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EconTalk
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No. 1 — < An Occasional Column on Ethiopian Economy>
— 1994
EDITOR’S NOTE: This is the inaugural issue of an
occasional column on economic issues affecting Ethiopia. It is
intended for a general audience at Cleo/EEDN; economics jargon
will be kept to the minimum, and current issues of debate will
have priority. Guest columns and questions are welcome as are
suggestions and replies.
They are to be sent off-line to the editor.
— Berhanu Abegaz ([email protected] )
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ON ENABLING ENVIRONMENT AND THE FOUR D’S
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The theme of this commentary was prompted in part by a
question from Theodros Kidane who, upon hearing that EconTalk was
about to enter the information superhighway on a mule-back,
suggested that the first posting be devoted to the economics of
devaluation. I thought it would be a good idea to discuss
devaluation briefly in the broader context of structural
adjustment programs (SAPs).
It is a truism that sustained economic development is
preconditioned on high rates of productive investment in human
resources and physical capital. Since investment entails risk and
long-term commitment, a stable and conducive policy environment
is required by both private and public enterprises in their
(hopefully) competitive search for profitable opportunities.
An ‘enabling’ environment (who wants a disabling one, anyway?)
must, therefore, be created by dismantling institutions and
policies that have outlived their usefulness, and by enacting
positive measures to encourage productive activities. In other
words, negative incentives must be replaced by positive ones.
For laggards like Ethiopia, the advice emanating from the
multilateral institutions (such as the World Bank Group and the
IMF) and most professional economists can be summed up as
follows: cure thy chronic ailments by taking the “four
D’s” as prescribed. Some kind of economic medicine, you
might wonder. Yes, a heavy dose of Devaluation, Disinflation,
Deregulation, and Denationalization. If the body economic has
been isolated from civilization (i.e., the world market) for too
long, or contaminated by socialismiasis, or run by Neanderthals,
the dosage will have to be administered carefully and with an
adequate supply of nourishment (adjustment assistance).
In the standard jargon, the first two fall under the rubric of
IMF- mandated Stabilization (read, resuscitation) designed to
restrain spending (i.e., reduce the budget and trade deficits to
sustainable levels). The second two focus on rehabilitation or
Structural Adjustment, under the purview of the World Bank. It
takes two know-it-all economic doctors and a large army of
expensive short-term consultants to save the patient from itself
(or from its misguided children, as many say). Do you ever wonder
why regime after regime in Ethiopia or country after country in
the Horn keeps making the same mistakes despite patently
disastrous results?
Any way, the two sister institutions, which are presently
celebrating their 50th anniversary, have encroached on each
other’s territories. The Volker Commission has just called on the
IMF to concentrate on macroeconomic stabilization, and the World
Bank Group focus on structural adjustment needed to facilitate
medium-term growth. Bilateral institutions such as USAID and EU,
important sources of economic aid for Ethiopia, generally follow
the latest fad of the Brettonwoods institutions and, most
importantly, the political leanings of the White House and the
European Parliament, respectively.
DEVALUATION
Devaluation may be nominal or real (adjusted for inflation
using the price indices of imports and exports). Devaluation of
the nominal exchange rate of the Ethiopian Birr (Birr per US$)
refers to the increase in the number of Birr one US$ can
purchase. That is, holders of Birr will have to give up more Birr
to obtain one US$ following a devaluation. The prices of
dollar-denominated assets or goods would inevitably go up
“in terms of Birr”.
When the Birr was devalued from 2.07 per US$ to 5.00 per US$
in October 1992, it is as if the cost of American-made goods rose
a whopping 250% for Ethiopians (assuming that U.S. exporters did
not
raise prices) in terms of dollars! All other things being the
same, this would discourage imports form the US and Ethiopian
exports to the US as intended by the reformers. This would also
discourage capital outflows from Ethiopia and encourage inflows
from America, again all other things being the same. If it is so
dandy, who would oppose devaluation or support an overvalued
Birr? Well, consumers/users of imported goods lose out and
exporters gain. In the absence of exchange control, those who
wish to keep dollar accounts lose, too. When you make something
that is desirable (US$) artificially cheap, there will be excess
demand for it and draconian exchange controls will have to be
instituted. And, if the losers from devaluation have political
clout (however few they may be), or if policy makers who count
subscribe to a different theory, then an overvalued exchange rate
may last longer than it should.
Under free market conditions, exchange rates are driven more
by speculation (capital flows) than by trade flows. Hence, they
tend to get too erratic and create enormous uncertainty. That is
one of the reasons developing countries try to keep their nominal
exchange rates stable (say by pegging them the US$ or the French
franc). But they are powerless to control the real exchange
rate– Ethiopia’s real exchange rate fluctuated a lot despite the
stability of the nominal rate.
How do we know the ‘optimal’ exchange rate of the Birr, any
way? When Ethiopian economists (Dr. Befekadu Deguefe comes to
mind) rant and rave about the devastating impact of the recent
devaluations on the cost of living and the cost of critical
imports, aren’t they suggesting that the old rate was somehow
better than the new? Great questions. Humility dictates that we
admit that we do not quite know the right exchange rate of the
Birr. In order to determine the ‘optimal’ exchange rate for a
given state of the Ethiopian economy, one will have to build a
computable general-equilibrium model … Oh, Sorry, I got carried
away. There is a damn good rule-of-thumb, though. That is, the
average exchange rate (say, Birr 7 per US$) in the parallel
market (never say, black market, please) gives us a ceiling that
would prevail under free market conditions. An official nominal
exchange rate of 5-6 Birr would, therefore, be a good
approximation of the equilibrium rate. If you have a better
answer, let me know.
What about the economic and social consequences of
devaluation? Well, the big debate centers around this issue.
Several considerations come into play. First, the effects of
devaluation must be seen in conjunction with other reforms
(remember the other three D’s?).
Secondly, the time horizon is important. The good effects
materialize tomorrow (it take coffee growers some time to expand
coffee production) but the bad effects are felt today (the prices
of imported oil in terms of birr will rise immediately). Assuming
that a certain level of devaluation is the right policy and it is
implemented with appropriate speed, then the real question should
center on whether steps will be taken to shield the poor from its
adverse effects. Besides, exchange system reform provides a
necessary but not sufficient condition for growth.
I have rambled long enough. The bottom line is that
(a) exchange rate flexibility is one of many
economy-wide policy instruments;
(b) international competitiveness ultimately depends on
the productivity of the Ethiopian labor force;
(c) the right policy is one that addresses the problem
at its root; and
(d) economic reform produces losers and gainers, and
fairness in the sharing of the burden/benefits of reform may be
frustrated by unscrupulous politicians as witnessed by the
ongoing debates in Ethiopia. As you occupy you minds with talk of
high finance, please never forget that the mind of the average
Ethiopian is occupied with thoughts of food for much of the day.
To end on a lighter note, Lord Keynes, in emphasizing that
macroeconomic policies must focus on short-run problems, once
quipped: “in the long-run, we are all dead.” I am also
tempted to retort, invoking the folk wisdom in this part of
Virginia: Everybody wants to go to Heaven, but no one likes the
dying it would take to get there!
I will discuss the other D’s in the near future. In the
meantime, may you have a devalued ego and revalued income.
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EconTalk Factoids (1992, billions of US$):
World GDP ………………….$23,060 (was $2,808 in 1970)
High-income economies…….. $18,312
Middle-income economies ….. $ 3,549
Low-income economies …….. $ 1,146
ETHIOPIA ……………….. $ 6
SUGGESTED READINGS:
Eshetu Chole, “A Preliminary Appraisal of Ethiopia’s
Economic Reform,1991-93” , H. Marcus, ed, New Trends in
Ethiopian Studies (Red Sea Press,1994).
Berhanu Abegaz, “Ethiopian Economic Reform”, in B.
Abegaz, ed, Essays on Ethiopian Economic Development (Avebury
Press, 1994).