Sustaining Growth: Ethiopessimism?

by Ken Ohashi
World Bank’s Country Director for Ethiopia and Sudan

The international community in Addis seems to have suddenly turned pessimistic about the prospects for Ethiopian economy. Inflation, which was troublingly high at 19% in January, has by June jumped to 55% (measured as the 12-month increase in the overall Consumer Price Index). Ethiopia's foreign exchange reserves are running low, making it more difficult for domestic investors to secure foreign currencies needed to import key materials and equipment. Though much better now, load shedding had affected daily life in many areas last several months. Above all, however, the food crisis and images of children in acute malnutrition are enough to make anyone not just saddened but gloomy about the future. Was the five years of rapid economic growth all so fragile? Was it only a result of good weather and a ‘rebound’ from the 2002/03 drought?

I do not wish to minimize the terrible suffering of those in hunger, or those who struggle with rising food prices. Nevertheless, I also believe this swing in outlook is unwarranted. If the past optimism was euphoric, the current "Ethiopessimism" is equally excessive. Over the last several years, Ethiopian economy has become much stronger, but it also faces complex new challenges today. In the first of a two-part series of articles, I will focus on the developments in the recent years and argue why the past achievements are more durable than the skeptics believe. In the second article, I will discuss the emerging economic risks and possible ways to address them.

How has the economy changed?

First, physical infrastructure has improved.

• Roads: Paved Federal roads, which form the main transport arteries, have increased from 3,800 km in 2000 to nearly 5,500 km by 2007, an increase of 43%. Including the expansion of other Federal and Regional roads (to 37,000 km) and the explosion of woreda and community roads, the total road length has tripled to 100,200 km. Extension of roads means improved access to market and more economic opportunities for everyone.

• Power: Since 2000, power generation capacity has nearly doubled to 791 MW today. It will rise to 1,970 MW within the next 18 months. The percentage of households with direct access to electricity has increased from 5% to 8%, and is expected to reach 15% by 2010. These are still modest figures, but the percentage of population living in areas with access to electricity has increased from 13% to 22%, and should reach about 50% by 2010. This ‘indirect’ coverage at least gives people benefits of many services that are impossible without electricity. Electricity brings more advanced technology.

Second, agriculture, which still generates 40-45% of GDP, is undergoing some changes, and there is now a base to sustain significant increases in productivity. The spread of new technology has been slow thus far. At only 36 kg per ha of cultivated land, average fertilizer use remains very low by international standards. In certain areas, however, use of fertilizer has increased sharply. The evidence suggests some farmers are successfully adopting new technologies. The key is to scale it up. In this regard, the deployment of Development Agents (extension workers) is important as the interface between farmers and new technologies. From about 15,000 in 2000, the number of DAs has risen to about 67,000 now. That is a significant institutional capability. Land certification programs have also improved land use security for many farmers, with tangible increases in investment.

Third, Ethiopia has become more investor friendly. For instance, whereas the Investment Climate Survey of 2001 reported a number of serious obstacles, such as access to land, tax administration, finance, etc., the new survey in 2006 found there had been significant improvement in all key areas. In the Doing Business 2008 rating, Ethiopia is ranked ninth by African firms in terms of the overall business environment. Targeted Government support to strategic industries (flowers, leather products, and textiles) has been quite effective.

Finally, the education and health status of the work force has been rising, supported by dramatic improvement in basic service delivery. For instance, from 1999 to 2006, primary school enrollment has increased from 5.2 million to 14 million. Of course, the impact on the overall labor force is only gradual; still, between 1999 and 2005, the percentage of employed urban workers with a minimum of 5 years of education has risen from 52.7% to 56.1%. A more educated work force is more productive.

Turning to the actual growth record, my contention is that Ethiopian economy is now capable of delivering much higher growth than in the 1990s, and that the recent strong growth is not just good luck. 1991/02 was the worst year in Ethiopia’s modern economic history. The per capita income level was about 30% below the previous peak in 1971/72. It is not easy to estimate the potential growth rate of a quickly changing economy, but if we compare 1991/92 and 2000/01, I think we get a pretty good estimate for those years. In the early part of that 10-year span, Ethiopian economy enjoyed a rebound from the disastrous economic performance of the Derg period (1974-1991). Later, Ethiopia suffered from a war, with GDP contracting by 3.7% in 1997/98. These exceptional factors are likely to offset each other to a large extent. Thus the average of 5.5% seems to be a reasonable estimate of the potential growth rate, a rate intuitively consistent with the kind of economy Ethiopia was in the 1990s, with improving economic policies but a modest infrastructure base.

Still this does not explain why Ethiopia has suddenly run into a multitude of economic difficulties? One way to think of it is that Ethiopia suffers from its own economic successes.

Rapid economic growth can be a double-edged sword. Its intrinsic benefits are obvious. Economic damage done during the Derg period was so severe that only in the last few years Ethiopian per capita incomes have surpassed the previous high of the early 1970s. Yet, Ethiopia remains one of the poorest countries in the world. Therefore, it desperately needs to grow in order to lift its citizens out of poverty.

Rapid growth, however, can also expose serious structural weaknesses in an economy, making such growth ultimately difficult to sustain. This is the challenge Ethiopia faces today. Aggressive public sector-led investment programs resulted in sharp increases in demand for both investment and consumption goods. But, without deeper structural reforms, the expected private investment—both domestic and foreign—did not materialize on a scale to keep pace with the demand growth. This imbalance between demand and supply is at the core of the rising trade deficit as well as inflation. The trade deficit has ballooned to an estimated $4.7 billion equivalent in FY2007/08, about 22% of GDP. Of course, the global rise in oil and other commodity prices has made it worse. But, the inflation in Ethiopia has been much higher than in most other African countries. I have little doubt that this is to an important degree caused by the domestic demand-supply imbalance.

Does this mean Ethiopian economy now needs to slow down sharply, at least to the recent trend rate of around 7.7%, and perhaps to an even lower rate temporarily to restore the basic balances? Or are there ways to preserve relatively high growth while dealing with the twin imbalances, i.e., inflation and external deficits? I believe there are things the Government can do to avoid a costly shock therapy.

(To be continued: Sustaining Growth: A Way Forward)