First, the Marshall-Learner (ML) condition may not hold in
the short run. The ML condition is a theoretical viewpoint that links exchange
rate fluctuations and trade performance from the perspective of elasticity.
According to this theory, ceteris paribus, a country will improve its current
account deficit by devaluing its currency provided that the sum (in absolute
value) of the elasticity of demand for its exports and imports is greater than
one. But most empirical results show that short run elasticities
are smaller than their long run counterparts and countries may not achieve
increased employment, investment and output following devaluation.
Second, if we allow for changes in some variables, such as
changes in the national income, devaluation will improve the trade balance only
if the improvement in trade balance generated by currency depreciation more
than offsets the improvement in imports brought about by a rise in the national
income. This is called the Lausen-Metzler effect.
Third, the so called J-curve effect may dilute the immediate
benefits from devaluation for two major reasons: a) even if the ML condition
held, export receipts may not increase in the short-run due to supply side
constraints associated with time lags, which is largely the case for
agricultural commodities that need several months to harvest; b) most imports
are less responsive, if not, non-responsive at all despite the increase in
their prices after devaluation. This applies to most capital goods and raw
materials (such as oil) that have inelastic demand in capital-deficient and oil
importing countries such as Ethiopia. As a result, the fall in foreign spending
on the country’s exports and the increase in domestic spending on imports will
cause the trade deficit to get worse before it improves, which makes the trade
balance curve assume the shape of letter “J.”
The
empirical evidence on the relationship between devaluation and export
performance is generally mixed with the conclusions differing depending on the
nature of the economies investigated, the type of methodology employed, and/or
the sample size and data frequency used in the specific study.
On the flip
side, therefore, devaluation may make imports less attractive leading to
increased spending by domestic consumers and investors as measured by domestic
currency. Moreover, inflationary infection induced by currency depreciation
could eat up the potential gains from nominal devaluation. A number of studies
have shown that changes in nominal devaluation entail massive increase in the
prices of goods and services, thereby diminishing the international
competitiveness of the economy. In other words, nominal devaluation results in
real devaluation and effectively improves a country’s trade performance only if
we have net positive change after adjustment in the price levels.
Still even
more interesting is the impact of devaluation on income re-distribution.
According to Paul Krugman and Lance Taylor (1997),
even when devaluation does not affect the country’s terms of trade, it,
however, could entail a number of income effects. To this effect, they have
identified three major channels through which devaluation could possibly
redistribute income among various economic actors:
Firstly,
when the devaluation measure is undertaken in an environment where trade
deficit prevails, the increase in the prices of traded goods are immediately
followed by a reduction in real domestic income and by a corresponding rise
abroad, since export receipts of the devaluing country are overwhelmed by its
swelling expenditures on imported items. Thus, the value of the home country’s
‘foreign savings’ rise ex ante, while aggregate demand falls ex post, and
imports decline along with it. The bigger the initial trade deficit, the more
pronounced the cotractionary effects.
Secondly,
even if the country had balanced trade initially, the prices of traded goods
increase relative to domestic goods following devaluation, resulting in
windfall profits and rents for businesses and investors engaged in export and
import-competing industries. If wages are rigid in the short run and if the
marginal propensity to save from profits exceeds the one from wages, ex ante
national savings rise. The magnitude of the resulting contraction is a function
of the difference in savings propensities between wage earners and businesses
specializing in exports and import-competing industries.
Finally,
devaluation can also affect the fiscal position of the national government.
Particularly, assuming that budget was initially unbalanced, the government can
raise substantial additional money if there are progressive taxes on income as
well as if taxes on profits are higher than taxes on wages. Moreover, if
exports or imports are subject to ad valorem taxes, devaluation generates
redistribution of income from the private sector to the state coffers, whose
saving propensity is unity in the short run. Once again, the final outcome is
reduction in aggregate demand.
Haughton and Kinh (2003), based on
disaggregated household income and expenditure data for Vietnam found that
devaluation of dong has modest effect on redistribution in favour
of the poor and the rich while the middle class was a net loser. Acharya (2010) investigates the impact of devaluation on
the Nepalese economy by applying general equilibrium model and finds that while
devaluation is expansionary most of the benefits, however, accrue to the rich,
thereby creating unequal income distribution. He attributes this pro-rich
growth to the fact that returns to high-skilled labour
and capital grow faster than returns to their low-skilled counterparts.
Moreover, while the expansion was more concentrated in agricultural and
industrial activities, the service sector actually suffered contraction
following devaluation.
While much of the redistribution literature focuses on
income transfer between domestic agents (workers, firms and governments), the
income transfer could also assume international dimension. Ciuriak
(2010) in diagnosing the demand and supply side constraints affecting Ethiopia’s
export performance observes that market structure may also diminish the positive impact of devaluation,
working in favour of few omnipotent global firms that dominate international
commodity markets. He notes that international commodity markets where developing
countries sell their products are dominated by a handful of buyers with
considerable power of influence that enables them to amass enormous profits and
rents. Thus, such asymmetric power of influence will likely create a situation
whereby the devaluation measure will boost the profits of multinational buyers
with little of the benefit trickling down to the Ethiopian producers.
Reforms
and Exports
In May
1991, the Ethiopian landscape was markedly overwhelmed by major economic and
political changes. The military junta that terrorized the country for 17 years
collapsed and a coalition of liberation fronts assumed political power.
Extremely delighted with and motivated by the fall of the communist regime in
the country, delegates of Western governments and institutions hurried to the
capital Addis Ababa to sell their free market economic policies toolkits,
packaged as Structural Adjustment Programmes (SAP), sponsored by the
International Monetary Fund (IMF) and the World Bank (WB). Though deeply communist
themselves, the new leaders, desperately in need of resources and foreign
exchange, were easily persuaded to undertake the proposed economic reforms in
exchange for low interest loans and development aid.
Under the
new reform program, foreign trade and exchange rate regimes were liberalized;
prices of domestic inputs and finished goods were decoupled from arbitrary
government regulation and interference; public sector reform that accorded
autonomy to the state owned enterprises (SOEs) was implemented; some
enterprises were privatized; the financial market was reformed to allow private
sector participation in commercial banking, insurance and micro credit
services; export tariffs were abolished; export subsidies to domestic,
export-oriented firms were eliminated and were replaced by incentives that
provided the duty-free importation of raw materials.
Most
important, in October 1992, Ethiopia’s national currency, the Birr, saw a major
free fall when it was devalued by 242% from its pegged rate of 2.07 per US
dollar to 5 per US dollar, signalling the first major onslaught on the value of
Birr which since then has been virtually in a slippery slope. The authorities
defended and justified such massive, one-time devaluation by pointing to the
high premium on the parallel market which was close to 238% on the eve of the
devaluation measure.
In May
1993, the transitional government also introduced a ‘Ducth
auction’ system for foreign exchange with the objective of liberalizing the
foreign exchange market. The auction system operated side by side with the
official exchange rate until the two were finally unified in July 1995. Before
the unification, the dual-exchange rate regime was maintained by an amalgam of
government decree (relevant for the official rate) and quasi-market mechanism
(which applied to the auction rate).
It was
expected that the new devaluation measure would enhance domestic production and
employment; eliminate the gap between the official and the parallel market
rates, and improve the country’s foreign reserves by minimizing illegal trade
in smuggled goods and by re-directing much of the unofficial remittance flow
towards official intermediaries.
Though still fragile and vulnerable to the vagaries of
nature and aid money, the export sector in Ethiopia has shown tangible
improvements since the country abandoned the fixed exchange rate regime in 1991
and implemented a series of macroeconomic stabilization and adjustment programmes.
For instance, real export receipts have increased fivefold
between 1992 and 2009. The export industry has also seen significant
diversification away from its dependence on coffee. In 1991, when the reform
package was launched, coffee brought more than 55% of the country’s total
export revenue but by the end of 2009 its share declined to less than 35% while
the shares of other goods such as chat, flower, leather and leather products
have increased substantially. The flower industry represents the major success
story, whose share registered remarkable growth from less than 1% at the
beginning of the 2000s to about 10% a decade later. Though much of this
diversification is within the same industry, the over all
result shows a significant departure from the traditional, mono-crop dominated
export sector.
Another way of assessing the performance of Ethiopia’s
export industry is to look at the employment figures that the export sector
generates, particularly in agriculture where almost 90% of the country’s
exportable commodities come from. Because data on export sector employment for
Ethiopia is unavailable, I make a back-of-the-envelope calculation to arrive at
the number of jobs created each year. To do so, first I calculated the GDP per
worker by dividing the real gross domestic product by the size of the work
force, where I assume the annual unemployment and underemployment rate to be
20%. The GDP per worker gives the average annual income that supports the
employment of a single worker. Then to find out the number of jobs created by
the export sector, I divide the annual export value by the corresponding
average worker’s income.
For example, in 1981 the GDP and export value of Ethiopia
measured in 2000 constant dollar were 5.147 billion and 389 million
respectively, while the estimated number of workers for that year was 12.8
million. So the GDP per worker in 1981 was about 402 dollars. If we divide the
value of export by 402, we get the number of jobs in export-oriented activities
(coffee plantation, brokering, transportation, etc.), which was roughly 967,
400. Following this line of reasoning, we would find that the number of jobs in
2009 stood at around 3 million, which is a 200% increase compared with the
level of export sector employment in 1981.
Period Export
Growth
(%)
Export Sector Job Growth (%)
1982-1986
23.57
19.25
1987-1991
-67.41 ;
-62.17
1992-1996
106.39
94.92
1997-2001
17.27
12.42
2002-2006
94.73
74.55
2007-2009
48.88
22.11
Source: Author’s calculation based on World Bank Data.
Table 1 above shows the five year cumulative growth rates in
export earnings and export sector employment generation for the period
1982-2009. Particularly interesting is the continuous decline in export growth
and employment during the five years (1987-1991) preceding the downfall of the
military junta, a period characterized by heightened conflict, uncertainty,
massive defense spending and impulsive resettlement and villagization programmes following the 1984/85 famine. During this
period, overall exports and export-oriented jobs shrank by 67% and 62%
respectively. Moreover, though cumulative growth rates are still positive, we
observe simultaneous drop in both exports and export sector jobs in the period
1997-2001 (a time period flanked by the costly Ethio-Eritrean
border conflict) and 2007-2009 (due to the impact of the Great Recession that
started in mid 2008). Not surprisingly, the most
dramatic improvements occurred in the two five-year periods following the end
of the civil war (1991/92) and the termination of the border conflict with
Eritrea.
Empirical Evidence
Now the key question is, how much of this improvement in
export growth and export sector employment can be attributed to exchange rate
reforms? Does devaluation always enhance export performance, domestic
production and overall national welfare?
In order to answer these questions, I conducted an empirical
test to examine whether or not devaluation encourages export growth by applying
Generalized Method of Moments estimators (econometric technique) on time series
data covering the period between 1981 and 2009. A conventional export
demand equation was formulated and estimated in which export growth is
explained by real exchange rate, imports and world per capita income. The findings?
The coefficient on the real exchange rate was positive
(0.09) but it turned out to be statistically insignificant, indicating that
changes in exchange rate have little or no effect on Ethiopia’s export
growth.
Like real exchange rate, imports do not directly impact
export performance which could be due to the fact that the country’s export
portfolio is composed of mostly agricultural goods that depend more on cheap
and surplus labour than on expensive imported
capital. It could also be due to the fact that a large proportion of the
country’s imports comprise non-durable consumer goods most of which could be
produced domestically. This implies that the country’s limited foreign reserves
which could have been spent on productive capital goods are wasted on low-tech
consumption items (such as biscuits and orange juice) that could be supplied by
homegrown firms. According to the National Bank of Ethiopia, in the first
quarter of fiscal year 2009/10, such consumer goods accounted for nearly 20
percent of the country’s total import bill.
Interestingly, only world income was found to positively
impact export performance in Ethiopia. The findings reveal that a 1% rate of
increase in world income induces about 9% rate of increase in world demand for
Ethiopia’s exports and this was statistically significant at 5% level of
significance.
Conclusion and Recommendations
Ethiopia’s export sector has shown certain signs of
improvement since 1991 despite the continued worsening in its current account
balance. While exports and export sector jobs have increased fivefold and
threefold respectively, it is possible that those poor Ethiopians engaged in labour intensive, tradable goods sector have benefited from
increased export of goods and new market opportunities. But unlike the widely
held view, whatever improvement was recorded in export growth, there is no
evidence that this improvement is due to exchange rate reforms. Particularly,
the coefficient on the real exchange rate was insignificant suggesting that
real devaluation or overvaluation of Ethiopia’s currency, Birr, has no
discernible association with trends in the country’s export receipts.
The most important policy implication of this study is that
a developing country like Ethiopia cannot revolutionize its export industry
through exchange rate manipulation.
Even when domestic and external circumstances call for
devaluation measures, such measures will facilitate export growth and enhance
aggregate economic activity when they are accompanied by conservative monetary
policies and fiscal restraints.
In contrast, post-reform Ethiopia has seen consistent
increase in budget deficits along with massively accommodative monetary
policies. While much of the foreign expenditure shortfalls have been covered
with international loans and grants, the Central Bank of Ethiopia has been the
last resort to cover domestic expenditure shortfalls.
For instance, broad money supply increased, on average, by
11.4% annually between 1961 and 1974. The average broad money expansion during
the military regime (1974-1991) was only slightly higher (12.4%), which is
essentially marginal, especially in light of the seemingly incessant civil war
and the huge government defense spending which financed that war. But the
post-reform period, and particularly the period immediately after the
conclusion of the Ethio-Eritrean border conflict
(1998-2000) has seen enormous increase in “quantitative easing” with average
broad money growth of over 17% between 2001/02 and 2009. Thus, not
surprisingly, devaluation and inflation spirals went hand-in-hand from 2002
onwards.
Moreover, on top of the need for credible and predictable
monetary policy and prudent fiscal management, concerted efforts should be
directed towards expanding and raising the quality of physical and
institutional infrastructures. For instance, poor transport infrastructure
networks increase the cost of trade and reduce the country’s international
competitiveness while poor institutions (bureaucratic morass, rampant
corruption, lack of transparency in public resource management and contract,
etc.) raise the costs of starting business, discourage creative
entrepreneurship, and thwart private sector development, which are the engine
of economic growth and prosperity for any economy.
In addition to poorly developed transportation and
communication networks, lack of maritime access has been another factor
impeding the growth of the export industry in Ethiopia. The state of being
landlocked has been costing the country nearly 1 billion dollars annually in
port fees and charges, a staggering amount which is almost equal to the
country’s annual export earnings these days. Unless the political leadership
takes the issue of port services seriously and champion for Ethiopia’s rightful
access to the sea based on international law, the country will continue to
hemorrhage huge amount of hard currency, a situation which will continue to
dampen the prospect of its export led/supported growth strategy.
The recommendations provided in here concur with the
findings of a recent study by Dan Ciuriak (2010)
which investigated the demand and supply side constraints affecting Ethiopia’s
export industry. Ciuriak identifies a number of
domestic and regional factors that hamper the country’s export growth, among
which the most important ones included inappropriate macroeconomic policy mix,
extremely prohibitive costs in trade administration (such as the lack of access
to the sea and the high costs of port service and massive fees for cargo
transportation); inefficient producer services (such as finance, transportation
and communication); cumbersome customs procedures; high business concentration,
huge costs of entry and fragile and poorly developed private sector.
Furthermore, SeidHassen (2010),
following the surprise 16% devaluation of Birr against the US dollar on
September 1, 2010, has written extensively on how recurrent devaluation could
not solve many of the longstanding structural problems associated with the country’s
limited capacity of domestic production. In his explanation he underscored the
malignant consequences of the numerous party-owned-and-operated business
companies that stifle competition and hinder the development of a vibrant
private sector-led economy. He further emphasized Ethiopia will not be able to gain competitive
edge and devaluation will not be a magic potion for the structural (political
and economic) problems of the country and the continuous manipulation of the
Birr will unlikely correct the general economic malaise.
Therefore, many of the impediments to Ethiopia’s export
growth are institutional and structural and need to be assessed and addressed
within the wider context of its geographic location, lack of access to the sea,
slow pace of regional integration and limited market opportunities for its
products, as well as its poor technological progress and increased dependence
on agricultural commodities which are vulnerable to wide price fluctuations,
etc.
