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Adios Commonsense Welcome Washington Consensus



Adios Commonsense Welcome Washington Consensus


Haile Kebret (PhD) 12-17-2019

The usual dominant IMF prescription for all macroeconomic ills in the 1970s and 1980s was a package of policies encapsulated in what was referred to as the Washington Consensus. The Hall Marks of this policy goes as follows.

-          Symptom:  external sector deficit and foreign exchange shortage;

-           Cause: overvalued exchange rate;

-          Prescription: liberalization of the economy anchored by devaluing the currency.

This simplistic diagnosis and prescription was, we thought, buried for good a couple of decades ago. But it seems it is alive and well in Ethiopia, a country with political and economic elites that seem to be obsessedwith swings like pendulums.  Recall the 1970s and 1980s. Everything that ‘smelled socialist’ was nationalized irrespective of merit or consequence. When we thought we have started to slowly come to the middle and move in steps to arrive at a happy medium, we just started to liberalize in ‘a whole-sale’ fashion even those public enterprises that are profitable.Infact, the government is even advised to liberalize the exchange rate regime from what is called a managed floating regime to a market based free floating (the complete liberal regime), like the almost frictionless economies of advanced countries in a country where to hold a single penny of a foreign currency outside of the banking system has been forbidden for years. The funny part is they call the liberalization initiative in Ethiopia ‘a home-grown economic policy’ (by those auditioning for higher posts or are half based economic advisors)even though this is ‘born and bread’ at the IMF in Washington D.C. and is as old as IMF itself.

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Liberalizing the economy and a free-floating exchange rate are the hall marks of the old Washington Consensus. Don’t get me wrong, I am not against liberalization in general or devaluation in particular. In fact, as all my students attest to, I hate categories or generalizations about any issue. I strongly believe every policy issue has to be evaluated on its merit.  Letme, then,explain why some of the liberalization ideas initiated in Ethiopia are based on wrong diagnosis and lead to wrong prescriptions.

1.      Macroeconomic imbalance:I agree that there are macroeconomic imbalances(reflected in external trade and fiscal deficits) and foreign exchange shortage and negative budget balance. Focusing on the external sector, the problem is not because the exchange rate is not completely liberalized. Rather the problems are:

a.       As everyone knows, there is a mismatch between the size of the import bill and the country’s exports revenue. Why the demand for imports is high is obvious and why supply of exports is weak is because of the quality and quantity of our exports.

b.      Here is where the Washington Consensus brings its ‘textbook solution”.  If you devalue your currency (or make it market based) you would lower the price of your exports, and you could sell more, and BINGO you could address your macroeconomic imbalance. It sounds logical doesn’t it?! Well, it is but unfortunately, the real world is more complicated than the textbook solution. This is why:

i.                     If the demand for your goods is low because of its quality this doesn’t work; and /or

ii.                   If you have a limitation to expand your production irrespective of demand for your goods or the price, this doesn’t work this doesn’t work either;

iii.                 Worst yet, if you lower the price of your exports (by devaluing your currency) but still import as before (or increase it) without increasing your exports because of the above reasons you end up making your externa balance even worse than before.

iv.                 Therefore, if your problem is emanating from the supply side (lower exports for any reason), devaluing your currency (lowering the price) is not (and has been proven not to be) a solution for your macroeconomic imbalances. We thought the Washington Consensus had apologized and retired in the 1990s following the criticism even from in-house experts (such as Nobel prize Professor J. Stiglitz, among others)but to our surprise it is alive and well in Ethiopia in the 2020s.

2.      Privatizing Pubic Enterprises: Let’s start from the cliché that the private sector is more efficient than the public while the later promotes equity than the former. In general terms, these statements are true but under specific set of condition. What are missing both in this policy and in what was described in (1) above is the relevance of the measures that should be taken or conditions that should prevail during the transition to ensure efficiency and guarantee equity. These are:

a.       The economy has started to have a competitive market structure such that collusion of firms is reasonably addressed or is under control(unlike in Ethiopia where hoarding to inflate pricesin particular and oligopolistic tendencies in general are the norm than the exception);

b.      an effective judiciary is established such that the rule of law guarantees a fair play by market actors; We know this is a dream than reality in Ethiopia;

c.       Corruption, nepotism, illegal and other short cuts are effectively addressed by the system in general and the court system in particular; again, to say the least, Ethiopia is not there yet;

d.      But most importantly, when and which enterprises do we liberalize and which ones do keep in public hands? I think there are some basic principles which should be used as a guide in deciding such issues. Among these:

ü  Activities are subject for consideration for privatization when efficiency is more maximized under a private ownership rather than a public ownership;

ü  assuming an acceptable distribution of resources the above condition could be summed up by the extent to which a given activity is profitable; and this has been the case in Ethiopia in, at least, two of  the institutions (Ethio-Telecom & Ethiopian Airlines)


ü  A more comprehensive criteria is,  public ownership of an activity is more appropriate when the marginal social benefit exceeds the marginal private benefit; that is to say the benefit to society outweighs than to a private citizen; I think this criteria must be emphasized because how Ethiopian Telecom decides whether to provide access to a rural community and how a private firm is likely to differ and hence the net social benefit will edge the net cost to society;

ü  a slightly related criterion is, the extent to which the activity in question is intrinsically a social or a private good. Example animal husbandry is more private activity while road construction is a social good because there is no exclusivity of use. Education on the other hand is both a social and a private good; various arguments could be provided why some of the enterprises do benefit society if they are in public hands than in private hands;  

ü  In short, the ultimate criteria to summarize all these is which ownership structure produces the most optimal outcome and by extension is incentive compatible in its production and distribution both in a short-run and long run perspective should guide the decision process.

Given the above criteria, privatizing Ethiopian Telecommunication, Ethiopian airlines, or any other enterprise that is either profitable (as these two have been) or whose marginal social benefit exceeds its marginal social cost (either in the short- or long-term) should not be sold to the private sector. There is one usual argument that says foreigners will come and buy those enterprises using foreign currency which will address the country’s crucial bottleneck (foreign currency). I am sure there will be some initial foreign currency inflow because of the sale.  But (a) how significant is this amount likely to be and (b) since those enterprises will have a guarantee to repatriate their income in the same foreign currency, the inflow is temporary and will again drain the foreign currency in many folds bringing the shortage in the country to square one, not to mention the employment considerations. Hence the diagnosis leads to the wrong prescription and the patient will not be cured for long! A LONG TERM SOLUTION LIES IN THE FUNDAMENTLS NOT IN QUICK FIXES!


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