To Graduate or Not?

Ethiopia’s Race to Middle Income

Middle-income countries are nations with a per-capita gross national income between USD1,036 and 12,615. Nations with lower per capita income than this are classified as low-income countries. This group – least developed countries (LDCs) – comprises 48 vulnerable countries including Ethiopia.
With a per capita income of around USD100 for much of the period before 2000, Ethiopia plans to become a lower middle-income country by 2025. In tandem with that, the country has been investing hugely in infrastructures and provision of basic social services.
The result has been robust as the country achieved double-digit economic growth for over a decade. Per capita income reached USD794 in June 2016. According to the WHO, life expectancy also reached to 64.8 years in 2015 from 47 in 1991. These astonishing performances compel many to believe that the country will achieve a middle-income status in nine years.
However, a recent UN report says Ethiopia will not graduate from LDCs list by 2025. EBR’s Ashenafi Endale delved into the details of this delicate issue by refereing research findings and consulting experts as well as government officials to offer this report.

Policymakers in Ethiopia proudly speak about the double-digit economic growth the country has been registering since 2004 as a silver bullet for the country’s aspiration to attain middle-income status by 2025. The dream seems very likely to materialise as per capita income, which is one of the indicators of middle-income status, doubled in the past five years alone, reaching USD794 in June 2016.
Yet, the ‘extraordinary achievement’, hasn’t win the minds of experts at the helm of the United Nations Conference on Trade and Development (UNCTAD), a body that works to maximise trade and investment opportunities for developing countries while helping them prepare for and face economic challenges .
The UNCTAD, which released its flagship report “Least Developed Countries Report 2016: The Path to Graduation and Beyond” last December, announced that Ethiopia is not one of the 16 Least Developing Countries (LDCs) forecasted to graduate to middle-income status between 2017 and 2024.
Ethiopia isn’t the only country to meet this fate. Some Sub-Saharan African countries that have experienced robust growth such as Rwanda, Tanzania, Zambia and Uganda are not included in the list of countries expected to attain middle-income status. However, Ethiopia’s exclusion was a less justified conclusion especially for people who have been following up the country’s fast growth narrative since 2004.
The report also confused officials at the National Planning Commission (NPC), an institution responsible for planning national priorities and directing the course of national development in Ethiopia. “If we see the growth of Ethiopia’s gross domestic product (GDP) in the past decade it shows that the country will attain middle-income status in 2025,” says Temesgen Walelign, Director of Follow-up and Evaluation at the NPC. “This shows that the projection of UNCTAD is wrong.”
Surprisingly, except Bangladesh, which has a population over 150 million, the majority of the countries forecasted to join the middle-income category between 2017 and 2024 are small countries in economic and population size as compared to Ethiopia. For instance, Kiribati, Vanuatu, Solomon Islands and Djibouti have population less than 1 million and less than USD2 billion GDP, which is 30 times lower than that of Ethiopia’s.
However, Taffere Tesfachew (PhD), former Director of the Division for Africa, Least Developed Countries, and Special Programmes at UNCTAD, says the fact that these countries are small in terms of population and economy gives them an advantage: “In these countries, changes in few economic and social indicators, like sudden increase in financial assistance or a major foreign direct investment can boost their economy massively.” Taffere is one of the experts who prepared the latest report, and retired six months ago, after 27 years of service at UNCTAD.
‘Graduation’ is the transition of a developing country from the low-income category to the lower middle-income category. This happens after meeting UNCTAD’s criteria and ensuring post-graduation economic sustainability. UNCTAD has three main criteria for graduation: gross national income (GNI) per capita income, Human Asset Index (HAI) and Economic Vulnerability Index (EVI).
An LDC needs to meet the eligibility thresholds three years before graduation. In fact, graduation has a higher threshold than eligibility. Under the GNI per capital criteria, for instance, a country must meet the USD1,035 GNI per capita thresholds, to be considered for graduation, while the graduation threshold reach up to USD1,242.
According to official data obtained from the NPC, Ethiopia’s GDP has grown from USD7.3 billion in 1991 to USD61.54 billion in 2015. Similarly, GDP per capita income increased from USD377 in June 2010 to USD794 in June 2016. “If the pace of economic growth continues, Ethiopia will fulfil the threshold by [2025],” argues Temesgen.
The country’s rapid growth is due largely to public investment, in infrastructure, skill formation, institution building, and agricultural productivity, which are all necessary ingredients for building the productive capacity of the country and initiate industrialisation, with a particular focus on manufacturing.
Temesgen argues that GNI per capita income is a controversial criterion because it measures average income increment even if there is a large ratio of poor people in the country. He argues that the main point should be creating a better living standard for everyone.
In addition to GNI per capita income, a country needs to meet the HAI and EVI criterion. The Percentage of population undernourished, under-five mortality rate, gross secondary enrolment ratio, and adult literacy ratio are elements used to calculate HAI. The minimum HAI threshold for consideration is scoring 60 points, while graduation requires meeting 66 points. According to the UNCTAD report, Ethiopia’s score is 39.2 points.
“Ethiopia has achieved much in the health sector, even meeting some of the deliverables before the deadline set for the Millennium Development Goals (MDGs). However, there are areas the country is far behind others. Mothers’ mortality rate and undernourishment remain high,” says an officials at the Ministry of Health (MoH).
Under-five mortality rate per 1,000 live births decreased from 205 in 1990 to 59 in 2015, while maternal mortality per 100,000 people reduced from 1,400 to 535 over the same period, according to data obtained from MoH.
Workneh Tafa, director of Public Relations at the Ministry of Education (MoE) also explains the success registered in the sector. “[Ethiopia] has already achieved MDGs enrolment targets, but a lot remains to be done on improving quality of education,” he said.
The number of pupils in schools was 6.25 million in June 1999; that figure reached 25 million as of June 2016. This has helped in improving literacy rate from 16.9Pct in 1996 to 46.7Pct after 15 years. The number of secondary school students has jumped from 416,082 in 1991 to 2.4 million in June 2016. The first cycle secondary school enrolment increased from 39.7Pct in 2009 to 40.5Pct in June 2015.
Ethiopia’s budget allocation to pro-poor sectors such as education and health also increased from 43Pct of the total annual budget in 2001/02 to over 65Pct last year. In fact, it was close to 70Pct for many years prior to 2015.
The third criteria, which is the EVI also has sub-criterion such as remoteness, population size, merchandise export concentration, and share of agriculture, forestry, and fishery in GDP. It also takes into consideration the population living in low-lying coastal zones, victims of natural disasters, instability of agricultural production and exports of goods and services.
Remoteness measures a given country’s distance from world markets, high transport cost and isolation, which affects performance on international trade. Export instability and highly variable export earnings cause fluctuation in production, employment and foreign currency, with negative effect on sustainable economic growth as well as development, according to the UNCTAD report. High variability of agricultural production indicates high vulnerability to natural shocks including drought and disturbance in rainfall patterns.
The upper bound for percentage of share of agriculture in GDP is 60Pct. The share of victims to natural disasters should be lower than 10Pct of total population. Overall, EVI must be less than 32 points, in order to be considered for graduation.
In Ethiopia, head count poverty rate fell from 49Pct in 1990 to 22.5Pct in 2015. Improvement in agricultural productivity contributed to poverty reduction in rural areas significantly. Recently, the government extended productive safety net programme to urban areas. The coverage aims to reduce absolute poverty in cities and towns.
However, according to the report, poverty is more prevalent in economies dominated by agriculture, forestry and fishery. More than 80Pct of Ethiopia’s population depend on agriculture.
The GDP growth during the first phase of the Growth and Transformation Plan (GTP I) period was achieved because of the growth of agriculture, industry and service sector by 6.6Pct, 20.2Pct and 10.8Pct, annually on average, respectively. The share of agriculture, industry and service sectors stood at 38.5Pct, 15.1Pct, and 46.3Pct, respectively, in June 2015 while the share of manufacturing to GDP remained 5Pct during the period, which is lower than the Sub Saharan average.
For the country to be ready for graduation, the share of agriculture to GDP should decline to 29.2Pct by 2025, while industry expected to rise faster to 22.3Pct. The share of service sector should slightly decline to 44.3Pct by 2025, which requires fundamental gearshift in the economy in the eight years left.
Ethiopia planned to improve earning from export of merchandise goods from USD2 billion in June 2010 to USD6.5 billion in June 2015. However, the country earned not more thanUSD3 billion by the end of GTP I period. In fact, the past three years showed negative growth in export earnings due to falling commodity prices in the global market, among other reasons. However, the merchandise import bill reached well over USD15 billion in June 2015, further exacerbating the already negative balance of payment.
Although agricultural production increased from 22 million quintals in 1981 to 270.3 million quintals in 2014/15, over ten million people were affected by the drought last year. This makes the share of victims to natural disasters to the total population to be well over 10Pct, the maximum threshold set by UNCTAD.
Although Ethiopia has a lot more to do to attain its goal, Temesgen argues that if the economic growth continues in the coming nine years, Ethiopia will definitely meet the required criteria for graduation from the LDCs category. “This view is based on the fact that Ethiopia has already passed the graduation threshold for EVI and it is well above the half way mark to fulfil HAI criteria,” he explains. “Meeting these two criteria alone will enable Ethiopia to graduate in addition to maintaining an economic growth rate of 7Pct and above consistently.”
There are three ways to graduate from the list of LDCs. The first is to fulfil the three criteria. The second is through “income only” means. A country graduates from LDC under the “income only” method, if its GNI per capita reaches three times the graduation threshold, which is USD3,100 or more, in this case. In the third route, a country has to meet two of the criteria.
According to UN rules, countries that fulfil these criteria should graduate because they have resources to finance their economic and human development. Although this principle doesn’t apply to Ethiopia, it has helped countries like Angola and Equatorial Guinea, which are expected to graduate within the next three to four years because of massive oil production and export that increased their GNI per capita income to over USD5,600 and USD15,000, respectively. However, neither meets the HAI and EVI criteria.
“With the decline of oil price, Angola has accumulated so much external debt that it may soon rely on IMF’s support to cover public expenditure,” argues Taffere. “In other words, countries like Angola and Equatorial Guinea are graduating because they have oil although they have not yet developed their human asset or diversified their economies.”
Countries such as Vanuatu, Nepal, Afghanistan, Kiribati, Djibouti, and Tuvalu meet the criteria for graduation. However, they decided to stay in the LDCs list because they have not diversified their economies. This means they are not structurally ready to graduate.
The General Assembly decides graduation from the list. This is based on the recommendations of the Committee for Development Policy, which is a subsidiary organ of the United Nations Economic and Social Council. The final decision for graduation, however, is left for the respective countries. In the past, Ghana, Papua New Guinea and Zimbabwe have declined graduation, questioning the accuracy and validity of the data used to calculate their progress. Countries cannot choose to be included into the LDCs category but can choose to leave the LDCs category, if they fulfil the criteria.
During the last 45 years, 25 countries have joined the LDCs list, while only four countries have graduated from the list. Currently, there are 48 LDCs, 34 of which are African. In spite of progress made in some economic areas, poverty remains pervasive, with almost half of the LDCs total population living in extreme poverty.
The international community adopted International Support Measures (ISMs) for LDCs to enable them escape from intersecting vicious circles that prevent their economic growth and derive developmental benefits from the global economy. The support includes grants, low interest and longer time loan payment and grace period, preferential markets, funds for infrastructure, supports through multilateral agencies, bilateral and multilateral donor, funds for LDCs specific programmes, support in research and analysis, scholarships and research grants.
In addition to technical and financial aids, LDCs also get trade preferential margins. However, they face production supply shortages, fails to meet rules of origin-restrictions and product standards.
The recent UNCTAD report questions the effectiveness of existing ISMs. To varying degrees, vague formulations, non-enforceability of commitments, insufficient funding, slow operation, and exogenous developments in international trade and finance undermine ISMs effectiveness. Therefore, the contribution of ISMs to development and graduation critically depends on institutional capacities of each LDCs.
As a result, experts recommend LDCs to strength their domestic resource mobilization effort. This has become more relevant as Official Development Assistance (ODA) has been declining as a number of grant offering countries increasingly engage more on their domestic affairs in their home countries. The worsening refugee crisis in the Middle East and Africa has also diverted ODA.
Ethiopia has been reforming its tax system for more than 15 years. Comprehensive tax reforms started in 2002. The main objective of the reform was to increase revenues with special focus on increasing the share of direct tax contribution to total tax revenues. This was necessary to ensure fiscal sustainability and reduce dependency on foreign trade tax.
Even though the tax to GDP ratio has been far below the Sub-Saharan average, Ethiopia has done fairly a good job in improving domestic resource mobilisations. By improving the tax regime and broadening the tax base, the country has enhanced revenue collection with special focus on increasing the share of direct tax contribution to total tax revenues. This was necessary to ensure fiscal sustainability and reduce dependency on foreign trade tax.
The effort has borne fruits, as tax collection has been consistently growing by more than 20Pct annually since 2004. The country has increased its reliance on domestic resources even to finance mega development projects such as the USD4.8 billion Grand Ethiopian Renaissance Dam, Africa’s biggest hydro-power project with projected capacity of 6,400MW of electricity.
The achievement of Ethiopia in maximising domestic financial resources and provide investment loans especially to the manufacturing sector through institutions like the Development Bank of Ethiopia has received praise in the report UNCTAD released recently. The report suggests that industrial policies need to support emerging activities but not promote rent seeking behaviours.
Taffere believes that the role of industrial parks, which the government has been constructing, will be critical in the implementation of structural economic transformation. “Industrial parks provide [better] support and conditions investors need to [start production] without much delay. It helps to improve quantity and quality of goods for export,” he stresses. “The establishment of higher learning institutions as well as sector-focused institutions and the coming of major public investment projects such as hydropower dams, the Ethiopia-Djibouti modern railway, all these show that the country is even more ready now than ever before for an economic take-off.”
“Given the current development trend, Ethiopia is on course for graduation within the next ten years,” hopes Taffere who stresses the need to stay focused on sustaining the current momentum of economic growth and transformation.
Temesgen says a genuine structural transformation requires shifting capital and labour resources from traditional to modern activities; from agriculture to manufacturing; from low-value to high-value production and from low-productivity to high-productivity sectors. “Not many African countries are moving in this direction but Ethiopia has already begun initiating the process,” he argues. “If Ethiopia achieves the high-level growth rate planned in the [GTP II and subsequent GTP III] there is no reason why the country should not graduate to middle-income status by 2025.” EBR