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Ethiopia’s growth miracle: What will it take to sustain it?

Lars Christian Moller's picture



If you are curious to know which country has achieved double digit growth in the last 12 years, making it the fourth fastest-growing in the world, the answer is Ethiopia. And what is more striking is that if Ethiopia sustains its current pace of growth, it will become a middle income country by 2025.

Over the last decade, Ethiopia has emerged as the fastest-growing non-oil producing country in the world (Figure 1). You may ask what’s fueling this stellar economic performance. Though the story is nuanced with several growth drivers at play, the single most important factor is substantial public infrastructure investment in energy, transport, communication and the social sectors.  It is a well-known fact that infrastructure investment can be a growth driver in rich as well as poor countries, though many countries are often not able to deliver and their economic performance suffer as a result.  Ethiopia got that part of the economic formula right.

We have attempted to unveil the success behind Ethiopia’s growth in a recent World Bank report, Ethiopia’s Great Run: The Growth Acceleration and How to Pace It. What’s unique about Ethiopia’s infrastructure drive is the way in which it is financed. Domestic resources, including savings and taxes, are actually well below peers yet the country has been able to achieve the third highest public investment rate in the world.  This was made possible, first, by keeping government consumption low thereby creating budgetary space for public investment.  Second, by designing the domestic financial system so that cheap credit and foreign exchange is directed to finance public investment.  Finally, through external borrowing from traditional (e.g. World Bank) as well as non-traditional creditors (e.g. China).

To become a middle income country in 2025, does Ethiopia need to change its economic strategy?
The report argues that Ethiopia may need to change strategy at some point in the future to continue the growth acceleration, but it is relatively open about the timing of such a shift. Rather, it recommends that policy makers pay close attention to the trade-offs embedded in the current strategy and make adjustments before the costs of the current policy starts outweighing its benefits.

Given a historical legacy of under-investment, Ethiopia needs much more infrastructure going forward. However, it needs sustainable ways of financing it. To begin with, the government cannot keep on borrowing externally at the current rapid pace for too long, especially since exports are not performing well. So it would need to raise more taxes and also bring in the private sector more as a partner in delivering infrastructure. Encouragingly, the government has taken important steps in this direction. But more also needs to be done to raise private investment which is currently the sixth lowest worldwide. A key factor in this regard is access to credit, which is a now bigger constraint to firms than lagging infrastructure (see Figure 2). This can be done either by shifting more credit towards the private sector or by gradually allowing higher real interest rates to increase total savings, as discussed in more detail in the report. Finally, Ethiopia could make further progress on implementing structural economic reforms which are positively associated with economic growth.

Ethiopia’s successful economic performance over the past decade has been noteworthy. With the recent launch of a new five-year plan and appointment of a new economic team, the timing is right to consider the proposals of this new report.
 
Figure 1. Real GDP Growth Rates (2004-14 average per year)

Source: World Bank Global Economic Prospects (June 2015).  *Oil/gas producer.

 
Figure 2. Credit to the Private Sector (Percent of GDP)
Source: National Bank of Ethiopia (NBE) and World Bank (FINSTAT).  Note: NBE definition includes credit from Development Bank of Ethiopia (DBE) as 100 percent private.  IMF definition excludes DBE.

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