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McKinsey’s: Lions On The Move II Report – Ethiopia’s Exemplary Growth

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“Ethiopia's state-led development model has delivered rapid economic growth, reduced poverty, and improved social welfare.” IMF
McKinsey recently released a Report on “Lions on the Move II: Realizing the Potential of Africa’s Economies.” In the Report, McKinsey categorised African countries into three: stable growers, vulnerable growers, and slow growers.
According to McKinsey, Stable growers group include countries, such as Ethiopia, Rwanda, and Tanzania, typically not dependent on resources for growth, are smaller economies that are progressing with economic reform and increasing their competitiveness. Vulnerable growers group includes countries such as Nigeria that are heavily dependent on resources, which have clear potential but need to improve their security, governance, or macroeconomic stability. Slow growers group include the Arab Spring countries of Libya, Egypt, Tunisia, and South Africa experiencing slow growth and high unemployment in spite of promising opportunities that could spur development.
Ethiopia, in particular, stands out with its state-led development model, which has achieved remarkable economic and social development gains during the past decade with an average real GDP growth rate of 10% per annum. According to the IMF, income per capita has more than doubled in real terms since 2004/05, poverty has fallen rapidly, while inequality has remained low. Ethiopia is on its way to a middle-income class status with its growth and transformation agenda. Rwanda and Tanzania have also managed real GDP growth rates of 7% respectively over the past decade without the benefits of major oil resources.
Five lessons stand out from their development model.
First, what strikes us within the categorization is that the three countries with the highest economic growth rates among the stable growers, Ethiopia, Rwanda, and Tanzania, have actually being public sector-led, or at the least, have adopted a balanced approach between a developmental state and the private sector.
Second, The key set of essential developmental ingredients are stable polity, transformative leadership, capable public sector and institutional governance. While Ethiopia and Rwanda have had their own shares of inter-state civil war, their post-civil war leaders have ensured stable polity and realised the imperative of securing people’s lives and properties as a form of public good with positive externalities for all. They eschewed regulatory capture and entrenched effective institutional governance emphasizing that institutions matter for development; and capable public sector institutions matter even more for a developmental state.
Third, Ethiopia’s economic achievements have been underpinned by the formulation and effective implementation of long term development plans, much as China and South Korea have used development planning to achieve economic transformation. Ethiopia’s most recent five-year Growth and Transformation Plans (GTPs II) covering the period 2015 to 2020. The GTP II aims for Ethiopia to reach middle-income status by 2025, with GDP growth rates of 11 percent driven by strong manufacturing sector and rise in exports.
Fourth, Ethiopia’sstate-led development model is also underpinned by high gross capital formation of close to 40% of GDP, just below 45% in China, and with government investment representing more than half of total investment rates. Nigeria’s gross fixed capital formation as a percentage of GDP stands at 15%; it is 26% in Rwanda, and 30% in Tanzania. Ethiopia’s public sector capital formation of 22% of GDP is nearly ten times, while Rwanda’s 13.5% is five times that of Nigeria, which stands at 2.5% of GDP.
Ethiopia’s heavy public investment in large scale infrastructure projects are supporting economic transformation in agriculture and manufacturing. Public sector investment in power is huge with major hydropower projects such as the Grand Ethiopia Renaissance Dam of 6,000 MWs, estimated as Africa’s largest, and expected to triple Ethiopia’s generation capacity to 9,000 MWs that would meet domestic demand and export. As a landlocked country, Ethiopia’s high trade transportation costs are projected to be lowered by a new rail link to Djibouti’s port. The Government’s owned Ethiopian Airlines is profitable and reputed to be one of the most viable African airlines, even when compared to Nigeria’s privately-owned airlines.
Fifth, to finance high investment rates, Ethiopia’s has relied on domestic tax revenue and banking system, external long-term foreign direct investment, private equity, and borrowings from multilateral and bilateral sources, with less emphasis on short-term portfolio capital flows. Foreign direct investments represent about 90% of foreign reserves compared to 10% for Nigeria in 2015. The country’s gross national savings rate of 18% is higher than that of Nigeria’s 12%. Ethiopia’s public savings rate is 5% compared to -0.7% for Nigeria, while its tax revenue is 13% of GDP compared to 4% for Nigeria.
Ethiopia’s banking system is highly regulated, and consists of 2 public banks and 16 private banks, with no banking licences issued to foreign entities. Commercial Bank of Ethiopia dominates the market with 70% of the total assets. According to the IMF, the average risk-weighted, system-wide capital adequacy ratio was 16.6 percent (double the minimum requirement); profitability has been robust; and the non-performing loan ratio was only 2.4%, compared to over 5% in Nigeria, where private sector banks dominate.
The Development Bank of Ethiopia extends medium and long-term loans for development projects in the construction, real estate, industrial and agricultural sectors. There is no secondary capital market, but one is currently in the process of been open in 2016; but Ethiopia has thriving commodity exchange. In 2015, Ethiopia borrowed about $1 billion in form of Eurobond. Its sovereign rating is about the same as that of Nigeria.
Nigeria can learn a lot from Ethiopia’s state-led development model while working at the same time to foster the dynamism of the market and private entrepreneurships. It is no gain saying that markets provide incentives for dynamic and creative economy via gainful exchange. As Princeton University professor of economics Dani Rodrick, however reminds us, “markets are not self- creating, self-regulating, self-stabilizing, nor self-legitimizing.” Markets need capable public sector institutions and infrastructure that reduce transaction costs for all participants. The pathway to shared prosperity in Nigeria is making market and government work together for the good of all.

**Dr. Temitope Oshikoya, an economist and chartered banker is CEO of Nextnomics Advisory.

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