ABSTRACT

The Ethiopian economy is in the midst of a

financial and economic crisis that threatens to
derail and reverse the dramatic economic growth
and development it has achieved over the last 15
THE ETHIOPIAN ECONOMY – years.

AT A CROSS ROAD Author

Ermyas Amelga
APRIL-2018
 Ethiopian Economy 2018 - AT A CROSS ROAD

Overview

The Ethiopian economy is in the midst of a financial and economic crisis that
threatens to derail and reverse the dramatic economic growth and development it
has achieved over the last 15 years.

While the entire nation has been distracted and preoccupied with the political
situation, the economy has deteriorated to a point of collapse. It is displaying all the
symptoms of a grossly out of equilibrium and deteriorating economy. These include
acute and chronic foreign exchange shortages, high and accelerating inflation and
declining economic activity.

The shortage of foreign exchange, in particular, has reached a point where it is

suffocating the economy. Large numbers of people are suffering due to the
unavailability of such critical items as blood pressure and diabetes medication.
Businesses and factories are closing due to an inability to open LCs and import raw
materials. Construction is at a standstill due to the lack of imported rebar for
construction. The currency black market premium has increased from a historical
average of around 10% to a historic high of 25%. Loan delinquencies and write-offs
in the banking sector have reached an alarming level and banks may report
operating losses for the first time in the industry’s history. Inflation is already out of
control and accelerating. Employment in the non-state sector is shrinking.
government coffers are empty. Debt repayments are being missed even by such
state owned institutions as the power and telecom companies. Government
projects have come to a dead halt. Even the Chines have cut back further lending.

The imbalances have reached a tipping point where economic activity across all
sectors of the economy has stalled. At the same time, inflation in the economy has
remerged at an alarming and accelerating rate. We have stagflation. It is among
the most problematic of economic problems to resolve as the policy prescriptions to
address one exacerbate the other, thereby, driving the economy into a circular
recessionary cycle.

It is clear that current economic policies need broad and comprehensive

adjustment urgently. Whether it’s the reforms suggested below or some other
prescription, change must be made.

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This crisis is the culmination of an extended period of structurally unbalanced and

distorted economic policies. The current financial crisis was foreseeable and there
is a distinct possibility that it may lead to a generalized economic crisis from which
recovery will be long and difficult. The 2012 annual Macroeconomic Review
published by Access Capital Research predicted the economy would face such al
crisis. The financial resources required to fund GTP-1&2 were simply not in place
and there was no indication of where such funding would come from.

The Grand Renaissance Dam (“GRD”) is an extreme indicator of this failure in

financial planning. At an initial project cost estimate of over $4 billion (almost 10%
of GDP at launch date), it’s massive. It was publicly and widely acknowledged that
there was no financial plan in place for this mega project. The very fact that there
was no financial plan was turned into a national point of honor, a test of national
pride for which any sacrifice would be paid by all. The dam’s construction is inching
along with public employees, the military, factory workers even shoe shine boys all
being implored to contribute their “share” to building this national monument.
Granted, an extreme example but indicative of a mindset.

Give the massive scale of the investment capital required and the equally daunting
and well known implementation capacity gaps of the state, the failure to have a
financial plan is inexplicable.

By chance, as GTP-1 got underway eight years ago, a variety of favorable internal
and external conditions coalesced into a receptive developing country debt market
that was particularly keen on Africa and its Rising Lions. Ethiopia was at the top of
the list of Rising Lions and was able to borrow freely and especially so from China.
It even managed to issue a billion dollar Eurobond under these favorable
conditions. GTP-1&2 ended up being fueled by large amounts of foreign debt.

The success of such a debt-fueled strategy is contingent on its sustainability. Its

sustainability is, in turn, contingent on the many large scale investment projects
undertaken being able to reach completion and generate returns on a timely basis
so as to be able to service the debt and maintain acceptable levels of debt
sustainability so as to be able to keep borrowing and investing.

Furthermore, the economic transformation of the economy to an export oriented

manufacturing economy that can generate adequate supplies of foreign exchange
to service the debt is a must.

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Unfortunately, this structural transformation has failed to emerge in Ethiopia. The

large sums of money invested in such state affiliated entities as Metec, the
Ethiopian Sugar Corporation, Industrial Parks, etc. have failed to generate the
required returns to maintain the economy’s debt sustainability standing. Ethiopia’s
national debt has ballooned to worrisome levels and its ability to service this debt
and keep borrowing is now substantially compromised at a time when continued
growth requires continuing high investment to GDP ratios (25%+). In addition, the
economy has developed chronic structural imbalances that are distortive and
disruptive of normal economic activity.

Corrective policy measures are urgently needed to restore economic activity and
balance. Fiscal and monetary policy cannot be restrictive but we must manage
inflation and the current account balance. The economy needs a large (non-debt)
foreign currency infusion and a liberalization of the exchange rate regime to a
managed float (it can be done). The large sunk costs in projects underway must be
salvaged. The collapse in aggregate demand caused by the collapse in public and
private investment must be reversed. We are facing stagflation in a poor
underdeveloped debt burdened economy. Seems like mission impossible but its
not.

Fortunately, in Ethiopia’s case, there is a viable path out of this mess. Privatization,
even if only partially, of a few large state owned enterprises (“SOE’s”) can finance
all of the GTP objectives.

Privatization will not just solve the GTP’s financing problem, a worthy enough
accomplishment in its self, but would also help address macroeconomic problems.
These include funding/driving aggregate demand, financing aggregate investment,
solving the foreign exchange shortage, rebalancing the balance of payments,
dampening inflation and reviving general economic activity. May seem improbable
but its not.

In the context of the huge financing needs to fulfill the plans under the GTP,
privatization represents an excellent means of cashing out on the accumulated net
worth of Ethiopia’s SOE’s. Indeed, there is arguably no more justifiable use of this
accumulated net worth than spending it on the GTP that the government itself
believes is worthy of supreme sacrifice from all corners of society.

We need look no further then the debt fueled booms and busts witnessed in Latin
America in the 1970’s and ‘80’s to see what the alternative is. It took Latin
American countries decades to recover.

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I will review the theoretical foundations of GTP-1&2 and examine the shortcomings
in strategy and policy that that have brought the economy to this point. From there,
I suggest a package of reform measures that would be appropriate in response.

What is Ethiopia’s Economic Development Strategy?

Every economy in the world started its journey of growth and development from
poverty. Underdeveloped economies such as Ethiopia’s are characterized
by backwardness and poor utilization of resources.

One of the major general development strategies for underdeveloped economies is

the "Big Push" or "Developmental State" strategy. According to this development
model, the biggest task of an under developed economy is to break out of a
"Poverty Trap" or vicious circle of poverty that all economies face in the beginning.
It postulates that only when this poverty trap is broken can the economy grow and
develop and that coordinated heavy investments in different sectors are needed to
push the economy into a virtuous development cycle.

Prime Minister Meles was a believer in the Big Push or Developmental State
strategy and it is the framework for Ethiopia's ongoing "Growth and
Transformation" plan.

The theory is based on the role of investment and industrialization in an economy

and on the assumption that an industrial economy enjoys many external
economies (1 + 1 = 3). To enjoy these economies, a massive investment is
necessary in the development of several industries at the same time. The theory
envisages the need for investment across different channels of growth so that each
channel sustains the growth of others by providing the necessary demand-base.
This, results in balanced and sustainable growth.

The theory stresses the need for planned industrialization of under developed
economies where backward and poverty riddled agriculture is the dominant sector.
The state takes the lead in creating high levels of aggregate demand in the
economy by financing and undertaking a high minimum quantum of investment in
infrastructure and interdependent industries to enlarge the size of the market. This
economic takeoff is analogous to a large jumbo jet taking off. It requires a minimum
speed and velocity to liftoff.

To finance the required level of investment for the Big Push, under-developed
economies must increase their national savings rates and also have an efficient
mechanism for sustainably, efficiently and optimally collecting savings and

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channeling investment. Either a well-developed financial infrastructure or an

effective alternative (state directed financial system) is a must. Ethiopia doesn’t
have either.

Regardless of the specific development strategy adopted, successful economic

growth and development requires three fundamental pillars.

1. Hard Infrastructure (roads, power, water);

2. Soft Infrastructure (education, health, public services, legal system, etc.);
3. Financial Infrastructure (the institutions, information, technologies and rules
which enable efficient financial intermediation and capital allocation).

Ethiopia has done an exemplary job in building hard infrastructure; a below

average job on soft Infrastructure and almost nothing in building financial
Infrastructure. This failure to build the country's financial Infrastructure or otherwise
adequately manage the economy’s financial flows fundamentally undermines the
strength and sustainability of Ethiopia's economic growth and development. It is the
Achilles heel of the economy and (in addition to the poor financial planning) one of
the root causes of the current financial crises.

This failure also undermines the important objective of making the economic
growth pro-poor. There is large body of evidence that shows that financial sector
development is an integral and indispensable imperative for sustainable economic
growth, development and poverty reduction. Financial Infrastructure increases the
savings rate and the availability of savings for investment. It facilitates and
encourages inflows of foreign capital and optimizes the allocation of capital
between competing uses.

Financial sector development further boosts long-run economic growth and

transformation through its positive impact on capital accumulation and on the rate
of technological progress. In addition, though the scale may be different, access to
financial services can reduce poverty through the same channels that affect overall
growth by increasing investment and productivity resulting in greater income
generation, and by facilitating risk management thus reducing vulnerability to
shocks.

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However, the poor in Ethiopia often do not have access to ongoing, formal financial
services, and are forced to rely instead on a narrow range of often risky and
expensive, informal services. This constrains their ability to participate fully in
markets, to increase their incomes and to contribute to economic growth.

Semi-formal channels such as micro-finance institutions play a role in providing

financial services to the poor, as do institutions such as postal banks, development
banks and credit unions. But all these institutions are reaching only a minority of
the bankable population. So a widening of financial services provision by private
sector institutions in the formal financial sector is necessary to tackle this problem
on an adequate scale.

What is Ethiopia’s Financial Sector Strategy?

Financial infrastructure is the brain, heart and circulatory system of an economy

and the lack of financial infrastructure (or an effective alternative mechanism for
mobilizing savings and channeling investment) is a fatal risk to sustainable
economic growth. The conscious and deliberate failure to include the building of
market based financial infrastructure as a key pillar of its development model is
rooted in the theory of market failures that are deemed to exist in in all sectors of
developing economies but particularly more so in the financial sector.

In the words of Prime Minister Meles, “The continent is trapped in a low lending-low
savings trap. Interest rate spreads and real interest rates have become very high
effectively pricing productive investment out. There is excess liquidity in countries
that have extreme scarcity of capital. Banks have no interest in actively mobilizing
savings and are at times turning savers away in countries where savings are very
low any way. The financial sector has completely failed in its task of financial
intermediation.

The neo-liberal paradigm is unable to recognize the fundamental market failures in

the sector that can only be overcome through effective government intervention. It
is unable to overcome its dogma of leaving the markets alone even when they don't
work well. It is unable to lead Africa's financial sector out of the dead end that it has
reached during the reform period.

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The reforms have not only failed in bringing about efficient financial intermediation
and have reached a dead end in this regard but have also failed to overcome rent
seeking in the financial market. The main actor in rent seeking in the sector is no
longer the state as state. The main actor is the private sector, although of course in
Africa with so much “straddling” it is not always easy to identify where the one
begins and the other ends. By narrowly focusing on rent seeking by the state it has
in effect opened widely the door for private sector rent seeking. By limiting the
effort of reducing rent seeking activity to reducing the role of government in the
economy, it has left the other aspect of rent seeking, the private sector aspect
almost intact.

Of all the variants of the neo-classical school of thought, the Washington

consensus was perhaps better placed to understand the pervasive market failures
in the financial sector, particularly in developing countries and even more
particularly in Africa. Its analysis of East Asian experience could not have been
clearer in recognizing these failures. But it came to the conclusion that government
failure was worse than market failure, and that markets however imperfect will in
the end muddle through. Letting markets be may not produce spectacular results
when they are imperfect, but they will at least bring about adequate growth, it was
argued.

Practice has shown that market failures are as bad as government failures and
both have led to a dead end. The predatory state and its “statist” policies, and the
Washington consensus have in their own different ways ended up by leading the
financial sector in Africa into dead ends. One dead end is as bad as the other. It
appears both approaches have to be scrapped if the financial sector in Africa is to
get out of these dead-ends.”

The Prime Minister’s views on financial sector strategy are very clear.

The alternative to letting market forces drive financial sector development is to

have the state replace market forces in directing capital allocation and investment
activities. Unfortunately, the Ethiopian experience with a state led financial sector
strategy has been miserable.

So the question becomes which is worse… the potential failures of the market or
the ongoing failures of the state?

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What to do?

Market forces within the context of state oversight, must be introduced and allowed
to guide the allocation of resources in the economy and rebalance the country’s
trade and current account imbalances. A large non-debt infusion of foreign
currency must be sourced to kick-start economic activity from which base the
appropriate set of market based and state coordinated policy reforms can kick-in
and sustain growth.

The strategy to address the immediate and serious threat to the economy arising
from the foreign exchange crisis is to liberalize the exchange rate regime by
moving to a managed float of the Birr as outlined below.

Economic theory is clear that a managed devaluation of the real effective exchange
rate should help reduce the costs of the required balance of payments adjustment
by shifting demand from imports to domestically produced goods and by
encouraging exports. And, although it may take some time to establish new export
capacities, the balance of payments improvement will be immediate (through
increased inflows from such sources as remittances, reduced export revenue
leakages, etc.).

For countries such as Ethiopia that are mostly price takers on world markets, a
depreciation should improve the current account balance by reducing imports.

A Recent Case Study - Egypt

The most recent and relevant example of successful foreign exchange

liberalization in Africa occurred In August 2016. Egypt reached an agreement with
the International Monetary Fund (IMF) to obtain a $12 billion loan to support the
three-year economic reform program. The liberalization of the exchange rate in
November 2016 had an immediate positive impact on the Egyptian economy and
sparked the economy’s recovery. The black market premium was substantially
eliminated, the price of the dollar fell and Egypt's reserve of hard currency rose.
Egypt's foreign reserves rose by about $ 18 billion in 14 months to $37 billion at the
end of December 2017 from $9 billion at the end of October 2016. Foreign
exchange shortages were eliminated and the economy was revitalized.

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Can Ethiopia Replicate the Egyptian Experience?

To answer this question, lets first look at what would be required to do so? What is
required is a hard currency war chest of approximately $6 billion to absorb the
initial currency demand surge from multiple sources that will accompany the
liberalization of the foreign exchange regime.

Privatization, even partially, of some of Ethiopia’s largest state- owned enterprises

(SOE’s) could generate this financing and more. As can be seen in the attached
Annex 1, the initial funding requirement to address the foreign exchange crisis,
resuscitate the economy and re-launch it on a self sustaining growth trajectory
(along with the appropriate policy reforms indicated) is approximately USD 4 billion
in year one and USD 2 billion in year two. Even the partial privatization of just
Ethiopian Telecom would be adequate to cover these amounts.

Privatization will not just solve the GTP’s financing problem, a worthy enough
accomplishment in it’s self, but would also help address three chronic
macroeconomic problems. Inflation, the suffocating foreign exchange crisis and the
unduly tight squeeze on credit to the private sector.

In the context of huge financing needs to fulfill the plans under the GTP,
privatization represents an excellent means of cashing out on the accumulated net
worth of Ethiopia’s SOE’s. Indeed, there is arguably no more justifiable use of this
accumulated net worth than spending it on the GTP that the government itself
believes is worthy of supreme sacrifice from all corners of society.

What Assets Does the Ethiopian State Own?

Ethiopia is somewhat unique in Africa in having an incredibly vast asset base of

over one hundred state-owned companies built up over a period of many decades.
This asset base was largely built up in prior governments, either through
nationalization of previously private properties or as green-field projects
established in the context of a socialist-oriented economic regime.

In an indication of the reach and breadth of the government‘s involvement in the

economy, the asset base of companies under the public sector includes a world
renowned airline, one of the largest commercial banks in Africa, the largest
insurance company in the country, a large shipping company, the telecom
monopoly, chemical industries, various consumer goods factories, cement
factories, metal works factories, hotels and more.

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Most valuable among the state-owned assets are what may be termed the BIG 5
state enterprises which have a particularly impressive operational and financial
record: Ethiopian Airlines, Ethiopian Shipping Lines, Ethiopian Telecom, the
Ethiopian Insurance Corporation, and the Commercial Bank of Ethiopia. These can
be seen as the crown jewels of the SOE’s, consistently showing high growth and
high levels of profitability in recent years.

Exactly How Valuable are the ― BIG 5?

Using standard valuation methodologies and estimated 2018 revenues and profits,
these five companies alone are worth well in excess of USD 30 billion. This figure
does not include dozens of profitable state-owned enterprises beyond the BIG 5
that could generate substantial additional sums.

To take Ethiopian Telecom as an example, its current market value estimate is in

the range of USD 15 to 20 billion. Ethiopian Telecom is now the continent’s largest
mobile operator. With over 57 million mobile subscribers as at November 2017,
Ethiopian Telecom has overtaken MTN Nigeria to become Africa’s largest in terms
of its mobile customer base. In spite of this apparent success, Ethiopian Telecom
has been rated number one of the top-five telecom monopolies in Africa retarding
their national economic growth and development.

Even a partial privatization could potentially not only generate a large foreign
exchange infusion for the economy but also pay the government more in future tax
and dividend revenues than what is earned by retaining the telecom in public
hands.

Beyond the financial benefits, a privatization of Ethiopian Telecom would help

address the poor quality of service and world leading tariffs, which are a major drag
on Ethiopia’s potential economic growth. We are in the information and technology
age and telecoms are the backbone infrastructure for the new economy.

India provides an interesting example of a large poor population that is being lifted
and transformed at amazing speed and scale by a vibrant and competitive
information and communications sector.

Currently, Ethiopia is the North Korea of telecoms regulatory practice but maintains
that its monopoly plays a crucial role in closing the digital divide. In reality, its
equipment and network procurement has been a mess and even with Chinese
loans, it is still serving fewer customers than it might if it were in private hands.
Prices remain high, service poor and market development retarded.

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Privatizing Ethiopian Telecom is as much about a government making a

commitment to having an efficient economy that can be competitive in a digital
world.

Is There Any Reason Why Ethiopia Should Not Privatize its SOE’s?

Given the large sums involved, there are of course alternate viewpoints that would
object to the above prescription to cash out on Ethiopia’s accumulated state
enterprise wealth. Broadly speaking, such dissenting perspectives would tend to
question: (i) the advisability of privatizing state-owned firms that are doing so well;
(ii) the appropriateness of such massive privatization for a developmental state;
and (iii) the loss of policy influence and national priority-setting that may occur
following the privatization of some key sectors. These are addressed in turn, but
none of them are persuasive.

Why Privatize the Best Performers?

The simple answer is that Ethiopia needs cash now and it makes perfect sense to
liquidate the net worth held in long-accumulated assets for something as grand as
ensuring a transformative change in the country‘s economic history. In other words,
it is precisely because the BIG 5 are highly valuable that they deserve to be prime
candidates for privatization. For example, the BIG 5 firms alone could, according to
our calculations, fully finance all of Ethiopia’s mega projects including the Grand
Renaissance Dam.

This Dam is a good example of a mega-project that is actually affordable but

whose key challenges from a financing perspective are that, first, it needs funds
upfront and, second, that it needs funds in foreign exchange. Part of the value of
privatization is precisely in these two vital respects.

In addition to the above, privatizing the best performers need not be seen as a
negative given the possibility of seeing them do even better and, over time, of
generating tax and employment benefits that may exceed the income they would
have generated within the public sector. The case of BGI, a beer factory privatized
is exemplary. Infused with foreign investment and management, it is now among
the country‘s largest taxpayers and employers.

Is Large-Scale Privatization Inconsistent With a Developmental State?

It is certainly the case that many other developmental states have had and still
retain large state enterprise sectors, most notably for example in Vietnam and

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China. And the fast-growth, industrialization, and poverty-reduction success of

such states has indeed taken place with these state enterprises continuing to
operate within large segments of the economy. On the other hand, we should keep
in mind that the trend over the past twenty years in all developmental state led
economies (including China) has been to pursue large-scale privatization.

The economic logic driving privatization worldwide is especially applicable to

Ethiopia, as it stands out from the Asian developmental states in two crucial
respects:

First, Ethiopia does not have a large FDI sector within the economy that is driving
growth in key areas such as manufacturing and exports. The East Asian countries
have large FDI-dominated sectors that have provided large pools of investment
that propelled economy- wide growth and exports even in the presence of large
state enterprises.

Second, Ethiopia simply doesn’t have the savings rates of countries like China or
Vietnam, or for that matter any of the East Asian miracle economies where large
domestic supplies of savings within the banking system offered enough financing
for both state enterprises and a thriving, credit-utilizing private sector.

Privatization (especially targeted at foreign investors) offers a chance to develop a

dynamic FDI sector that can drive manufacturing and exports while at the same
time leaving the banking system‘s supply of loanable funds for a domestic private
sector that also needs to grow and expand.

In addition, for a country such as Ethiopia, it is in any case undesirable to have

very large jumps in saving (and, by necessity, a drop in or restrained growth of
consumption) given the low incomes from which the economy is growing. In short,
a country such as Ethiopia should not rely too strongly on domestic savings as a
source of investment funds, especially when a solution such as privatization is
readily on hand and can provide additional resources for new investments without
depressing consumption.

Why Privatize and Lose Policy Influence?

Given the sheer scope of state enterprise holdings, there is very little substantive
and meaningful loss of policy influence that would result in selling some state
enterprises. There are of course some potentially sensitive cases, such as the
large state-owned bank (CBE) where the ability for policy-directed lending could
conceivably diminish with privatization.

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In such cases, and if public ownership must be retained, there is of course a readily
available middle-ground solution: government can retain majority stakes of 51
percent (with the associated ability to keep majority Board seats and strategy-
setting rights within the enterprises) while selling off the remaining 49 percent to
private foreign/domestic investors.

To summarize, the logic for pursuing an aggressive privatization program makes

sense for the same reasons that large agricultural lands and mining concessions
are being offered to investors. Private investors bring plenty of up-front cash and
expertise to manage specialized activities; the government benefits from
considerable gains through future tax and export revenues; and the public has the
opportunity to benefit from what will be much increased public goods made
possible by higher fiscal resources.

Not Just Money for the GTP

The benefits of privatization extend well beyond just providing funds for the GTP,
though that itself would be a worthy and remarkable accomplishment in itself. Two
other major advantages of privatization are as important, if not more so, than
getting funding for the GTP.

First and foremost, privatization will, if done rightly, offer a cure for inflation.
Inflation in Ethiopia has been linked heavily to a financing problem. The public
sector‘s large financing needs have been met through large credit growth in the
banking system and high levels of direct advances from the Central Bank. If past
patterns continue, the situation will only get worse in the coming years as the
prospective financing requirements will not abate.

Such massive borrowing can be sought from three sources - from the central bank,
commercial banks or from abroad. The first (essentially printing money) is highly
inflationary, the second sucks away bank loans that would have otherwise gone to
the private sector, and the third leads to an accumulation of potentially dangerous
external debt. In short, given the scale of the GTP financing needs and the need to
moderate and even reverse rising debt ratios, government needs funds that can be
secured without any borrowing. Privatization offers precisely such a non-inflationary
and non-indebting source of funds.

In this sense, it can be seen as the magic bullet needed to reach many GTP
targets without having to follow a slower or more moderated strategy as advocated
by some.

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Second, privatization will provide a welcome rebalancing of private-public ratios in

many key areas of the economy. By providing the public sector with funds from
external sources, privatization can potentially reverse years of declining and
stagnant ratios of private credit to GDP.

More broadly, with government divesting its holdings in key areas of the economy,
there would be a healthy rebalancing of ratios such as private investment-to-GDP
and private manufacturing-to-GDP. This would be all the more important since
some new parastatals are already emerging or expanding well beyond their
traditional tasks. The Metals and Engineering Corporation (METEC); the Ethiopian
Sugar Corporation; the Ethiopian Railways Corporation; the Ethiopian Shipping and
Logistics Enterprise; the Ethiopian Grain Trading Enterprise (which has somehow
got itself into large-scale coffee exports though once a domestic cereals trading
firm); and finally a new public sector commodities distributor.

In summary, it is desirable to have not one but two strong engines (both private
and public) driving Ethiopia‘s economy and privatization by attracting foreign
investment, know how, and dynamism in key GTP supported sectors can play a
major part in making this possible. Privatization would also be a cure for the
nations current account deficit, which is driving the foreign currency crisis.

Privatization really may be the magic bullet that can cure the Ethiopian economy.

Privatization Theory and Practice

Privatization has become the normal process by which state-owned enterprises are
converted to market economy players with visible gains for the industry, its
employees and its customers.

As recently as the 1970’s and 80’s even in advanced economies like that of United
Kingdom, the state owned and controlled vast swaths of the economy including the
coal industry, the steel industry, electricity generation, gas supplies, railways,
docks, canals, and trucking. The government owned the telecoms industry, along
with aircraft and shipbuilding, much of car manufacture, North Sea oil, and more.

The overall performance of these industries was characterized by low productivity,

high costs, high prices, bad labor relations, inefficient use of resources and
unsatisfactory service to customers. It was not the quality of the work force that
produced these ills. The nature of state ownership itself was to blame, because
state ownership inescapably produces poor performance.

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The lack of the discipline of the marketplace allows state-owned industries to

perform poorly with impunity. The plain fact is that nationalized industries do not
have to succeed in order to survive, and everyone working in them knows it. The
absence of accountability for performance that would otherwise drive private
industry to innovate, increase productivity and improve efficiency kills motivation
and initiative is dysfunctional. The argument about state versus private ownership
of industry is for all intents and purposes, over. Private ownership has won
because it works and state ownership doesn’t.

In spite of this, governments thinking of moving important industries from the public
to the private sector will confront a number of specific anxieties expressed as
concerns for the national interest. The opponents of privatization will raise fears
about foreign involvement and possible foreign control, about endangered
revenues and strategic supplies, about the survival of uneconomic but socially
necessary services. The list will be long, and most of the issues raised will be
perfectly legitimate matters for a responsible government to worry about.

The mistake made by those who raise these fears as obstacles to privatization,
however, is in assuming state ownership to be the only remedy. It is entirely
possible for a government to protect and defend any aspect of any industry without
owning it, either through provisions in the privatization legislation or simply through
the use of normal government powers.

Revenue is an obvious example. Government does not need to own a successful

industry for the nation as a whole to benefit. Taxing its profits is an even more
effective and expedient, especially since state ownership can make those profits
disappear.

A government that correctly decides it is inappropriate to own a particular industry

has in no way abdicated its responsibilities as guardian of the public interest.
Governments make and enforce the laws within which free societies operate, and
this, not ownership, is government’s proper role.

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 Ethiopian Economy 2018 - AT A CROSS ROAD

Appropriate Additional Reforms

Build financial infrastructure to mobilize local and international savings:

 Stock Exchange
 Venture capital
 Private equity
 Investment banks
 Commercial banking – allow foreign banks and address National Bank’s
capacity constraints
 Build national electronic payment system
 Modernize insurance industry; allow foreign insurance companies

Develop strategies for mobilization of diaspora and “other” remittances and

investment flows:

 Eliminate the black/parallel FX market rate differential by liberalizing the

exchange rate regime as outlined above
 Enable direct mobile/electronic transfers
 Develop Diaspora investment program
 Develop strategies for better mobilization of foreign financial/portfolio
investors:
 Establish a stock exchange
 Open foreign exchange regime
 Establish investment banking services

Develop strategies for better mobilization of funding from Development Partners:

 Implement high priority policy changes with regard to exchange rate policy. A
liberalization of Ethiopia’s capital account and foreign exchange regime would
find several billion dollars in the form of a stabilization fund from the IMF and
other development partners.
 Prioritize and initiate private sector development policies and programs, which
could garner substantial additional financial support.

Author Ermyas Amelga Page 16 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

Prioritize major import substitution strategies:

Ethiopia’s Top 10 Imports

Ethiopia’s import purchases amounted to US$14.7 billion in 2017, up 34.1% since

2013 but down by -10.5% from 2016 to 2017. The following product groups
represent the highest dollar value in Ethiopia’s import purchases during 2017. Also
shown is the percentage share each product category represents in terms of
overall imports into Ethiopia.

1. Machinery including computers: US$2.7 billion (18.1% of total imports)

2. Vehicles: $1.4 billion (9.6%)
3. Electrical machinery, equipment: $1.3 billion (8.8%)
4. Mineral fuels including oil: $1.2 billion (8.4%)
5. Iron, steel: $799.3 million (5.4%)
6. Cereals: $639.9 million (4.4%)
7. Plastics, plastic articles: $634.2 million (4.3%)
8. Articles of iron or steel: $569.5 million (3.9%)
9. Animal/vegetable fats, oils, waxes: $539.9 million (3.7%)
10. Pharmaceuticals: $536.1 million (3.6%)

Ethiopia’s top 10 imports accounted for over two-thirds (70.3%) of the overall value
of its product purchases from other countries.

Author Ermyas Amelga Page 17 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

Summary

In total, as much as $50 billion or more of new foreign currency earnings/savings

can be achieved over the next five years with the above set of policies and actions.
These policies and actions are desirable, not only for the foreign exchange they
can generate, but also because they will help address many of the structural
weaknesses and imbalances in the economy which have caused the current
financial crisis.

This being said, the set of policy recommendations indicated may seem to be an
improbably drastic and liberal departure from the policies pursued to date but they
are not. The suggested policy package is not a departure from the fundamental
theoretical framework of the Big Push or Developmental State model. The
suggested recommendations are in line with the evolution and refinement of the
best practice delineations of the roles and responsibilities of the state and market
forces within the theoretical model.

Ethiopia must urgently adopt and implement more appropriate economic policies
and reforms to navigate the economic crisis confronting it. The seemingly strong
GDP numbers in the range of 6%-8% still being forecast by the government and
others have given us a false sense of complacency. This is a historically precarious
and pivotal time in the country’s history and a failure to act with deliberation and
speed would be a historic failure. The political crisis has been center stage for the
past three years but we neglect the economy at our peril.

The numbers

To crystalize the situation, below are a set of projections for the key
macroeconomic indicators for the Ethiopian economy. Keeping in mind how
macroeconomic forecasting is as much art as science, these projections still
provide a useful tool to crystalize the problem diagnosis and policy prescription.
The assumptions underlying these projections are the author’s and do not reflect
the views of any institution or group.

Author Ermyas Amelga Page 18 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

Author Ermyas Amelga Page 19 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

Author Ermyas Amelga Page 20 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

The above five-year projections of the Ethiopian economy’s key parameters under
“reform” and “no-reform” scenarios flesh out the quantitative outcomes of each
policy path. Aggregate GDP growth, even under the no-reform scenario, still
manages to stay in the 4% range. This number is probably in the mid range of
realistic probable outcomes of staying the current policy course. Even this scenario
is dependent on the crippling foreign exchange crisis somehow being addressed
over time via increased inflows and lower outflows.

Adverse conditions such as a continuing foreign exchange crises, political

instability, drought, adverse external conditions, etc., could result in negative
growth. The goldilocks conditions of the early years of Ethiopia’s big push are
unlikely to persist and we should expect some adversity.

More importantly, the projected growth should be understood for what it is - an

ongoing divided from Ethiopia’s massive (state-led/debt-fueled) fifteen-year
investment spree and the resultant gains in structural change, factor endowments
and productivity. Ethiopia’s demographic divided is also a key ongoing driver of
growth. These are strong and pervasive tailwinds that support the economy in all
scenarios.

So, given moderate projected growth rates even in the no-reform scenario, one
could ask how this can be the kind of alarming problem the body of this paper
presents. It may even seem misguided and unduly alarmist. Sustained four percent
growth in the near term hardly seems like an economic crises but, in its current
form and structure, this growth is at the price of ending our middle-income nation
ambitions.

The hidden underbelly of this growth will lead us into a low-income trap that will be
structural, long term and difficult to break. Just as Ethiopia is breaking out of a
multi-generational poverty trap, it is stepping into a low-income trap. The acclaimed
aggregate GDP growth rate is the tip of a dangerous iceberg.

This becomes evident when disaggregate GDP growth and look at the projected
sectorial growth numbers. In the no-reform scenario, we see agricultural sector
growth rates drop from 8% in 2016 to 4.5% in 2022. The industrial sector growth
rates collapse from 20% in 2015 to 5% in 2022. Services growth rates drop from
11% to just 3%. The danger is visible. The extraordinary projected collapse in the
growth rates of industry and services, if not avoided, is a time bomb.

Author Ermyas Amelga Page 21 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

These are the sectors, which are to provide jobs for the swelling (increasingly
urban) youth population.

The numbers show industrial and service sectors intended to drive jobs, growth
and structural transformation are faltering badly. The combination of widespread
unemployment, high inflation, shortages of basic food and consumer items in urban
centers and the sense of exclusion among the youth is at the core of the recent
unrest. The change in political leadership has bought the government some time
but not much. Starve the countryside and they die quietly on their farms - starve the
cities and they riot, revolt and burn. We just had a taste of this and it’s not the last
of it unless things change and change quickly. We need look no further than the
Arab Spring or the current unrest in Jordan to see the danger.

Looking at other key indicators such as exports, remittances, foreign investment

and currency reserves, the difference between the two scenarios is striking and
alarming. One critical and telling indicator not included in the forecast is the parallel
foreign exchange market premium to the official rate. This premium, which has
historically stayed within a 5%-10% range, has spiked up to the 25%-30% range
reflecting an ever-increasing gap between supply and demand. Currency reserves
drop to zero in this scenario implying a thriving black market with even more
dramatic premiums and their related distortionary and destabilizing affects. Urban
inflation, which isn’t disaggregated from the seemingly moderate national numbers,
is skyrocketing and impoverishing the largely young poor urban population. There
is nothing to be complacent about.

Economics is characterized by delayed affects from past policies and actions.

Policies and investments undertaken in the past can have residual affects for years
and even decades. The massive hard and soft infrastructure investments that have
been made over the past 15 years will continue to pay dividends into the future.
Investments in roads, power, health and education will for some time pay dividends
in the form of increased productivity of labor and capital. Structural shifts from
agriculture to services and industry will add further to long term increases in
productivity. Most of all, increasing agricultural productivity from years of heavy
investments on the sector will continue to pay dividends.

The policies to date were successful in moving Ethiopia from a poor pre-market
agrarian economy to a moderately more productive market oriented smallholder
agricultural and urban services dominated one - its first step in the development
continuum to middle income country status.

Author Ermyas Amelga Page 22 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

The exclusion of similar growth, transformation and productivity increases in the

manufacturing and industrial sector in spite of all effort requires a review of strategy
and policy in this area. Manufacturing, the designated engine to drive long-term
structural transformation and growth refuses to start. We either have to fix it or start
another engine.

As economies grow and develop, their natural endowments, structural composition

and, therefore, their competitive advantages change. As this happens, their
development strategies and policies must evolve to keep driving growth from one
level of development to the next. It’s a never-ending process. There is no one
economic strategy that works across all levels of development. The appropriate
strategies and policies must adopt and change with the changing endowments and
opportunities of the economy. Economic strategy is dynamic not static. It must
anticipate and embrace systemic change in line with its shifting structural changes
and factor endowments.

What does all this mean in the Ethiopian context?

The Big Push/Developmental State strategy is the right strategy at the beginning of
the development process that all economies have undergone. Ethiopia has
managed to take the first step in the development process by implementing a
development state strategy. The role of the state in achieving liftoff is predominant
and necessary. Once liftoff is achieved, the aerodynamics of growth and
development change. Continued elevation to middle income status and beyond
requires a change in the main engines of growth and the building of the appropriate
new economic institutions, systems and infrastructures. This is where we are now.

The state must pull back and make room for market forces to take the lead in
directing and allocating resources within the economy. No state has the capacity to
do this once an economy reaches a certain level of momentum and complexity. If
appropriate reforms are not introduced, the bottlenecks, distortions and imbalances
that have developed will (have) become crippling. The economy may float along
with the support of dividends from its early heavy investments for some time but it
won’t gain any altitude. With time, the continuation of the current outdated policies
combined with diminishing returns from historical investments will make growth
difficult.

Author Ermyas Amelga Page 23 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

The appropriate reforms must be anchored in the specific peculiarities of the

economy at this given point in its growth and evolution from one stage of
development to the next. This requires that we disaggregate the Ethiopian
economy’s structural composition; it’s current factor endowments and comparative
advantages.

As an economy grows, develops and becomes more complex, its development

strategy must evolve and adjust accordingly. Dynamic economic thinking and
planning is an ongoing necessity for all economies at every stage of development.
Ethiopia’s development strategies and policies have fallen behind the driving
megatrends sweeping the nation. Explosive population growth, sweeping
demographic shifts and rapid urbanization are driving forces in Ethiopia’s economy.
These megatrends can be both an opportunity and a threat.

Ethiopia’s FDI dependent manufacturing based structural transformation strategy is

simply inadequate in scope. We can’t put all our eggs in one uncertain and
evidently problematic basket. Even within manufacturing, the nature of the capital-
intensive manufacturing we aim to achieve through initiatives such as FDI centered
industrial parks and state sponsored conglomerates like METEC and the Ethiopian
Sugar Corporation to the neglect of indigenous inward looking manufacturing and
industrialization is misguided.

In developing our industrial strategy, we need to understand that technological

advances are disrupting traditional manufacturing. Manufacturing is becoming
more technology and capital intensive and the role and value added of labor is
diminishing. The sector’s capacity to absorb labor even at the low end of light
manufacturing is shrinking. Factories that used to run on hundreds of employees
just 20 years ago are now being run 10 or less. The value of low skilled labor in
both developing and developed countries is falling and will continue to do so.

We need to see these technological advances and their implications coming and
think afresh about the appropriate structural transformation in the context of these
changing realities. There is no history for us to look back and learn from. We have
to make our own new history in the face of new realities. The recent experience of
early deindustrialization (manufacturing/GDP ratios) in virtually all developing (and
developed) countries is part of the new reality in the global economy. The service
sector is now the largest sector in almost all but a few (Asian) economies.

Author Ermyas Amelga Page 24 April 2018

 Ethiopian Economy 2018 - AT A CROSS ROAD

If Ethiopia is potentially condemned to be a service driven economy, maybe it

should seek to optimize the opportunities this presents? In manufacturing, maybe
the economy’s factor endowments aren’t ready for capital-intensive export based
manufacturing yet? Maybe Ethiopia’s large domestic consumer markets present a
more appropriate opportunity for manufacturing?

The appropriate balance between the role of markets and the state as well as that
of the private sector and the state need recalibration. Financial sector reform and
liberalization aimed at reversing the current policy of financial repression and
building robust financial sector is a must.

Ethiopia needs to make it’s own economic history. It must focus as much on
building its information and communications infrastructure as it does on building
dams, roads and bridges. It must invest in creating livelihoods for the youth as
much as it does for the poor farmer. Economic strategy and policy in todays fast
moving and changing world requires insight and foresight. The policy reforms
advocated earlier in this paper may be a good starting point.

Author Ermyas Amelga Page 25 April 2018