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 Such an ‘outdated’ hypothesis simply does not hold true for this nation.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.