Every country’s economic goals revolve around growth and for most economies, growth is equated with progress. Economic growth is defined as an increase in the value of goods and services produced by a country. This growth effectively translates into an increase in living standards for the country’s inhabitants. When a country has an established, stable economy, this growth becomes regular and expected, but when we look at third world countries with developing economies this growth becomes harder to predict and achieve.
This paper’s aim is to analyze a few of the efforts being made to transform those developing economies into stable ones in order to promote growth. In order to effectively analyze these policies I will use Ethiopia as a case study, comparing its economy to stable ones while looking for similarities and differences in them. With these differences in mind I will then take a brief overview of the microeconomic and macroeconomic situation in the country and identify key challenges each of these areas face. With a basic understanding of the economic situation in Ethiopia I will then outline some research and policies targeted at promoting healthy markets and economic growth in Ethiopia. The first is an inclusive makeover of Ethiopia’s entire agricultural market called the Ethiopian Commodities Exchange. This exchange features a stabilizing infrastructure for every step of the agricultural process and looks very promising. The second is research on using food aid in Ethiopia as a way to supplement growth. We know that food aid will reduce prices but some claim aid creates a dependency and weakens local markets. The research analyzes that claim, testing to see how the aid affects the economy. Third, we will inspect some research on property rights in Ethiopia; currently the government does not allow citizens to own property, it only allows extended periods of lease. Research shows that this creates a negative effect on long term investment in Ethiopia and lowers the returns on land.
Ethiopia is a country labeled as one of the poorest in the world; GDP per capita in the country was estimated in 2006 at 1000$ per year from “CIA – The World Factbook” (2007). The country has a rapidly expanding population and is currently increasing the workforce on the order of onehundred thousand per year. Its economic history is a cyclical one, featuring growth for a few years and a recession for a few years, leaving it to gain very little GDP per capita over the long run. The economy in Ethiopia is largely dependent on its agricultural sector which makes up over 50% of the country’s GDP, 90% of its exports, and 80% of the labor force. Only 7% of the country’s land is irrigated, leaving the crops and subsequently the country’s GDP and survival at the mercy of the rains. The country relies on coffee as its primary export with nearly 70% of total exports, and due to the recent drop in world coffee prices the country has lost over 300 million dollars per year in GDP. The country experiences rapid deflation and inflation of its currency, exasperating buyers and sellers efforts to find reliable market prices for goods. The country’s inflation rate was nearing 20% in recent months. These volatile aspects of the Ethiopian economy paint a very risky picture for buyers and sellers and a dim outlook for the country’s economy.
All of these qualities of Ethiopia’s economy are common to developing economies. Richard (2007) lists, in a more general sense, the facets of a small developing economy. 1. A concentration on a few (one to three) exports, such as Ethiopia’s dependence on coffee exports. 2. Imperfect markets in which a few firms dominate the market and price signals are distorted. 3. The small size of firms, such as the farmers in Ethiopia, which can not realize the economies of scale. 4. Physical vulnerabilities, such as Ethiopia’s reactions to drought, are realized in a much greater magnitude for small economies as well. In Small Developing Economies in the WTO the author also lists export market concentration and dependence on trade taxes as common to small economies. In order to strengthen Ethiopia’s economy these problems must be overcome before we can begin to foster growth in their economy.
Let me break down these issues a bit further; first, the microeconomic situation of the country. This realm of the economy is composed of buyers and sellers. These buyers and sellers come together to create a market, and their interaction causes Adam Smith’s “invisible hand” to allocate the resources that the buyer and seller bring to market in the most efficient manner. A problem arises when the markets are fragmented and volatile; the invisible hand, in these cases, is not able to efficiently allocate resources. “Building a Commodities Market in Ethiopia” (2007) outlines the famine which occurred during 2002 which is a good example of this; a bumper crop the previous year drove the price of Ethiopian cereals below the price of production, forcing many farmers to let their crops rot in the fields. The next year many farmers did not reseed their crops, distrusting the validity of making a profit there, instead looking for alternate forms of income. That year the northern portion of the region fell victim to a drought which threatened 15 million with starvation. One can pull a couple of ideas from this situation, each show how the hand’s market allocation powers are obstructed. First is the lack of strong market signals which let the farmer know when to plant and sell. The country lacks an information infrastructure necessary to carry market prices to the farmer at home and the volatility of prices make it hard for the farmer to discern when to sell his produce. The country is very spread out and there exists little transportation infrastructure to move good around the markets. The farmer’s trip to the city to locate a buyer is quite costly, and the chance that prices that day could be below the equilibrium puts the farmer in a bad position. The farmer also lacks capital; with capital the producer could choose to not sell until prices have risen to acceptable levels, but if he does this he will have no money to invest in seeds, supplies, or food for his family. Thus, the farmer sells his produce at the point when prices are lowest, during the harvest. This relates both to a failure of the guiding hand of markets and to one of Mankiw’s 10 Principals of Economics: that rational people think at the margin. Even though it appears that the farmers are irrational in selling when prices are lowest, in actuality they remain rational because the economic cost of saving their produce is greater than the benifit.
So the challenge to a producer is an extremely high risk when transacting in the market, prices fluctuate as much as 50% from year to year. This price volatility is a result of physical vulnerabilities, like rain, common to small economies, combined with the weak fragmented markets that buyers and sellers must interact in. Therefore, the basic challenge of strengthening the market for sellers involves combating these problems. The difficulty of attempting this is easily seen. Investing in irrigation requires capital which there is little of, making markets larger requires trust through grades and standards, lowering production costs for farmers involves building transportation infrastructures inside a country which is one of the poorest in the world. The problems for the economy extend beyond the seller and to the buyers as well. The basic premise is the same. Weak market signals, high transaction costs, and the lack of capital to buy when prices are low create a challenging situation. So where does one begin when all these problems exist?
One proposal comes in the form of the Ethiopian Commodities Exchange (ECEX). In “Understanding Commodities Markets” Eabre-Madhin, a World Bank senior economist, outlines her plans for a commodities market in Ethiopia. This proposal has received the support of the Ethiopian government and was instated in September of 2007 and was set to begin trading in December of 2007, though no reprts on its success are being circulated yet. The broad goals of this exchange include a market for all the participants, integrity, efficiency, transparency, and risk management. The plan addresses the weaknesses in Ethiopia’s current market structure with six core facets. First, a trading platform; this will bring market buyers and sellers together in a low cost, efficient way. Second, brokers; the brokers will be the leis eon between the trading platform and the exchange, enabling all clients to participate in the market. They will assist in matching potential buyers and sellers through the trading platform. Third, contracts; contracts on the ECEX will be in relation to the item and grade of the item. They will be tailored to the ability to deliver and to attract the largest number of buyers. Fourth, risk management; the exchange will protect buyers and sellers from one defaulting on the contract through a bank like system. Fifth, product integrity; the product will have a standard, understood grade and be guaranteed in terms of deliverability. Finally, regulation and enforcement; the Ethiopian parliament has passed a bill legally supplementing the exchange, allowing trust in the system to be formed by buyers and sellers.
The path through the system begins with a seller bringing his product to the exchange’s warehouse. Here his product will receive a grade, weight and certificate. This certificate will allow him to sell his product on the ECEX market. Because the seller holds a legal entitlement to something in the warehouse (the certificate), the warehouse can also be thought of as a bank; This will allow a more efficient disturibution of the goods. After the seller has certificates he may at any time sell them on the exchange through a broker to a buyer. In the same way a buyer would approach the exchange, from any of the 200 trading centers in the country and place a bid for a traded product. The buyer must transfer funds to a settlement account before the bid is finalized to prevent contract default. From there the nearest warehouse will have the buyer’s good ready to deliver. Throughout this process a satellite powered system will send daily price information to each of the country’s 200 price boards, allowing buyers and sellers to be aware of the national prices for the products.
In my opinion this is the most exciting and plausible option for economic growth in Ethiopia. The plan seems to strengthen every bit of the market, moving the power of resource allocation back into Adam Smith’s invisible hand. The ECEX will nationalize the market for Ethiopian grains, bringing together sellers from every corner of the country and stabilizing prices. If this plan succeeds in strengthening the market and stabilizing the agriculture sector, then the small farmer will gain much needed resources and a rational ability to take the risks involved in investing in things like irrigation or fertilizer. Over time, the success of the ECEX means the lift that country needs to escape poverty. Furthermore I expect to see the success of this commodities exchange spur the birth of similar designs in other developing economies.
The ECEX plan is not a sure thing, though; this idea is definitely not tried and true so the idea of moving an entire country’s economy onto a theoretical model is scary. The entire system requires the trust of buyers and sellers, and if during the premier months of the program problems are uncovered it could undermine the trust for the system forever. Also, the brokers must withstand corruption, because as they are the gateway to the trading system I could see them being used to leverage it to their advantage. I am unsure of how the system is going to affect small farmers on the brink of profit; the stabilized prices throughout the country could be a radically different than previously, and push many farmers out of the market. The system also doesn’t deal with Ethiopia’s dependence on coffee exports, and a deflation of those world prices could still adversely affect its economy. Overall, I fully agree with the Ethiopian government’s support of this bill, and see it as the most hope Ethiopia’s economy has.
The Ethiopian economy is also receiving foreign food aid from various countries and world organizations. There are differing opinions as to whether the addition of food aid to a country’s economy has a positive or negative effect. Food aid, in the positive sense, provides a relief for starving countries and can provide a starting point allowing a country to get back on its feet. In the negative sense food aid can create a dependency on foreign aid, and take away from the power of the local grain merchants; it can effectively lower grain prices and drive out market producers. We actively see both of these phenomenons wherever food aid is present, but the question to be answered is whether or not the overall shift in the economy is positive or negative. In “Does food aid harm the poor: household evidence from Ethiopia” (2005) James, Levinsohn, and McMillan find that food aid disproportionately benefits the poor more than the rich over the entire country.
In their paper they make several observations to arrive at their conclusion. They begin with the facts that buyers of wheat in Ethiopia are, on average, poorer than sellers of wheat and there exists more buyers than sellers in the economy. Then, through market analysis they conclude that the food aid is more likely to be received by the poor, and the benefit the poor receive is greater than the loss the producers feel. Using a household census conducted throughout the country combined with cereals production data the authors are able to isolate the buyers and sellers and collectively analyze their benefit from aid. The authors reduced the broad market for cereals to the wheat market only, for their analysis, stating that 33% of Ethiopia’s wheat supply comes from aid increasing the affect aid will have on price. They find that though food aid does drop wheat prices, that drop in price negatively affects only the farmers, a smaller and richer group than the consumers. For this reason, the net welfare of the country increases.
I am uncertain of the reliability of the author’s findings in the respect of food aid. The research uses an average of households in income brackets, meaning that the variation there could hide a large negative effect on the poor. Currently, prices vary a lot throughout the country, and the regional benefits in one area, could be a large loss in another. Overall it can be seen that the introduction of food aid into Ethiopia’s economy is helpful in the short run, and should be used as such. In the long run however, the dependence the country will build on food aid is a detriment. Without food aid a country would have higher prices which would in turn encourage more farmers to enter the market. Over the long run, this change would expect the prices to drop with increased production, achieving a goal of food aid without the aid.
I see the foreign food aid as a perfect complement to the ECEX. If the aid agencies distribute the aid throughout the ECEX without undermining it they could use the aid to prevent against total market failure while strengthening the power of the exchange. The aid would supplement consumers as farmers build trust in the system. As the exchange builds the strength of the economy, food aid can slowly be removed from Ethiopia, allowing the market to eventually effectively regulate supply and demand. One thing I cannot see food aid doing is strengthening the economy. Therefore I view food aid as a short term relief effort and not a long term support option.
The final aspect of Ethiopia’s economy I will look at Ali, Deurcon, and Gautam’s (2007) investigation into property rights in the country. The basic economic property of weak property rights in a country is that they discourage the accumulation of and investment in capital. The paper furthers that conclusion, linking Ethiopia’s weak property rights with discouraged planting, and maintenance of land in the long run. The paper focuses on the lack of land transfer rights and the affect that has on Ethiopian farmers. The authors conclude that the lack of transfer rights for land discourages the planting of longer term crops like coffee, Ethiopia’s primary export. They also find that the threat of land redistribution does the same and discourages the preservation of land, and planning for future crops. Land redistribution and the lack of transfer rights were identified as the two key aspects of weak property rights.
Their conclusions are based on the Ethiopian Rural Household Survey and focus on the allocation of land to coffee production and the investment of longer term capital, such as eucalyptus trees. This allocation was tracked over time, through some alterations in Ethiopia’s property rights laws. The evidence showed that when considering long term investment in land, property rights cause a large inefficiency in the market. When the farmers are able to trust the ownership of their land into the future, they invest more heavily in coffee and eucalyptus trees. Altering property rights to support this investment would in the long run remove a market inefficiency caused by that uncertainty which lowers the supply of those two crops. Along with this paper there exists an obvious correlation between economic progress and strong property rights in developed countries.
Property rights are one area that the ECEX and foreign aid cannot help at all. The problem is aggravated by political unrest in the country and a lack of a strong government lead. I see the strengthening of property rights as a large hurdle Ethiopia has to face to strengthen the producers trust in the future of their operations. With strengthened property rights all the findings of the authors are plausible; increased investment in the future of land, an equalization of the crops that would be planted, and the ability to use land as a way to back your capital accumulation loans.
Ethiopia’s economy will face some large challenges before it can achieve real growth. Those challenges include a strengthening of the markets, a way to manage and reduce the risk farmers face, and stabilizing prices. Each of the plans in this paper provides ways to achieve some of these goals. The ECEX will strengthen markets and bring together the nations fragmented trading circles. Food aid will support the country’s risk until it is able to manage it on its own. Strengthened property rights will give farmers more resources needed to invest in capital and manage their risk. All of these, combined, will stabilize prices in Ethiopia’s agriculture sector and strengthen the economy as a whole. A stronger economy means stronger growth and a boost away from poverty and towards increased living standards; this is the goal for any economy.?
References
Bernal, Richard. Small Developing Economies in the World. WTO, 2001. 31 Oct. 2007 .
Gabre-Madhin, Eleni. "Building a Commodities Market in Ethiopia." TED Confrence. Mar.-Apr. 2007. 31 Oct. 2007 .
Levingson, James, and Margaret McMillan. Does Food Aid Harm the Poor? Household Evidence From Ethiopia. NBER, 2005. 31 Oct. 2007 .
"Ethiopia." CIA - the World Factbook. 4 Dec. 2007 .
Leni Zaude Gabre-Madhin. "Understanding a Commodity Exchange." 4 Dec. 2007 .
Madhur Gautam, Daniel Ayalew Ali , and Stefan Dercon . Property Rights in a Very Poor Country:. The World Bank. 4 Dec. 2007 .
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