NS4301 Summer Term 2015

Ethiopia’s Development Experience

Overview

• IMF, “Ethiopia’s Development Experience and Comparative Analysis with Asian Peers, September 2014

• Ethiopia’s public sector led development strategy has delivered strong results over the past decade

• However, facing significant challenges in recent years

• Analysis of the country’s investment program indicates that despite positive long-run growth effects, the strategy not sustainable

• Transition challenges and macroeconomic trade-offs are associated with different financing strategies

• Case illustrates

• Links to theories earlier in the class

• Comparisons with East Asia countries

• Idea of diminishing returns to development strategies2

Overview II

• Comparing Ethiopia's development experience with that of selected Asian countries – especially in terms of structural transformation and competitiveness Indicates differences

• Point to possible adjustments in Ethiopia’s development approach

• For Ethiopia to continue sustaining robust growth -- leveraging the transformation of the private sector, especially entrepreneurs is essential

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Development Strategy I

• Ethiopia pursuing a development strategy focused on promoting growth through high public investment

• Strategy involves

• Concentrating government expenditures on human capital and social sectors and

• A dominant role for public enterprises in undertaking critical infrastructure investments

• Authorities adopted a 5 year Growth and Transforming Plan (GTP) in November 2010 which aimed at

• Average annual GDP growth of over 11 percent and

• Achieving the Millennium Development goals (MDGs)

• Among its pillars are

• Raising agricultural output and productivity

• Promoting industrialization, and

• Investing heavily in infrastructure.4

Development Strategy II• Economic growth averaging double-digits since 2004

• Initially led by agriculture

• Growth has been broad based

• A rising contribution from the services sector and

• Some degree of export diversification

• Ethiopia’s development approach influenced by the recent successful transformations in East Asia between the 1960s and 1980s

• These countries underwent rapid economic growth and socio-economic change over period of 30 years

• With supportive public policies these countries went from

• being agrarian societies in 1960s to

• producers of high technology and high valued added goods by the 1990s.

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Development Strategy III

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Development Strategy IV

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Development Strategy V

• While Ethiopia has achieved some success over the past decade, sustaining the ambitious economic strategy is becoming increasingly difficult

• The macroeconomic picture is mixed

• Robust economic growth and inflation in single digits coexisting with

• Negative short term interest rates

• An overvalued exchange rate and

• Low reserve cover in months of imports

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Comparison with Asia Tigers I• IMF wants to compare the experience of Ethiopia to that

of the Asian countries and highlight their key differences

• Analysis covers for each country a for a ten year period characterized by

• high growth and

• implementation of various reforms

• Countries chosen because Ethiopia's development approach has been influenced by their recent successful transformations -- considered as models for Ethiopia

• China, 1982-91

• South Korea, 1968-77

• Thailand, 1970-79

• Vietnam, 2000-09 and

• Ethiopia, 2004-13 9

Comparison With the Asia Tigers II

• Structural Change, shifting resources – especially labor from agriculture to industry important aspect of economic development

• Experience shows that manufacturing as a share of GDP typically climbs from about 20 percent in the low phase of development to about 40% in the middle phase

• The employment contribution from the industrial sector increases in importance for countries as they shift from low income to emerging economies

• Asian countries broadly follow this pattern

• A structural sift in successful Asian countries towards manufacturing with substantially diminished share of agriculture

• The pattern in Ethiopia shows only some shift from agriculture toward service sector

• Share of manufacturing relatively stable and low10

Comparison With the Asia Tigers III

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Comparison With the Asia Tigers IV

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Comparison With the Asia Tigers V

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Comparison With the Asia Tigers VI

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Comparison With the Asia Tigers VII

• Industrialization is a key strategic pillar of the GTP

• Plan envisages an increase in the share of the industrial sector from 13 to 19% in the plan period (2010/11-2014/15)

• Implies average annual growth in the sector of 20%

• Actual performance in this sector is falling considerably short of the plan objectives, and in marked contrast to the Asian Countries

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Comparison With the Asia Tigers VIII

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Comparison With the Asia Tigers IX

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Comparison With the Asia Tigers X

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Comparison With the Asia Tigers XI

• Achieving and maintaining the high growth rates set out in the GTP requires substantial capital formation and associated resource mobilization

• With binding external financing constraints, critical investments need to be financed from domestic sources

• Requires high levels of domestic savings• Relatively low GDP per capita limits the potential for domestic

savings in the short run which• Would be encouraged by offering attractive interest rate for

savers• Ethiopia’s record in mobilizing resources compares

unfavorably with the Asian countries with domestic credit to the private sector and gross capital formation

• While domestic resources have been crucial in financing investment in Asia – Ethiopia less room on that front.

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Comparison With the Asia Tigers XII

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Comparison With the Asia Tigers XIII

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Comparison With the Asia Tigers XIV

• Both import substitution and export promotion are key elements in Ethiopia’s development strategy

• Export earnings provide the foreign exchange needed for some investments that require capital goods imorts

• However the exports sector in Ethiopia has not been as dynamic as the Asian economies while

• Import requirements have remained high relative to the Asian countreis with the exception ov Vietnam.

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Comparison With the Asia Tigers XV

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Comparison With the Asia Tigers XVI

• It appears that Ethiopia’s performance has been lagging considerably behind that of Asian competitors.

• Beyond the differences in initial conditions, this raises the question of why Ethiopia so far has not been able to replicate the performance of the successful Asian countries

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Ethiopia’s Export Competitiveness I

• Ethiopia's export competitiveness is hampered by an overvalued exchange rate and lagging export productivity

• Key factor in export productivity is trade costs• Assessed using the World Bank’s Logistic Performance Index

(LPI)• Overall LPI score measures the efficacy of a country’s logistic

based on

• Efficiency of customs clearance process

• Quality of trade and transport-related infrastructure

• Ease of arranging competitive shipments in terms of price, quality of logistics services and

• Frequency with which shipments reach destination on time

• Scores range from 1 to 5 with a higher score representing better performance

• Ethiopia ranks at the bottom

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Ethiopia’s Export Competitiveness II

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Ethiopia’s Export Competitiveness III

• Ethiopia’s poor logistics raises costs for local industries and hamper the country’s competitiveness in global markets

• Ethiopia is a landlocked country and trade and border logistics are critical for it to develop a thriving and diverse export sector

• According to the World Bank (2012) it costs US$2,600 to import a container to Ethiopia (and US $1,760 to export) compared with US$545 in China and US$670 in Vietnam

• Thus poor trade logistics is a key contributing factor to Ethiopia’s poor performance compared to the Asian countries

• Ethiopian authorizes have identified logistic systems a key priority and have tried to improve the system

• Progress has been very slow – have begun opening many operations to private companies 27

Investment Financing Strategies I

• The high economic growth envisaged in the GTP is in line with the country’s objectives of reaching middle income status by 2025

• The GTP requires a large public sector borrowing and domestic resource mobilization to finance the high levels of investment needed to meet plan targets

• The current levels of domestic saving is insufficient to finance the high investment (particularly public) thus opening up a large resource gap.

• There is a risk that the investment levels envisaged under the plan would not materialize and may outstrip the absorptive capacity of the economy.

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Investment Financing Strategies II

• In addition achieving the GTP’s growth objectives requires a significant scaling up-of investment

• Plan characterized by substantial up front financing with a significant part undertaken by public enterprises

• Financing plan in the GTP envisages borrowing levels that average 15% GDP annually, of which some two thirds is to be borrowed externally

• Given that external financing at appropriate terms is constrained puts greater pressure on domestic financing

• Developments in the first three years of the GTP suggest that the investment dive in the priority projects through directed domestic credit is squeezing the availability of credit and foreign exchange for the rest of the economy

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Investment Financing Strategies III

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Investment Financing Strategies IV

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IMF Assessment I

• IMF analysis suggests that careful consideration needs to be given to Ethiopia’s investment program especially in terms of:

• Its financing options

• The impact on the private sector

• Despite positive long-run growth effects, transition challenges and macroeconomic trade offs are associated with the different financing options

• Heavy reliance on domestic bank borrowing may require substantial fiscal and macroeconomic adjustments

• As well as entail sharp increase in inflation

• External commercial borrowing may ease these adjustment's but at cost of significant increases in debt to GDP ratio

• Domestic bank borrowing may require substantial fiscal and monetary adjustments

• Privat esector croding out as well as• Sharp increase inflatin 32

IMF Assessment II

• While Ethiopia’s state led development strategy has so far generated good results in terms of economic growth and improving social indicators

• Structural transformation towards manufacturing and export oriented activities has not materialized as in the successful Asian countries

• Factors hampering progress include:

• Environment hampering entrepreneurship

• Inadequate leveraging of the private sector

• Weak business climate and

• Weak incentives for domestic savings – negative interest rates, limited financial instruments and an underdeveloped financial system.

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IMF: Way Forward I

• Strategy should be oriented towards the private sector• Ethiopia's development strategy has favored heavy

investment in capital and labor• However despite their importance capital and labor would

not be enough for high and sustained growth to take place• There is a need for entrepreneurship to connect them• Entrepreneurship has played a key role in Asian countries

success• Experience with authorities early incentives to improve the

country’s competitiveness through improvements in the logistic system which forced them to open up to private operators, underscores need for private sector involvement in the country’s development process

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The Way Forward II

• The relationship between entrepreneurship and economic development exhibits an S-shape form depending on the stage of development

• Different phases of development can be grouped into three broad stages:

• Factor driven stage;

• An efficiency driven stage; and

• An innovation driven stage

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The Way Forward III

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The Way Forward IV

• Ethiopia appears to be in the factor driven state

• Most of the Asian comparator countries are in the efficiency driven stage or innovation driven stage with the exception of Vietnam

• Although Vietnam still in factor driven stage, its performance in the WEF Global Competitiveness Index (CGI) is much better than Ethiopia

• Vietnam ranks 70 out of 148 countries while Ethiopia ranks 127

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The Way Forward V

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The Way Forward VI

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The Way Forward VII

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The Way Forward VIII

• Ethiopia’s policies to promote entrepreneurship – necessary to transition out of the factor driven stage need strengthening

• The country’s score in the 2014 Global Entrepreneurship and Development Index (GEDI) which captures contextual features of entrepreneurship across individual and institutional variables is 19.8 out of 100

• Ranks 111 out of 121 countries

• Korea ranks 33, China 47

• Ethiopia’s very low score is an indication of major obstacles for entrepreneurship

• By comparison, despite its state-led development strategy with a strong political regime, China provides and environment that is markedly more conducive to entrepreneurship than Ethiopia 41

The Way Forward IX

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The Way Forward X

• Ethiopia's aim to reach middle income levels by 2025 implies moving to the efficiency driven stage which would necessitate a greater entrepreneurship role

• Given the importance of entrepreneurship in the efficiency and innovation stages, it is important that the authorities better leverage the private sector, especially entrepreneurs

• One option – developing a proper legal framework for public-private partnerships (PPP)

• Would incentivize private investor’s participation while allowing the government to still have stake in ventures in strategic sectors

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