The Impact of United States’Financial Meltdown on Ethiopia’s Economy: An Observation

Desta, Asayehgn (Ph.D.), Sarlo Distinguished Professor of Business-Economics, Dominican University of California.

Prior to the 1980s, a number of less developed countries were handling their own economies. They pursued dualistic development, growth-with-equity, and structural change models for their economic growth. Then, the developing countries were forced into various financial packages that restructured their economies for the benefit of the developed countries. The enforcers were, and still are the International Monetary Fund and the World Bank under the umbrella of global capitalism—led by the United States of America.

In short, because the United States is an economic powerhouse and the U.S. dollar is the world’s reserve currency, their officials have been relentlessly propagating the lie that developing countries could modernize if they followed the so-called “Washington Consensus” model instead of pursuing state-led dirigisme. The Washington Consensus development paradigm which is market-oriented, winner-take-all economic system is presented to developing countries as if it is a magic pill. More often than not, it is a pill that is hard to swallow.

In broad terms, the Washington Consensus paradigm requires developing counties to open their economies to the rest of the world—through heavy emphasis on free markets; creating conducive environment for foreign direct investments; deregulation; privatization; and limiting state intervention in the economy. The countries that blindly follow the Washington Consensus prescriptions are rewarded with international capital flows. That is, they easily qualify for economic assistance and financial credit from various multilateral organizations. Conversely, developing countries that don’t follow the Washington Consensus prescriptions are penalized—they are cut off from various forms of multilateral loans and assistance.

The Southeast Asian financial crunch of 1997-98 occurred because the Washington Consensus model was strictly followed. It was these policies that led to the crunch and yet, the United States was opposed to bailing out the ailing banks (Gore, 2000). Now, with that exorbitant financial turmoil in the United States that threatens the rest of the world, one cannot help but notice the contradiction in policy. The United States is bailing out (or almost nationalizing) the various banks and financial institutions that are at risk, much to the chagrin of the developing countries. As argued by Gray (September 28, 2008), “despite increasingly urging other countries to adopt its way of doing business, America has always had one economic policy for itself and another for the rest of the world. Throughout the years in which the US was punishing countries that departed from fiscal prudence, it was borrowing on a colossal scale to finance tax cuts and fund its over-stretched military commitments.”

With huge budget deficits in the United States that are heavily financed by China and the oil-rich countries, it can be persuasively argued that there is no way that the US dollar can hold as the world’s reserve currency. In fact, the financial engineering position that the United States has within the International Monetary Fund and the World Bank, more than ever, is now in doubt. Thus, as the result of the US-led financial crisis, a number of countries that have been pursuing the free-market model will be in unchartered territories. Their financial institutions will be facing an insurmountable liquidity crisis.

For example, the Ethiopian economy is composed of a mixture of state-owned and privately owned enterprises. But recently, based on the persuasion of the International Monetary Fund (IMF), Ethiopia has been relatively engulfed in the global market economy. As a result, Ethiopia’s export has been growing at the rate of 25% per year. The inflow of foreign direct investments has been remarkable. Remittance inflow by Ethiopian relatives living in foreign countries has been growing at the rate of 5% of the Gross Domestic Product per annum. Given this, there is no doubt that the U.S. financial meltdown is likely to hamper Ethiopia’s economy. Thus, the purpose of this paper is to briefly highlight its ramifications on the Ethiopian economy.

As the economic growth of European and Middle Eastern countries declines, their demand for Ethiopian exports such as coffee, hides, and horticultural products is likely to diminish. Ethiopia’s foreign exchange reserves will be declining. These reserves are vital for Ethiopia, as they are used for importing capital goods and for tackling unexpected external shocks.

The U.S. financial crisis, which resulted from an unregulated, speculative financial sector, is likely to create global credit crunch. Thus, as foreign investors are by and large risk averse, they will be restrained from investing in the Ethiopian geo-political environment (See for example, Rojas-Suarez, September 22, 2008). Thus, a decline in foreign direct investment will reduce Ethiopia’s access to the inflows of know-how; reduce tax revenues (which are vital for social services); increase unemployment; and diminish the sustainability of the various infrastructure projects which the country is currently undertaking.

With economic crisis in the advanced countries, there is no doubt that the Overseas Development Assistances, which Ethiopia has been using as a cushion to balance its annual budget deficits, is likely to be reduced to a trickle. The current rate of inflation (gauged by the Consumer Price Index), which is now intolerable, is likely to hike more as demand surpasses supply for the limited products that the economy produces. It is possible the inflation is caused by the Ethiopian government’s need to print more money. They are doing this to fulfill the needs of its constituencies and to maintain peace and security—very vital to the existence of the Ethiopian polity.

Financial remittances (both fixed and discretionary), being about 5 percent of the GDP, have been very vital sources of finance for the Ethiopian economy. There is no doubt that a large portion of the Ethiopian family depends on remittances from relatives and friends living abroad. Thus, remittances have been very essential for smoothing incomes and contributed greatly to the development of human and social capital in the Ethiopian family. However, with the financial meltdown that has precipitated in the United States, it is possible to argue that the unemployment rate in the advanced and the Middle Eastern countries is likely to create a shortage of remittances flows to the Ethiopian economy.  Stated differently, it could be roughly estimated that there are about 2 million Ethiopians living in Western Europe, North America, and the Middle East. Since remittance can boost disposable income and enable affordable education, the shortage of remittance, if global financial crisis is not averted, it is likely to have unintended consequences on the families that dependent on remittances from abroad, and the Ethiopian economy.  

Under the Agricultural Development Led Industrialization (ADLI) paradigm, as Ethiopia has diversified its commodity export base, farm exports have grown on average by 25 percent per year. In addition, to diversify its exports and bring in foreign cash, Ethiopia is indulging in growing horticulture commodities. More particularly, most of the agricultural land in the proximity of highways is tailored to the production of horticultural crops (i.e., floriculture fruits and vegetables) for export. This policy makes the horticultural goods easier to export, and by extension, makes it obtaining food harder and more expensive for locals. The food must travel from further away, or even from another country.

As Ethiopia has devoted more of its precious arable land to horticulture, the price of staple products has gone up. Taking the best land in order to secure the best financial returns by growing floriculture does not make sense. Since the market for horticultural products is strongly dependent upon knowledge, human capital, and technical inputs, “small producers are frequently eliminated from markets for failure to understand market dynamics or because of their inability to meet new production, sanitary, and quality standards” (USAID, 2005). In the long run, the dependency of Ethiopian farmers on the production of horticultural commodities is not only less lucrative but is also environmentally costly (See Desta, 2008).

In addition, it needs to be underlined here that due to an extensive use of chemical fertilizers, the limited rural Ethiopian land is currently facing a number of environmental challenges. The challenges range from land degradation to environmental pollution. Due to the misguided application of chemicals in agriculture, it is estimated that Ethiopia has accumulated one of the largest stockpiles of obsolete pesticides on the African continent. The accumulation of toxic chemicals of imported herbicides, pesticides, and fertilizers for horticultural products, is not only exhausting the productivity of their agricultural land, but is also creating toxic and hazardous waste that could pollute the surrounding environment and damage human health (Desta, 1998).

The lesson that Ethiopia could learn from the global financial crisis is that it should make a conscious effort to unfetter itself from the global capitalist economy. Being proud of its history and culture, Ethiopia has to assert itself and design a different, viable strategy—other than being bumped aside each time the US economy tumbles or keep on swallowing the bitter pills prescribed by the International Monetary Fund and the World Bank. “The most recent financial crisis in the U.S. has dealt a mortal blow to the failed but deadly practices of neo-liberal the world over and undoubtedly lays the groundwork for the crafting of alternative policies more responsive to the needs of the powerless and marginalized…” (CenPEG, 2008).

As discussed in detail elsewhere ( See Desta and Kofi, 2008), if Ethiopia is to achieve long-term sustainable growth, it has to reject the inherently disastrous economic model designed by US-led capitalism. Ethiopia’s developmental process has to be rooted in the Ethiopian system of thought and its people-oriented economic policy, rather than depending on the Western capitalist model designed to make it dependent on external assistance. Since agriculture is the backbone of the Ethiopian economy, its sustainable development model must be one of self-sufficiency—to feed its own people instead of producing and exporting environmentally-insensitive products to amass foreign currency.

By securing the land and adhering to environmentally-sensitive, cooperatively-managed systems, it is reasonable to assume that Ethiopia could not only achieve growth and equity but could also empower the Ethiopian people to fully participate in the design and management of their country.