Saturday, September 30, 2023
InterviewUnpacking the Ethiopian Economy Dilemma

Unpacking the Ethiopian Economy Dilemma

Mussie Delelegn (Ph.D.) is the Acting Head, Productive Capacities and Sustainable Development Branch, Division for Africa, LDCS and Special Programmes at United Nations Conference on Trade and Development (UNCTAD), where he has worked for nearly 25 years. He has also led the conceptualization, development, and implementation of numerous country-specific and regional UNCTAD initiatives over the years.

Mussie, an economist by education, has recently published a book on the Africa-China partnership. The Reporter’s Samson Berhane of sat down with Mussie during his recent trip to Addis. They talked about economic policies and how they are implemented in Ethiopia, how the country can get out of its current economic predicament, and what lessons can be learned, among other subjects.

The views and opinions expressed in this interview are his own and do not represent the views of UNCTAD or the United Nations.

Excerpts:  

The Reporter: You have written a book recently; can you tell us a little bit about the book?

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Mussie Deleleng: The book, titled “Africa-China Partnership: A Holistic Analysis,” looks at the relationship between China and Africa from a trade, investment, and development finance perspective. Not only does it look at the China-Africa relationship, but it also compares the African partnership with that of the United States, the European Union, and also Japan. It draws operational lessons for Africa on how to adjust the policy preoccupation and policy direction, how to tap the opportunities that China brings in, and how to build the relationship that Africa had with traditional development partners.

The book has about nine chapters. The first two chapters focus more on Africa’s issues, such as its difficulties with development, errors in policy prescription, how it came to believe that liberalization was the only path to progress, and how external forces have occasionally imposed its policies. The first two chapters also revisit whether the growing relationship between China and Africa is quantitatively and qualitatively different from the existing relationship of the continent with the US, Europe, and also with Japan.

The next two chapters deal with trade diversion, while the last two chapters focus on the Southeast Asian experience. The importance of looking into the Asian experiences is to learn what countries, such as Vietnam, did. They made a lot of transformations and a lot of developmental gains. What did they do differently that Africa couldn’t do? Where did they succeed? And what exactly went wrong in Africa? Is it policy choices, policy sequencing, or implementation?

So, this is something that I looked into, and these are the chapters that I take to heart. I really wanted anyone—the younger generation or any African policymakers—to look into these kinds of things. Asia, like Africa, has gone through colonial history. Vietnam was a French colony; they fought a brutal war of independence. There was the war between northern Vietnam and southern Vietnam, divided along ideological lines into the socialist north and the communist north, and also the more ‘capitalist south’. But more importantly, like most African countries, Vietnam also went through such adjustment programs. But why did Vietnam progress while most African countries have not seen any developmental gains from the policy prescription that Africa itself has been implementing? What is the distinguishing factor between policy formulation and implementation? Also, in terms of political description in Africa and Asia, how did they come around and overcome all the kinds of challenges that they have been facing? What can Africa learn from Vietnam? These are the key chapters.

The last chapter, chapter nine, is congested with about 320 pages. It is a dense book with close to 60 demonstration figures and data, which build an evidence-based analysis. The book is actually based on real, current data to look into whether there is a qualitative transformation in Africa and whether there is any change in the direction of Africa’s development paths as the result of the emerging China.

There are several lessons that can be drawn from the Asian experience. One issue is policy choice. The policy choice matters because most Asian countries designed policies based on their comparative advantages and based on five or six key binding constraints. The second issue is the sequencing of policies. So, the problem in Africa is that it was forced to implement everything at once: economic reform, institutional reform, democratization, and privatization. In Asia, there is a deliberate effort to sequence policies. That is strategically important and the kind of message most important for Ethiopia and other African countries.

Another issue that came out clearly from the study that I did on Vietnam and other East Asian economies is pragmatism. They design policies on the basis of pragmatism and will not spend efforts and resources on policies they cannot implement. They know what they are going to achieve in the next 5–10 years in advance of actually crafting a policy. The study looks into the productive capacities of countries, whether they are productive resources, entrepreneurial capabilities, or production linkages.

The three pillars together determine the country’s ability to produce and develop. What Asia did, even before building partnerships, was enhance their productive capacities. No nation has ever developed without fostering productive capacities and without kick-starting structured information in their economic fundamentals. This is what Africa should learn. It’s not simply about partnership; you have to know what to produce, where to produce and sell it, or where to add value. These are the kinds of issues that make Asia distinctly different from most African countries.

 

 

 

 

 

 

 

For the past two decades, especially before the new administration took power, the focus of the Ethiopian Peoples’ Revolutionary Democratic Front (EPRDF) government in particular was on emulating the success of a developmental state. From what the policymakers were saying, it appears it didn’t work. However, scholars like Francis Fukuyama and a lot of other people say that the type of developmental state model Ethiopia implemented was quite different. Can you tell us what Ethiopia exactly missed while implementing the developmental state model?

There are two things to look into first. I think that in every country, copying policies will not help in any way because each country has its own specific circumstances, mindset, culture, environmental circumstances, political setup, and resources involved. You cannot copy any model from Asian countries or from any successful country and bring it directly to Africa. But what you can do is learn from the experience. So, the focus should have been on learning about what they did to achieve certain development goals instead of emulating or copying the Asian Tigers.

The second issue to look into is the policy aspiration and the vision, which are both very important. But you must also be realistic. That is when the pragmatism comes in. So, instead of simply saying that Ethiopia is going to be like Singapore or South Korea, you have to be proudly pragmatic in terms of setting the vision and what your resource constraints are, among others.

The other dimension is implementation. You can have good policies, but if you don’t implement them, you cannot achieve the results that you want. This is the problem in all African countries. The quality of policies, their content, and their definition have changed a lot, but their implementation is still significantly lagging behind.

This is one aspect that countries such as Ethiopia and most African countries should address first. How are they going to back up their policies with adequate resources, human capital, and implementation based on results? You can have a policy, but what is it that the policy is yielding? Not just at the end of the five-year cycle or the 10-year cycle, but every year.

These are the kinds of things that, by doing so, you can immediately identify policy gaps and limitations and determine whether the policy that you put in place is going in the right direction or the wrong one. Experimenting lets you find out early on where you’re doing well, where you’re having trouble, and where you need to make changes to the course. So, instead of simply waiting until the end of a five-year or a 10-year cycle to evaluate and see the results, it is broken into months and weeks.

For example, the two previous cycles of policy formulation in Ethiopia during the EPRDF regime focused on agriculture-led industrialization. So, in terms of conceptualization, nothing is wrong because Ethiopia is an agrarian economy and 80 percent of our population still works in the agriculture sector. However, the implementation is not there. We didn’t improve the irrigation system, invest in rural infrastructure, enhance the productivity of the agriculture sector, or change the farming method.

One point I would like to add is that in terms of policy discrepancies and policy gaps, sometimes you have good policies with good intentions. Look at the Ethiopian economy, and also if you go to Kenya, Rwanda, or any other country in Africa, they will tell you the same story on how the country will become a middle-income country by 2030 or 2035 and will become an industrial zone, an industrial hub, or the manufacturing hub in Africa. They also say that the economy is going to be private sector-led.

But when you look at the reality and the policy implementation, what you find is that the domestic private sector is very weak and access to finance is problematic. These are the kinds of contradictions that we have. The share of private sector lending in Ethiopia and sub-Saharan Africa is about 30 percent of the GDP. In Asia, it is on average 170 percent. In Latin America, it is 88–90 percent. So, there is no way for the private sector to make headway and make the economy vibrant, dynamic, and competitive. These are the kinds of irreconcilable contradictions within the policies in Africa. Thus, implementation is key.

Keeping implementation issues in mind, don’t you think that the civil service requires some kind of reform because implementation is handled largely by the government? Seeing the experiences of Vietnam and China, an efficient civil force helped them a lot in achieving a real economic growth reflected on the lives of their people. But it is quite different when it comes to Africa and Ethiopia.

When I talked about productive capacities, I just talked about the three pillars: production factors, entrepreneurial capabilities, and production linkages. Based on these narratives, the three pillars will not function without additional drivers. Additional enablers, if you wish, are information and communication technologies, which are now changing the course of policy implementation for this drive and development in many other countries. So, we have to factor in how to harness the potential of the ICT sector.

The other issue that we have to look into is the institutions. The institution not only provides civil services but the entire institutional framework of any country, and the capacities to formulate and implement policies come from the institution, which includes human capacity. Human capital is strategically important for any nation, but its quality matters more. Without human capital, energy, electricity, the private sector, infrastructure, and the like, there is no way for any country to be productive.

It’s not only one sector of civil society that needs reform or brings change to the overall government. What is key for Africa is to see development in a circular and holistic way. You cannot harness the potential of ICT if you don’t have trained human capital. You will need electricity to harness its potential. Without electricity, you cannot build industrialization. You need efficient, trained logistic and transport systems; without these, you cannot compete internationally, because your economy becomes less attractive to investors if your cost of trade is huge vis-à-vis your competitors globally; everything is connected.

So, it is not a single fragmented policy approach that helps African countries. Another lesson coming from the Asian experience is seeing development from a holistic perspective. In many countries, we have seen highly modern, huge investments that went into the infrastructure sector, but if you don’t do similar investments in the production sector, what are we going to transport?

This is not only about single-sector reform; reform is good most of the time, and we see it as the only way out to solve problems, but we have to look at what it is going to generate. What is the connection between the pillars of growth, the drivers of growth, and the economy? Without linkages, there is no way any country can move forward in terms of addressing most of the social and economic problems.

As you said, linkage, especially between the industry and the agriculture sector, is critical. Over the past decade, Ethiopia has been trying to increase the contribution of the manufacturing sector to the economy, but it hasn’t shown much growth and is still probably less than seven percent. Keeping that in mind, the government also says they are trying to work on the backward linkage. Yet if you see all of the factories that we have here, they are dependent on imported goods, so what are we missing here?

When we talk about investment, we have to see the proportion of private and domestic investment and the relationship between foreign direct investment and the public investment that the government makes. When are we going to amortize the cost or the outlay that the government puts into these facilities?

These are some of the critical questions that have to be asked now. I think over 170 countries have put in place those industrial parks, including many African countries; sometimes they call them Export Processing Zones or special economic zones or industrial parks, but the objectives are more or less the same, which is to promote manufacturing and add value, export, and become competitive.

Most African countries have also gone through it since the 1980s. It is not a new thing in the policy discourse. But very few countries succeeded in Africa: Morocco, Tunisia to some extent, Mauritius, and South Africa. The goal of changing the economy in the rest of the countries hasn’t been reached yet. Adding values, becoming more competitive, increasing the manufacturing value added, increasing the manufacturing component and share of exports, creating employment—these all have been missed or lost objectives in many countries. Only Asian countries made headway again in terms of benefiting from the structures.

The first problem is with the design, not the physical design. The goal is not just to create jobs and make money, but also to add value to the economy. Instead of starting by simply producing, you have to improve what inputs are required, what market regulations are necessary, and what institutional facilities will be needed. Of course, the industrial zones are important because they create jobs for low-skilled people, but these are short-term gains. We have to focus on the long-term gains from those export processing zones. Doing that requires enhancing the role of the domestic private sector in their presence and then also taking advantage of those industrial parks.

Most African countries do not have a business plan as to when they will recoup the cost of the investment that the government has made in infrastructure. In Asia, it’s not like that. You give them a timeline to produce linkages, add value to the economy, and create decent jobs and employment. There is an inbuilt structure for when to recover the cost of production through taxation and tax on profits.

These are the kinds of plans that we need to have. I have not seen any business model in any of the African countries that is prepared to weather the effects of investment leaving the export processing zones or parks. These are the key issues that we have to look into to make those facilities valuable, important, and of added value to the economy. Most of the time, we have a tendency in Africa to provide more incentives to foreign firms at the expense of domestic firms. We need to rebalance those kinds of things. At the end of the day, what remains in the economy is the domestic private sector.

You were saying that pragmatism is the right way to develop policies. In the last four years, scholars have been pushing the government to publicize what kind of economic model it really follows. When asked, they say that we are pragmatists and that they follow whatever is convenient or good for Ethiopia. Is ideological lineage important to set goals and have a common understanding across civil forces with everyone on board?

When we say pragmatism, I think it is closer to realism. You can achieve what you can implement. Pragmatism is making policies to address specific country problems. It’s what we call binding constraints to development. It means to analyze and assess what comparative advantages we have for the economy. This is not only in agriculture but also in other services like manufacturing, transport, and everything else.

Once you identify your comparative advantage from a strategic point of view, it could be a revealed comparative advantage or an implicit or hidden comparative advantage. Going back to Vietnam, they were not producing a single bean of coffee, and the small production was really destined for local consumption. This is before 1986, when they started a reform program. By understanding those latent comparative advantages that they have, they harnessed coffee plantations. Today, Vietnam is the second-largest exporter of coffee after Brazil.

You have to know the key comparative advantages you have in the economy. Then you have to understand what the five most binding constraints are that prevent any country from taking advantage of the comparative advantage you have. Then you will need to focus on policy intervention, addressing those areas and the binding constraints.

In the case of Ethiopia, there is no doubt that peace and stability are the most important qualities. Without peace and stability, no country can take advantage and force the kind of unified development and political narrative that lets it take advantage. We need to know how to harness those potentials, and we need to address those gaps in this political challenge. Otherwise, it will all be planning without finally seeing any result.

Pragmatism for us is to address some of those political disagreements and some political narratives that are not developmentally aligned with a lot of these issues. It is important to understand the value of peace and stability under unified development.

A unified political narrative is critical for development. Maybe conceptually, can you elaborate on that?

Countries that have made a lot of progress are those that have a unified political and economic agenda—not those that are divided along ethnic lines or linguistic polarization or religious kinds of conflicts. We have not seen a breakthrough in terms of economic level. We may be different; we may be diverse, but diversity is not a liability; diversity in the rest of the world is an asset. When diversity becomes a liability, you need to correct your political narratives. These are the kinds of visions we need.

The moment you believe in identity politics, you restrict the movement of knowledge, capital, people, goods, and services, and you create barriers. The world is becoming one in terms of globalization. You must have a unified political identity, agenda, and development narrative to be part of this integrated global picture.

In most countries as diverse as Ethiopia and the rest of Africa, religion is key in terms of fostering social cohesion and putting ethics and norms into the governance structure and work ethic. This is how Asian countries have been taking advantage, but when it goes against these values, that’s the problem. I’m not saying that you should give up your own identities, but having a vision means saying, “This is my country; I want it to grow, so what is my part, no matter what my religious, political, or ideological beliefs are?”

Talking about policy prescription, in the past four years, we have seen that somehow the government is liberalizing everything, including the telecom sector. Even recently, there was an announcement that the retail sector was going to be liberalized. Should we liberalize or not?

We have to really see the history of liberalization in Africa; that’s very important. That is going to be a good starting point. A long time ago, there was an airline called Air Afrique, and they wanted to liberalize the air transport sector, so they contracted international subcontractors to look into the structure of the liberalization and how to do it. Today, Air Africa doesn’t exist. Those who came in to restructure Air Africa took advantage, and they currently have a monopoly throughout West Africa. But the point is, is it a prescription from abroad? We must differentiate this.

We are not opposed to liberalization. We do not believe the government is the exclusive provider of all services. We also do not believe that privatizing sectors is a treatment. In Nigeria, they recently liberalized the energy industry—I believe about five or six years ago. Citizens are now attempting to reintroduce the government into the generation and distribution of power in Nigeria.

Profit generation is the motive for privatization and private sector involvement. There is nothing wrong with that; they need to make a profit on their investment and see some returns, and that’s a good principle. However, when private profit drives your interest, there is no way to balance the social outcome of liberalization or the overall economic outcome of liberalization with the policy measures that are put in place. It is critical to follow the principles of cost and benefit assessment of any policy action or any policy goal, and we must be aware of the repercussions, not just the positive outcomes.

We do not believe that one size fits all. We do not believe that privatization is the only option to revitalize a country’s economy. However, liberalization is beneficial when done correctly. When you know the results of the first phase of the liberalization effort, you know the cost of benefits and the benefit outlays, so it is a stage-by-stage process in the liberalization. Liberalization means removing or minimizing the role of the state or removing restrictions, whether it’s on the private sector, within the delivery of services, or within the production of goods and services. It is also removing subsidies.

The Asian countries embraced it but modified it for their specific circumstances. Instead of privatizing state-owned enterprises, they made them competitive. There is no way that if the private sector is competitive, your state-owned enterprises must also be competitive. If there is no competitiveness, it is not only in the private sector. It is also about removing administrative burdens and making those companies agile and responsive to their own actions.

The issue is that you have to know what your goals are, how you will sequence them, how you will derive benefits, and how you will minimize your costs and maximize your benefits. So, no one is against liberalization, which can have a lot of economic benefits for any nation if it is properly and effectively implemented.

The implementation that we talked about at the policy level also applies to the liberalization that you are putting in place. We also have to consider what we want to achieve. Is it simply to abandon the role of the state in any economic activity, or is it simply to remove subsidies? There is no automatic gain from liberalizing every sector in one group. Within the sector, you can have different phases. In distribution, you can identify sectors, which requires understanding where the government is inefficient. When the government is not able to provide, you have to identify those sectors. You have to know your strengths and weaknesses.

In the case of Ethiopia, the government has already said that it wants to open up the financial sector. The central bank has already set up a legal framework so that foreign companies can start working in the banking industry in less than a year. Keeping that in mind, what changes should we expect from the finance sector’s liberalization?

Because it is a way for the economy to move, the financial sector is the most important part of the economy. Much like lubricant in an engine that allows it to run, anything that happens in the financial sector can quickly spillover into the real economy. The financial sector is a separate sector, but it is also a real economic sector. As a result, anything that goes wrong will immediately have implications in the real economy. That’s the first point. We have seen many crises, like the Asian financial crisis, which began in Thailand and has ravaged the economies of southeast Asia, which has a more stable economy than those of Africa.

My point is that the financial sector’s contagious character must be acknowledged, and anything that goes wrong in the financial sector must be properly understood. For instance, our organization is not open to any foreign investment, including the participation of foreign banks in other countries, but we are open to learning from successful countries that have effectively managed financial liberalization. It is critical for Ethiopia to seek out such lessons and to learn pragmatism, operational specifics, and actions that must be followed.

In my opinion, these are critically important and vital issues for Ethiopia to consider. Ethiopia needs a different generation of banks, even domestic ones. We need a real and actual development bank, not a bank that is not doing any kind of development-related financial transactions. We need a bank that is dedicated to addressing some of the infrastructure gaps. We don’t even have a bank that is agriculture focused. The modalities of operation for an agriculture bank are entirely different from those of investment banks, construction banks, or commercial banks; these are the kinds of things you have to create before inviting foreign banks to make your banking system safe and sound.

The government intends to float the birr in the future. But, as many economists predict, it will be inflationary. Some Western economists, although they believe that floating the birr is the right thing to do, say that the government should at the very least set up safety net mechanisms and ensure that they have enough forex reserves to control the market before applying market clearing mechanisms. What is your reflection on the issue?

Currency policies are particularly important for any economic sector and a healthy growth of the economy, whether it’s a fixed or floating exchange rate. Because of trade, you trade with those currencies, and you will need those policies to have the smooth functioning of your sectors. When we talk of free float, or pure float, we are actually saying that the exchange rates will be determined by the demand itself.

It has its own advantages and disadvantages. Ethiopia has followed a fixed exchange rate for many years in the past and managed floating until recently, but now we are having the same kind of problems, and inflation is a problem, as is unemployment. It’s not the question of the exchange rate. We have to know whether these are structural problems within the economy. If it is a structural problem, whether you change your exchange rate policy back and forth or not, you may not address the real issue.

The floating exchange rate system has its own advantage since it frees the government from daily managing exchange rate policies, whether their fluctuations are high or low. Instead, the government will have time to focus on systemic issues, how to accelerate economic growth, how to create more jobs in the economy, and how to make the economy more stable. So that’s one of the advantages of floating exchange rates.

Under floating exchange rate regime, you still need to be careful because it’s governed by demand and supply, and the government will have no role unless the fluctuation is beyond control. The central banking system always has this leverage of intervening when instabilities and volatility are beyond control. The danger of intervening will be much more disastrous to the economy than letting the exchange rate float the way it was designed.

What I’m saying is that we need to look at the long-term equilibrium of exchange rates. That balances the efficient allocation of risk and resources from the economic sector, enhances the exportability of Ethiopian goods, and enhances the demand for Ethiopian currency. If, for any reason, the demand is low and the value is low, your ability to import will be curtailed because no one wants your currency now that its value has gone down. But in that case, you must identify sectors that can quickly supply substitutes for the imports that you cannot get because you floated the exchange rate.

When the government is free-floating, there is no need to have a huge reserve of foreign currency because it’s not the market that determines the economy. The second issue is that the government is going to liberalize the forex, as you have seen in Nairobi, Kenya, which enhances the convertibility of the Ethiopian birr.

For example, in Ethiopia, in relation to most currencies, the convertibility of the birr is low and barely needed. By the way, this is the only country where duty-free shops don’t accept local currency. By law, your national currency must be accepted in any place in the country. There is no place in the world where they tell you that they don’t accept their own currency.

If in your own country they don’t accept your currency, it means there is no confidence in the currency, which means the currency is not convertible, which means they know that the currency is going to lose its value tomorrow. We have to ensure the convertibility of our own currency. These are the kinds of things that undervalue a country’s currency. The reason we have a black market is because there are restrictions on the market.

It is absolutely essential for the government to legalize the parallel market even before moving to the floating exchange. This is a sequence issue that we have been talking about. I have not seen the details of the decree, the policy, or the program, but I think these are the kinds of issues we have to fix.

For the last two years, officials claimed that they have tried their best to curb inflationary pressures by working on the supply side. But what they are actually doing is the opposite. For instance, since the government has started to lift subsidies, the cost of fuel, the price of electricity has increased. Is it possible to reduce inflationary pressure while eliminating safety net mechanisms like subsidy to help consumer manage inflationary pressure?

Unless we know the real cause of the inflation, whatever measures are put in place, we will not see the results. There is a tendency for the government to finance megaprojects, and there is a huge amount of money in circulation in the economy. When a large amount of money chases a few goods, it leads to inflation. Because large projects are run by the government, they need to be completed on time.

The project completion rate in Africa in general and even in Ethiopia has improved. But still, there is a significant lag between inception and completion. The moment you prolong your project’s completion, the price of raw materials will change, the price of construction materials will change, and because you import most of them, import prices will also go up, adding to the cost of the project, which will be financed by borrowing from domestic banks, in which case it would be easier to print money.

If not, you have to pay for it with official development aid, direct foreign investment, or your own international reserves. If you step up the project completion rate and if the government stops printing money, that’s one way of controlling inflation. It’s not about getting rid of subsidies. Instead, it’s about taking a hard look at the monetary policy and money supply in the economy to see if they really match up with the demand and needs of the economy.

Another issue is that in most African countries, including Nigeria, what you have to look into to control inflation is the issue of corruption. Corruption is Ethiopia’s number one enemy. It affects the poor, who do not have access to finance. Instead of financing development projects, banks finance consumption, which automatically leads to inflation.

The population is also important because the youth need jobs and they need to absorb the labor market. You need them to produce goods and services that are not only consumed. If you don’t mobilize those resources to produce, then it also triggers structural problems in the country.

There is also the remittance component; people send remittances from abroad, and of course the families who receive them have better purchasing power. The competition between people who have better purchasing power and people who don’t affects the price of consumer items. We need to use remittances for production and development instead of consumption. If we don’t do that, it triggers inflation.

A few months ago, the government put a ban on certain items, including liquor and cars, telling banks not to open LC for these goods. But the problem is, the government has given them a permit to import it via Franco Valuta scheme. Is not that contradictory?

The problem with Franco Valuta is that if you are not careful, it increases prices of goods. The reason it increases is because you don’t know the source of foreign currency. You allowed people to import from wherever they were free of a letter of credit, which means people will go to the black market exchange rates and compete for hard currency. People’s competition drives up the demand for currency, causing the price to rise. What are we going to control? Are we going to control consumption or are we going to save our foreign currency? When the government implements these policies, there are decisions that must be made.

Going back to the floating exchange rate system, the economy did not do well when the exchange rate was fixed, and it is not doing well now that the rates are being managed. It may suffer even more during the early phases of the floating exchange rate regime. We need to be prepared to address the negative consequences to maintain the stability of the currency and exchange rate.

If the interest rate differentials between major countries that are Ethiopia’s trading partners determine the value of Ethiopia’s currency, it may cause havoc or triple inflation pressure, but we need to be prepared. The trade balance is above USD 10 billion because what we export cannot cover what we import.

If we don’t address these kinds of gaps quickly and under these instabilities, it will cause more harm to the economy if we leave the currency to float. With the float, the free float, or the current exchange rate regime, it will be hard for Ethiopia to keep inflation, currency volatility, and instability under control.

Another challenge for the government is budget deficit. With the problem reaching at climax now, the federal government is employing all means to finance its deficit. What is your reflection on this?

Generally, a government runs budget deficits or sometimes called (fiscal deficits) when the revenue generated through taxes and other means falls short of the expenditure during a given fiscal year. In any case, the government that spends more than its income runs fiscal deficit.  Intertemporal budget deficit is usual or common particularly among developing countries because their development needs are far too many and their incomes too low, undermining their capacities to meet all their socioeconomic needs. For instance, to ensure equitable access to basic social services such as maintaining low and order and ensuring security and justice governments spend more resources than their incomes during political instabilities, wars and conflicts. Similarly, for improving access of the poor to education, health,  affordable electricity, and potable waters for urban and rural communities,  developing country governments generally provide subsidies and run into budget deficits. Or else, in developing countries such as Ethiopia, building infrastructure, creating an industrial base, and encouraging new business formation require governments to spend more than its income (revenue). Such situations or circumstances are common and often regarded as “developmental”.   Governments can also run budget deficits during global economic shocks, risks, and uncertainties. During oil crises or in times of currency crunches, developing countries often run significant budget deficit which increase the ratio of such deficit to the GDP. 

When developing country governments run into fiscal deficit due to overspending on development priorities or to mitigate the impact of unforeseen shocks and crises, the international support measures (ISMs) come into picture where development assistance, loans, market access, or debt cancellation as well as remittances and royalty fees from foreign direct investment bridge the budget gap or come to the rescue of budgetary system processes.

However, it is important to note that governments also run fiscal deficits due to erroneously conceived priorities or badly designed projects or programmes. In most countries of sub Saharan Africa (SSA) fiscal deficits reach epic proportions because of mismanagement of resources, wastage of scarce economic resources, corruption, cronyism, nepotism and unbalanced development priorities often based on erroneous political narratives such as ethnolinguistic or religious biases. Overspending on defense and security due to frequent conflicts including interethnic conflicts, polarization and fractionalization also entail increased spending and hence uncontrollable budget deficits particularly in countries of SSA.

Budget deficits are tolerable during the time of economic recession or depression to stimulate economic revival and recovery. However, structural, and systemically interconnected budget deficit that run for a long period is dangerous as it upsets macroeconomic stability of a given economy. Large and persistent deficits increase interest rates, reduce investment opportunities, and create a burden of indebtedness that is difficult for governments and taxpayers to bear. Moreover, budget deficits interfere with the effective functioning of markets at home and abroad. Most important, they compromise the living standards of current and future generations. Therefore, Governments must deal with long-term, deep seated, and unsustainable budget or fiscal deficits in their economies.

Governments in countries such as Ethiopia and many in SSA run budget deficit due to a combination of several adverse internal and external factors, including uncontrolled spending, mismanagement (wastage), corruption, cronyism, external economic and financial shocks, corruption, armed conflicts (wars) or political instabilities, etc. Inflation, unsustainable debt burden and debt repayment obligations as well as inability to execute mega- projects on time and as planned, may also force governments to overspending beyond revenues it is able to generate. As with most countries in Africa, lack of decent jobs and gainful employment opportunities limit the tax base.

Also, the largest share of employment in Ethiopia is in the informal sector (outside the formal economy), making taxation very difficult.  Similarly lack of financial (capital)  markets  in Ethiopia make it hard for the Government to finance its debt repayment obligations. These challenges  combined with massive corruption, internal interethnic conflicts,  internal displacement of  population, frequent drought and famine as well as inability to complete projects in time, inflation, etc are among the main suspects  behind  the explosion of budget deficit in Ethiopia beyond the reasonable or optimal level of  fiscal deficits.

Some links the budget deficit in Ethiopia with fiscal decentralization. What is your view?

In my view centralization or decentralization of budget has little or nothing to do with budget deficits. Ethiopia has been on expansionary policies for many years- policies that depend on expansion of expenditures because of overspending on development, social or sometime political programs. Surprisingly, Ethiopia has been running budget deficit despite registering one of the fastest economic growths in the developing world (at least until 2017-2018 G.C.). Ethiopia’s dependence on external sources of financing (ODA, loan, remittances etc.) has always been one of the highest in the developing world even by the standards of sub-Saharan African countries. Ethiopia is also the country with the lowest urbanization rates and increased population pressure on its predominantly agrarian economy.

When the economy of the country is unable to provide employment opportunities for the growing youth population, when taxable incomes are narrow (low),  business are very small and unprofitable and when the productivity of agriculture precipitously declines, the over expenditure of the country and its dependence on food import, food aid and overall development aid increases. It is not about budget decentralization (with respect to political decentralization) that generates budget deficits, but how priorities are set,   budgetary allocation is realigned with the priorities and how scarce resources are used and managed.

There are countries with political and budgetary centralization that are not as high budgetary deficit as Ethiopia. There are also countries with both political and budgetary decentralization that run excessive fiscal deficits.  In short, budget deficits are caused by imbalances between income and expenditure and when expenditures exceed income, irrespective of political or budgetary decentralization or vice versa.

Given the budget gap the federal government facing and the increase budget need of regional states as well as the rise in both governments’ expenditure due to inflation, adding the increase in debt expected to be serviced, what option the federal government has to achieve a balance?

There are several options for the Government to deal with budgetary crises or deficits. While cutting back on certain expenditures or increase in revenue-generating activities is the feasible way out, for developing countries such as Ethiopia,  simply reducing expenditures may not lead to balanced budget. Therefore, a series of complementary measures may be necessary. The immediate priority for Ethiopia is to institute budgetary discipline, reduce wastages, fight corruption, stamp out cronyism and “ethnic entrepreneurship” as well as ensure political stability. To that end, the Government needs to reinforce audit and supervision mechanisms to ensure effective and efficient use of allocated budgets. It must introduce accountability and transparency in budgetary allocation and improve its capacity to enforce these. Without sustained peace and political stability, it will be very difficult for Ethiopia to refocus on its development agenda and use its scarce resources to accelerate socioeconomic transformation. The key for Ethiopia’s economic revival and progress is to address systemic and prolonged interethnic fractionalization, polarization, or tensions.

In the intermediate period,  the Government of Ethiopia must prioritize the employment-intensity of economic growth instead of simply squeezing smaller percentage of population that is able to pay taxes.  When the government generates more employment opportunities for the working population through macroeconomic, industrial, agricultural, and infrastructural policies and investments, it broadens taxable incomes of the population. Along with such employment-rich growth and investment policies , the Ethiopian Government needs to make the private sector dynamic, innovative and competitive through various incentive policies in the short run,  which, in the long-run, helps the economy to amortize the incentives and contribute to enhanced profitability of firms and enterprises which can pay taxes to reduce fiscal deficits. Ethiopia must also channel resources and incentive structures toward production instead of continuously subsidizing consumption. Investment in sectors where Ethiopia has comparative advantages such as agriculture by mobilizing public and private capital including foreign direct investment is critically important. Because in the long-run economic growth is vital to foster capital accumulation, improve public investments in productive sectors and enhance economywide productive capacities and structural economic transformation of the country.

Reducing capital expenditure has been one strategy deployed by the federal government to reduce budget deficit. However, this was undermined by a surge in budget required to complete capital projects that was already in pipeline due to inflationary pressure. What is your reflection on this?

Cutting expenditures and increasing revenue though some of the suggested solutions to balance budget, these are not straightforward or simple solutions. Cutting expenditure – known as “contractionary fiscal policies”- may have unintended impact on prospects of socioeconomic progress, growth and development of the country. Particularly for Ethiopia, in the current circumstances, when infrastructure is destroyed in Amhara, Afar and Tigray regions and when schools, health stations and all public amenities are destroyed by the war, it will be difficult or impossible to cut capital expenditures. On the other hand, the current inflationary pressure and related macroeconomic imbalances facing the country will not allow Ethiopia to exercise “expansionary fiscal policies”- which, under normal circumstances, seeks to stimulate the economy by boosting demand through monetary and fiscal stimulus. Likewise, increasing taxes can make the economy less attractive for businesses and investments, undermining long-term development and the ability to generate employment to absorb growing labour. This means that Ethiopia’s policy options, instruments or choices available to address budget deficits are very much limited. Available choices, at least in the short run,  are confined to political, regulatory and institutional aspects to reduce wastage of scarce resources, fight corruption and address issues of systemic political problems such as interethnic conflicts. Ethiopia should also prioritize economic growth to boost capital accumulation and deal with its budget deficits than cutting spending or increasing taxation. It must channel remittances from the diaspora and royalty fees towards development priorities than enhancing consumption. Further steps that the Government of Ethiopia should strive to renegotiate the terms and conditions of its debt repayment obligations, cancel fully or partially its external debt overhang. Responsible borrowing and responsible lending must be exercised in tandem with responsible and efficient use of public resources.

Ethiopia’s budget constraints is linked with the unmatched growth of the country’s GDP and the government tax revenues. Why do you think tax revenue to GDP ratio remain static in Ethiopia? And your recommendations in this regard?

This is always the case for the governments of developing countries to play a blame game. What is critically important is to examine the sources of Ethiopia’s GDP growth. Ethiopia is among the countries of SSA that has been witnessing premature deindustrialization. Despite the fact that the overall share of industry in GDP has been increasing (largely due to construction sector), the manufacturing value added of the country at 7% of the GDP for many years,  is less than the average for SSA. Therefore, industry is not actually contributing much to the economic transformation of the country. Agriculture which employees where 80 per cent of the country’s population resides and generates over 80 per cent export is still dependent on natural rain and rudimentary or backward framing techniques. Substantial and investible income generating capacity of agriculture is severely constrained and the large chunk of the population pays less or no income tax. As I mentioned earlier Ethiopia’s labour force is largely and predominantly in the informal sector- where there is low or no taxable income. Therefore the sources of economy growth in Ethiopia are no high-income generating to enable the government to increase its tax revenue.

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