Developmental State Under the Radar

Is it the Right Model for Ethiopia?

When Ethiopia adopted the developmental state as its growth model almost two decades ago, many did not expect the East African nation would reap massive economic gains. However, the country was able to register one of the fastest economic growths in the world for more than a decade. This contributed to the increase in per capita income and significant reduction of poverty.

Many, on the other hand, discredit the achievements because of gross human rights violations, narrowing political space, and a stifling private sector. The development model has also been criticized for making the state a dominant economic actor in the economy by hugely investing in infrastructure development projects. To finance its huge development plans, the government has excessively borrowed from local and foreign sources. This led the national debt to more than USD50 billion as of June 2019. More than half of the loans were acquired from foreign sources.
As the government was pumping huge supply of money in the economy, the situation created a surge in demand amid a huge supply constraint. The supply was poor because equal volume of investment was not made in the productive sector of the economy, agriculture and manufacturing. The result has been a bulge in the trade deficit because of mounting imports while exports remained stagnant or declining in those years. Now, aiming to address these macroeconomic woes, the administration of Prime Minister Abiy Ahmed has been trying to deviate from the past trends of development. EBR’s Samson Berhane investigates.

For over half a century, Ethiopia has been the emblem of food insecurity and famine. Courtesy of the outstanding economic growth of the last decade, however, the narrative has started to change. Ethiopia’s economic growth trajectory puts it among the world’s fastest-growing economies.

Ethiopia’s economic success, however, was not easy to come by. Economic growth was justified by the dominance of the state in the economy. Under the leadership of the late Prime Minister Meles Zenawi, Ethiopia adopted the developmental state economic growth model contradicting the neo-liberal model of development; alternatively known as the Washington Consensus that prescribes a set of free-market economic policies.

For Meles, prioritizing the state’s role in development over human rights or genuine political pluralism was a matter of survival. The growth trajectory started during Meles’ time running at close to 10Pct per annum until recently. Back then, it seemed that the country could achieve middle-income status and drag most of its people out of absolute poverty in about three decades.

Even though Ethiopia credits its fast economic growth to its developmental state policy, the issue remains contentious among politicians and scholars. Polarized opinions have been reflected on the cost and benefits of the developmental state paradigm and whether it is the right choice for Ethiopia given its political and socio-economic situations. While the debate has been highly exacerbated by political differences, the lack of consensus on the concept and major features of the developmental state itself has made the issue contentious.
Genesis of the Developmental State Model

Economists define economic growth as an increment in the national output. In order to increase the aggregate output, many theories have been developed over the last four centuries. The evolution of economic growth theories dates back to the 17th century. Adam Smith is the first economist who explained the relationship between demand and supply as well as their impact on economic growth in his famous book, ‘Wealth of Nations,’ published in 1776.

The concept developed by Smith was further explained by other classical economists such as David Ricardo and Tomas Malthus. According to the classical theory of economic growth, the interaction between aggregate demand and aggregate supply will determine the level of output. Under a competitive environment, the market will self-regulate and supply will create its own demand. According to Smith, the market’s ability to self-regulate emanates from the fact that aggregate demand and supply move towards their natural equilibrium without outside interference. This phenomenon is known as the “invisible hand”.

The Classical Model remained popular until the Great Depression, a brutal economic recession that began in the United States and swamped the rest of the world from 1929 until 1939. But, another economist John Maynard Keynes, who observed that demand and supply do not always move towards their natural equilibrium, came up with another theory in 1936: the Keynesian model. Keynesian theorists believe that aggregate demand gets stuck because it is influenced by a series of factors. This causes the economy to operate below its potential output and growth rate. To overcome this problem, stimulus is needed in the form of reduction of interest rates and boosting the level of government investment.

The Developmental State theory can be seen as an extension of the Keynesian model. The theory mainly emphasizes that a large amount of investment by the government is needed to stimulate the aggregate demand or/and supply in developing nations. Keyneswrote that a series of stimulus package is needed to lift their economies from a backward status into sustainable growth.

Since the 1950s, following the emergence of newly independent states in Africa and Asia, the international community gave emphasis to a state-led model of development intended to bring about industrialization and entrepreneurship through intensive and deliberate efforts and state intervention.

The model was criticized for bringing macroeconomic instability, especially in Africa and Latin America during the 1970s and early 1980s. Since the mid-1990s, however, another shift in understanding the role of the state in development has become apparent. This new way of thinking transpired after a very different experience of state-led development was witnessed in Asian countries.

Particularly in East Asia, the so-called ‘Asian tigers’, which include Hong Kong, Singapore, South Korea and Taiwan, managed to register rapid economic growth and radical socioeconomic transformation over a period of 30 years. The tigers transformed themselves from being poor agrarian societies or city-states in the 1960s to producers of high technology and high value-added goods by the 1990s. After the global economic crisis in 2007/8, the role of state intervention to address the failures of the market gained even more attention in the global arena.

It was during this period that Ethiopia also started to experiment with the developmental state model. Meles, in his series of discussions with Alex de Waal between 1988 and 2012, said that the fundamental problem Ethiopia face was the constraints of factors of production, which made the country less competitive in the global market. Hence, the late leader argued, Ethiopia would never fill these gaps in a globalized market without an activist state guiding the country’s development. “This activist state isn’t just investing at a micro-scale but is guiding the entire economy, allocating state rents in a strategic manner,” Meles said.

Counting the Success, Failure
The Ethiopian economy has experienced strong and broad-based growth for more than a decade since the ruling party adopted the developmental state paradigm in 2004. Booming service and construction sectors account for the growth, while the performance of the manufacturing sector was relatively modest. This economic growth had positive impact in reducing the level of poverty, which the government claimed to have gone down to 23Pct based on an assumption that one can survive with a monthly salary of ETB600 (25 dollars). What makes the Ethiopian economic growth unique is that it is not dependent on natural resources such as crude oil or minerals like other African countries. This implies the economic progress does not arise from the distribution of the rent from natural resources but rather from massive investments in infrastructural development.

The expansionary economic policy was guided by the demand-side economic model championed by Keynes, who argued that an increase in aggregate demand by the government, businesses, and consumers influence economic activity more than market forces. Like most of the developmental states, public investment is the engine of growth in Ethiopia. The government is the only player in building road networks to expand basic social services and make a big push in the energy sector. The Ethiopian government has been spending about 20Pct of its GDP and more than two-thirds of its budget to re-engineer its infrastructure, such as roads, schools, health institutions, railways, air transport, hydroelectric and irrigation dams, and telecommunication services.

By adopting the developmental state policy, the Ethiopian government encouraged an increase in public expenditure and money supply to finance these projects. Broad money supply increased to ETB740.6 billion in 2017/18 from ETB68.1 in 2007/08 billion in , while the debt stock of the country climbed to as high as USD50 billion.

Citing the economic growth registered as well as the rise of per capita income in the past decade, former Investment Commissioner, Belachew Mekuria (PhD) deduced that the developmental state model paid off. “The developmental state, with the strictly censored political environment, has delivered on the economic fronts,” he argues.

In his latest address to Members of the Parliament, Prime Minister Abiy Ahmed (PhD) also acknowledged the positive effects of the model in inducing aggregate demand. “Aggregate demand increased. For instance, the demand for sugar and many other non-food products, including mobile phones has increased,” Abiy told MPs.

Yet, the prime Minister did not deny the fact that aggregate supply remained unchanged while demand kept increasing. “Although the demand has increased, we have failed to increase the supply compatibly.”

For Tadele Ferede (PhD), an economist, the emphasis given to the demand-side of the economy is the core of the problem. “The model miserably failed to serve its purpose because the supply side was totally overlooked,” he remarked.

In the past decade, focus was given to the urban infrastructure development, including the construction of railway lines and roads connecting towns, while the agriculture sector received little attention. In fact, the portion of public investment towards agriculture, which employs about 80Pct of the population and contributes more than half of the GDP, remained insignificant especially in the past 10 years. For centuries, the structure of the agricultural sector has not changed mainly because of its poor performance in terms of generating surplus that could be used as raw material in other sectors of the economy. The sector is still characterized by low-input, low-output and low productivity as well as rain-fed smallholder production.

The economy, which is heavily dependent on the agricultural sector, suffered from extreme fluctuations of output on top of recurrent droughts while domestic food production failed to meet the food requirements of the country. Although the productivity of small-scale farmers increased by 70Pct in the past ten years, according to reports; insufficient investment in expanding commercial farming severely constrained the full realization of the sector’s potential. This forced the country to rely mainly on imports to satisfy the growing demand for food as well as non-food items.

“Instead of spending a lot in the productive sectors of the economy that can help the country boost local production and substitute imports, the government chose to do the opposite. This is where things went wrong,” argues Tadele.

The lack of attention towards the supply side of the equation has brought macroeconomic imbalance and instability. The first adverse effect is the growing trade deficit, which stood at USD 12.4 billion at the end of 2017/18. Since the government neglected to invest its resources and boost local production not only to satisfy the growing demand but also to substitute imported items, the country is forced to spend more money annually on imports than it receives from exports. Over the last decade, the country’s import bills swelled from USD6.8 billion to USD15.3 billion.

On the other hand, export earnings only increased from USD2 billion in 2009/2010 to USD2.6 billion in 2018/19.

Studies confirm that persistent trade deficits will be detrimental to a given country’s economic outlook by adversely influencing price levels and growth. The damage is even worse for developing countries like Ethiopia because of its effect on interest rates, which puts a downward pressure on the country’s currency. This makes the prices of goods in that currency more expensive. In other words, trade deficit can lead to inflation.

Imported inflation occurs due to an increase in the price of imported items. However, the inflation effect will not be limited to only imported commodities. Rather, the price of locally produced items produced using imported raw materials will also increase, causing an increment in the general prices of goods and services. The data obtained from Central Statistical Agency reveal that inflation rate is on the rise in Ethiopia. Last month, it stands at 15.5Pct.

One way of averting this problem could be enhancing local production by boosting the participation of the private sector, which is one of the pillars of the developmental state economic growth model. Besides his contention that the developmental state has been misconceived by the government, Tadele believes that a developmental state does not necessarily mean that the state must have a key role in the whole economy. “Rather, a developmental state entails that the state’s role is facilitating and preparing the ground work for a strong and vibrant private sector.”

This is why experts say the previous administration miserably failed to understand what the developmental state model is. “The EPRDF-led government misunderstood the concept of a developmental state from the get-go. A developmental state is not only about ensuring economic development by making the state the driver of the economy,” said Atlaw Alemu (PhD), an assistant professor of economics at Addis Ababa University. “A developmental state, in fact, encourages the participation of the private sector and it only encourages state intervention when there is a market failure.”

Although the past administration openly stated that the Asian Tigers, especially South Korea, have been an important inspiration and role model for Ethiopia when it comes to the developmental state model, economic analysts argue, the reality on the ground was different. Francis Fukuyama (PhD), professor of political science at Stanford University, who was in Addis Ababa last month for a public lecture and dialogue, is amongst those who have observed the difference between the models adopted by Ethiopia and South Korea. “The Asian developmental states all started with a very vigorous reform to realize an entrepreneurial private sector, while Ethiopia’s developmental state has basically been state-driven development with a very weak private sector. Going forward, that is going to be a real disadvantage,” he told EBR.

Alemayehu Geda (PhD), Professor of macroeconomics at the Addis Ababa University, shares this argument but from a different perspective. “Despite the widespread conclusion that the state has a big role in the economy, my analysis shows that the private sector indeed is dominant,” says Alemayehu. “More than 80Pct of outputs from the agriculture sector comes from the private sector; the private sector also accounts 90Pct of the output in service sector. This clearly indicates how small the state’s role in the economy is and that the economy is dominated by a very weak private sector.”

The other big difference between Ethiopia and the Asian countries that adopted a developmental state is the fact that the Asian countries had modern bureaucracies in place since the beginning. “Many of these countries had such bureaucracies with an embedded autonomy, high level of technocratic capacity based on good education and very little politicization of those bureaucracies,” explains Fukuyama. “And this is not something that is true for Ethiopia. The civil service of Ethiopia is not efficient.”

Tadele also shares this argument. “When South Korea implemented a developmental state, it gave due attention to meritocracy and managed to create noble civil servants, while the reverse is true in Ethiopia, where the educational status of most civil servants, including those at the top is very doubtful. Some of them have fake credential and are appointed based on their loyalty to the ruling party.”

Due to the inefficiency in the public sector, benefits generated by the state-led development were turned into rents for a small group of elites and clientelistic networks that captured the state. Some analysts, mentioning the successive reports by the Auditor General that exposes over a hundred billion Birr audit gaps in federal government institutions, say that the developmental state has become a tool for personal gain to politicians instead of becoming instrumental to pursue developmental ends. “Flawed implementation of the developmental state has created horizontal inequality and led to corruption and elite conflicts,” argues Alemayehu. “This problem emanates not out of the model, rather from the way it was put into practice,” he concludes.

Deviating from the Past
Soon after Prime Minister Abiy Ahmed (PhD) took power in April 2018, the government embarked on opening up the economy targeted at correcting macroeconomic imbalances and distortions created by previous growth drives. Some say this is a deviation from the past while others argue that it is possible to continue opening up the economy even under a developmental state model of growth.

Responding to a question raised by EBR during a press briefing held at the Ministry’s premise, State Minister of Finance and Economic Cooperation, Eyob Tekalign (PhD), said that the government is ready to replace the developmental state model if necessary. “It is not a religion. If it is unworkable, there is no reason that prevents us from replacing it. For instance, from the financial point of view, the developmental state model lacks clarity and brought no feasible results.”

Alemayehu, on the other hand, recommends for Ethiopia to remain a developmental state to ensure sustainable economic growth. “The private sector is very weak and fragile. It is not in a position to replace the role of the state in the economy. Trying to reduce the dominant role of the state would cost the country dearly in terms of economic development,” Alemayehu warns. “The private sector still needs the help of the state to develop and grow. But rushed privatization could be no less that a transfer of monopoly from the state to private entities.”
However, in the face of a growing economic imbalances and macroeconomic instabilities, Ethiopia is indeed due to take a new path of development within developmental state model or even beyond.

8th Year • Aug.16 – Sep.15 2019 • No. 77