Ethiopia’s Long, Hard Road - Milken Instituteassets1c.milkeninstitute.org/assets/Publication/MIReview/...public, according to the latest Cato/Frazier/ Naumann Human Freedom Index

15First Quarter 2016

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Ethiopia’sLong, Hard Road by robert

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16 The Milken Institute Review

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61But the continent has since surprised just

about everybody. Six of the world’s 10 most rapidly growing national economies over the past decade have been in Africa.

Blanket optimism has replaced blanket pessimism. The Economist, which as recently as 2000 labeled Africa “hopeless,” made a 180-degree turn in 2013, rebranding the con-tinent as “hopeful Africa” and predicting that

“the next 10 years will be even better.” The

magazine signed on to the now common nar-rative that broad-based growth would follow from a virtuous circle of accelerating invest-ment, stepped-up regional trade and the rise of a middle class with more disposable in-come and – probably more important – a major stake in efficient government and po-litical stability.

But putting a magnifying glass to the big picture reveals some less-than-rosy details in some of the most celebrated success stories. Africa’s collective growth has not resulted from countries across the continent adopting

RobeRt Loon ey teaches economics at the naval Postgraduate School in Monterey, California.

FFor decades, the economies of sub-Saharan Africa were, to put it euphemistically, laggards. With rampant corruption, ethnic strife and miserable governance the rule rather than the exception, Africa’s prospects were routinely written off as hopeless well into the 1990s.


a development model based on the bold eco-nomic liberalization and improved gover-nance advocated by the West. Rather, authoritarian governments have assumed the growth leadership role – notably in Ethiopia, which ranks a dismal 145th, just behind Ven-ezuela and ahead of the Central African Re-public, according to the latest Cato/Frazier/Naumann Human Freedom Index.

Ethiopia’s government credits its impres-sive growth to the adoption of the develop-mental-state model of the East Asian tigers. This, on its face, is suspect, since development

economists have long been skeptical that an East Asian strategy could be sustained in the teeth of ethnic heterogeneity, widespread cor-ruption and rent-seeking, and woefully defi-cient governance.

But Ethiopia is claiming the role of the not-so-little engine that could, an example for the rest of Africa to follow. And at least by one key metric – growth in per capita income

– it has a case. The big question is whether the initial successes of an economic strategy in a country that is still one of the poorest on the planet and is facing growing resistance to its antidemocratic practices can meet its goal of becoming a middle-income country by the end of another decade.

the developmental state For the past quarter-century, the World Bank and the IMF – and most Western-influenced development specialists – have united behind the so-called Washington Consensus pre-scription for development. It’s a now familiar mix of macro-stabilization, free markets and openness to trade and investment, leavened by a moderate role for government as pro-vider of public goods and enforcer of the rule of law. And, indeed, a more or less consistent application of the formula has been credited with awakening many of the economies of sub-Saharan Africa.

But Ethiopia has been marching to the beat of a different drummer. The idea that an African economy could prosper using a varia-tion on the one that brought much of East Asia out of poverty in the 1970s and 1980s began as the master’s thesis of Meles Zenawi, later to be Ethiopia’s prime minister, when he was at Erasmus University in Rotterdam.

At the core of the Asian model is a highly professional group of technocrats who admin-ister it. While officially attached to a ministry, the technocrats maintain a high degree of


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autonomy. They cultivate close links with (but incur no obligations to) the business elites.

The Asian developmental state model al-lows the technocrats to implement strategies that leverage private initiative without wholly unleashing it. Meanwhile, at least in its early years, the state’s political legitimacy lies in its success in delivering the goods rather than in faithfully responding to the voices of the people. Indeed, it took decades for South Korea and Taiwan to make the transition to democracy.

Meles argued that conditions in Africa were not conducive to government that chan-neled a rational growth policy through pri-vate enterprise. Without direct government intervention, corruption would remain per-vasive. Rent-seeking – using market power or political pull to cream off unearned profits – would dominate, diverting investment into wasteful projects and cash into the bank ac-counts of the elite. Thus, rather than let Adam Smith’s invisible hand work its magic, Meles believed that the state itself must cap-ture the fruits of growth and plow them back into productivity-enhancing capital.

Following this philosophy, his variant of the developmental state can be characterized as authoritarian developmentalism – that is, prioritizing state-directed growth and invest-ment over private initiative. Think of it as top-down rather than bottom-up development.

In contrast to the outward-oriented East Asian tigers, Meles looked inward, initially giving agriculture priority as the bedrock for growth. To this end, Ethiopia subsidized farming and protected it by clinging to an overvalued currency at the expense of export competitiveness. Incidentally, both these devi-ations from the Asian brand harkened back to the early 1990s roots of Meles’s party as a rural-based, peasant-backed liberation movement.

Following Meles’s death in 2012 at the age of 57, his dominant, long-ruling Ethiopian People’s Revolutionary Democratic Front emphasized there would be no change in eco-nomic policy. And, indeed, under Meles’s suc-cessor, Hailemariam Desalegn, the party has remained committed to the top-down model. The government has stuck by a five-year plan adopted in 2010 with a goal of a phenomenal 11 percent GDP growth annually, which has almost been met.

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A cursory comparison of the Ethiopian economy’s overall progress in the 10 years after the establishment of its developmental state (2005-15) and the 10 years before (1994-2004) suggests some fairly impressive results. In the earlier period, Ethiopia’s economy grew at an average rate of 5.5 percent – sub-stantial by African standards and often attrib-uted to Meles’s initial success in achieving political stability. But growth vaulted to an average rate of 10.4 percent for the decade

following the adoption of Meles’s develop-ment strategy.

Much of this acceleration can be attrib-uted to stepped-up investment as a share of GDP, which increased from 19 percent to 28 percent. All of the net increase was financed internally, as the gross national savings rate rose from 15 percent to 24 percent.

There are glimmers here, too, of a payoff from the state’s choice to push growth through government intervention rather


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than through market deregulation. The por-tion of the government budget directed at helping the poor doubled. And the one-two punch of rapid economic growth and a tilt to-ward the poor made a very real difference in the living standard of low-income Ethiopians. According to the United Nations, the portion of the population classified as poor fell by one-third between 2004-5 and 2012-13.

Arguably most striking, the government found the will and a way to avert widespread famine during the 2011 drought, breaking an age-old pattern of mass suffering and death whenever the rains failed. Meanwhile, Ethio-pia’s scores on the UN’s Human Develop-ment Index, which reflects life expectancy, per

capita income and schooling, improved on average by 3.5 percent annually between 2005 and 2013.

underperformance, ethnic tensions and corruptionThat, however, is only half – the brighter half – of the story. While these broad indicators sug-gest a successful introduction of the developmental state in Ethiopia, closer analy-sis reveals serious underlying weaknesses, be-ginning with the flagship agricultural sector.

The foundation of the ruling party’s devel-opment strategy was accelerating growth through agricultural-development-led indus-trialization. The policy rationale offered by


the ruling party was that government invest-ment would increase agricultural productiv-ity (and thus enhance food security), while stimulating the development of new indus-tries, such as food processing. That, in turn, would create internal demand for increas-ingly sophisticated, locally produced agro- industrial products.

From a comparative-advantage perspec-tive, it made intuitive sense for a labor-rich, capital-poor country like Ethiopia to initially focus on labor-intensive agriculture, making use of fertilizer, improved seeds and irriga-tion rather than mechanization to increase yields. The plan was also consistent with the ruling party’s goal of broad-based rural share-holder prosperity as the anchor of political stability.

All land had been nationalized during the catastrophic upheavals following the death of Emperor Haile Selassie, wiping out the land-holding elite and redistributing user rights (but not ownership) to smallholders (i.e., holders of small, cultivatable parcels). Until recently, the ruling party largely maintained this arrangement, arguing that land privatiza-tion and consolidation of ownership would add to food insecurity and displace the peas-antry. Thus, agricultural-development-led industrialization advanced the multiple goals of food self-sufficiency, equitable growth and smallholder security.

But agriculture has not performed as an-ticipated. In particular, there have been only limited improvements in productivity and the marketable surplus remains small be-cause of a shortage of land, failure to increase the supply of improved inputs and volatile crop markets that make investment risky for smallholders.

One consequence is high grain prices, which erode living standards. Another is the anemic production of crops such as edible

oils that serve as industrial inputs, which im-plies the failure of smallholder farming to contribute to industrialization through for-ward linkages. Ironically, foreign food aid has allowed the government to maintain agricultural-development-led industrializa-tion along with ideological resistance to priva-tization and farm consolidation. The latter would both raise productivity and facilitate growth of crops with export potential and the desired forward linkages to industrialization.

In Ethiopia, with its vulnerability to severe drought, food security remains a prime con-cern. And while the government did manage to prevent disaster in 2011, the UN’s Food and Agriculture Organization still classifies over seven million Ethiopians (from a total population of just under 100 million) as

“chronically food insecure.” The Economist

Intelligence Unit’s 2015 Global Food Security Index ranks Ethiopia 86th of 109 countries – up from 100th in 2012, but hardly much to brag about.

In an acknowledgment of these cracks in the model’s facade, the government has mod-ified its agricultural policy in recent years to attract new investment without truly aban-doning agricultural-development-led indus-trialization. Large foreign agribusinesses are now permitted to lease big acreage, with the government actively encouraging export- oriented investments. The idea is to generate more foreign exchange, which, in turn, can

Agriculture has not

performed as anticipated.

One consequence is high

grain prices, which erode

living standards.


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help the country achieve greater food security and industrialization by another route.

This shift to an export-oriented agricul-tural strategy has resulted in reduced support for locally generated investment and small-holder-based food production as the anchors of the economy. While pragmatic, it is not without significant risks. Volatile interna-tional food prices and foreign-exchange earn-ings increase the risk of food shortages beyond the government’s control.

Furthermore, the shift away from small-holdings raises the specter of renewed politi-cal instability. Soon after coming to power in 1991, the ruling party adopted a constitution that structured the country as an ethnic fed-eration. The goal of this unusual political structure is to maintain Ethiopian unity by protecting the equality of the country’s mul-tiple ethnic groups. In principle, the constitu-tion guarantees each major ethnic group the right to self-determination, and even seces-sion from the federation if so desired.

Until 2009, each of Ethiopia’s nine ethni-cally delineated regions independently allot-ted land according to its own criteria. That’s in keeping with regions’ constitutional rights. However, Ethiopian policymakers became concerned over the size and terms of many land transfers in peripheral regions. They claimed that less than one-fifth of the 8,000 foreign and domestic applicants who were approved by regional governments between 1996 and 2008 had begun project implemen-tation, and many parcels were being used for unapproved purposes.

In 2009, the central government cracked down, establishing the Agricultural Invest-ment Support Directorate, which has co-opted responsibility for land leases to foreigners as well as leases of parcels over 5,000 hectares (a bit more than 12,000 acres)

to domestic investors. And not surprisingly, the regions are unhappy – an ominous reality in a country in which regional governments represent individual ethnic groups.

To justify the encroachment on the use rights of the locals, the government is arguing that the large parcels of land thus far leased in outlying ethnic regions were previously empty. But while population density in these regions is comparatively low (80 people per square mile, about the density of West Vir-ginia), it is inaccurate to describe the unculti-vated areas as empty. Much of the land in question constitutes traditional village or pastoral commons, and the government’s leases and follow-on agribusinesses have dis-rupted rural life.

In one documented case, some 34,000 members of the Suri tribe lost their grazing lands to a Malaysian group setting up a palm oil plantation. The result was to impoverish the group and to ignite violence between them and other local tribes. If such conflicts spread to other regions, they could further undermine not only the government’s efforts to implement its agriculture-led industrial-ization strategy, but also the stability of the country’s delicately balanced political system.

Other developments are similarly discour-aging. Corruption, which Meles used as a ra-tionale for strict government oversight of the economy, remains rampant. According to the World Bank’s Worldwide Governance Indica-tors, Ethiopia scored in the 38th percentile for control of corruption in 2004, a dramatic im-provement over 1996, when Ethiopia made it no further than the eighth percentile. By 2009, however, the country had regressed to the 26th percentile and did not return to its 2004 high until 2013. Patronage and rent-seeking, the main forms of corruption in Ethiopia, are par-ticularly disruptive, because they undermine the credibility of government technocrats

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who have been given considerable discretion in planning and administering the develop-mental-state strategy.

Corruption is especially problematic in manufacturing, where members and sup-porters of the ruling-party-dominated gov-ernment have been granted protection from domestic and foreign competition. A key goal of the five-year Growth and Transformation Plan adopted in 2010 was to expand the share of manufacturing in GDP from 13 percent to 19 percent. Instead, the sector’s share actually contracted in the decade following the adop-tion of the developmental-state model.

In comparison, after 10 years of high growth and reforms under a developmental-state strategy, the share of manufacturing was

33 percent in Taiwan (1977), 24 percent in South Korea (1979), 21 percent in Thailand (1979) and 18 percent in Vietnam (2009). Rent-seeking in Ethiopia’s manufacturing sector has become so pervasive and its effects so corrosive that the government recently set up special industrial zones in areas well re-moved from the capital in an effort to breathe a little competition into the sector.

Thanks to the underperformance of man-ufacturing, the government has been unable to leverage the sector’s role in the economy. Consequently, little progress has been made in efforts to diversify exports, with the share of manufacturing exports virtually un-changed in the 10 years the developmental state has been in place.

A forced loss of Suri grazing lands impoverished the group

and ignited violence between them and other local tribes.

Further conflicts could undermine the stability of the

delicately balanced political system.


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Meanwhile, the share of exports in GDP has been halved during the developmental-state period, to just 7 percent. At the same time, imports have increased to 15 percent from 9 percent. Accordingly, the current- account deficit rose sharply during the de-cade of the developmental state. And that deficit must be financed with a combination foreign capital and remittances from Ethiopian expatriates. Equally troubling from the per-spective of Ethiopia’s state-driven development model, government revenues as a per-centage of GDP fell by almost a point across the decade, limit-ing the government’s ability to finance projects directly.

The growth of manufactur-ing and the planned shift toward export-oriented activities are also impeded by the low quality of Ethiopia’s infrastructure. Ac-cording to World Bank metrics, it is improving, but slowly: the Bank’s Logistics Performance Index score rose to 2.17 from 1.88 (5 is the highest) from 2007 to 2014, implying that Ethiopia’s infrastruc-ture is still inferior to that of other countries in the region and in Ethiopia’s income group.

One reason is that much of Ethiopia’s economy, including telecommunications, banking and insurance, power, transport and most tourism, remains off-limits to foreign investors. The government has resisted advice to liberalize these sectors. And it will most likely continue to do so as long as members of the ruling party’s old guard hold important positions in economic management. With in-frastructure creation dependent on funding from modest (and stagnant) government rev-

enues, it is unlikely that Ethiopia’s transport, power and communications will improve suf-ficiently to make the country’s exports com-petitive anytime soon.

On top of corruption and deficiencies in infrastructure, Ethiopia’s manufacturing sec-tor suffers from a critical lack of entrepre-neurial activity. While the East Asian tigers were initially handicapped by similar defi-

ciencies, the problem was addressed through programs that both encouraged entrepre-neurs and provided financial support to allow them to take on more risk.

To be sure, East Asia could look to tradi-tions of entrepreneurship, while Ethiopia can’t. But the government apparently isn’t helping. Ethiopia ranks 134th among 142 countries (1 being best) on the Opportunity and Entrepre-neurship measure of the 2014 Legatum Pros-perity Index. South Africa and Botswana, African states that have employed more demo-cratic variants of the development-state strat-egy, rank 44th and 72nd, respectively.

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what next?On the one hand, Ethiopia’s growth strategy has produced a decade-long surge that would have been highly unlikely had development been left to free-market forces alone. On the other, problems now looming in agriculture will likely plague the government and econ-omy for years to come. As the controversy surrounding agricultural-development-led industrialization illustrates, there is a basic incompatibility between centralized control of the economy and Ethiopia’s federal system of government.

Another key issue involves the source of Ethiopia’s recent decade of ebullient growth. In much of Africa and Latin America, growth during this period was largely driven by the boom in commodity prices. Since this was not the case in Ethiopia, defenders of the country’s economic polices argue that the credit should go to the developmental state model.

They ignore, however, that there is a rich history of rapid early-stage autarkic growth financed and commanded by authoritarian governments. Think of the Soviet Union and China, which seemed to be the economic wonders of the world for the first few decades after World War II. In both of these cases, it turned out that the delay in switching to mar-ket-driven systems slowed the maturation of the economy.

The more immediate problem is Ethiopia’s dependence on government investment, which is now the third highest in the world

(measured as a portion of GDP). Govern-ment revenues, the primary source of funds for investment, are lagging. Clearly, Addis Ababa cannot keep up its pace of expendi-tures without either borrowing from the do-mestic banking system (at the risk of inflation) or incurring a large external debt (at the risk of higher interest costs and damage to the country’s credit rating). And without rapidly growing investment, the phenomenal growth of the past 10 years is likely unsustainable.

A little perspective is needed here. The Ethiopian economy was a wreck when Meles

embarked on his most-excellent adventure in authoritarian developmentalism. And, in spite of a decade of rapid growth, it’s still suf-fering, even by the modest standards of East Africa. Measured in terms of purchasing power, per capita income is just $1,500. More-over, while Ethiopia has plainly made real progress in the quality of life as measured by the UN’s Human Development Index, it still ranks a miserable 173rd in the world on the index – a reflection of just how deep its socio-economic problems run. For example, one baby in 20 still dies in infancy, and less than half the population can read.

Will Ethiopia’s government, founded on developmental capitalism and now commit-ted to it by reason of both ideology and the interests of its ruling class, be able to change paths before it is overwhelmed by ethnic divi-sion? It seems improbable. But, then, in 2005, nobody expected Ethiopia to become the economic darling of the New Africa.

while Ethiopia has plainly made real progress in quality

of life as measured by the U.N.’s Human Development Index,

it still ranks a miserable 173rd — a reflection of just how

deep its socioeconomic problems run.

Documents

Ethiopia’s Long, Hard Road - Milken Instituteassets1c.milkeninstitute.org/assets/Publication/MIReview/...public, according to the latest Cato/Frazier/ Naumann Human Freedom Index