By Lemma W. Senbet
After twenty years of departure, I visited my home country on a two-week trip in August. The trip was filled with excitement, sadness, and at times hopelessness. My remarks focus on my observations of the current developments in Ethiopia primarily along an economic front. I would then hope that my remarks would stimulate our attention to opportunities and obligations facing us as Ethiopians here toward Ethiopia.
My visit lead me to conclude that, despite the enormous problems facing the country, Ethiopia has immense untapped resources and vast investment potential virtually in every sector of the economy. I came back convinced that Ethiopian’s future is dependent upon how successfully its government can implement a radically redesigned economic system, one based on the principles of the market economy.
The Problems
Ethiopia is currently an economic basket case! It is uniformly viewed as a beggar country and widely considered as the poorest in the world. It faces billions of dollars of foreign debt and growing budget deficit. As soon as you get out on the streets of Addis Ababa, you are struck by the semi-starved and painful looks of pedestrians.
Agriculture, long the backbone of the economy, is in dire straits. The government owns and runs losing agricultural farms. These farms take much needed government funds but nothing in return.
The infrastructure, such as rural roads, irrigation facilities, health care facilities, water supplies, soil treatment facilities, are either in extreme shortage or devastated by wars. There is persistent drought, massive deforestation, overgrazing, and over- cultivation.
The industrial sector is also in a disastrous situation. The government owns everything and mismanages it utterly. The state-owned enterprises carry surplus employment reportedly ranging from 50 to 70%.
A third of the nearly 150 factories (by official estimates) are no longer in operation. The remaining are run grossly undercapacitated. This is partly due to shortage of raw material inputs and shortage of foreign exchange reserves. The industry is heavily reliant on foreign exchange reserves, because it needs imported inputs. The export sectors are all losing, because goods are shipped overseas below cost to generate foreign exchange.
Company managers grapple with both commercial and non-commercial objectives. These objectives are governed by periodic guides formulated by officials of the Ministry of Industry (or the relevant Ministry, such as defense) and passed down to managers. These objectives are often in conflict with each other, but more importantly, managers do not know the right tradeoffs between commercial and social goals. In the event that things go bad, which is more often that not, the poor performance is blamed on social goals. The perverse managerial incentives are actually magnified by the lack of performance-based compensation such that managers obtain their fixed salaries no matter what.
Pursuit of social goals is the ultimate goal of an economic system. However, it cannot be achieved through distorted production, pricing, employment, and wage policies. An economic entity should be run with maximum efficiency to make the available “pie” as large as possible.
To address the issue of equity (or fairness), then direct means and distributional rules, such as taxation or other transfer mechanisms, may be used to split the pie in any socially desirable way.
Another enormous economic problem arises from severe shortage of foreign exchange reserves. By some estimates (unofficial), only about US $3 million was available after the alleged depletion of foreign exchange by Mengistu. This pitiful situation has sawned its own humor: Mengistu, confronted with the allegation that he embezzled Ethiopian money, responded: “I did not take any Ethiopian money; I only took U.S. dollars.”
Unemployment is yet another major economic obstacle. It is getting out of control. The universities have minuscule space relative to demand, and they can accommodate only a very small fraction of high school graduating students. Thus, some of the country’s brightest students are left to join the rapidly growing ranks
of unemployed young people. Further, massive demobilization of the defense forces under way has added hundreds of thousands of former soldiers to unemployment roll.
Token Economic Improvements
There are some pockets of improvements over the last seventeen years. I made a trip to Hosanna area through the Gurage and Kambata regions, and I saw a modest improvement in the road system, urban planning, and health facilities. I was told that such uneven and token improvements existed in some other areas as well, such as in Sidamo (e.g., Awassa area), Wollega, etc. Nevertheless, ecologically those areas seemed in danger with dense population, overgrazing, over-cultivation, and deforestation. A forest in my birth place, for instance, is completely gone.
I was told those meager signs of development were the results of private initiative of the people themselves, and not the past regime. The regime’s inaction must have unintentionally helped these areas. It is then a reflection of what Ethiopians would be able to accomplish on their own initiative, despite severe shortage of resources, if they are free from government intrusion and mismanagement. Here, it is worth mentioning another prominent example — the famous Ethiopian Airlines. For some strange reason, Mengistu left the carrier alone, and, by all standards, it has become one of the most competitive airlines in the world.
The Task Ahead
We have an abundance of horror stories about Ethiopia. But what can we do for Ethiopia? We may continue to send charitable contributions as we react to some vivid TV images of Ethiopian famine. This is certainly helpful in alleviating the short-term difficulties, but it accomplishes little for the long-term.
I know that there is a surplus of movements on a political front here and in Ethiopia. There is no doubt that we need political pluralism in Ethiopia, but the people must also be economically liberated.
The other side of the economic debacle and depravation in Ethiopia is the existence of immense economic opportunities now on the brink of opening up for private initiative. Ethiopia must begin cleaning up after the legacy of Mengistu and move into a free market economy with adequate social cushioning.
I must point out that sooner than later, state-owned enterprises would go up for sale or for transfer of ownership to the private sector. Who are the potential private owners of these enterprises?
During my trip I was invited by the Ministry of Industry to give a talk to industry officials. Note that industry officials, including managers of major corporations, such as beverage and cement, are employees of Ministry of Industry, and hence government officials. Thus, the audience included top officials, including the minister, vice- ministers, and also some members of the Council of Representatives.
After a two-hour speech and break, there was an hour long discussion of the issues by the audience. I must say that it was heated. My talk included heavy dosage of the functioning of the market system and succeeded in “shocking” the audience consisting, in part, managers of predominantly Marxist orientation. I was keenly aware that no one would become a “capitalist” by baptism. A successful transition to a market economy requires a thorough understanding of how markets work. In my speech on August 28, 1991, at the Ministry of Industry, I called for wholesale privatization of state-owned enterprises and public services, including financial institutions, such as banks and insurance companies.
Proposals for Privatization
The fundamental job of the government is not to run industry, commerce, or hotels, but to formulate policies. A growing economy is the key (perhaps the only) answer to unemployment; a government cannot create jobs simply by adding layers of people to its payroll.
I strongly disagree with the view that ownership transfer to the private sector makes no difference. Of course, the net worth of the public sector is unchanged by a mere transfer of ownership through the privatization process. Perhaps that is what the proponents of continued government ownership have in mind. The real economic gains from privatization come from productive efficiency improvements to the way in which the assets are deployed. The efficiency gains are generated from the exposure of the corporation to the disciplines of the market place through the stock market, the private banks, security analysts, and various monitoring mechanisms built into the private system itself.
When corporations are owned by the government, ownership rights are not transferable within the market place. The non- transferability of ownership rights has far- reaching economic consequences. It prevents the existence of markets for corporate control in the sense that entrenched managers who run corporations inefficiently cannot be disciplined or replaced through the takeover market. The threat of takeover alone is a powerful discipline on managerial behavior and increases efficiency for the overall economy. Takeover opportunities are absent in the absence of transferability of ownership rights through an open financial market system.
Another efficiency gain of privatization comes from the recognition that a government-owned enterprise is in principle owned by all citizens, and hence the corporation is diffusely owned. That is, owners are much more widely dispersed than when the corporation is owned through the private market. No individual alone has a sufficient incentive to monitor the management of the enterprise on his/her own when it is costly to do so.
Of course, the more obvious advantage of privatization is an enhancement of the development of the capital market itself through a spread of shareownership. It is a widely held view that capital markets enhance allocational and productive efficiency. By extension, there is then a positive relationship between capital market development and economic development.
As a general principle, I believe in the privatization of every enterprise or service. This view does not allow the supremacy of the so- called mixed economy. In my view the market economy predominates. That is not to say that the society should leave the entire range of economic activities to be determined by market forces.
My idea of privatization includes financial institutions. These include banks, insurance companies, investment banking firms, etc. These institutions intermediate between lenders and borrowers, between supplies and users of funds. Privatization of financial institutions creates competition among financial institutions for funds to lend and earn a fair (competitive) rate of return on their savings.
Second, it promotes efficiency. Competing financial institutions will seek out the most profitable investments. Thus, the financial system can be thought of as the brain of the economy. It determines how scarce resources are allocated to the most productive uses.
The seemingly adverse consequence of privatization is that some people would be simply unable to be employed productively upon private and efficient ownership. I argue that the problem be solved directly through a transfer system, such as unemployment insurance and social security system. There are already resources expended on surplus work force, and these funds should be used as an initial pool for unemployment benefits. In the long-run, the social security system should be funded by contributions from both the employees and employers. I also think that the country can solicit financial/technical support from international/foreign agencies in setting up the system, since it is entirely motivated by considerations of productive efficiency.
The system should be designed with care, though. The objective should be to prevent the standard of living of those affected (the unemployed and dependents) from falling below some minimum standard. The level of support (employment benefit) should be such that it gives minimal incentives for some to quit existing jobs and maximum incentives for the unemployed to seek and accept new employment (part-time or full- time) and to acquire new skills.
It seems relatively easy in Ethiopia to create a disincentive for existing workers against quitting jobs to join the unemployment benefit pool. Those on unemployment benefit can be used to build infrastructure (roads, irrigation, railroad system, health care facilities, etc.) and other public goods not easily accessed by the private initiative. Thus, the system can lead to greater efficiency both in the agricultural and industrial sectors.
The government should move with speed and establish a Privatization Commission to dispose of a range of state-owned enterprises, including financial institutions. Banking laws and practices should also be brought in conformity with international standards.
The World Bank and The International Finance Corporation have facilities to help with privatization and restructuring of the commercial banking services. For instance, the Commercial Bank of Ethiopia would be denationalized so that its branch network can be restructured into multiple newly formed competing commercial banks. Consequently, I recommend a two-tiered banking system consisting of a single independent central bank with regulatory control over a network of competing commercial banks.
The international financial community should and will respond positively to such an economic reform program. In countries with such reform programs (e.g., Pakistan), local investors have become partners with the world Bank and other international agencies in carrying out large-scale projects. Also, the Export-Import Bank of the US has jointventures with local investors in implementing projects, such as power plants, highways, and river projects. These joint partners often seek indigenous expertise, and we Ethiopians here should play a role in providing such expertise.
Opportunities and Risks
The movements toward the market economy are irreversible. Ethiopia is a country with a vast, largely unexploited investment potential, accompanied by tremendous opportunities for growth and profit. The country is predominantly agricultural with about 90% of the population living on farms. In terms of national output, agriculture is said to account for about 50% of the gross domestic product annually. However, only 12% of the total arable land is known to be currently under cultivation, principally due to lack of proper infrastructure. Farming is highly traditional and weather dependent;
poor rains meant crop failure and famine.
There are large, unexploited investment potentials virtually in all sectors of the economy. The industrial sector is wide open and it is in its infant stage of development. Opportunities are abundant in various handicraft, small (cottage) and large-scale industries, including textiles, chemicals, fertilizers, beverages, processed food, leather products, etc. Opportunities in the construction industry include residential housing and urban development, commercial and residential buildings, and infrastructure projects.
Agricultural opportunities include dairy and meat products, cattle ranching, poultry, and animal feed processing. Mining opportunities include oil and gas exploration. Mining may emerge as a major component of the economy. The rivers in Ethiopia have great potential for hydroelectric powers; only a minute fraction of the potential has been exploited.
These investment opportunities are not left unnoticed. I was invited to a gathering of the founders of Corporation of Ethiopian Entrepreneurs (CEE) in Addis Ababa. It is headed by a founding member, Ato Debebe Habte Yohannes, former owner and chairman of Addis Ababa Bank. The corporation is committed to a free market system, and its primary objective is to rehabilitate and promote the private economic infrastructures for the self-reliance of Ethiopia. Its goal is to identify projects and proposals and promote business investments in all major areas that I mentioned above.
I believe that this is a very promising avenue to rehabilitate and privatize Ethiopia by Ethiopians themselves. This promises to be mutually beneficial for the country and the CEE members. CEE is recruiting associate founders (100 members) internationally on the basis of a member’s potential to contribute 1) talent, 2) initiate projects, or 3) capital.
Ethiopia is at a cross-roads. We have an opportunity and obligation to move it forward, and we can. We also represent a vital force capable of contributing to an efficient and productive market economy in Ethiopia. The alternative of inaction is a choice facing us, but it would be a missed opportunity and quite regretful. I already visualize a day (not far away!) when the party headquarters of Mengistu would be the headquarters of the Addis Ababa Stock Exchange in a pluralistic, peaceful, and prosperous Ethiopia.
Dr. Lemma W. Senbet is the William E. Mayer Professor of Finance at the University of Maryland, College Park. The above article is based on his recent keynote speech at the Second Annual Gatherings of Ethiopian Business and Professional Association, Washington, DC.