Ethiopia: Devaluation and dismal scientists

By Fetsum Berhane

Ethiopia is blessed with brilliant economists however thanks to their aversion of the public space and abdication of their intellectual duty to educate the public, the public is forced to be confused by dismal scientists of “the dismal science”

Ethiopian birr
Ethiopian birr

I realized this when i came across a questionable article titled “The Devaluation of the Birr – a Layman’s Guide” by an Ethiopian economist. The article, though painful for anyone who has respect for the discipline, was not surprising.

The “guide” was provided from the same person that brought us the 2008 analysis “Is Ethiopia Really Enjoying Economic Development?” that, according to the author, Dr. Seid Hassan, was “designed to dispel and demystify the myth” of Ethiopian economic growth. The analysis then attributed the economic growth of Ethiopia to “bounce-back effects”, which is when a recession is followed by an above average growth, from the 2004 

Well, six years of growth passed since then and the bounce back effect, if there was any by 2008, is long gone with the credibility of the economist who relied on it.

It threw all the mud he could muster, from “unreliability” of WB/IMF data to a theoretical debate on GDP as a measurement in a desperate attempt to “dispel the myth”. It must be only in Ethiopia that you find an “economist” that finds the fact that “Ethiopian economy was on a higher growth trajectory and at the same time experiencing food shortage” puzzling. Higher growth trajectory is a state of economy that, if maintained for decades, can lead a nation out of food shortages. One does not have to learn economics to figure that out, apparently a PHD holder gets puzzled by it. It is always advisable to take with a grain of salt an economic analysis from economists that make their analysis subservient based on political convenience.

Devaluation 

The buzz word of the month is now devaluation after the World Bank recommended the Ethiopian government to devalue the Birr in order to boost exports by 5.2 percentage points and economic growth by 2.2 percentage points. The government said it is considering it. That was followed by every political pundit turning into an economist overnight and a heated though unusual debate on the social media. Even though a debate on substantive issues is commendable, the lack of authoritative intellectuals setting the tone of the debate is unfortunate.

One of the reasons for our foreign exchange (forex) shortage is the loss of production output due to power shortages and we can only solve this by developing our power generation and distribution infrastructure. That requires a huge supply of foreign currency of which we are getting short of in the first place. The solution is the problem, a poverty trap.

The sustainable measure to mitigate the forex shortage is to increase the quantity and/or the quality of export goods and diversify our export items to enhance our market competitiveness so as to boost our foreign currency earnings. But this is a long term solution that requires the implementation of various policy measures to enhance labor productivity and production efficiency. Even though we could do it in the short term, as long as the exchange rate remains overvalued, exporters will not be competitive in international markets and investors are unlikely to invest in domestic productive capacity.

In the mean time we are left with two monetary tools at our disposal to reduce our forex shortage, austerity and devaluation.

Austerity, which is the reduction of government spending, entails (one among others) the government reducing its spending on the many railway, road and hydropower projects that consume the bulk of its forex reserves. This infrastructure projects are our only hope to build an industrial economy and for a fast growth that can ensure our escape from poverty. These projects are also what attract foreign investors (FDI) to come even before we build them since they include our plans for the future in their considerations. Reducing the projects will only delay our escape from poverty especially in a dynamic world where geopolitical situations change and economic opportunities easily go away.

The other tool and a common response to sustained foreign exchange shortage is to devalue the currency. Devaluation is a decrease in the value of a country’s currency relative to that of foreign countries. This lowers demand for imports as import prices rise in domestic currency terms, while at the same time foreign exchange earnings from exports rise as demand for more competitively (relatively lower) priced exports rises. (Click here – for a detailed explainer)

The tool is however, comes with its own risks like a potentially higher cost public investment, a relative increase of government debt and inflation

The potential to imported inflation is higher, especially in import-intensive countries such as Ethiopia. The impact of the inflation will be negatively felt by the solely consumer segment of the population. However inflation will also have a positive or (at least offsetting) impact on the more larger segment of the population that is engaged in producing export items or employed export intensive industries that will raise wages and hires to meet the increase in demand. The urban poor that is not employed in the export sectors like horticulture and industrial production will be hurt by rising prices while rural households (and farm households in particular) likely benefit from improved export opportunities.

Implementation of subsidy and other pro-poor policy measures can however reduce the negative impact of rising prices on the segment of the population that will be affected by it. The central bank is also expected to determine how large the devaluation will be taking the negative impacts and its capacity to reduce them into consideration.

Devaluation is a must. The question is how, when and by how much to do it. The current foreign exchange shortage is not a short-term problem that the country can ride out by borrowing on international markets or implementing foreign exchange rationing measures. While this looks our only strategy in the short run to reduce our forex shortage it is not sustainable in the long run. Faster implementation of policies to diversify export items, to boost labor productivity and production efficiency is long term measures to be started now.

I am sure we can agree the WB economists deliberated on it before recommending devaluation, keeping in mind the ideological bias of the institution. We can similarly understand when the government economists, those folks that brought us a decade of fast growth, say they are deliberating it. It is only logical for us to agree on the notion that an economist have to refer data and deliberate on an issue before coming out for or against it and to do otherwise even before reading the WB document will only be intellectual dishonesty and an act of relegating economics for political expediency.

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