Being one of the fastest growing nations in the African continent, Ethiopia is set to become a crucial economic hub in eastern Africa. If the statistical evidence presented in the case study is anything to go by, the remarkable growth rate and unprecedented improvement in per capita income and poverty levels in the country indicate its potential for posing a competitive threat to its regional rivals. However, this economic progress is only possible if the government loosens its tight control of the economy, and allows for competition through free trade initiatives. One aspect of free trade is liberalization which involves a reduction of tariffs and other trade barriers. The roots of the trade liberalization concept in most developing countries trace back to the early 1980s; a wave that intensified throughout the 1990s in Africa, Asia, and Latin America.
Trade liberalization works under the premise that private agents, under the guidance of market forces, are better placed to achieve an efficient allocation of resources, and spur the growth and diversification of output/GDP, employment, and exports (Shafaeddin, 2005). A reduction of internal trade barriers such as the elimination of natural monopolies (public utility corporations) will allow other competitors (private entities) to enter the domestic market. In Ethiopia, government organizations offering public or merit goods such as infrastructure, defense, education and healthcare operate as monopolies since local and foreign competitors are banned from operating in the market on the fears that private actors will exploit consumers. Monopoly markets constitute a single seller dealing in a unique product. The high barriers to market entry in Ethiopia stem from excessive regulation, cumbersome bureaucracy, and the awarding of exclusive rights of production to public companies. As a result, the monopolies determine market prices for commodities that are usually higher (Pm) than those existing under perfect competition (P*), enabling them to receive higher profits.
Trade liberalization will also promote the growth of exports. The international trade theory postulates that free trade supersedes protectionism by allowing countries to take full advantage of their comparative advantages. The reduction or elimination of tariffs from international trade permits faster and cheaper export/import activities between countries. Thus, nations can specialize in the production and exportation of commodities that they can produce most efficiently while importing other products and services from countries that can manufacture them at relatively lower cost (International Labour Office [ILO], 2001). The comparative advantage of a country mainly depends on its relative factor endowments. Thus, if a country has an abundance of capital, it will concentrate on the production of capital-intensive goods while a labor-abundant country will focus on producing labor-intensive commodities (ILO, 2001). Being a developing country, Ethiopia is rich in labor, especially unskilled labor, given its burgeoning population ("Ethiopia: What if they were really set free?” 2016). Unskilled labor can obtain jobs in new manufacturing plants and extractive industries that will crop up as a result of domestic entrepreneurship and an influx of foreign investors or corporations. This move will increase the production of labor-intensive products, leading to exponential growth in employment level and a decline in income inequality. The volume of exports will increase because Ethiopia will incur relatively lower costs in producing labor-intensive goods than its trading partners. Increased exports contribute to the creation of a favorable balance of payments (BOP) and balance of trade (BOT) for the country. The reason for this adjustment is that Ethiopia’s reserves of foreign currencies (such as the Dollar or Sterling Pound) will increase, leading to an appreciation of the domestic currency. Hence, local products become cheaper than foreign goods, causing a fall in imports relative to exports. The result is a decline in the BOP deficit that will improve the bargaining power of Ethiopia in matters of trade. Export revenue can also be reinvested in the diversification of export commodities from primary (raw materials) to secondary (manufactured) goods in order to fetch higher prices in the international market.
Moreover, a favorable BOP will make the country attractive to foreign investors who will channel capital into the economy in the form of foreign direct investment (FDI) (Shafaeddin, 2005). FDI in developing countries usually takes the form of loanable capital available to entrepreneurs for investment. The removal of state restrictions on market entry and the availability of capital will increase investment in the form of the expansion of existing industrial capacity and the efficient channeling of funds to new ventures within the identified productive sectors of the economy. According to the Keynesian theory, any anticipated or unanticipated change in aggregate demand (AD) causes a short-run change in real output and employment. Since investment is an essential component of aggregate demand, its increase will cause a rise in the latter through the multiplier effect. Hence, the overall productive capacity of Ethiopia will expand while market prices remain unchanged, further improving consumer welfare. The stability of prices arises from the Philip’s curve phenomenon identified by Keynes. Accordingly, unemployment tends to decline with rising inflation. Ideally, a surge in AD as a result of increased investment would cause inflation as prices go up. The existence of inflation means large profit margins for producers that enable them to hire more workers. As a result, unemployment falls. Keynes emphasizes that it is the trade-off between inflation and unemployment that helps keep prices stable in an efficient market. Therefore, an expanded productive capacity will work to promote the growth of domestic industries through technological development, knowledge transfer, and the influx of foreign capital into the country. For those industries nearing the maturity stage, additional benefits in the form of strategic alliances and partnerships with both local and international companies accrue to them.
While free trade is crucial to opening up Ethiopia to economic development, it also presents certain problems that might expose the country to external shocks. First, trade liberalization may harm infant domestic industries that are used to government protection (Shafaeddin, 2005). The majority of state-owned corporations and public utilities benefit from tax incentives, subsidies, and budgetary allocations that lower their operation costs. Thus, the entry of more efficient and competitive private actors into the business arena may lead to the closure of most parastatals and locally-owned enterprises. Private entities, especially multinational companies, possess superior production technology and know-how that enables them to benefit from substantial economies of scale. The fear of foreign domination in the domestic market and the possible exploitation of consumers and workers drive the reluctance of the Ethiopian government to relinquish its hold on the economy. The local industry may also collapse because of their fixation with primary commodities. Being a developing country, Ethiopia depends on extractive industries such as agriculture and mining, which yield unprocessed or semi-processed raw materials. Such products fetch lower prices in the international market compared to the manufactured goods such as machinery, equipment, and automobiles produced by developed countries. According to the theory of demand, primary commodities generally have a low income elasticity of demand – display marginal changes in demand regardless of the change in income (ILO, 2001). Furthermore, developed countries are continuous investing in research and development with the aim of developing synthetic substitutes for raw materials with the aim of minimizing their industrial production costs (ILO, 2001). This move will render the primary goods produced by Ethiopia and other developing countries useless.
The second problem associated with trade liberalization is the exploitation of workers. Given that the majority of the Ethiopian population is unskilled and semi-skilled, the labor force is likely to receive lower wages compared to workers in developed countries. The availability of cheap labor stems from the poverty, which increases their desperation for any job regardless of the level of pay. According to labor economics, the higher the labor supply, the lower the wages because many workers are chasing very few jobs, thus eroding their bargaining power. This scenario makes them fall prey to unscrupulous business people whose only goal is profit maximization at the expense of societal welfare. In addition to depressed wages, Ethiopian citizens may be subjected to stringent employment standards and inhuman working conditions, including child labor. Such consequences may negate the benefits of free trade.
In conclusion, setting the Ethiopian economy free through trade liberalization initiatives is vital in promoting rapid economic progress by turning over ailing industries to the private sector for efficient resource allocation. The comparative advantages that the country stands to benefit from free trade include market efficiency through perfect competition, export expansion, specialization, favorable BOP, and the growth of investment, employment and GDP. However, limited government intervention is necessary to protect domestic industries and prevent the exploitation of consumers and workers. The bottom-line is that a mixed economy is much preferable to either of the extreme ends of the protectionism-liberalization continuum.
References
Ethiopia: What if they were really set free? (2016, January 2). The Economist, 36-37. Retrieved from http://www.economist.com/news/middle-east-and-africa/21684816-if-government-let-people-breathe-they-might-fly-what-if-they-were-really-set?zid=304&ah=e5690753dc78ce91909083042ad12e30
International Labour Office (ILO). (2001). Trade Liberalization and Employment. Retrieved from http://www.ilo.org/public/english/standards/relm/gb/docs/gb282/pdf/sdg-2.pdf
Shafaeddin, S. M. (2005). Trade liberalization and economic reform in Developing countries: Structural change or de-industrialization? (179) Retrieved from United Nations Conference on Trade and Development website: http://unctad.org/en/docs/osgdp20053_en.pdf
