Remodeling Ethiopia’s Economy

Before reflecting on what kind of economic model Ethiopia needs, it is imperative to analyze what Ethiopia’s economic potentials are. In order to achieve fast and sustainable growth, the model must prioritize three things. First, we must recognize that we are a low income economy or LDC. Second, we must recognize that we have huge untapped resources. There is huge underemployed and unemployed labor, land, and other resources. For instance, there is redundant labor in agriculture. The third is structural rigidity. There are many problems that hold us back from utilizing markets, infrastructure, resources and others. The model must remove the structural rigidities. Let’s see widely accepted economic models and what they could bring one’s nation.
Social democracy is about redistribution of already produced economic gains and accumulated wealth. It is a European model. Europe has already reached its maximum productivity rate and most of the economy is controlled by a few corporate companies. Ethiopia’s model must be incentive based and start from the base. Therefore, it does not take Ethiopia to growth.

Neoliberalism is to the contrary. It is survival of the fittest. If you are educated and competent, you can get a job. Otherwise, you can die and that is nobody’s business. Living or dying is your business. The public sector role is limited to introducing policies. If you are unfit for the incentives, you die. Neoliberalism is a copy of Darwin’s survival of the fittest. It is the economics version of natural science. It is also similar to Malthusian theory, which concludes hunger balances population. Basically, Darwin only improved Malthus’s theory.

In neoliberalism, government leaves everything for the market except ensuring peace and security. Everything must be done by the private sector. This is impossible in Ethiopia. Neoliberalism, in fact, has failed even in America under COVID-19. In America, universal health coverage is not in place and the pandemic has forced government to intervene in the provision of health services. It has also failed the COVID-19 test, both in the USA and the UK. COVID-19 is the last test for neoliberalism. Social democrats did better.

Yet IMF and the WB were desperate to liberalize everything in Ethiopia. But the country resisted the pressure from the IMF on key reform areas. The Government of Ethiopia (GoE) was very cautiously following up. The first IMF recommendation we resisted was exchange rate liberalization. The second was capital account liberalization. They requested to liberalize the balance of payment. This means you can deposit the foreign currency you earn anywhere you want, in Ethiopia or outside of Ethiopia. You can open foreign account anywhere. The third was interest rate liberalization. These three priorities were core economic determinants for growth. There were many more IMF recommendations we rejected.

We decided to make phased adjustment on exchange rate, capital account and interest rate. But in other African countries, all these were forcefully implemented. We are able to improve export because we kept that decision for ourselves. Inflation was also reduced. So, our stabilization program was successful. We laid the fertile ground for growth. Between 1993 and 2003, average real GDP growth was 4.5pct. This enabled the growth in the second phase.

But we decoupled our relationship with the IMF after 2003. Had we followed their recommendations, everything could have destabilized and become out of control. So, we decided that the IMF needs to participate only under the article 4 consultation. Article 4 is not a program but a responsibility of any IMF member country. Under the Article, they come, see the economy and write reports. We explain and defend our policies. Usually they accept them because our arguments are strong. But they usually forecast economic growth at lower rates. They do not tell the actual figure. This is because they do not think growth can be achievable without the IMF model. They are only allowed to deal with us under the article 4 consultation. We are successful to have been able to do that.

In order to succeed with IMF, you must be decisive. That is what is happening with the new Ethiopian ‘Homegrown Economic Reform’ program. The scheme needs to reduce IMF’s role, except financing and supporting the program. But the solutions should be local. But I don’t want to comment on the details of the Home Grown policy. In many African countries like Uganda, IMF and the WB went as far as establishing their own departments in central banks. Unlike Ethiopia, those countries are not successful. Having said that, I must say that neoliberal, social democracy and similar ideologies cannot be viable options for Ethiopia.

On the other hand, our understandings of developmental state were crooked over the past couple of decades. The developmental state idea was over-stretched and expelled the private sector in our context. It considered the private sector as enemy. We want the growth of the private sector but we did not support it. It was as if only government could bring development. This was a huge gap in wisdom. It was also a big model and policy inconsistency.

Unfortunately, we had to go through such times. As someone who was part of the administration, I was aware of the problems and tried my best to change things around. All my effort was in vain, as it turned out.

That was a big misconception. Ethiopia should have diverted the capital from service sector to the needy manufacturing sector. Manufacturing should have been made more profitable through capital availability, less tax and more incentives. The financial sector should have been taxed more.

The only private sector Ethiopia has is the farmer and that group does not produce for profit. The private sector is better in the service sector, especially in finance and trade. But the service sector does not produce. The real strength of the private sector should be in manufacturing, construction and mining. We don’t have a high value productive sector at all. We have low value sectors like textile and leather. Sustainable development is achieved only through the high value productive manufacturing sector. Manufacturing industries report bankruptcy, which is why export failed. Ethiopia’s economy is not based on the productive sector, unlike other developing countries. Our products are not competing in other markets. However, there are policies to alter that.

Therefore, Ethiopia must focus on creating the private sector it wants. Whether through privatization, liberalization or rearranging, we must create real private sector. Our policies must be geared towards creating a vibrant productive sector that does excellent in export and manufacturing.

The private sector is the end user for governmental undertakings. Unless there is private sector, investment by the government in road and power is useless. The private sector should play its crucial part. But the private sector must be created in Ethiopia first. The private sector should profit the most and the government should not envy that. The government must be happy to let the private sector profit more.

The public sector must also find its true place. The public sector must decide whether it is complementary to or substitute for the private sector. If it is complementary, the private sector cannot survive without the public sector. If it is a substitute, they can live without each other. Only the private sector can be efficient and productive. So, the public sector is in the wrong place under such a scenario. Under the condition of complementarity, there is an issue of public goods. This public goods issue can be well achieved under PPP. The private sector builds, the public sector regulates. If the private sector does not have the capital, the public sector can build it and the private sector makes profit using the infrastructure. This is positive externality.

The third actor besides the private and public sectors is the financial sector, especially the central bank. The role of the central bank is balancing between the public and private sectors. It maintains macroeconomic stability and ensures growth. Ethiopia needs such a central bank. In developed countries, central banks are not growth oriented because the countries have already reached their full growth potential. They have reached their last actual productive possibility curve. They are also near their natural employment rate as the necessary unemployment rate is around 5pct. The role of central banks in such developed countries is only to maintain these rates, not aspiring for new growth. Growth, which is increasing productivity, is done only by the private sector.

All in all, Ethiopia’s model must be kind of ‘development-oriented.’ Other countries, developed or developing, have less structural rigidities. Most countries achieved full employment and they have only cyclical unemployment. Therefore, we cannot copy anyone’s model. Besides, Ethiopia’s social and psychological make-up require unique model. The upbringing of an Ethiopian person is not similar to that of a Kenyan or Tanzanian. Our people are fast, obedient and trustworthy, if you trust them. So if the model trusts our people, they can work in the model. Religion also dictates. There is no ‘survival of the fittest’ mentality in Ethiopia. Ethiopians are generous. You can consider the active participation of the population and the private sector in efforts to control COVID-19. This creates social stability and good consumption culture. So the model must recognize such unique features.

Reinventing Developmental State Model
The idea of developmental state was highly misunderstood in Ethiopia. Ethiopia’s shot at it was only developmental by name while it was far from it practically. Developmental state cannot succeed unless it creates effective private sector. Developmental state operates within the realm of capitalism. Developmental state is used in a bid to create capital. Capital is created only by the private sector. Private sector cannot exist unless policies allow profit. China’s developmental state created capital. China is a top capitalist country today. The world’s top five capital owning companies are from china. It is a system that created Huawei. China’s private sector is investing all over the world.

In Ethiopia, there was only the idea of developmental state. It was not practiced on the ground. We have built some roads but developmental state model is more than that. It is linked to every macroeconomic string. The economic machine works only when every string is in place. When you invest in infrastructure, it must reduce private sector expense and boost its profit. Then the private sector pays more tax and the government invests more. Private sector profit and government budget grow proportionally. This creates competitiveness and more foreign currency. I doubt that we understood developmental state correctly.

Effective developmental states have surplus fiscal and balance of payment. They are even capital exporters like china, Korea, Taiwan and Singapore. They started from deficit and become capital exporters.

Much of Ethiopia’s capital is tied up in the unproductive import sector. There are two models for import substitution; the old model and the new way. The old model was widely used in the 1970s and 1980s by many countries including Ethiopia. This is protection-based import substitution. Many countries in Latin America and even Ethiopia tried this and failed. Ethiopia levied up to 300pct tariff for protection purposes under such a scheme. There are still sectors that have up to 100pct tariff, adding up the taxes. But this is not helping import substitution.

According to a recent research, the textile and leather sectors have the highest protection in Ethiopia. Metal has the lowest protection. The old model made domestic industries lazy. Domestic industries received incentives but they sold the products in domestic market, rather than exporting them. They got used to living under protection.
Growth is achieved through value addition, not by protection. Value addition is achieved through exploiting new resource or increasing productivity. Since neither productivity nor resource expansion is achieved, there is no real growth in Ethiopia. Production cost per unit decreased as productivity increased in the Asian tigers. But in Ethiopia, hampered by the bulk import, efficiency and productivity went down. The thought that the government is protecting them is putting our industries to sleep and even death. Currently, our industries have reached the point where they cannot compete anymore.

The new way of import substitution is market, incentive and competition-based import substitution. East Asians are using this model. Every incentive is provided apart from making the exchange rate most suitable and internationally competitive. Bank interest rate is also subsidized until the industries become competitive. Government investment like road efficiency is also used to make the private sector competitive. Government protection, may be up to 30pct, is also necessary. Through time, the protection declines and the industries are exposed to competition. At this point, the government must make sure that they are profiting. East Asians used the new way.

Ethiopia is practicing the old model. But our mentality is in the new way. Practically, industries are sitting, protected. They are not selling domestically, neither are they exporting. I studied, identified this problem and presented it to the relevant party. Further studies are needed to design the incentive packages required to transform our policies to the ‘new way’, practically.

This is also required for agriculture, not just manufacturing. Government cannot do much to increase small-scale productivity, besides providing improved inputs. It is the farmer who decides how to produce. The government might march into danger zones, if it tries to increase productivity using other options like GMOs, which are not advisable.

But the government must study why the private sector is not investing in commercial farming while it actively invests in banking. Why would an investor go for a 5pct profit in commercial farms while they could reap 40pct profit in banks? This showcases the faulty approach in capital allocation. The commercial farmer operates in the absence of infrastructure, labor and services. They need more incentives and that calls for better capital allocation policy. The government cannot achieve profit maximization with a short-term campaign. Green revolution cannot be realized through a campaign.

During the industrial revolution of the eighteenth century, labor and capital flew from agriculture to the successful industrial sector. This created shortage of food and inflation. Then the industry became unable to buy agricultural inputs at inflated price. The green revolution took place in 1870 in Europe. They managed to increase agricultural productivity, reduce inflation and transform the industry. India, Pakistan and china also undertook green revolution in order to transform agriculture. Green revolution is critical for Ethiopia in order to increase productivity, transform agriculture and industry, reduce inflation and stabilize the macro-economy. This is achieved only through increasing productivity and profit, not by campaign or price caping.

Profit increases when the growth of productivity is higher than inflation. For instance, if productivity increase by 4pct and inflation by 2pct, profit increases by 2pct. Ethiopia could not achieve this mainly because the import substitution model was wrong. The policies are not competition based.

The main reason business people engage in exports from Ethiopia is because import is profitable. Our research has shown that to be the case. Those people are logical, not looters. They export so they can access foreign currency for their import business. It is wrong but the private sector cannot be blamed for this. The model needs to be revised. This is an area where the central bank fails to balance the government and the private sector. Government can increase productivity, only by maximizing the profit of the private sector. To this end, private sector salary must increase in order to maximize its efficiency. More profitable private sector then pays more taxes. Therefore, there would not be a public servant who worries about what to eat, or how to loot and pay his children’s tuition fee. Banks and Ethiopian airlines employees work hard because they are well-paid.

On the other hand, the public servant is underpaid, less incentivized and inefficient. The public sector must match the growth of the private sector. Private sector growth multiplies when the public servant grows. The growth of the private sector, in turn, generates more tax and finances the public servant. Instead of hiring 50 inefficient public servants, government can hire ten professionals for better salary. Government can increase public sector productivity without increasing its expense. The laid off public servant can find even better jobs in the growing service sector. In other countries, individuals have personal doctors, lawyers and others. As the economy grow, more job opportunities arise; so employment increases. Even the tax offices expand.

Ethiopia’s existing model has created a fast growing private sector and a static public service sector. The public servant turned to looting. The public sector also taught the private sector how to loot. Then both got stuck in it. If the government increases public servant salary under the existing model, it will be inflationary because the model is detached from productivity. Salary increment is not an incentive in this model. There are ways to reform the private sector without causing inflation.

Devaluation and better exchange rate regime could also have made export more profitable. Higher exchange rate benefits exporters. Depreciation doubles an exporter’s profit. Our policy measures failed to bring the dynamism that East Asian countries used. Market failure means wrong incentive or flow of capital to less necessary sectors. Both absence of incentives and wrong incentives result in market failure. Real developmental states provide everything the private sector lacks, besides bridging market gaps. All this is to maximize private sector profit.

Ethiopia’s problem is not absence of incentives, but providing incentives to the wrong sector and providing them detached from productivity. After provision of incentives, the government needs to check whether that incentive led to more profits in the private sector.

There are effective and inefficient developmental states. Ethiopia has been an inefficient developmental state. That is the reason for our macroeconomic imbalance, wrong balance of payment and high external debt. We had policy inconsistency.

The public sector must be efficient for private sector to be profitable. Government must deploy efficient public servants. This can be achieved by employing professionals, creating the best public servant infrastructure and system. Four professionals can do what ten public servants are currently doing. Production must grow, for tax to grow. If tax grows, the government can hire high quality public servants without causing inflation. That could allow investors start operation in a month’s time, instead of the years it is taking now.

It is the government structure that could not evolve from the communist mentality, not the population or the private sector. The private sector always looks for profit. This is why we see looting and corrupt practices in the private sector. If government always grips, controls and directs the private sector, it is practically a socialist government. It is detached from the private sector and the model. A government that does not increase public servant salary is socialist. All in all, there is a strong presence of state socialism in Ethiopia’s government. That is why the effort to create developmental state model failed. Even our import substitution model, existing tax system and many policies are old socialist policies. I have doubts that we understood developmental state model exactly. Even our economists have grey areas. They say exchange rate has no role to improve export. But they cannot explain how.

Socialist thinking also dominated academics. That is why our gross thinking pattern is inconsistent. Socialism has such inconsistency. Socialism says ‘for each as its demand.’ This means human beings have programmed demand. It does not recognize the need for profit. Human nature is incentive based, not static. People send their kids to school so the kid becomes professional and generates income, not because they want him to serve his country. A family that adheres to the latter must be highly spiritual or considerably nationalist.

Ethiopia’s public sector also failed after numerous reform efforts mainly because it is fundamentally socialist. You can deploy BPR, BSC or whatever public reforms we have around but people cannot change and become efficient without incentive. Socialism is a non-incentive ideology. Ethiopians love to work for their country. If that thinking was to be backed by incentives, there could be tremendous effort outflow. The incentive should also not make people materialists. Religious institutions could also contribute to efforts to decrease corruption. You can teach religious dogma day and night. But when they go home, people only see their hungry babies. But there are many potentials to change this.

Ethiopia is a secret, in economy as well as in all other aspects. If we can wisely use the potentials, it can exceed other countries. Otherwise, it turns out to be a failure. So, our model and approach determine a lot of things. Ethiopia needs its own model and that model needs all rounded researches to be conducted first. We cannot copy from any country because we have unique features in all aspects.

9th Year • July 1 – July 15 2020 • No. 88

Yohannes Ayalew (PhD)

served as Chief Economist of the National Bank of Ethiopia for over two decades. Currently, he is the Director of the Ethiopian Development Research Institute.

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