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10:55 am - Friday July 20, 2018

Don’t Privatize Ethiopian Airlines. Part II (By Worku Aberra (PhD)

Don’t Privatize Ethiopian Airlines

Part II

By Worku Aberra

Will privatization generate revenue for the government? In the very short term, the answer is yes. But in the long run, the payment of dividends to private investors will reduce the proportion of the profit that the government receives from the privatized SOEs, assuming that they are making profits. To be sure, many are incurring losses, but as I will argue later, there are different ways of improving efficiency than privatization; further, profitability should not be the sole criterion for justifying state ownership of firms. There also is no guarantee that the currently inefficient SOEs will start all of a sudden making profits because they have been privatized.

The world of business is replete with private companies that are incurring losses and declaring bankruptcies. Privatization is not a magic wand that transforms losses into profits overnight. Moreover, private investors will not invest in SOEs that are losing money; they are primarily attracted to the highly profitable SOE, the EAL. Even in the short run, considering that most of the SOEs for sale are losing money and hence not too appealing to private investors, the revenue generated through privatization will be small.

The claim that privatization will reduce or eliminate corruption is untenable. The private sector is not free from corruption; think of Enron,  World Com, AIG, Arthur Anderson, and predatory lending in the US, to name just a few. In Ethiopia too, the private sector is inextricably involved in corrupt business practices. Every corrupt act involves two parties, the perpetrator and the beneficiary, one or both of whom can be from the private sector. Media reports indicate that some of the privatized SOEs engage in unethical practises just like their counter parts in the public sector. The problem, as acknowledged by the Prime Minister, is systemic. As long as there is a political system that fosters corruption, privatization will not have any impact.  

There are other sources of tax and non-tax revenue, much more important than privatization, that the government should pay attention to. For Ethiopia, as for other developing countries, import duties are one of the largest sources of tax revenue, but the government is not collecting enough duties because of corruption, non-collection of tariffs, and smuggling of imported goods.  It has also been widely reported that large firms, especially those owned by political parties, are not paying their fair share of taxes. The size of the black market in Ethiopia is estimated to be as high as 35% of Ethiopia’s GDP. Because of these problems, Ethiopia’s tax rate is currently around 13% of GDP, much lower than the average of 20% in the rest of Africa, according to studies by UNDP and the World Bank.

Consequently, administrative measures to decrease the black market, to reduce the smuggling of imported goods, to improve the collection of import duties, to eliminate tax evasion, and to raise the rate on land lease; and to institute a fair, equitable, and efficient tax regime will generate much more revenue for the government than privatization.

The argument that privatization will result in technology transfer is unconvincing. In equity ownership, foreign investors don’t bring new technology; they may bring cash to buy shares in existing firms. It is foreign direct investment that transfers technology. Some of the SOEs set aside for privatization are already using up-to-date technologies. The EAL flies some of the youngest fleets and most sophisticated aircraft in the world. Privatization will not transfer technology to the EAL. So, if the concern is about the transfer of technology, the government should encourage foreign direct investment as joint ventures with the private and public sectors, as has been done in China.  

Privatization may initially attract foreign capital and ease the country’s severe shortage of foreign currency in the short term, but in the long run, as foreign investors repatriate their dividends, the outflow will negatively affect the country’s foreign exchange reserves.  

Further, privatization may engender financial crises. If Ethiopia wishes to attract a substantial amount of foreign capital in equity ownership, it will have to ease its controls on capital outflows. Sometimes, foreign investors would like to sell their stocks of the privatized SOEs and send their capital back home.  The same rule regarding capital outflow could apply to domestic investors as well. If foreigners can take their capital out of Ethiopia, why shouldn’t Ethiopians do the same?

Allowing foreign equity ownership requires the free flow of capital, domestic and foreign. With Ethiopia’s low level of economic development, it cannot afford the free-outflow of capital.  Even China, a country with huge foreign currency reserves and at a higher level of economic development than Ethiopia, restricts capital flows.

Private capital is highly susceptible to speculative jitters, often for no apparent reason. In low-income developing countries like Ethiopia, there are ample economic and political reasons to make investors jittery and the jitteriness can trigger a financial crisis.  The financial crises, sparked by speculation in Malaysia, Indonesia, Thailand, and other countries in the 1990s should be a warning for Ethiopia against privatization of the large SOEs.

The flow of capital will also destabilize the value of the Birr. Initially, as capital flows into Ethiopia because of privatization, the value of the Birr will increase, but as dividends and capital flow out of the country, the value of the Birr will decrease.  The instability in the value of the Birr will create instability in Ethiopia’s balance of trade. These fluctuations could feed speculative drives.

In situations like these, the Bank of Ethiopia (BE) intervenes in the foreign exchange market to stabilize the Birr, but with Ethiopia’s low level of international reserves, the BE may be too weak to stabilize the Birr, in view of strong speculative forces. (Remember, in 1992 George Soros, single handedly defeated the Bank of England’s policy to stabilize the Pound). Thus, instability in the value the Birr could be an added source of financial instability in Ethiopia.

If the government wishes to increase Ethiopia’s foreign exchange reserves, it should explore other options, such as reducing illicit capital outflow. In 2009 alone, Global Financial Integrity reported Ethiopia lost US $ 3. 3 billion in illegal capital outflow. In the current political situation, in which those who have illegally amassed wealth are not sure of the future, it is safe to assume that illicit capital outflow has increased, contributing to the country’s shortage of foreign exchange reserves.

The solution is clear. In the short run, the government should clamp down on illicit capital outflow, illegal exports, unreported exports (gold), and the misallocation of foreign currency. In the long run, it should promote the export of manufactured goods. These solutions, I admit, are easier to propose than to implement. I understand the huge systemic problem the Prime Minister faces, but the vast majority of the Ethiopian people are with him in his fight for economic justice.

Worku Aberra (PhD) is a professor of economics, in Montreal, Canada.

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