3-D System Approach to Private Sector Development in Ethiopia

In order to understand the exact role of the private sector and its level of development, it is important to know the value and composition of output produced in the country over a period of time (growth patterns), and the relative changes in the size and productivity of the various components of the macro aggregates (economic activities and structure).

Doing this will help to show the true nature of the Ethiopian economy, which is composed of three types of independent economic systems that coexist side-by-side: the market economy, state economy and population economy. So, my analysis is based on three theoretical pillars: comparative economics, political economy and demographic economics.

Theoretical Pillars

Comparative economics, a methodology of classifying economic systems based on property ownership and incentives, identifies two different processes of decision making in resource use and allocation. I used the assumptions and approaches of comparative economics to define the market system economy in Ethiopia. A market economy is defined as an economy that is governed by the laws of supply and demand that direct the production of goods and services.

In the case of Ethiopia, it is only the private corporations (both financial and non-financial), which have adopted these market principles as a mechanism for allocating resources among alternative outputs.

The second theoretical pillar of the 3D system approach is based on the concept of political economy. This is a study of the interaction of politics and economics. Political economy combines the ability to exercise power and the knowledge of optimal use of scarce resources. According to this theory the problem of policy choice is not simply a technical or computational one as in the case of market economy. The process of deciding technically what policy to adopt rather is dependent on political constrains and exercise of power.

I used the perspective of political economy to define the economy controlled by the state. State economy is that part of a nation’s economy which is controlled by the political power elite. It is a planned economy in which the power elite decide how the factors of production are used and distributed. State economy is not subject to the sovereignty of the market; production, distribution and exchange market is controlled by the government, not by individuals or privately owned corporations. The definition of state economy includes party-owned businesses.

The third theoretical pillar of the 3-D system approach is the concept of demographic economics, which is the application of economic analysis to population growth and demographic transition. It is used to fill the theoretical gap and discusses aspects of the economy that are not captured by micro or macroeconomics, particularly the phenomenon of population change (the values of age group size, growth rate, dependency ratio, distribution, socio-economic behaviours, objectives and activities of age groups). I used the temporal and spatial effects of demographic forces and rapid population growth to identify population economy system in the country.

Population economy can be defined in terms of the management of an economy by part of the population that is growing rapidly in the country. The objective of the population economy is for reproduction, survival and multiplication of households under conditions of demographic transition, institutional and technological constraints rather than for profit, capital accumulation and investment. The definition of population economy includes the activities and outputs of smallholder agriculture and the urban informal sector. It includes all “non-observed economies” that are not covered in national accounts. In the population economy households determine what to produce, how to produce, and how to distribute. This means, neither the state (authority) nor the market (demand/supply) dictates it on how to allocate their scare resources and how to distribute the produced goods and services.

So, in Ethiopia there are three types of decision making processes in resource allocation, production and distribution. Thus, the Ethiopian economy is not one-dimensional. Rather it is a three dimensional economy where the market, the state and demography plays the major role while co-existing side-by-side.

The three dimensional approach has implications in measuring and accounting gross domestic product (GDP), the value of the goods and services produced by the Ethiopian economy in a given time period.  Traditionally, GDP is calculated using the expenditure, income or production approaches. But, this approachis relevant for only a one dimension economic system where the necessary conditions that affect scale and growth rate of output capacity like division of labor, specialization, and technology are already in place.

In Ethiopia where the factors of one dimensional economy (such as the market economy) have not yet reached to a critical mass of economic actors, it is not enough to know the value (size and growth rate) of the output but also who produce the output? what is produced and how is it used. There are institutional differences in the ways how and why the society allocates resources, produce and distribute goods and services. In three dimensional economic systems the growth determinants differ depending on the institutional character and organization of the economic systems belonging to different entities.

Economic taxonomy approach is particularly important to understand why and how to develop market based private sector in Ethiopia.The 3D approach combines institutions, technology and factor markets as one and this is important for identifying long term policy strategies for developing the private sector, which was and is the engine of economic growth in Europe, USA and Asia.

Data Sources

Before proceeding to the research findings it is necessary to say few words on data sources. The economic activities of the households, firms and state are systematically recorded in national accounts. National Accounts Department of the Ministry of Finance and Economic Cooperation (MOFEC) systematically prepares data on institutional and industrial sectors to measure macroeconomic categories of production and purchase of the country. The most widely used values that is measured in national accounts are the aggregate measures of gross domestic product or GDP.

But, the official publication of the Ministry provides information on GDP by broad sectors of the economy such as agriculture, industry and services. So, disaggregated data on the share of different institutional sectors (public, private and households) is not available for a satellite account (which can be called 3D Satellite Account). As a result, I have used the consistent series compiled by the Ethiopian Economics Association (EEA) to estimate the outputs of the three economic systems.

For the purpose of this article I have modified the values of the consumption expenditure series. This data represents the final uses of output of goods and services in the given period of time. It is the sum of consumption expenditure (by households, government and non-profit institutions serving households), capital formation (sum of gross fixed capital formation, change in stocks and valuables) and net exports (exports less imports). I have reworked the share of the components of the consumption expenditure based on suggestions of study on private sector development in Ethiopia.

Findings: Trends in Output Growth

Figure 1 illustrates the trends in the total value of output of goods and services produced within the respective economic systems of the country over the period of 1961-2015. The output growth of the three economic systems has been remarkably low during the period (1961-1991), and came to increase in the period 1992-2003/04, and became rapid and stable since 2005.

Economic Contribution of the Systems

Figure 1 shows the importance of each type of economic system in generating total value-added in the economy. The figure shows that the Ethiopian economy is going through transition where the contribution of population economy is decreasing with a gradual increase in the rise of state economy. There seems to be negative correlation between the two types of economic system, in which the state economy increases as the population economy decreases. The contribution of the state economy has increased from 22Pct in 1992 to 39Pct in 2015. In the same period the contribution of the population economy decreased from 65Pct to 45Pct.

Further investigation is needed to determine cause-and-effect relationship between state and population economies. For our purpose it is important to note that the national output is still concentrated in the population and state economies. In terms of the amount it contributes to national GDP, the market based private economy is by far the least important economy. The private sector’s share of GDP on the average is estimated at 17Pct for the last 25 years. In developed countries, the market based private sector generates on the average 80Pct of aggregate gross value added in the national economy. What is happening to the “engine of economic growth” in Ethiopia?

The 3-D approach to economic progress shows the low level contribution of the private sector to the aggregate national economy (which currently is about 20Pct). Employment measure of the private sector’s contribution to the national economy shows that the share of private corporations was around 6Pct. Compared to the public sector, the private sector share in total investment in Ethiopia is relatively low.

Conclusion

The three simple measures of the private sector’s contribution to the national economy (share of GDP, share of aggregate employment and share in gross capital formation) shows the low level of private sector development in Ethiopia.  Without a private sector, economies tend to deliver much lower standards of living because they have no means of generating profit and investment. The prospect of profit and investment drives efficiency, productivity and ultimately economic growth from which rising material living standards then flow.

What we have observed in the past decades is twofold increase in the share of GDP by the economic system controlled by the state, while the private sector remained almost constant at low level. Since the dawn fall of the military socialist regime, the federal government used many economic policy instruments and programs to increase its control over trade, financial market, fiscal relations, production enterprises and public services.This is done in the name of poverty reduction, liberalization, developmental state and growth and transformation plans, among others.

Currently, the state economy has expanded to such an extent that its institutions have literally become inefficient. This is conclusively demonstrated in the 17 strategic studies conducted by the government’s Policy Study and Research Centrein areas of industrial development, urban development, agricultural modernization and good governance. Following these studies the Government has arrested considerable number of officials on suspicion of corruption.

Ethiopia now stands at a defining moment if/whether or not to develop the private sector economy. The institutional inefficiency of the state economy, the low productivity trap of the population economy and the deterioration of the market economy underline the need for long term strategy of private sector development in Ethiopia. The economy cannot operate as usual and massive strategic change is inevitable.

6th Year . November 2017 . No.55