“When Confidence in the Government is Lost, Price Hikes Become Normal.”

Atnafu Gebremeskel (PhD), is an Assistant Professor of economics at Addis Ababa University and an executive member of the Ethiopian Economics Association. In December 2020, he published a study entitled “Inflation Dynamics and Macroeconomic Stability in Ethiopia” in which he identified key sources of inflationary pressure in Ethiopia through the analysis of commodity price changes observed between 1997 and 2020. It became a timely reference and antidote as inflammatory inflation breaks loose since January.
Atnafu argues the actual permanent inflation rate in Ethiopia during the study time was 38.9Pct, driven by expansionary monetary phenomenon, though government has been underreporting inflation at 15Pct annual average. This problem of denial is keeping the solution at bay. Apart from the persistent as well as immediate causes, Atnafu stresses market responds by increasing price, whenever ineffective government is in charge. EBR sat down with the leading expert on Ethiopia’s inflation dynamism, conversing on his findings and its ramifications towards stabilizing current price hikes.

What are the immediate causes to the price hikes of the last few months?
The recent ascent of prices can be attributed to numerous factors. The shortage of wheat—the major input for bakeries—is one. Instability and conflict in the northern and western parts of Ethiopia have also prohibited the free movement of goods and people. Various industries, especially food processers, have been closed due to this reason. Others are operating under capacity. The foreign currency shortage has created additional problems.

The lifting of fuel subsidies and subsequent upsurge of fuel prices is another contributing factor. The effect of the increment was transmitted to other areas and industries beyond the transport sector as commodities have to be transported from one part of the country to another.

Uncertainty is another factor for the escalating inflation of recent months. There is a lack of trust between the government and public; people have lost confidence in the government. When there is a loss of confidence in the government and its inefficient regulatory capacity, market distortion and price hikes become normal.

Do you think it is the right time for the government to lift subsidies and increase fuel prices?
Ethiopia cannot achieve much for long by subsidizing food and fuel. The science supports the lifting of subsidies when the economy is stable. But it is unreasonable to do this when the price of every basic commodity is increasing steadily. Price hikes in the transport sector affect every villager in the country. Goods have to travel. When transport costs increase, all goods and services become more expensive. Fuel price growth automatically affects every item. So, it was not the right time to lift the subsidy.

At the same time, I understand the pressure from the International Monetary Fund (IMF) and other western institutions to lift subsidies and open up the market. They do so because it is in their best interest, not ours. Once government starts to obey them, you have lost your policy independence.

What about the long-term dynamics of accelerating inflation?
Historically, the Ethiopian economy was not inflationary until 2004. After the 2005 national elections, there was conflict and mass killings. Due to this, western governments refused to provide previously-afforded financial assistance. Thus, the incumbent had to raise resources domestically for huge investments in infrastructure and other projects in order to restore public support. As such, government decided to finance projects by borrowing from domestic sources. When I say borrowing internally, it is to mean printing money. Printing money is problematic if not used towards productive sectors.

Due to the massive increase in money supply financed primarily through printing, inflation more than doubled during post-2005. Since then, it increased by 15Pct annually, on average. This figure is given by the government. My research indicates that the annual average inflation rate reached as high as 39Pct.

Since the great depression, governments have been injecting huge monies to initiate growth. Why did the same method fail to bring change and increase productivity in Ethiopia?
The same policy does not always work in all places. This theory, developed by John Mayard Keynes, only works to increase aggregate demand. For instance, after the great depression, aggregate demand declined dramatically because the financial system collapsed. Under such circumstances, the method can be an effective instrument. Government can invest in projects that can create job opportunities and increase income. These, in turn, induce demand and thus encourage producers.

The same policy cannot apply to Ethiopia because demand has never been a problem. Rather, supply shortages are the problem. Another reason for the failure is that the government tried to initiate growth by injecting money under a highly corrupted institutional system filled with nepotism.

How do low productivity and supply shortages affect the problem?
Of course, the low competitiveness level of the Ethiopian economy is another major cause for unhealthy inflation. Ethiopia’s competitiveness in sectors like agriculture, industry, and service is very low. The 2019 World Bank Competitiveness Report ranked Ethiopia 126th out of 141 countries.
My research reveals capacity utilization in Ethiopian industries is only at 60Pct, meaning our cost of production is 40Pct higher than the rest of the world.

Can Ethiopia improve productivity by expanding access to finance?
Expanding access to finance is only part of the solution. Investing in Ethiopia today is difficult. There are many institutional problems and hurdles. For instance, investors cannot access land. So, improving access to finance alone cannot improve productivity under current circumstances.

Which cities in Ethiopia are affected more by inflation?
Addis Ababa, Dire Dawa, and Mekelle are highly prone. Addis Ababa is very volatile because an additional 3,000 people migrate to the city daily from rural areas. This means demand increases by the same level every day while supply remains constant. Addis Ababa is suffering a lot because of this.

What are the costs of inflation for society and the nation as a whole?
For the last two decades, the average inflation rate has been 38.9Pct. This is confirmed via data calculations from the Central Statistics Agency, National Bank of Ethiopia, and the Ministry of Finance. It is also equal to the rate of inflation required to maintain the 11Pct GDP growth Ethiopia achieved over the last fifteen years.
The 38.9Pct core inflation correlates to the welfare of the public declining by the same amount. In other terms, their purchasing power has been dropping by 38.9Pct year upon year. In layman terms, a product purchased with ETB100 last year now costs ETB139.

Due to high inflation rates, the welfare of retirees, pensioners, and others with fixed incomes has declined dramatically during the last 15 years. In monetary terms, the average annual welfare loss to these people is ETB22 billion. Economists call this welfare loss inflation tax.
My research indicates that when there was high inflation, government effectiveness was very low. The real economic sector also becomes unproductive.

Can we relate current price hikes with the political system administering the country?
Politicians and government officials use the central bank to manipulate money supply, particularly during election times. Scientific studies confirm, though not always true, that when the central bank is independent from government, inflation will be at normal levels. When the central bank is not pressurized by politics, the economy becomes stable.

Do you think government understands the root causes as well as the extent of the problem?
As per my experiences, there is a problem of denial from the government’s side. When the government does not recognize the severity and speed of the predicament, the problem will be prolonged and everybody will continue to suffer more.

Is it possible to stabilize inflation by reducing money circulating in the economy?
Reducing circulating money is only part of the solution.

What are other employable actions to stabilize inflation?
The immediate action that should be taken is ensuring political stability. Political stability affords the government credibility and power of enforcement. If the political environment is stable, the government becomes trustworthy. Businesses, academicians, and the general public will have trust in the government. As a result, rules are better applied. This should be the priority for the current administration.

The next action should be utilizing already installed capacities. The scarce resources we have must be widely allocated. For instance, Ethiopia does not need to invest and develop industrial parks at this time. We must exhaustively utilize the installed capacity first. The industrial parks operating in the country at this moment are working below capacity.
Strict coordination between monetary and fiscal policies also needs attention. It seems that institutions tasked with implementing monetary and fiscal policies work towards different goals.

Do you believe the country has an efficient monitoring capacity allowing the identification of macroeconomic problems like inflation before they cause too much damage?
No. To make this happen, the country needs an independent central bank. We need an operationally independent central bank with a strong and credible research department to monitor macroeconomic problems in depth as well as guide and manage monetary policy instruments to achieve price stability and accelerate growth.

The central bank is a public entity created based on a social contract. It should address the public’s demand. For this to happen, it should be independent enough to select and implement its own monetary policy, interest rates, and credit levels. This helps the central bank maintain inflation at a reasonable level. EBR

9th Year • Mar 16 – Apr 15 2021 • No. 96