Ethiopian Business Review

Discovering Oil in Ethiopia: A Curse or a Blessing? The Macroeconomics of a Commodity Boom (Part II)

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.

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, local-content 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 to 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.

Alemayehu Geda (Prof.)

Alemayehu Geda did his PhD in Development Economics at the Institute of Social Studies, the Netherlands, in 1998. After that he had been teaching at the University of London, School of Oriental and African Studies. He was also a research fellow at the University of Oxford. Prior to that he was at the World Bank in Washington on a special appointment to work on Global Model Building and the Place of Developing Countries in the World Economy. He is currently Professor of Economics at Addis Ababa University. Comments can be sent to ag112526@gmail.com

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