Price hike in Ethiopia, Is that the inherent nature of Economic growth or mismanagement.

By Equar D. Negash

June 20 2008

The argument that economic growth leads to higher price is not totally invalid, there is some truth to it. However, it is misleading argument when it is seen generally as part of the whole economy. This concept is relying upon one of the oldest economic theory, Philips Curve. This curve has been considered as economic law by some policy makers. This theory asserted that there is a trade off between unemployment and inflation. This curve came as a dominant theory decades ago and might be useful during those days to explain the relationship of unemployment and inflation. However, things are changing fast and we are in the area of globalization. Definitely, the weakness of one economy affects the other economy in today’s world. There are interdependence and interrelationship among countries.

Inflation is a general rise in price indices. Economic growth is believed to be a key factor in determining the rate of increase in prices. Economic growth pushes the demand for goods and services up. Consequently, this leads to high inflation. On the other hand, a weaker economy leads to low demand for goods and services and causes lower inflation. This sort of analysis raises some questions that why economic growth pushes the demand up without boasting the real supply of goods and services. Supply of goods and services are increased as a direct result of economic expansion and if this is accompanied by a given stock of money it will definitely boast the purchasing power of consumers. That means it may not lead to an increase in inflation or lead to manageable increase in price which can be more than compensated by the increase in income of the people. Obviously, inflation is not an inherent nature of economic growth as some politician argues.

The current price hike in Ethiopia is not good news for the mere fact that it will eventually lead to economic crises. Economic figures (numbers) are sometimes misleading because there are expressed in terms of nominal values. Real values are more representative than their nominal counter parts. Before we believe that there is an economic growth in Ethiopia, we have to able to see beyond the nominal numbers. As we all know there is a global increase in prices because of soaring fuel price and food stuffs. These price increases have a major impact on economies of developing countries, like Ethiopia. Central Banks have a major role in fighting inflation because they have the policy tools at their disposal to bring a desired change. In this regard, National Bank of Ethiopia (NBE) is expected to interfere to contain inflation and its negative effect. I do not think my old bosses have the courage to advice against the will and intention of the prime minister’s office. Most likely, I believe NBE is part of the current problem instead of giving solutions to price hike. I will try to see some of the possible causes of the problem. First of all, there has been a surge in demand in Ethiopian economy with out a corresponding increase in supply. The demand has increased because of an injection of liquidity into the market. Where these liquidities come from? The transfers of money from Ethiopian in Diaspora have been increases for some time now. Flows of foreign loan and aid also increased. Printing of paper money by the National Bank of Ethiopia contributed to this already money crowded market. Actually, these all contributes to increase demand but have a little effect on real supply of the economy. Even, the behavior of some farmers has changed and producing cash crops for the lucrative export market instead of grains for domestic use. This affects the supply of grain market negatively and contributes to divergence of demand and supply which leads to high price. Had the NBE acted to bring the desired effect, we would not have seen a record high inflation in Ethiopia history.

Second, there is a big difference between interest rate and inflation rate in Ethiopia. What is the implication of this divergence? The real interest rate (Nominal interest – inflation rate) is negative. In simplest analysis, people loss money if they put it in a bank because the inflation rate is higher than their interest earning. During this time people naturally opt to buy real goods to stock it instead of holding paper money or convert it to more stable foreign currency. In both causes it contributes a price hike. Again the National Bank of Ethiopia can adjust the rate to make sure the negative interest dose not contribute to inflation.

Off course, the global trend of the world economy has a major effect which in this case the government’s policy does not have a power to change it. But, if you make your house clean and prepare for external factors ready, it is possible to minimize the effect. The crude oil price reached a record high of $136 US dollars a barrel. This is by any standard high and definitely has an impact in the economy of non-oil producing country. A gas is everything from transportation to electricity, hence contributes to price of every commodity across the board.

The effect of Shaibia is also having significant effect in this issue. Eritrea a small country in the region with a very weak economy created a huge instability around the Horn. The recent failed attempt to invade Djibouti is a great example. As long as Shaibia is allowed to behave the way they are acting, the region will continue to pay high price of instability. In a face of instability, economic development is unattainable. Because of Shaibia, Ethiopia has fought a war in Somalia and other region of the country since the end of 1990. It is not difficult to image how this war has been financed. Government wanted to finance the war by printing more money instead of increasing a tax. Because increasing a tax is politically sensitive and difficult to collect when the tax base is weak. However, to print money is relatively easy. The National Bank of Ethiopia is not independent enough to counter check the government in this case. Therefore, printing money and inject into the market will definitely a major cause of inflation. These I think are the major causes of the current price hike among other causes. It is very difficult to explain all possible causes in this small article. If readers ask and need me to mention more, I promise to do it next. In a nutshell, I believe the current price hike in Ethiopia is not caused by economic growth but by mismanaged policies. Please, come forward and let me hear your opinion in this issue.