Ethiopia's Silent Turn to Austerity While Attempting Economic Liberalisation

Jun 3 , 2023
By Yehualashet Tamiru Tegegn

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Ethiopia appears to be on the cusp of an undeclared austerity policy, driven by economic necessity. Its successful navigation through this turbulent phase will depend on carefully calibrating fiscal, monetary, and industrial policies and effective communications to ensure public understanding and buy-in, writes Yehualashet T. Tegegn (yehuala5779@gmail.com), an Associate at MLA.

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In the animating landscape of Ethiopia's economic reality, an increasingly fervent trend towards the free market is palpable. Prime Minister Abiy Ahmed's (PhD) administration has ushered in an era of unprecedented privatisation and liberalisation. Prime on the list of actions is the privatisation of the telecommunications sector, the “golden goose”, and the relaxing restrictions on foreign investment in the financial sector, the veritable arteries of capital flow in a nation.

Beneath the veneer of economic liberalisation, an unspoken, yet increasingly stringent, austerity regime seems to be taking root.

The conventional wisdom for austerity amongst economists comes from the notion of the “crowding out” effect. This argument, dating back to Adam Smith and David Ricardo, posits that government spending, whether financed through taxes or borrowing, tends to divert resources from potentially more productive use by private actors. Winston Churchill encapsulated this concept when he argued that government borrowing makes the state a competitor with industry for the scarce resource of capital, inadvertently raising the cost of capital for all market participants.

Contemporary economists echo this perspective.

John Cochrane, for instance, argues that every dollar of increased government spending must necessarily correspond to one less dollar of private spending. Essentially, the stimulus can result in a reallocation of resources but cannot increase total production. This would mean we might build more roads at the expense of factories, but we cannot increase the overall production capacity of the economy through fiscal stimulus alone.

Two main strategies have historically been used to implement austerity policies: consensus and coercion. The latter strategy comprises three primary components: fiscal, monetary, and industrial policies.

At the forefront of Ethiopia’s economic tightening is fiscal policy, bifurcated into expenditure cuts and revenue boosts. Expenditure austerity is typified by reductions in public funding, with social investments such as education, health, and infrastructure often bearing the brunt. Governments pursuing such policies often face pressure to reduce welfare and social expenses, abstain from price control over primary goods, and limit unemployment benefits.

The primary purpose of these expenditure reductions is often to free up resources for the repayment of debt, typically held by domestic or external creditors. The Ethiopian government has recently signalled a move in this direction by announcing its intention to gradually reduce public funding for universities. The legislation granting autonomy would require universities to generate income and cover expenses.

Concurrently, the federal government has decided to cut fuel price subsidies. Deemed “not well-guided by a well-organised policy,” the subsidy has reportedly led to a national debt of 171 billion Br. As the subsidy is withdrawn, consumers will bear the brunt of rising fuel prices, with the money previously used for subsidies diverted towards meeting international obligations.

Fiscal austerity also involves revenue boost, usually accomplished through tax changes. Introducing new taxes bolsters the public coffers, allowing the government to fund public services. Recently, the Council of Ministers introduced a social welfare tax on imported goods, in addition to existing taxes. A new property tax has been introduced, imposing additional financial obligations on property owners.

Ethiopia’s austerity drive extends into monetary policy, the second pillar of the austerity trinity. Often characterised as a ‘dear money’ policy, it involves raising interest rates and reducing the amount of money in circulation. Higher interest rates increase the cost of borrowing for both the government and the public, potentially reducing consumption as disposable income decreases.

In recent years, many Ethiopians have financed home purchases through bank loans. As interest rates rise, the cost of these loans will increase, further reducing disposable income and consumption. Conversely, the increase in interest rates may encourage increased saving as the value of money becomes more substantial. This dynamic echoes the broader ethos of austerity: save more, consume less. Recently, the central bank doubled the reserve requirement for banks from five percent, and increased the lending rate by three percentage points to 16pc.

A recent directive has required commercial banks to surrender 70pc of the foreign currency they accumulate from the export of goods and services, private transfers, and not-for-profit organisations. In an attempt to restrict the circulation of cash, the government has prohibited the sale of fuel for cash payments.

Such a monetary policy can have a long-term impact on the economy. Higher interest rates make borrowing more expensive, not just for the government and the general public but also for investors. This can lead to a decline in investment, potentially increasing unemployment. As the job market becomes more competitive, workers might accept lower wages, allowing companies to hire more skilled labour at a lower cost.

Simultaneously, lower public and private investments can lead to an economic contraction. Governments, fearing that capital or investors might relocate to other countries – a phenomenon known as capital flight – may be forced to make significant concessions to retain them. Reducing imports due to decreased investment can help correct the balance of payments.

The third prong of Ethiopia’s austerity policy, the industrial policy, relates to maintaining industrial peace. This peace is crucial in securing property rights, wages and monetary stabilities in the long run. Policies such as interest rate hikes, which can push investments and employment down, play a crucial role in maintaining this peace. Workers who secure jobs in such economic conditions may feel compelled to discipline themselves as they face the prospect of easily being replaced by others from the large pool of unemployed people.

This diminishes the political leverage of the labour force and suppresses wage demands.

Government regulations can further contribute to this industrial peace. For instance, prohibiting strikes or enacting stringent controls suppress labour activism. When unemployment is high, labour costs decline. This can reduce production costs, potentially attracting more buyers and boosting international trade. The government’s recent prohibition of demonstrations organised by the Confederation of Ethiopian Trade Union (CETU) could be interpreted as a move to ensure industrial peace.

Austerity is not inherently a negative economic policy. It can be necessary for countries dealing with high debt or economic crises. However, the short-term consequences can be severe for the public, mainly when reductions in public welfare and increased taxes are implemented in the name of economic sovereignty and privatisation. Thus, while Ethiopia’s apparent shift towards an undeclared austerity policy may be economically rational, the broader implications warrant careful consideration.

With austerity’s potentially substantial impacts on social welfare and public sentiment, the path towards economic recovery will likely be challenging, and the way to prosperity may be steep and fraught with pitfalls.

For Ethiopia, a country in the throes of economic upheaval and transition, these measures may provide necessary corrective actions to structural imbalances, but they are not without costs. The social implications of these austerity measures could be particularly significant given the country’s diverse demographic and ongoing political challenges. As public resources are retracted and personal expenses increase, ordinary Ethiopians may be shouldering this austerity’s burdens.

The impact on public sentiment cannot be ignored. Public universities, for instance, have traditionally been seen as beacons of opportunity; their gradual defunding could trigger discontent among younger generations seeking quality education and upward mobility. Similarly, the cessation of fuel subsidies and the imposition of new taxes may strain the public’s goodwill, particularly if the benefits of these austerity measures are not immediately apparent or are unequally distributed.

Monetary policy changes could also hit consumers hard. High-interest rates may encourage saving, but they can be a harsh deterrent to vital spending and can drastically affect those with existing loans. Even more, a rise in unemployment due to decreased investments could heighten economic disparities and engender a sense of social unrest, thereby leading to industrial unrest.

Undoubtedly, the successful implementation of an austerity policy requires delicate balancing. Too little, and the policy’s objectives may not be met; too much, and the country’s social fabric may be stretched taut. It is a walk on a tightrope, with each step potentially fraught with peril.

In this landscape of change, communication will be critical. A clear articulation of the reasons behind these policies, the envisioned benefits, and a roadmap to economic recovery could go a long way in maintaining public trust. Transparency about these policies’ expected hardships and potential rewards may also address public discontent.

The views and opinions stated in this article are solely the author's and do not represent the institutions or projects he is affiliated with.

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PUBLISHED ON Jun 03,2023 [ VOL 24 , NO 1205]

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