The Ethiopian Economy: Proud Of High Deficit?

“Our country,” said Milton Friedman, the twentieth century’s most prominent free market advocate, “would be far better off with a federal budget of $1 trillion and a deficit of $300 billion than with a fully balanced budget of $2 trillion.” The 1990s “balanced budget” argument led Friedman to make this bold claim; it was the period, after all, in which economists forwarded their thoughts on the importance of government spending for a well-functioning economy. The logic here was clear: whatever the amount of money in government hands, let it be flung into the market. More emphasis was placed on government expenditure over balanced budgets if the deficit led to economic growth.

The story here is like “chalk and cheese”. Had Friedman been the adviser to Meles Zenawi, he likely would have argued the importance of a balanced budget for Ethiopia, one of the poorest nations in the world. Such an ‘outdated’ hypothesis simply does not hold true for this nation.
For the last forty years, the economy has experienced huge budget deficits accompanied by sluggish economic growth. Under the two most recent regimes-the Derg and now the EPRDF-expenditures have reached their maximum, to little public benefit.

As if all the past evils of the economy were not enough, the same budget deficit problem is recurring. Last week, the proposed budget for the 2010/11 fiscal year, which was approved by the Council of Ministers, was sent to Parliament. Happily, the budget is projected to reach 77.2 billion Br for the first time. The Ministry of Finance and Economic Development also pledged to allocate 35.9 billion Br for capital expenditures. But such figures could not materialize without pain. The budget, as proposed, leaves the nation with a deficit of 13 billion Birr, accounting for 3.2 percent of the gross domestic product (GDP) of the country. This implies that, in order to fill such a huge gap, the nation is in need of approximately 20 billion Br from outside financial sources.

Ethiopia is consequently growing increasingly dependent on outside financial sources. Had financial aid not been more cautiously flowing in recent years, the deficit would have reached far beyond the current record-low. By plotting the last five years on a graph, one can easily identify the negative trend. From the fiscal year 2005/06 to 2008/9, the economy experienced a budget deficit of more than 67 billon Br.

In theory, an economy that is too dependent on the external world to satisfy its financial desires falls into many traps. The country might, for instance, be prone to corruption, civil unrest, hyperinflation and various other economic, social and political traps that deter further progress. That is why developing nations are highly advised to follow the principle of a balanced budget.

How large a deficit?

Whether a nation strictly follows budget procedures or not, deficit remains an inevitable phenomenon in every economy at some point in time. Sometimes, nations may cautiously run short deficits to meet specific targets such as high employment. Keynesian economics suggests that a budget deficit is the best ways to stimulate aggregate demand. Accordingly, this strategy can be suggested during recession to lead the economy towards full employment.

However, even to the Keynesian enthusiast, running a continuous budget deficit can hardly signal a move towards positive change. Countries like Ethiopia might tend to move towards higher inflation, trade balance deficit and foreign currency shortage. For instance, budget deficit causes inflation as far as the Ethiopian economy is concerned. Trade balance deficit, high government debt and high interest rates are also positively correlated with budget deficit.

The Ethiopian government could not manage to balance its expenditures, particularly after the 2005 national elections. Average growth rate of the budget increased by 20 percent yearly. The total expenditures also share 23 percent of the national GDP, but the share of its revenue only accounted for 13 per cent. If we leave the direct budget support from outside financial sources aside, more than 70 percent of the government budget is allocated to recurrent expenditures. From those expenditures, the shares of defence and security have been increasing tremendously. In the last five years, it scored a one hundred percent change.

Fortunately, the expenditure for education and health sectors has also changed significantly. Many schools and health posts have been built. The expenditure for school increased by 14 per cent yearly. The same is true for the health sector, although its 90 percent expenditure should be funded from outside sources. It is true that such budget allocations are publicly appreciated since both sectors provide basic necessities. But economists have pointed out major flaws and argued that many of these projects were not consciously planned. According to them, most of the projects were considered as reflexive actions for the 2005 election rather than deliberate moves, leaving the nation with high deficit.

Dependent on aid for how long?

Finance Minister Sufian Ahmed pledged to collect 40 billion Br from tax revenues over the next fiscal year. From this sum, 10 billion Br is expected from Value-Add-Tax (VAT). However, the past experience of the tax authority does not support his claim. The domestic tax system performance is presently below the sub-Saharan average and its contribution to total expenditure remains minimal, accounting for only 12 percent of the GDP.

Hence, the weak revenue generation trend and uncontrolled expenditure of the Ethiopian government push the nation to become more dependent on external assistance. More than 40 percent of the current deficit is financed by either loans or grants. Currently, public utilities like health and other big projects require direct budget support.

This high level of donor dependency is not a positive indicator of future economic growth and political satiability. As aid is only determined by the will of the donors, there is no guarantee of its sustainability.

In addition, donors are presently becoming too keen as far as their money is concerned, requiring not only the ability for growth by the receiver but also the creation of a democratic environment. With those arguments, economists urge the government to follow the principles of a balanced budget. Otherwise, if the government allows the trend to continue in similar fashion, the deficit could likely become the source of additional problems.

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11 Responses to “The Ethiopian Economy: Proud Of High Deficit?”

  1. “But economists have pointed out major flaws and argued that many of these projects were not consciously planned.” Two points on this statement:1) undefined references such as economists is not proof of your statements (fallacy: appeal to authority), 2)It is not true that roads and dams are built with reflexive actions.

    The hope is that the economy will grow so much so that Ethiopia will no more be dependent on aid and still be happy with the progress made in health, education, etc with help of international donors. Investments in these and similar sectors will pay off later economically, socially and politically.

  2. I am a bit disappointed to see the writer identifying the monetarist school of thought as a universally accepted Economics principle. Of course, if you are parroting Friedman’s and his Chicago disciples’ cult like believe in free market and smaller government, no wonder a deficit less than 4 % GDP will come as a shock. But take this, deficit financing is generally a good thing as long as government spending goes to activities that raises the future productivity of the economy. Example includes investment in health, education and infrastructure. On the other hand, bad practices can be financed by governments as well such as purchase of military hardware and stuff. Now the questions is which one has been consuming the greater share of government consumption in Ethiopia, investment in human and physical capital or military hardwares. you provide answer to this and may be we can take your article seriously.

  3. Mulugeta M Ayalew 25 June 2010 at 7:19 pm

    I do not get it! How come you use Friedman to argue for a balanced budget. Friedman is an ardent proponent of a nigh-watchman government. He opposes a proactive government whether acting on the basis of balanced or deficit budget.

    Good point Chuna!

  4. As you said Chuna the writer of this article is either a political opponent of the current regime, which is not a crime but puts in question the relevance of the article as an economic article, or has the ultimate flaw of being written by a mainstream dogmatists… Here are facts the author did not include in his article, the deficit is 3.5% of GDP the bulk of it goes to The Ethiopian Roads Authority for roads and highways constructions, Education and capacity building take the other larger parts, then health infrastructures, then comes the military… Military spending are on the rise but most of it will go to establish research and renewing military hardware which given the situation (as our neighbors are or Swiss or Luxembourg) is understandable…
    You can criticize Ethiopian government on many points but not on the way it uses the money available, that is universally recognized truth… Just read Stieglitz…
    Yes their is a dependency of the Ethiopian economy on aid, but if aid stops the budget is constructed such that building new facilities are stopped not the working of existing ones…
    We should I guess point to the writer of this article where Mr. Friedman’s theories lead the world, and to update his opinions by reading non mainstreams authors, or critical scholar reviews that are abundant these days…

  5. With all due respect, applying modern economic theory on a country like Ethiopia is like pouring water on a rock. Deficit spending on borrowed and charity money in a country that does not produce much with almost a non existence private sector with low tax base is hogwash. Reshuffling wealth, exporting primary commodities and spending charity money is not going to make a dent on revenue to warrant deficit spending not to mention the rampant corruption in a one party state. The regime is playing its old trick relying on extractive foreign investment and donation and the usual suspects like Diaspora remittance to finance its legitimacy.

    A fundamental restructuring is required for the country to create domestic capital by manufacturing consumer goods and upgrading the infrastructure primarily for internal trade in order to create wealth thus a middle class.

    What the regime does is auctioning the cheap labor and the natural resources of the country to the highest bidder and building infrastructure to facilitate it on borrowed and donated money. The trickledown economics is not sustainable and a good recipe for dependency.

    Tesfaye’s comment sounds like the old tried mantra over and over again for the same political end. He said “The hope is that the economy will grow so much so that Ethiopia will no more be dependent on aid and still be happy with the progress made in health, education, etc with help of international donors. Investments in these and similar sectors will pay off later economically, socially and politically”
    He started with the hope for the economy to grow by building infrastructure with Aid and borrowed money? These kind of political motivated comments are rampant in all camps. It is partly ignorance about how an economy grows or purely self interest to benefit out of a corrupt system. What he should ask is who decide what is to spend on what, those who donate, borrow or the ruling party?
    In the same line, Chuna commented to his disappointment on the writers assumption as to the Monetarist school thought is not a universally accepted principle but a cult, arguing “Deficit financing is generally a good thing as long as government spending goes to activities that raise the future productivity of the economy”

    In his argument to justify the regimes spending to fit in any theory out there he can find he reduced the justification of deficit spending between ‘productive and unproductive’ sector without addressing the fundamentals of the economy or the meaning of prodactivity. In his attack on free market and small Government as a cult he failed to acknowledge the theory (the cult as he want to refer it) does not apply to a government like Ethiopia even if he wanted it. Apologizing for the status qua that does not resemble any thing in any economic theory is laziness at best if not outright excuse.

    Any functioning Economy (which Ethiopia is not) is a collective activity of independent institutions with rules and procedures, not politically motivated decrees and encroachment of a one party rule. It is also an efficient allocation of limited resources not politically motivates spending. It is sustainable wealth creation not a charity and politically motivated wealth reshuffling. And most importantly it is security and safety not extortion and corruption.

    In all counts the ruling regime in Ethiopia failed to ignite the private sector, instead pretend to be one itself through corruption and cronyism.

    Therefore, there is no national policy to grow the economy through deficit spending, or by other means but what ever expedite to the regime’s and its partners political and economic interest.

    A more sober assessment of the Ethiopian economy tells us it remained primitive and dysfunctional on the mercy of donors and who ever want to throw money to extract natural resources. The government is a facilitator and is not motivated to develop the economy but to control it.

    Therefore there is a fundament political problem to be addressed before the economy function as it should and modern economic theory can be apply to measure it.

    What we will be seeing for the foreseeable future is the regime’s apologist attack on any theory that does not fit their political and economic interest. The two fellows above are leading the pack and more to follow.

    For God sake the budget of 70 million birr(roughly 5 Billion dollar) for the size of the population of the country should tell us some thing. It is a budget of a good size university a firm in the west. Let’s get serious and talk about the basics than arguing over a theory of modern Economics.

    Melse came up with his own theory too before he can figure out the difference between private and public sector. May be we should start there.

  6. “An updated debt sustainability analysis shows that Ethiopia is in the low risk range of public external debt distress, providing room for more external borrowing. However, external borrowing, especially on commercial terms, needs to be carefully managed and directed to projects that demonstrate a high rate of return.”

    [IMF June 22/2010]

  7. If you observe more closely the comment made by “guest” you see he uses the neo-liberal arguments to criticize, then opportunistically shift to Keynesian ideas to criticize, which is not a problem by itself but he left’s out this…
    If indeed the “guest” is a neo-liberal commentator then he must accept the idea that Ethiopia should specialize where the country has a competitive advantage, which is as he puts it “cheap labor and commodities export”…
    If on the other hand the “guest” is a Keynesian then he must acknowledge that government spending on infrastructure is essential, even if that means deficit (One must refer to Barro’s model of long term sustained growth.)
    If memory serves right, Europeans economy at the end of world war II was indeed in a dangerous position and it was “american charity money” of the Marshall plan that put their economies on the track, and growth of the glorious later years financed all the external debt.
    But one must see that influx of money by itself is nothing if not well managed… Here I must concede to our “guest” that Ethiopia needs better management, all sectors included, private and public…
    Then ones again “guest” would argue as he puts it that “applying modern economic theory on a country like Ethiopia is like pouring water on a rock…”
    What this kind of comment is ignorant at best and racist at worst…
    If the case is Ignorance let me explain, because I have no solution for the later..
    Economy as a discipline and all Economic theories either new or old are constructed in order to describe of sorts of economies backward, poverty stricken, deficit accumulating, not well managed, centralized… And that from the individual’s budget (refer to microeconomics) to Huge countries budget’s…
    Again I would point out here that this is a economic article so comments like “Melse came up with his own theory too before he can figure out the difference between private and public sector. May be we should start there” are irrelevant to the discussion, nor are the many half truth in the article like “instead pretend to be one itself through corruption and crony-ism” when we know as a fact that corruption has been reduced to a minimum since ever in the country and is still on the down road, but here I would not oppose the idea of the “guest” that party affiliated companies monopoly of Ethiopian markets…
    I would suggest to coming commentators to at least be fair to the Ethiopian government, as the guest said if their is failure of the private sector it is not only the fault of the government but also of the Ethiopian diaspora that agitates western media’s, hell they would want that no aid money flows to Ethiopia if they had their way to punish EPRDF but instead they will be punishing the very people they say they want to protect…

  8. The fellow named Selam made the usual argument in line with ‘let me have the cake and eat it too’. I understand how the new Revolutionary Democracy proponent uses their old Marxist habit of cooking the book to drag the country back while they are skimming the resources.

    The fellow called Selam would do us all a favor, instead of racing to fit an invalid data coming from the regime governing Ethiopia to fit any theory he or she can explain to us the process and the institutions that collects it. Claiming any data coming out of the regime reliable is like a junk bold dealers to run the rating agencies to set the price right. The quality of data depends on the transparency and impartiality of the institution that collects it.

    Selam speaking on corruption said “when we know as a fact that corruption has been reduced to a minimum since ever in the country and is still on the down road” with out saying who said it is reduced?

    As I said, before Economic theory is applied the source of the data must be validated for a reliable outcome with a degree of certainty. The rest of the hoopla is simply an exercise in futility and a deliberate attempt to camouflage criminality.

    No theory please, let’s go back to the basics of cleaning up the sources and the data.

  9. How can there be a sustainable economic system relying year after year on foriegn aid. This government is addicted to foriegn aid since they came to power. What is Ethiopian economy based on – agriculture, manufacturing or what. So what is their future plan except to beg for more money. How long are we going to do that. Revolutionary democracy is a new name for Marxism. The failed ideology warmed up and spiced with new terminology. Nothing new a way for a few elites to dominate both the economic and political arena. The reason marixst systems were hoplessly corrupted is because the government controlled everything. No need to explain why that is. Just go to a government office to get you id renewed and that alone should convince you that the government is the least qualified to do most services. Of course government has its role too. But to have the government be a main engine of economic development is to not learn from history. Besides shouldn’t people be trusted to make their own decisions rather than big brother above all such a hopelessly corrupt government as the Ethiopian government. How anyone argues otherwise is unfathomable

  10. Tazabi,

    The Democrats who want to free Ethiopians are undermined by Marxists in sheepskin who wants to control Ethiopians. You can say Woyane outsmarted their Marxist comrades by repackaging Marxist Revolution substitute it by Revolutionary Democracy and added ethnicity on the title of peasant farmers. The old ideology of land for peasant is now land for ethnic peasants.

    TPLF took Marxism further; In the Economy front they replaced private sector as an exclusive domain of TPLF/MLLT politburo’s EFFORT, Foreign Investment for Green Revolution, Donation for Capital.

    In the political front, they replaced the Secretary of the party for Prime Minster, Party Committees with Council of Ministers, the Workers party with EPRDF, the Party Congress with the Parliament.

    Under this structure is where spending (deficit or not) or governace (Democracy or not) must be measured. But there is a problem; the data coming out of the system is rotten, back to zero.

    Any one who argues to measure the Ethiopian economy by conventional economic theory and excuse the system is part of the rotten system or getting something out of the rotten system, or has no clue of how an economy works and supports the rotten system for other reasons.

    Warning for TPLF cadres: Your slash and burn crime can not be concealed by propaganda and confusion. Every word you utter is as rotten as the system you are part of and hope to sustain.

  11. Dear Guest,
    we appreciate the lucidity with which you attempted to make your point, rather shall i say your preposterous demagoguery. For you anyone who doesn’t bash the current regime , who doesn’t ridicule the growth figures and who doesn’t sing your mantra is ignorant, a sell out or a member of the ruling elite. Well Ken Ohashi (country directory of the world bank), Robert B. Zoellick (president of the bank )and prominent economists such as Joseph Stiglitz and Jeff Sachs must be members of the politburo. Cause all these people have repeatedly lauded the economic figures coming out of “the rotten system”. My compatriot, i think you have completely lost track of the essence of our discussion or you deliberately ignored it. had we been discussing about whether there is political repression in Ethiopia or not, you could have won hands down. But dare you suggest that Economic growth is not possible without political freedom, I only have one word for you; STUPID!
    In fact some of us who are fortunate enough to read empirical works on the r/ship between governance and growth are increasingly perplexed. the evidence is extremely mixed and even sometimes suggestive of negative relationship. I think you are at least remotely familiar with the phrase “the East Asian Tigers”. Countries like Korea, Taiwan, Singapore, Malaysia and Thailand were never and never democratic and whether you like it or not the miracle occurred without election, open governance system and the rest of democratic hoopla. And now look at China and Vietnam growing at astonishing rate starting from 1979 (the cultural revolution)and 1986 ( The Doi Moi reforms)respectively. Neither of them are democratic rather brutal, oppressive and sometime thuggish. But this never prevented them from growing. Please understand that i am not trying to defend repression neither I dare say that it facilitates growth. I leave judgments and hasty and nasty generalizations to those that share the mentality of our Guest. but I believe that we should give credit when and where it is due.
    The Guest repeatedly said modern economic theory can never explain the economic situation of Ethiopia because the data is cooked and politics is abused. Now let me refrain from making any comments on his/her ignorance but i urge you to do some more reading; particularly books such as The Democratic Developmental State, The Developmental State, The Bottom Billion and so on…
    Although, i realize your hate is running deep, I hope you will be able to disentangle your hate and disappointment in the political sphere from what is happening in the economic front.

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