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Economic Commentary  
 

There may be a debate as to the source of Ethiopia's painful shortage of foreign currency reserve. Some attribute it to the growing size of the economy, while others use it as evidence to challenge the official claim of sustained economic growth. Zinabu Samaro, a development consultant, argues that it is a sign of deeper troubles of stagnated productivity, failure to achieve structural transformation and inability to advance in technology.

What Causes Ethiopia's Perennial Trade Deficit?

 

In recent months, there have been lots of discussions regarding Ethiopia's problem of foreign exchange shortages. It has become so serious that Sufian Ahmed, minister of Finance and Economic Development (MoFED), was quoted by this newspaper, in April 2009, as saying, "Our weakest link is the foreign exchange . . . So we need external assistance in the form of foreign currencies".

Digging a little deeper into the matter reveals that the most important factor behind the shortage is a huge gap between what the country earns from its exports and what it pays for its imports. In fact, Ethiopia imported merchandise worth 5.95b dollars but earned goods worth slightly over a billion dollars during the first three quarters of the last Ethiopian fiscal year, according to a report published by the National Bank of Ethiopia (NBE). As a result, Ethiopia's trade deficit with the world economies has reached 4.7b dollars during this period.

One of the policy measures taken to narrow the gap is a significant devaluation of the Birr so that imports become expensive and exports become cheaper in the international market. However, the overall policy direction that has been proposed and is consistently being pursued by the administration is export promotion where devaluation is just one of a set of measures to this end. The idea behind this policy prescription is that, if Ethiopia could increase its export of traditional products such as coffee and 'non-traditional' primary products such as flowers, it can address the trade deficit problem, hence the foreign exchange shortage.

But is this move logically sound and does it address the root causes of the problem?

Historically, all available data indicate that Ethiopia's foreign trade balance has basically been in deficit ever since it began meaningful trade exchange with the developed world. For instance, Negadras Gebre Hiwot Baykedagn wrote that during the year 1912, Ethiopia imported through the Port of Djibouti, merchandise worth 7.77m Br and exported merchandise worth 7.58m Br. The trade deficit was around 192,000 Br.

All available data indicates that, with the exception of years 1973 and 1974, when a combination of unusually large receipts from sales of oilseeds and pulses resulted in a surplus, Ethiopia's trade balance has been in deficit.

Not only has the external trade been in deficit but also the gap between export earnings and import expenditures has been consistently widening over the three successive governments. Specifically, in the 1950s, imports were relatively low but started to grow steadily with economic expansion. The value of merchandise imports increased at an annual average of 10.07pc while that of exports increased at 8.94pc between 1962 - 1974. During the military regime, the growth rate of imports averaged about 16.4pc while the figure for exports was a minuscule 0.98pc.

As a result, the trade deficit kept on widening over the whole period. Similarly, since 1991, the trade deficit has been continually growing. For instance, trade deficit as a percentage of Gross Domestic Product (GDP) widened from 12.4pc in 1991-92 to around 15.1pc in 2007-08.

Therefore, even though Ethiopia's export growth for the past several years has been healthy and high by any standard, this positive development has been over-shadowed by an even more robust growth in the value of the country's imports. Export growth has consistently failed to solve the problem of trade deficit and hence the problem of foreign currency shortages. Successive Ethiopian governments have been financing the trade deficit from foreign aid and credit leading to the country becoming increasingly dependent on foreign aid and loans to cover its imports.

I do not see Minister Sufian's plea for assistance as either the first of its kind and or likely to be the last to come from the Ethiopian government.

Since the deficit is widening rather than narrowing, all debt relief initiatives including the Highly Indebted Poor Countries' Initiative (HIPIC) would provide only a short-term relief rather than a cure to the problem. This is because the country will automatically begin accumulating another round of debt right after its old debt is canceled. This is the more likely scenario as most of the foreign assistance comes in the form of loans rather than grants.

To rephrase the prophetic words of Gebrehiwot Baykedagn, unless things drastically change for the better, the coming generations might be held hostage for the debt of their fathers; and unless their productive capabilities (knowledge) are increased and they are able to pay their fathers' debts, they face an imminent danger of perishing in abject poverty or migrating to the developed countries from which Ethiopia had been importing.

Why has the trade deficit kept on widening despite the fact that the efforts to increase exports and export earnings have borne results in terms of increasing the volume of exports and, to an extent, export earnings?

Ethiopia's balance of trade deficit can be largely explained by the unequal terms of trade between agricultural commodities such as coffee and all manufactured goods including capital goods which are Ethiopia's major imports.

International markets accord a higher price to products that are manufactured - or "value-added" - than to those that are in their raw form. There is also a well-known problem of structural decline in terms of trade between primary commodities and value added ones.

In addition to the terms of trade issue, most of such countries, including Ethiopia, have extensively liberalized their external trade regimes mostly due to external pressure. However, studies undertaken to measure the impact of trade liberalization on imports, exports and the overall trade balance of developing countries have found that liberalization stimulated export growth raised import growth, leading to a worsening of the overall trade balance.

A glance at the recent trend in the import-export data of Ethiopia confirms this finding.

Recognizing the uneven terms of international trade, many countries, including Ethiopia, pursued policies of protectionism throughout the 1960s and 1970s to develop national industrial capacity or import-substitution. The record on such efforts has been mixed: In many cases they failed; for others, however, such as the economies of Southeast Asia, the policies were more successful.

In the case of Ethiopia, the imperial regime attempted the import substitution policy and export. However, the plans were not properly implemented. Overall, the drive for import substitution during this period was inadequately planned and executed. The overall efforts were half-hearted at best.

The military regime had also tried to address the issue with the aim, " to expand foreign exchange earnings, to diversify exports, to accelerate the socialization of foreign trade and to promote import substitution."

However, what was meant by diversification of exports was not as such focused on value addition ('vertical diversification') per se but promoting other primary products such as minerals (horizontal diversification). As is the case with almost all of its development policies, the 'import substitution' drive of the Derg also failed to bring about any significant change in the structure of the economy for various reasons.

With the current administration, the tendency has been to try and increase the volume of traditional exports such as coffee and hides and skins as well as non-traditional exports such as flowers. However, even though there are initiatives to increase exports of lower end manufactured products such as textiles, there appears to be a bias towards horizontal diversification. It appears that the country has given up on the issue of addressing the other side of the equation related to trade deficit problem; reducing and substituting imports.

But this flies in the face of some important historical facts about economic development such as the issue of secular terms of trade deterioration mentioned above. I believe it is nave to expect the terms of trade between, say, Ethiopian coffee and Japanese automobiles to remain constant or to improve over time. This is for the simple reason that today's Japanese automobiles are qualitatively and technologically far superior to those of, say, the 1950s while Ethiopian coffee has been more or less the same in terms of quality and technological complexity over the whole period.

The 'unequal exchange' between primary products on the one hand and knowledge intensive, finished products on the other hand, is not the result of some conspiracy on the part of developed countries. It is prominently due to the superiority in terms of knowledge and technology intensity of the latter.

Ethiopia's trade deficit and the related foreign exchange problems are symptoms and reflections of deeper problems of productivity stagnation, absence of structural transformation and technological advancement. And these are the root causes of the 'unequal exchange'; and which is why horizontal diversification and currency devaluation will not solve the problem.

It also seems why developmentalist thinkers down the ages such as Antonio Serra of Naples (in 1613), Friedrich List of Germany (in 1841) and Gebrehiwot Baykedagn of Ethiopia (in 1922) declared the futility of trying to solve the problem by horizontal diversification or increasing the volume of primary exports, and staunchly advocated structural transformation and technological advancement as the only lasting solutions. Their advocated development path would require addressing the root problem from both sides of the equation.

From the export side, it implies a systematic, gradual and relentless drive to move away from production and export of primary commodities and "commodified" manufactures. It would also require well-studied, selective and dynamic import control and substitution policy which has become unfashionable these days but have amply paid dividends to those countries that applied it properly. The approach advocates a dynamic mix of export promotion and import substitution.

In Ethiopia's case, import substitution does not necessarily mean trying to set up overnight complex industries that require frontier technology. Initially, it may simply mean an incisive push and support to straightforward areas such as production of barley for breweries which is currently imported, or substitution of wheat imports from Italy for the purpose of making pasta. It may imply controlling the import of apples and powdered milk from New Zealand, and producing them within the country.

In a more substantive instance, the strategy might require assessing how much of the indispensable medicine and medical imports could be produced in Ethiopia by way of catalytic and substantial incentives to attract foreign technology, foreign direct investment and joint ventures.

It could also imply a thorough assessment and comprehensive intervention to kick-start domestic production of most of the construction materials that are currently being imported and that are eating away the miniscule foreign currency reserves.

It implies that spending the meagre hard currency, earned the hard way either from export of the unreliable agricultural products or through foreign aid, on non-essential items such as toothpicks, ordinary tables and chairs would make the nation a squanderer and profligate.

In passing, one might also ask: Would it not make sense to ration the scarce foreign exchange in a well-planned manner to priority imports rather than allowing blanket access during relatively 'sunny days' and blanket access denial during 'rainy days'? Is it not sensible to pre-plan and use hard currency rationing as a tool for controlling imports?

One notable feature of the external trade of the country is that trade in services has more or less always been in surplus even though the surplus has not been large enough to cover the deficit in the merchandise trade. Oddly, little attention is given to this positive element whenever ways and means are proposed to address the problem of trade deficit. Ethiopia's policymakers and implementers ought to consider promotion of trade in services as an important and arguably easier avenue for tackling the trade deficit.

If Ethiopia's trade deficit and the related foreign exchange problems are symptoms and reflections of deeper problems of productivity stagnation, absence of structural transformation and technological advancement, then all the development efforts in the country should be planned and geared in this perspective; and all the development debates in the country should centre around these challenges. The key to international competitiveness and hence economic development is improving knowledge, skill and technology intensity of production and service delivery.

Of course, this does not mean that other issues such as reduction of transportation costs and financial sector development should be ignored.

Such an understanding of the matter would thrust aside the long-standing policy squabbles related to selecting a champion sector that can serve as a linchpin to all economic development problems of the country. Specifically, this approach to national development would shift the debate and the policy focus away from both the agricultural and industry sectors. It also advocates a more nuanced (in terms of geography and product) highly differentiated approach with the overarching objective of tackling the root problems mentioned above.

For instance, agricultural development interventions in one locality may entail provision of targeted, tailor-made support for production of apples by small-holder farmers. In another locality, it may entail doing the same for large scale producers of high-value agricultural products in an agglomerated manner.

In the case of the industrial sector, the approach may, for instance, mean focus on promoting and developing large and occasionally specialized industrial zones in selected priority locations (say adjacent to the export routes) instead of the current tendency where each major town is attempting to setup one of its own.

 
COMMENTARY PLUS
 

Does Growth in GDP Signal Positive Social Well-being?

 
 
 
 
 
 
   
   
   
 
 
 

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