Ethiopia: International Borrowing and Its Consequences
By Daniel Teferra*
October 16, 2014


Governments in rich as well as poor countries borrow money from domestic and international markets. In rich countries, government borrowing stimulates the private economy. It creates jobs, raises incomes and improves standard of living of the majority of the population.

However, in poor countries, government borrowing does not generally produce the same results. In Ethiopia, for example, the government enjoys a monopoly over domestic as well as international borrowing. But this has not stimulated the private economy as such.

Between 2000 and 2012, Ethiopia’s international public debt increased by 85% from US$5.339 billion to US$9.941 billion (see table below). The government is the only borrower from international sources. International banks are not allowed to operate in the domestic financial market. Portfolio investment (investment in private securities) is unknown.

Source: The World Bank, International Debt Statistics, 2014 & Development Indicators, various years.

The role of foreign direct investment (FDI) in the economy was not significant. During 2005-2012, the average annual FDI was just US$319.5 million.

Between 2005 and 2012, the government engaged heavily in international borrowing. This was reflected in the balance of payments deficits. In 2005, the current account balance was -US$1.5678 billion and rose to –US$2.9853 in 2012; an increase of 75%.

Despite the heavy borrowing by the government, generous grants received, and debts rescheduled as well as forgiven, the nominal income per capita has not shown significant improvement. The average income per capita during 2005-2012 stood at US$305 only, which was below the US$500 average income for the poorest African countries.

Ethiopia has recently faced an unprecedented population growth. In 2013 Ethiopia’s population was about 94 million compared to 47 million in 1989; a doubling of the population in 24 years. Given an annual population growth rate of 2.6%, the population doubled three years earlier (70/2.6=27 years) than usual.

Although the population is increasing at an alarming rate, its purchasing power is not. This has two effects. The first is that the rapid increase in population impoverishes the country as a whole, thus making the accumulation of capital all the more difficult. And the second is that the low purchasing power limits the internal market.

The government’s growth policy of infrastructure development through heavy external borrowing fits one of the early theories of economic development, known as the “Big Push” (P. N. Rodan, 1961). The theory was long debunked in the development literature.

The theory argues that in order to initiate growth, there has to be massive investment in modern infrastructure, such as, power plants, good roads, etc. Furthermore, the theory believes that to justify investment, all the infrastructural projects have to be carried out simultaneously.

In addition, the theory states that a poor country cannot afford the initial massive investment in modern infrastructure. Therefore, the money has to be borrowed from outside sources.

The theory has major limitations. In the first place, if economic growth can only be initiated through massive investment in modern infrastructure, there would be no other possibilities of growth. Secondly, the logical result of economic growth, which is dependent on outside sources, is stagnation.

Massive investment in modern infrastructure is not a prerequisite for economic growth. Infrastructural projects come in different sizes, so that the planned output can be produced efficiently using the appropriate size.

Thus, modern infrastructural projects produce at low cost for large markets. But, in small markets, the operating cost of modern infrastructure is high. Economic growth can start with small projects, which can grow in size as the market expands over time.

Furthermore, everyone in poor countries is not poor. There is substantial saving potential internally. Thus, growth can be self-generated by first focusing on products commonly consumed by the low-income people. Even small improvement in the productivity and income in such fields will capture a sizeable market and help sustain development of other products and markets.

Instead, the government embarked on massive infrastructural projects rather than start with improvements in small plants and roads; improvements that make production cost-effective. Because of its emphasis on investment in modern infrastructure, the government had to borrow heavily from international lenders.

Despite the growing payments deficit and rising public debt, the government continues with its international borrowing to finance its investment in infrastructure. Therefore, it has announced recently its plan to issue bonds in the international capital market.

At the moment, there are no incentives for the government to change its course. In the first place, the government is not accountable to the people. Therefore, it can borrow as it chooses, and the people pay the bills now and in the future.

Secondly, the government will continue borrowing as long as there are international lenders. Presently, China is competing in the international capital market to recycle its accumulated reserves. It has been lending money to Ethiopia and other African countries.

Thirdly, there is politics involved in international lending. Thus, the government can use its international connections to access loans from official and non-official sources. But, for how along can the government continue to depend on external borrowing? One may have to put the answer in light of the 1980s Third World debt crisis.

During 1967-1973, the developing countries were growing at a high rate. Their annual average growth rate stood at 7%. And the newly industrialized countries grew well over the average growth rate.

Therefore, in order to meet their growth needs, many developing countries began to import heavily, especially, capital goods, oil and food. They all pursued mostly export-oriented strategy.

But, in the industrialized countries, average growth rates dropped from 5.2% to 2.7% due to high oil prices and world-wide recession. Therefore, many developing countries tried to sustain their high growth rates through increased borrowing.

Lending by the IMF and World Bank increased significantly. Yet official lending alone was not sufficient to meet the massive growth needs of the developing countries. Therefore, commercial banks began to compete in the international lending market.

These banks held most of the OPEC surplus and international lending gave them an opportunity to recycle petrodollars. Thus, countries with trade deficits were able to borrow directly from the commercial banks at favorable rates. They avoided implementing the Structural Adjustment Program (SAP); and consequently, they continued to borrow heavily from the private lenders to cover their payments deficits.

These countries had two choices. One was to implement the SAP, which could then help them narrow their payments deficits; but would also slow down their growth. The second was to continue borrowing to cover ever-widening payments deficits. They chose the second option.

Hell broke loose when the second oil shock occurred in 1979. The oil import bills of developing countries suddenly increased. The cost of industrial goods imports rose very high. Economic stabilization policies in the advanced countries caused a big increase in interest rates. Export prices of primary commodities declined precipitously. Foreign exchange earnings vanished. The accumulated debts and the debt service payment obligations got out of control.

As a result, from 1970 to 1992, the external debt of developing countries increased by more than 2,000%, and the total debt service payments increased by 1,530%. The World Bank identified 16 severely indebted countries, most of them in Latin America.

Worse still, a large portion of the debts were owed to private lenders at variable rates, which pushed the borrowing countries to the edge of default. The indebted countries became no longer bankable in the capital market. Private lending finally dried up.

Confronted with high inflation, severe budgetary and trade deficits as well as mounting external debts, the debtor countries had no choice but to renegotiate their loans with the private lenders. However, there was a catch. They had to deal with the IMF first before their debts were refinanced or deferred by a consortium of international banks.

The IMF then imposed its SAP conditionality on the deficit countries to force them to take the steps necessary to reduce their payments deficits and earn sufficient foreign exchange to pay back their loans. Thus, they had to devalue their official exchange rates, abolish or liberalize foreign exchange controls, introduce anti-inflationary programs and adopt a free trade policy.

However, the SAP did not produce successful results in all cases. It was very painful for many poor countries, especially for those in Africa. Furthermore, the SAP did not end the debt trap.

Ethiopia is a case in point. Since 1992, Ethiopia has devalued its currency several times and taken other SAP measures. Yet, Ethiopia’s payments deficits have worsened and international borrowing has increased rapidly.

How can then Ethiopia escape the confines of the debt trap? The answer is that the government has to shift course from an internationally-dependent growth to domestically-based economic development plan.

Thus, in order to embark on an independent development plan, it has to be recognized first that agriculture is where everything begins in Ethiopia. Ethiopia’s potential surplus for food and industrialization lies in earnings from its agricultural sector.

But, the majority of the population still relies on small-scale, low capital, subsistence farming for its survival. Unfortunately, Ethiopia has taken a long time as a subsistence economy. This has to end through capitalization of agriculture.

Peasants still work with little or no capital and even less incentive to spur them to greater productivity. The country still practices archaic systems of commons and government land monopoly. All these are major impediments to the flow of capital into agriculture.

A subsistence system does not have a buffer against starvation and famine in critical times. Starvation and the threat of famine are all too real in Ethiopia. These can be avoided only through capitalization of agriculture.

The capitalization process requires implementing land reform that can give peasants private ownership of land. This will enable them to own the land they work, invest in agricultural improvements and raise their incomes and social status.

However, one cannot expect hungry peasants to undertake the capitalization process voluntarily. Thus, land privatization will help attract domestic and foreign entrepreneurs to invest in agriculture.

Ethiopia is a food deficit country. Therefore, it has to develop its agricultural potential to feed its rapidly growing population and acquire the earnings needed for industrialization.

The present policy of modern infrastructure development and massive international borrowing does not focus on present-day facts of Ethiopia. It is simply increasing Ethiopia’s debt obligations and impoverishing the population further. Real growth occurs when a government gives its people priority.

--
*Emeritus Professor of Economics at Ferris State University; teferrad@uww.edu, UW-Whitewater.


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