Author: basiloberholzer

Where is Ethiopia going after the deal with the IMF?

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The agreement recently negotiated between the Government of Ethiopia and the International Monetary Fund (IMF) not only imposes austerity on the government, but also risks destroying the country鈥檚 model of economic development.

Ethiopia, Africa鈥檚 second-most populous country, has featured tremendous progress in its economic development in the past twenty years. A developmental state driving public investment while imposing tight regulations on the financial sector, a managed exchange rate, and capital controls, achieved a significant decline in hunger and malnutrition, and improvements in literacy and other relevant human development indicators.

Nonetheless, Ethiopia is facing serious macroeconomic challenges including high inflation of close to 30 percent, a current account deficit, foreign exchange shortage, and slowing growth, jointly with domestic conflicts and climate change impacts. This situation has forced the country into negotiations with creditors on its external debt, even though Ethiopia鈥檚 external debt stock compared to GDP is less compared to other low-income countries. International financial institutions see government budget deficits as the main culprit in causing inflation and an overvalued real exchange rate that causes trade deficits and balance-of-payments problems while crowding out private investment in the country. End of July 2024, the Government of Ethiopia and the International Monetary Fund (IMF) concluded an agreement on policy action to be taken for a stepwise release of a loan of USD 3.4 billion from the IMF, starting with the immediate release of USD 1 billion, as well as additional grants and loans from the World bank. The agreement is built on the following : 1) floating the exchange rate; 2) modernizing the monetary policy framework going from reserve targeting to interest rate targeting; 3) ending monetary financing of the government budget via the National Bank of Ethiopia (NBE) and exiting financial repression; 4) improving mobilization of domestic government revenues; 5) debt restructuring with external creditors; 6) strengthening the financial position of state-owned enterprises.

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Internal and external constraints: economic development without currency crisis

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Simply speaking, development macroeconomics can be summarized as the challenge of improving productivity and production capacity in poor countries. This involves the conditions that need to be fulfilled for a development process to start as well as the policy framework and instruments that support it. Heterodox approaches consider the state鈥檚 role in steering productivity growth as essential (Cardim de Carvalho, 1997). Markets may be able to exploit price signals and adjust resource allocation correspondingly. However, they guarantee neither sufficient profitability of key sectors nor the demand for the goods produced. Both the profit rate and effective demand are conditions for investment to take place (Oberholzer, 2020). It is thus up to the government to make public investment in priority sectors and to apply instruments such as taxes and subsidies in ways that simultaneously allow for economies of scale, higher productivity large-scale employment and demand. This is what is generally referred to as industrial policy (see for example Chang, 2006; Oqubay, 2018).

But this is not everything. Policymakers have to pursue such a development strategy in face of an (often permanent) shortage of foreign currency. While domestic currency can be generated via the domestic banking system including public development banks, the availability of foreign currency is limited unless a country is able to increase exports or restrict imports. Since larger export capacity and a higher degree of import substitution are long-term goals, the current account is determined by domestic and foreign economic growth. This insight has come to be known as the balance-of-payments-constrained model or Thirlwall鈥檚 law, respectively (Thirlwall, 1979, 2013): it is reasonable to assume that demand for a country鈥檚 exports grows in income in the rest of the world while imports increase with domestic economic growth because a part of increasing incomes is reliably spent on imported goods. Therefore, stability in the balance of payments requires that imports do not grow faster than foreign exchange earnings via exports allow. A limit to the growth of imports implies a limit to the country鈥檚 economic growth, hence the balance-of-payments-constrained growth rate.

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Economic Sovereignty for Developing Countries: What Role for Modern Money Theory?

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With modern money theory (MMT) receiving impressive attention, the implications this theory has for developing countries have also been discussed more intensely. Emphasizing both its strengths and gaps provides a great chance to further develop macroeconomic strategies for poverty reduction and environmental sustainability.

In brief, the starts from the statement that money is issued by the government and brought into circulation via its expenditures. The government does not rely on taxes to fund expenditures when it is itself the source of money. Therefore, money can be created upon demand, is not limited, and can be used by the government to finance all expenditures it considers necessary to achieve policy goals such as full employment or a . The reason why agents in the economy accepts this money only consisting of numbers without any intrinsic value is the obligation to pay taxes. Since the state has the power to impose taxes, individuals need to get hold of money as this is the only way to meet their obligations; this is how the currency is accepted as a means of payments. The government thus has the power to run unlimited deficits because the fact that money is needed to pay taxes guarantees its acceptance even if those taxes do not cover expenditures. In fact, the government should run deficits because it creates the demand required for full employment while a balanced budget constrains it. The government cannot go bankrupt because there is no lack of currency it issues itself. The conditions identified by MMT for the system to work are the following: 1) the country must be sovereign of its own currency and 2) inflation needs to be kept under control. Once the latter starts accelerating due to increased nominal demand stemming from government expenditures, taxes can be increased in order to withdraw money from circulation. However, as long as full employment is not achieved, prices are argued to remain stable.

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