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Ethiopia Comes to a Crossroads on Economic Reform

7 MINS READApr 3, 2019 | 10:00 GMT
A picture taken on March 13, 2019, shows the construction of a number of new buildings in Addis Ababa.

A picture taken on March 13, 2019, shows the construction of a number of new buildings in Addis Ababa. Ethiopia's developmental state strategy has brought the country's economy this far, but Prime Minister Abiy Ahmed will have to change tack if the nation is to push on to bigger and better things.

(LUDOVIC MARIN/AFP/Getty Images)
Highlights
  • Ethiopia is unlikely to totally abandon its developmental state economic model, which gives the state a leading role in fostering development but has also burdened local banks, led to increases in foreign debt levels and suppressed the private sector.
  • While Prime Minister Abiy Ahmed is likely to make some progress toward liberalizing the economy, he and his allies will encounter resistance from a bureaucracy that favors growth fueled by the state rather than the private sector.
  • If Addis Ababa fails in its gamble to switch to an economy driven by more private sector growth and consumption, it might not be able to capitalize on a wave of investment interest in East Africa to make the leap to the next level of economic development.

 

For the past decade, Ethiopia's economy has expanded rapidly, largely thanks to public spending on massive investment projects like the multibillion-dollar Grand Ethiopian Renaissance Dam, roads, industrial parks and other projects. It has all come as part of Addis Ababa's "democratic developmental state" model, the brainchild of late Prime Minister Meles Zenawi, who championed a state-led path to growth after witnessing the policies of Asian states like South Korea, China and Singapore. Using this model, Meles tried to prevent foreign companies from stripping Ethiopia of the resources Addis Ababa needed to construct a solid base of infrastructure to develop and grow the economy.

The Big Picture

After a year in office, Ethiopia's ambitious Prime Minister Abiy Ahmed has made considerable progress on multiple fronts by striking a peace deal with Eritrea, ousting entrenched elites, reforming the security sector and opening up the political system. But after promising to open up several key economic sectors, foreign investors are eager to see more progress. Nevertheless, Abiy and his allies are taking a careful approach to easing state control over key sectors as part of a larger bid to move the economy away from state-controlled growth to one of private sector-led growth.

But while many in Ethiopia have hailed the developmental state model as an overall economic success, it has not come without its costs. For starters, government spending has kept inflation rates high. At the same time, authorities have effectively turned domestic lenders into piggy banks by obliging them to contribute portions of their deposits to the Development Bank of Ethiopia, often through mandatory bonds. Efficiency in the vital telecommunications and logistics sectors, for example, is poor, as the industries are dominated by state-owned monopolies. Complicating matters, a notoriously complex and risk-averse bureaucracy coupled with a lack of access to technology has depressed productivity and discouraged entrepreneurship. As a result, the state has crowded out Ethiopia's private sector. But if the country is going to truly benefit from the rush of investment to East Africa and promote development, Abiy will have no choice but to pry open an economy that remains firmly in the hands of the state.

Finding a Foundation for Growth

To fund its large infrastructure projects, Ethiopia has had to assume a sizable amount of foreign debt. Addis Ababa's biggest creditor has been Beijing, which has loaned between $13 billion and $17 billion in recent years to build big-ticket projects like the recently completed Addis Ababa-Djibouti railway and install the electrical distribution grids for the Grand Ethiopian Renaissance Dam. Ethiopia's government argues that the rail project was crucial to its infrastructure goals, but reports indicate that Addis Ababa has missed over $1 billion in debt repayments to Chinese lenders in recent months, underscoring Abiy's difficult task as his country seeks to balance its debt obligations and its desire to build its infrastructure base. In seeking to construct an economic foundation and pay off investments, Ethiopia's leaders ultimately want to foster more organic economic growth as well as a domestic middle class. As it stands, Abiy appears to have put the brakes on new large-scale projects until Ethiopia completes those it is currently constructing.

At the moment, Ethiopia's fast-growing population — particularly its ever-growing cohort of recent university graduates — is expressing increased frustration at the lack of job opportunities or even the freedom to create opportunities for themselves. In fact, the overwhelming focus of growth among Abiy's predecessors resulted in the forceful expansion of Addis Ababa (to the detriment of neighboring regions) in 2016, sparking destabilizing protests that ultimately forced out the government at the end of 2017.

Flirting With the Free Market

Shortly after assuming office in April 2018, Abiy announced that the country planned to privatize — either fully or partially — large state-owned enterprises, including giants such as Ethio telecom, a telecommunications monopoly that boasts more than 60 million subscribers and functions as a local cash cow. The list also included the Ethiopian Shipping & Logistics Services Enterprise and Ethiopian Airlines, the last of which is a key generator of foreign currency for the government. Naturally, Abiy's announcements sparked considerable international interest from foreign investors.

But while splashy privatization signals have captured the attention of Western and other investors, other quiet changes are occurring that may have an even bigger impact on Ethiopia's economy, such as Abiy's appointment of Yinager Dessie as the new governor of the National Bank of Ethiopia. Yinager's predecessor took up his post over two decades ago, and had long implemented policies that adhered to the ruling party's Marxist ideology, leaving private banks partially incapacitated due to over-regulation. Indeed, the new governor has already instituted some sweeping changes, including a move to cool down inflation. Most crucially, perhaps, he has eliminated the requirement that borrowers possess fixed asset collateral to acquire private bank loans. This change will allow entrepreneurs to obtain loans based on their ability to grow or repay (as determined by the banks), removing a hefty impediment to private sector growth. Yinager further granted members of the large Ethiopian diaspora (estimated at over 3 million) the right to hold stakes in the financial sector and eliminated the limit on the amount of money they can deposit in their Ethiopian-based foreign exchange accounts.

There is also the case of the long-awaited stock market. The country remains perhaps the largest in the world yet to establish a bourse, because its leaders were afraid that its introduction would complicate their efforts to maintain tight regulations. This reticence, however, appears likely to end in line with the new regulatory atmosphere. Ultimately, a stock market will provide the private sector with another means of acquiring finances and create additional transparency for listed firms, since going public will force them to report their financial statements to investors and the government alike — something that does not currently occur with state-owned enterprises.

Amid the push for targeted reform, Addis Ababa is sticking to its developmental state model while adding some new tools to its toolbox.

Old Habits Die Hard

Since coming to power a year ago, Abiy has undoubtedly instituted significant changes. Nevertheless, his power is limited, as he operates in a political system whose guiding light remains a Marxist ethos, as well as the developmental state model promoted by Meles. In such a situation, Abiy can proceed with liberalization on some fronts, like the full or partial privatization of indebted state-owned companies like Ethiopian Airlines or Ethio telecom, but the status quo is likely to reign in other areas. For one, given that high public spending is a key component of the developmental state model, the government is unlikely to reduce its expenditures any time soon, especially as such action has helped lift millions out of extreme poverty. Additionally, there has been no talk of changing the country's land policy, in which the state owns all land and only permits its distribution at the discretion of officials, thereby giving such civil servants vast power. By maintaining state ownership over land, the government has been able to find locations for large investment projects at inexpensive rates. That policy is unlikely to change, as Addis Ababa intends to provide cheap land and low taxes for the construction of even more industrial parks, huge housing projects, large-scale farms and other undertakings.

Amid the push for targeted reform, Addis Ababa is sticking to its developmental state model while adding some new tools to its toolbox. As it is, the imminent privatization of state-owned enterprises like Ethio telecom and Ethiopian Airlines, the ongoing restraint in taking on more debt for big infrastructure projects and the overtures to the diaspora indicate that the government is trying to shift the engine of high gross domestic product growth to the private sector at a time when investment interest in East Africa is at a high. Should Ethiopia succeed in riding this success by luring more investment thanks to its liberalizing economy, it could leap to another level of economic development and avoid falling into the trap of other developing nations that continue to rack up debt as they fail to find a sustainable economic model. While this may be a gamble, it's one that Ethiopia's leaders have to take: The country's future prosperity depends upon it.

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