Ethiopia’s Growth and Transformation Plan:

A CGE Analysis of Alternative Financing Options

(Preliminary Results)

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Seneshaw Tameru, Eyasu Tsehaye and Ermias Engida(Ethiopian Development Research Institute, EDRI)

Dario Debowicz, Paul Dorosh and Sherman Robinson(International Food Policy Research Institute, IFPRI)

EDRI-ESSP2 SeminarApril 12, 2011

Outline1. Background– Recent economic performance– PASDEP, GTP

2. The model– Structure of the Dynamic CGE– Closures– Data: SAM 2005/06 and SAM 2009/10

3. Simulations– Scenarios– Parameters

4. Results : – TFP growth requirements;– Financing alternatives.

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BackgroundRecent economic performance

– Consecutive high GDP growth since 2004. – Growth: broad based with balanced growth

among activities. – Growth mainly achieved through increased

total factor productivity and partly through investment.

– GDP Growth through 2005/06 – 2009/10 exceeded the targets set under PASDEP.

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Plan for Accelerated & Sustained Development to End Poverty -- PASDEP

• Plan for 2005/06 -2009/10• Prepared based on MDG targets• Growth projected with two scenarios

• GDP performance higher than targets under both scenarios

• Industrial growth lower than plan

Base Case High Case

Real GDP 7.0 10.0 11.0

Agriculture 6.0 6.4 8.4Industry 11.0 18.0 10.0Services 7.0 10.3 14.6

Sector Planned growth (2006-2010) Growth achieved (2006-2010)

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PASDEP: Macro-economic Outcomes Aggregate Demand Shares (% of GDP)

• No significant change on aggregate demand structure • Domestic saving rates significantly lower than target.

Item 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10

Total Consumption 94.1 95.4 91.3 94.8 93.6 94.4

Gross Capital Formation 23.8 25.2 22.1 22.4 22.7 22.3

Exports 15.1 13.8 12.7 11.4 10.5 13.6

Imports 35.5 36.5 32.0 30.8 28.7 33.0

Resource Balance -20.4 -22.7 -19.3 -19.4 -18.2 -19.3

Gross Domestic Saving 5.9 4.6 8.7 5.3 6.7 5.5

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PASDEP• Domestic revenue growth 26%: higher than

target (20%);– Revenue grew mainly as a result of inflation;– Revenue as a share of GDP marginally declined

• Remarkable achievements in social and infrastructural development

• Major Challenges– Weak finance mobilisation– Inflation– Foreign exchange shortage, – Power shortage, etc

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Growth and Transformation Plan (GTP)• Prepared based on PASDEP experience and

achievements;• Carry forward the important strategic

directions of PASDEP;• Growth targets higher than PASDEP;• Growth outcomes projected in two scenarios:– Base (lower) Case– High Case

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GTP: Projected GDP growth

Significant growth differences between the two scenarios in all sectors, especially for agriculture

Base Case ScenarioSector 2010/11 2011/12 2012/13 2013/14 2014/15 Average

Agriculture 8.5 8.5 8.6 8.6 8.7 8.6

Industry 14.0 17.9 21.4 23.0 23.7 20.0

Services 12.5 11.5 10.5 9.5 9.0 10.6

Real GDP 11.0 11.1 11.3 11.2 11.4 11.2

High Growth ScenarioSector 2010/11 2011/12 2012/13 2013/14 2014/15 (Average)

Agriculture 9.5 13.5 16.1 17.1 18.4 14.9

Industry 14.8 19.4 20.8 23.7 27.9 21.3

Services 14.6 13.8 12.9 11.8 10.9 12.8

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Financing the GTP• “Implementation of the GTP requires huge

resources and commitments”• Allocation of government finance: based on the

Medium Term Fiscal Framework (MTF);• Beyond the MTF, large amount of planned “off-

budget” financing for infrastructure and industrial development – A total of Birr 569 billion for the five year– 30% from own source of developmental enterprises

and 70% from domestic and foreign sources.• Private sector participation deemed important

(although how private investment will be financed is not discussed in detail)

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The Model: Dynamics

• The recursive dynamic version of the standard IFPRI CGE model (Dorosh, Robinson and Ahmed, 2010) is used for this study

• This kind of dynamic model is based on the assumption that behavior of all economic agents is characterized by adaptive expectations – – decisions are made on the basis of past and current

conditions, with no role for forward-looking expectations about the future.

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• The model also provides three different options in order to clear the factor market:

o Skilled labor and Capital are assumed to be fully employed & activity-specific;

o Semi-skilled and Un-skilled labor are assumed to be unemployed and mobile across sectors;

o Land is set fully employed & mobile across sectors.

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Model: Macro and Factor market closures

Model: Macro and Factor market closures

• The model includes three macroeconomic balances: o Government balance: Government savings are

flexible, and direct tax rate is fixed;

o External (current account) balance: Exchange rate is flexible, and foreign savings are fixed;

o Savings-Investment balance: Savings driven investment (Flexible capital formation and fixed MPS for all non-gov’t institutions) ;

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The EDRI Ethiopia 2005/06 SAM • The national SAM is disaggregated into:– 60 activities (with 24 agri. activities by AEZ’s), – 64 commodities, – 16 factors (by AEZ’s except capital), and – 13 institutions including 12 households.

• The SAM also has different taxes, saving-investment, and rest of the world accounts.

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Updating the 2005/06 EDRI SAM to 2009/10• The dynamic CGE model is used to simulate the

growth of the Ethiopian economy between 2005/06 SAM based on actual economic developments from 2005/06 -2009/10.– The resulting solution for 2009/10 is a new, balanced SAM for

2009/10.

• The projected 2009/10 SAM and GDP are converted to current prices.

• Actual value added shares of activities and actual aggregate demand components of 2009/10 (from national accounts) are then used to adjust value added by sector in the projected 2009/10 SAM.– The inclusion makes the SAM unbalanced.

• A cross entropy program is used to balance the 2009/10 SAM.

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Simulations and Results

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SimulationsBase Scenario (continuation of 2005/06 – 2009/10 trends) 1) GTP Financed through increased level of foreign savings

a) Low growth scenariob) High growth scenario

2) GTP financed through increased household savings

a) Low growth scenariob) High growth scenario

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Simulation AssumptionsAll Simulations– Annual labor supply growth of 2.5% (urban) & 2% (ag. labor)– Agricultural land area growth of 2.8%– Flexible government savings and fixed direct tax rates– Flexible exchange rate and fixed foreign savings – Investment is endogenous, and is driven by savings

Simulation-specific Assumptions

– .

Base-run Low-case High-caseTotal factor productivity growth

4.9% 5.8% 7.6%

Investment Growth 11.6 (trend) 12.6%(plan) 22.6% (plan)

Growth in Gov’t Consumption 5.7% (trend) 13% (plan) 13% (plan)

Tax as % of GDP (growth) 3% (trend) 7.5% (plan) 7.5% (plan)

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Simulation Assumptions (cont.)Major simulation parameters:

– Total Factor Productivity of activities, – Tax rates,– Government expenditure,– Foreign savings, and– Households propensity to Save,

CES Production Functions:

• QVAa = quantity of (aggregate) value-added,• a va

a= efficiency parameter in the CES activity function,• δ va fa = CES activity function share parameter, and• ρva

a = CES activity function exponent.

Instruments

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Simulation Assumptions (cont.)

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Value (Bill. Birr)2009/10 BASE Low-case High-case

GDP (basic price) 355.0 10.6 11.2 14.9Investment 85.5 11.6 12.6 22.8Gov't Consumption 31.8 5.7 12.9 12.9

Annual Growth Rate (%)

GTP Simulations adjust TFP growth rates by sector, foreign savings, household savings rates and government consumption to hit target growth rates of GDP, total invesment and government spending.

• TFP has been growing by annual growth of 4.9 percent in the last five years.

• TFP growth rates are adjusted so as to achieve the projected GDP growth and planned investment of the GTP.

• Overall, total factor productivity grows by 5.8 and 7.6 percent per year in the base and high-case scenarios respectively.

BASE GTPL GTPHAgriculture 1.4 1.5 3.5Electricity 21.0 28.5 27.5Other Industries 20.6 27.6 28.3Construction 7.0 10.3 14.0Other Services 5.3 5.8 7.3Total Average 4.9 5.8 7.6

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Exogenous TFP Growth

Saving-Investment Gap

• Based on the GDP and Investment plans of the GTP and past trends, about birr 89 billion is required to fill the gap between Investment and Savings

Saving-Investment GAPLow-case (2014/15)

High-case (2014/15)

Investment 154.5 238.6Gov. Saving 19.2 59.8Priv. Saving 39.8 41.9Foreign Saving 47.7 47.7

Saving-Investment GAP 47.8 89.1

(Bill. Birr)

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Results: Macro-economic Variables(Increased Savings and Tax Rates)

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Base-run Low-case High-caseGDP 355.0 10.6 11.2 14.9Investment 85.5 11.5 12.6 22.8Government Consumption 31.8 5.7 12.9 12.9Private Consumption 338.6 9.6 9.4 10.6Export 52.1 20.8 22.5 28.5Import -126.5 12.7 13.6 17.1Real Exchange rate 90.9 0.1 -1.4 0.9Foreign saving 35.7 6.0 6.0 6.0Government saving 35.5 9.1 -11.5 11.0HH Income 360.4 10.3 11.5 13.7

Rural 273.1 10.6 10.7 13.2Urban 87.3 9.1 13.7 15.3

Initial Growth Rates (Average -Five years %)

• GTP investments lead to substantial increases in exports (and imports).• With lower productivity growth, government savings fall over time; high productivity growth, however, raises tax revenues and government savings.

Results: Macro-economic Variables(Increased Foreign Savings)

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• With increased foreign savings, private consumption rises much more than in the higher tax and savings rates scenarios. The real exchange rate appreciation, however, slows the growth in exports.

Base-run Low-case High-caseGDP 355.00 10.60 11.20 14.90Investment 85.50 11.60 12.60 22.80Government Consumption 31.80 5.70 12.90 12.90Private Consumption 338.60 9.70 11.40 14.40Export 52.10 20.90 17.00 18.50Import -126.50 12.70 15.40 19.70Real Exchange rate 90.85 0.13 -3.57 -2.78Foreign saving 35.7 6.0 21.8 31.5Government saving 35.5 9.2 -15.9 6.8HH Income 360.4 10.3 12.0 14.6

Rural 273.1 10.6 11.5 14.4Urban 87.3 9.1 13.6 15.1

Growth Rates (Average -Five years %)Initial

Results: Household Incomes(Increased Savings and Tax Rates)

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• In almost all cases, all household groups enjoy higher income gains under the MTP scenarios, even with higher direct taxes and savings rates. • In the low growth scenario, increases of most groups are similar to the base run.

• In both scenarios, the urban non-poor, who benefit from higher returns to capital as well as increased labor demand, see the largest percentage gains

Household Income Initial Base-run Low-case High-caseRural 273.1 10.6% 10.7% 13.2%Urban 87.3 9.1% 13.7% 15.3% Rural Poor 74.6 10.6% 10.0% 12.1% Rural Non-poor 251.2 10.3% 11.5% 13.9% Urban Poor 3.7 9.0% 11.6% 14.2% Urban Non-poor 30.9 9.0% 14.4% 15.5%

Results: Household Incomes(Increased Foreign Savings)

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Household Income Initial Base-run Low-case High-caseRural 273.1 10.6% 11.5% 14.4%Urban 87.3 9.1% 13.6% 15.1% Rural Poor 74.6 10.6% 11.2% 14.0% Rural Non-poor 251.2 10.3% 11.9% 14.7% Urban Poor 3.7 9.0% 11.6% 13.9% Urban Non-poor 30.9 9.0% 14.3% 15.3%

• With increased foreign savings, all households see larger percentage gains in incomes than in the increased tax and savings rates scenarios.

• However, if the increased foreign savings is due to loans, there is an implicit tradeoff between increased current consumption (financed by loans) and reduced future consumption (when loans are repaid).

Results: Household Incomes

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0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Rural Poor Rural Non-poor Urban Poor Urban Non-poor

Base Run GTP Low Growth (HH Sav) GTP Low Growth (For Sav)

GTP High Growth (HH Sav) GTP High Growth (For Sav)

Summary and Preliminary Conclusions• The GTP has set higher growth and investment targets

than those of any of Ethiopia’s earlier national plans.• Implementation of the GTP requires huge resources:

domestic and foreign.• In addition to planned investment, the growth targets

of GTP require faster TFP growth.• Given the projected tax rates and official borrowing,

financing the investment entails huge FDI flows, foreign borrowing and/or large domestic saving mobilization.

• Without additional foreign borrowing, if private savings rates are to grow marginally, FDI flows need to grow like never before: with an annual growth of 28 percent (base-case) and with 38 percent (high case).– This requires better a incentive package and investment

environment, as well as macroeconomic stability.27

• Mobilization of domestic financial resources, and improvements in domestic savings are critical– Entails further monetization of the financial

sector, increased level of saving interest rate, expansion of saving and credit associations, price stability etc.

• A final caveat:– Much further work needs to be done to explore

these issues in more detail… This is only the beginning.

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Summary and Preliminary Conclusions (2)