exchange-rate and monetary policies, each played an important role in creating the incentives that led to the particular size and character of external financing and internal misallocation of resources. Many of the problems these countries face today arise not because governments did too much, but because they did too little – and because they themselves had deviated from the policies that had proved so successful over preceding decades. In several countries, for instance, poorly managed financial liberalization lifted some restrictions, including restrictions on bank lending to real estate, before putting in place a sound regulatory framework. Here, I’d like to acknowledge a number of similarities be-

tween these Asian economies prior to 1997 and the condition in Ethiopia today. In addition, the following features of the Asian economies then are very similar to conditions in today’s Ethiopia – each of which was a major factors behind the crisis: Financial Sector Weakness The first is the credit boom, especially growth of both bank and non-bank credit to the private sector, which exceed the high level of real GDP growth. A good part of this credit is also concentrated in the speculative (property) sector. The pressure to maintain exchange rates (with high interest rates) led to falling property prices and hence non-performing bank loans. Moreover, loans were very lax and there was too much ‘connected lending’ (lending to bank directors, mangers and their related businesses). Government ownership of banks also was turning banks into quasi-fiscal agents by providing government (off-budget) assistance to ailing industries. On top of this, the quality of public disclosure and transparency was poor. In general, the lack of prudent regulation of the financial sector was one of the major problems. These are features quite apparent in Ethiopia today as indicated in the table above. External Sector Problems First, these countries suffered significant current account deficits. Second, the exchange rate in much of these economies led to appreciation of their (trade-weighted) exchange rate, which


A striking Similarity The 1997 Asian Financial Crisis vs. Ethiopia’s Foreign Exchange Problem

The 1997 financial crisis in Asia occurred after several decades of outstanding economic performance. Annual gross domestic product (GDP) growth in the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) averaged close to 8Pct over the decade before 1997. This is similar to the official growth rate registered by Ethiopia in the past decade.

Then, in 1997, these economies witnessed a major financial crisis. In general, economic growth in the region suffered dramatic decline. Equity prices fell by 10 to 45Pct while exchange rates declined by 12 to 68Pct. Exports suffered as well: the median annual growth of exports, which was about 23Pct before the crisis, had declined to 4Pct.

The Origins of the Crisis

The origins of the 1997 Asian financial crisis were a heated debate on a world scale. For instance the famous American economist Stanley Fisher and the Nobel laureate Paul Krugman argued that the key domestic factors that led to the crisis were the failure to dampen overheating of the economies, which resulted in large external deficits as well as property and stock market bubbles.

Secondly, it was the maintenance of prolonged fixed exchange rate regimes that encouraged external borrowing and led to excessive exposure to foreign exchange risk. Thirdly, Fisher and Krugman argued that the crisis was due to lax prudential rules and financial oversight, which led to a sharp deterioration in the quality of banks' loan portfolios.

As the crises unfolded, political uncertainties and doubts about the authorities' commitment and ability to implement the necessary adjustments and reforms exacerbated pressures on currencies and stock markets. Reluctance to tighten monetary conditions and to close insolvent financial institutions also added to the turbulence in financial markets. A good number of these signs are apparent in Ethiopia today as described in the table below. Gross Domestic Investment (% GDP) Gross Domestic Saving (%GDP) Resource Balance (Saving less Investment) Total Financing of Public deficit (In millions of Birr) Net External Borrowing (% of total financing) Net Domestic Borrowing (% of total financing) Others and Residual(% of total financing)

2009/10

2010/11

-17.7

-14.9

27.0 9.3

32.1 17.2

2011/12

37.1 19.2

-17.9

2012/13

35.8 19.2

-16.6

5,097

8220.2

8,758.2

16,736.2

34.5 -29.2

1.4 -13.9

43.3 -49.4

10.5 -18.4

81.0

94.9

74.6

100.7

2013/14

40.3 22.5

-17.8

27395.3 74.8 49.3

-32.1

Table 1a: Fiscal Development & Trade Deficit: Pattern of Public Revenue and Expenditure Source: Alemayehu Geda (2015) Profile of Ethiopian Macro economy (mimo, Department of Economics, AAU) Based on NBE Annual Report, 2012, 2013 and 2014

In contrast to this view, another Nobel laureate American economist Joseph Stieglitz, who at the time was vice president and chief economist of the World Bank, noted that the aforementioned opinions went

further than is justified by the fundamentals. In his view, no other economic system had delivered so much in such a short span of time. He further noted that financial and currency crises have occurred elsewhere in the world. Although the lack of transparency in the East Asian economies contributed to the problems, it is probably not responsible for the crisis itself. East Asian countries have high national saving rates The East Asian governments had all run budget surpluses or minimal budget deficits at the time. Also, macroeconomic policy has been relatively stable, as evidenced by their low inflation rates. Thus, he argued, the financial crisis in East Asia can be understood as the result of a number of factors that have made these economies especially vulnerable to a sudden withdrawal of confidence.

The problems – including misallocation of investments, unhedged short-term borrowing and, in Korea, very high debt-to-equity ratios – were rooted in private-sector financial decisions. This is not to absolve governments of responsibility, Stieglitz argued. Insufficient financial regulation and implicit or explicit government guarantees, as well as misguided exchange-rate and monetary policies, each played an important role in creating the incentives that led to the particular size and character of external financing and internal misallocation of resources. Many of the problems these countries face today arise not because governments did too much, but because they did too little – and because they themselves had deviated from the policies that had proved so successful over preceding decades. In several countries, for instance, poorly managed financial liberalization lifted some restrictions, including restrictions on bank lending to real estate, before putting in place a sound regulatory framework.

Here, I’d like to acknowledge a number of similarities between these Asian economies prior to 1997 and the condition in Ethiopia today. In addition, the following features of the Asian economies then are very similar to conditions in today’s Ethiopia – each of which was major factors behind the crisis:

Financial Sector Weakness

The first is the credit boom, especially growth of both bank and non-bank credit to the private sector, which exceed the high level of real GDP growth. A good part of this credit is also concentrated in the speculative (property) sector. The pressure to maintain exchange rates (with high interest rates) led to falling property prices and hence non-performing bank loans. Moreover, loans were very lax and there was too much ‘connected lending’ (lending to bank directors, mangers and their related businesses). Government ownership of banks also was turning banks into quasi-fiscal agents by providing government (off-budget) assistance to ailing industries. On top of this, the quality of public disclosure and transparency was poor. In general, the lack of prudent regulation of the financial sector was one of the major problems. These are features quite apparent in Ethiopia today as indicated in the table below. TOTAL Debt Disbursement China’s Share Total Public Debt (stock) External Debt Stock Domestic Debt Stock Extern Debt/GDP Ratio

USD 1,564.5

168.8 11,496.7 5,633.3 5,863.4

2009/10 % 100.0

10.8 100

49.0 51.00 27.5

2010/11

USD 2,081.5

% 100.0

7,807.6 6,826.1

53.4 46.7 26.8

299.4 14,633.7

14.4 100

2011/12

USD 1,650.4

371.6 17,600. 6 8,888.7 8,712.0

% 100.0

22.5 100 50.5 49.5 25.7

2012/13

USD 2,706.7

% 100.0

11,222.8 10,862.7

50.8 49.2 27.4

743.1 22,085.4

Table 1b: External Debt Disbursement by Creditor & Debt Stock (in Millions of USD)

27.5 100

2013/14

USD 3,150.0

1,322.5 25,703.3 14,007.0 11,696.2

Source: Alemayehu Geda (2015) Profile of Ethiopian Macroeconomy (mimo, Department of Economics, AAU)

% 100

41.98 100.0

54.5 45.5 28.6

Based on MOFED, 2013 and 2014 Public Debt Bulletin.

External Sector Problems

First, these countries suffered significant current account deficits. Second, the exchange rate in much of these economies led to appreciation of their (trade-weighted) exchange rate, which leads to low competitiveness. Third, 1996 was a year where many Asian countries experienced a significant decline in merchandise exports, which was attributed to slow down in world trade growth. As indicated in the table below for Ethiopia shows, this pattern is observable today and in much more serious way than East Asia in 1997. Particulars Trade Deficit (% GDP) Current Acct Deficit (% GDP) Export Cover (Export/Imports, %) Reserves (Months of Imports)

2009/10 -21.1 -10.5 24 2.4

2010/11 -19.0 -6.5 33 2.8

2011/12 -18.3 -10.6 38 1.9

2012/13 -17.6 -9.2 28 1.7

Table 2: Trade and CA, Export Coverage and Reserves Source: Alemayehu Geda (2015) Profile of Ethiopian Macroeconomy (mimo, Department of Economics, AAU) Based on NBE Annual Report, 2013 and 2014

2013/14 -19.1 -10.7 24 2.3

As can be read from Table 1 and in general, if a country invests more than its saves, the country can do one of two things: either run down its financial foreign assets (if there are enough) or borrow from the rest of the world.

In either case, the excess of investment over saving leads to a trade or current account deficit (-19.1Pct of GDP trade deficit; -10.7Pct of GDP current account deficit in Ethiopia; Table 2). If such current account deficits continue year after year, as has been the case in Ethiopia for the last decade, net foreign assets will fall to zero and the country will become indebted (Tables 1 and 2).

Since a country's ability to service its external debt in the future depends on its ability to generate foreign currency receipts, the size of its exports as a share of GDP is another important indicator of sustainability. For Ethiopia this is just about 5Pct (just compare this to 60Pct for South Korea’s more than USD500 billion in exports per year).

Most episodes of unsustainable current account imbalances that have led to a crisis have occurred when the account deficit was large relative to GDP, as is the case in Ethiopia today. Lawrence Summers, the U.S. deputy Treasury secretary, wrote in The Economist that “close attention should be paid to any currentaccount deficit in excess of 5Pct of GDP, particularly if it is financed in a way that could lead to rapid reversals.” Thus, Ethiopia’s deficit level of 10.7Pct is twice the amount of the warning zone suggested by Summers.

In sum, there is a striking similarity between the 1997 Asian crisis and the condition in Ethiopia today. This is because there is a booming construction sector invariably financed by bank and connected lending and there is an alarming level of trade balance deficit, shortage of foreign exchange and a rising level of debt as shown in the tables above. Additionally, planned projects both in the finalization of the Growth and Transformation Plan (GTP) and its second phase, the GTP II, are foreign exchange intensive despite a rudimentary export sector; there is a significant gap between saving and investment and a rising external debt too.

There seems also a missing foreign exchange planning in designing these plans. This is complicated by structural problems of food supply. The only fundamental differences are first the Ethiopian capital account is closed: which means one can’t take dollar freely out and in to the country and the major external finance in Ethiopia is coming from China and not from diversified sources as in East Asia.

To finalize, when Stieglitz concluded his observation about the 1997 Asian crisis he concluded, and with the benefits of hindsight he is proved right – that some of the most important features of East Asia's development were sound macroeconomic fundamentals: high savings, a commitment to education, technologically advanced factories, a relatively egalitarian distribution of income, and an aggressive pursuit of foreign exports. “All of these elements, he said, were still present, suggesting that East Asia's economic prospects continue to be bright. And these elements of the East Asian success continue to provide a model for successful development throughout the world”. We have to ask here whether Ethiopian growth so far has been based on such fundamentals. If not, even reviving back is impossible. What is the solution for Ethiopia? This is a million dollar question and, hopefully, learning the lessons of the 1997 Asian fiscal crisis is part of the solution.

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What if Ethiopia is Taxing Too Much and Still Losing Revenue? The story of the Laffer curve and three points about Ethiopia’s tax revenue


In economics, the Laffer curve is one possible representation of the relationship between rates of taxation and the resulting levels of government revenue. It postulates that no tax revenue will be raised at the extreme tax rates of 0Pct and 100Pct and that there must be at least one rate that maximises government taxation revenue. The curve is typically represented as a graph (see the figure on the following page), which starts at 0Pct tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100Pct tax rate. The Laffer curve earned its name from a 1978 article by the late Jude Wanniski (then-associate editor of the Wall Street Journal). Wanniski recounted a 1974 dinner he attended with Arthur Laffer (a professor at the University of Chicago, pictured below), Donald Rumsfeld (then Chief of Staff to President Gerald Ford), and Dick Cheney (Rumsfeld’s deputy and a former classmate of Laffer’s). When their dinner discussion turned to President Ford’s “WIN” (Whip Inflation Now) proposal for tax increases, Laffer is said to have grabbed his napkin to sketch the curve as an illustration of the trade-off between tax rates and tax revenues. Wanniski dubbed the trade-off as the ‘Laffer curve’. Although it bears his name, the ideas behind the curve were not new nor his alone; Laffer himself noted, for example, the philosopher Ibn Khal-

dun alluded to the concept in his 14th century work, The Muqaddimah: “It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields small revenue from large assessments.” In the September 2015 issue of EBR (No. 33), the editorial noted the serious problems related to tax avoidance in Ethiopia that are being carried out in front of tax officials, whereas registered companies and individuals are mercilessly treated. This may well relate to the aforementioned Laffer issue. Here, I’d like to note three more points related to taxing in Ethiopia. First, over the course of five years (2009/10 -2013/14), public revenue doubled and that of expenditures nearly tripled. While the substantial increase in revenue is mainly attributed to the

increase in direct and indirect taxes, the threefold increase in expenditures is mainly related to the high growth in public investment and related spending. Due to this significant increase in total expenditure over revenues, the overall balance of the fiscal account has been persistently negative and gives the impression that taxes are low.

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F cus

.....................................................................................................................................................................................................................................................................................................................................

Tax Revenue

.................................................................

.................................................................

0

35%

70%

..........................................................................................................................................................

Tax Rate

Yet this is misleading. As the former US President Bill Clinton said in his 1992 campaign, “it’s the economy stupid!” – Ethiopian leaders may say “it is the expenditure!” that is causing this imbalance in the country’s fiscal accounting. Second, when the government plans to collect more taxes it usually cites the performance of other African countries. It says, for instance, that Ethiopian tax revenue as percentage of GDP (National Income) is about 13Pct while the African average is about 18Pct, so Ethiopia has to do a lot more to match its African peers. However, it is known that taxes are generally accurately recorded while GDP is not. A simple illustration of this is the IMF’s forecast for Ethiopia’s economic growth, which is about 7 to 8Pct, which differs from the government’s figure of about 11Pct. If the IMF is right, the GDP, which is the denominator in the tax-to-GDP ratio, will be lower; hence, the share of Ethiopian tax revenue in GDP could be even larger than the African average of 18Pct, perhaps even more than 20Pct. So Ethiopia may already be taxing too much and need to consider the Laffer curve. Finally, the tax revenue has increased from 65 to 84.5Pct of total revenue in the last five years. This improvement in domestic resource mobilisation has helped the government to finance about 80Pct of its public spending domestically (with taxes alone financing about 70Pct). This is an excellent achievement. However, this tax revenue growth is primarily driven by the growth in indirect taxes, which require relatively less effort to collect. Moreover, the fact that the growth of ordinary revenue has been erratic - having grown by nearly 50Pct in 2009/10 but dropping to 22Pct in 2013/14 - suggests that the domestic resource mobilisation endeavours might not be established on a firm and informed basis.

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Lessons from the Industrialisation- and Export-Friendly Policies of East Asian Countries

A


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frica’s drive for fast growth has garnered a great deal of attention over the last decade. This means taking lessons from the economic policy-making process of fast-growing East Asian countries like Taiwan and South Korea is important. Both nations confronted similar problems in their drive for fast growth and poverty reduction, without which the registered success in those countries would have been unthinkable. One distinguishing feature of the process in Taiwan and Korea was the tradition of research, planning, implementation and monitoring of proposed policies based on an in-depth study and accurate information by the best and the brightest brains in each of these countries. I would say this is missing in Ethiopia and in many countries in Africa. The Council for Economic Planning and Development (CEPD) of Taiwan is a case in point. It had over three hundred professional and non-professional staff. Of these, 250 had university qualifications, of which engineers comprised up to 20Pct; economists about 40Pct; and the rest were accountants, finance experts and statisticians. These professionals were divided into various departments: overall planning, sector planning, economic research, urban development, performance evaluation, financial administration, manpower planning, personnel and financial administration. The economic research department had 50 professionals, each of which monitored one sector in addition to other duties. As an advisory body of the cabinet, the CEPD operated outside the ordinary machinery of the government, which allowed it to pay higher than normal civil service salary to its staff and recruit high-quality talent by offering better benefit packages. There was also an explicit political economy dimension to the success story of both Taiwan and Korea. The private firms in Korea were led by people who had close ties to the government and over time came to be major financiers of the governing party and its president. This was not

the case in Taiwan, however. Rather, the government, which was comprised mostly of mainland Chinese, expanded its economic power through the formation and expansion of state enterprises. In both countries, the role of the state in the industrial economy and promotion of exports was significant; this included protecting the domestic market. One factor apparent in Taiwan is that the leading sectors after the 1960s were also major exporters, and most of them were privately owned. Government policy played a critical role in helping attain the boom in export manufacturing. In the 1980s, the emphasis in industrial policy shifted to technology intensive industries, and the issue became how to upgrade Taiwan’s industries so that they remain internationally competitive. Scientific research also pivoted from basic academic research to practical scenarios, which included the establishment of Taiwan’s science-based industrial park, the reversal of the brain drain through introducing appropriate incentive schemes, and a science and technology research plan, including the required budget that the government demanded from each relevant ministry. Korea had similar programmes as well. In sum, as noted by the famous economist of the region, Alice Amsden, the developmental state in these countries was crucial for their industrialisation and export expansion. The state set four functions for itself. These were development banking, local content management, selective seclusion (opening some markets for foreign transactions and closing others), and national firms formation (such as Samsung, which was working then as a simple trading business of 40 employees dealing with local groceries and made noodles and pasta). Two principles guided this effort, as noted by Amsden: To make manufacturing profitable enough to attract private entrepreneurs and to induce enterprise to be result-oriented and to redistribute their monopoly profits to the population at large. It is instructive to look at the gap between the best practices of the East Asian experience and

the condition in Africa. Specifically, we need to look variations in initial conditions, the institutional and political difference between the two, as well as the global environment such as the Cold War, which shaped the foreign relations of Taiwan and Korea and its impact on their success. Notwithstanding such differences, we can draw the following lessons that may help the design and implementation of appropriate development policy in Africa. The major lesson is the importance of participatory development both in making policies and their implementation. This method of development requires effective government leadership, as was the case in the aforementioned countries, where the heads of state enacted sound, well-researched economic policies. These, in turn, were implemented by capable technocrats with the best capacity available. More specifically, macroeconomic policies and industrial strategies cannot be developed in isolation and need to be set in the political economy context of a country’s development strategy and the role of different economic agents (such as the state and the private sector) in that process. With the exception of a few countries, such as Egypt, Tunisia, Morocco, South Africa, and Mauritius, African nations are largely uninformed about how to formulate industrial development plans. In fact, many countries are dependent on primary commodity export, which has become a booming sector in the last decade owing to a surge in demand for such commodities from emerging economies such as China, India, Brazil, Russia and others.

Thus, the task of industrialisation in Africa is complicated by the need to shift from the booming commodity export economy to manufacturing diversification. First, the appropriate management of the resource from the booming sector and a strategic direction of diversification are in order. This requires good institutions and genuinely skilled personnel that will avoid rent seeking and can manage to adopt good policies that will promote rapid accumulation, investment and the efficient exploitation of resources. Second, it seems that agricultural development was a pre-requisite for industrialisation in Asia. The government needs a labour market policy compatible with the stipulated growth, both in the agricultural process as well as for industrialisation and exporting. It also needs to keep the price of food and housing provision at a subsidised price to keep labour costs for the private sector low and make them competitive. This also ensures political stability, as was the case in Korea. Third, the role of government in ensuring success may need to go beyond policy making. The government may need to alter the incentive structure for public and private firms in the operation of the free market so as to ensure the success of exporting and industrialisation. This is particularly important in the design and implementation of a growth strategy that may include the development of export processing zones as well as industrial zones. Government intervention is also required to make firms forward-looking in the diversification of exports, in building productive capacity though enhancing competitiveness

and attraction of foreign investment. The incentive schemes need to be result-oriented and with the principle of graduation from an initial support system as firms develop over time. Fourth, partnerships with foreign firms and countries were central for successful industrialisation and export development strategy in Asia. This will help not only to get access to the markets of the developed countries but also serve as a tool in facilitating technology transfers for countries in Africa that have a brief industrial history and limited technological capability. Fifth, the experience in Asia shows that Taiwan took up export-promotion of labour intensive manufacturing products, just as Korea did, but both differed in their approach. Taiwan took the dominant role of its small firms into account in the design of its policy, thus focusing on small and many firms and the private sector, which was not the case in Korea. Thus, export and industrialisation development policies need to depend on the structural and institutional context of the country Finally, the institutions of private property, good policy and the competence of the government in economic governance were central to the growth and development process of countries in East Asia. This is generally missing in Africa and needs to be adopted. This requires capacity building in the public and private sectors. To make this possible, the Ethiopian government should be staffed and advised by the best and the brightest minds in the country, its skilled citizens living abroad, and progressive development partners. 52