Privatization and its Influence on Deficits:

An Empirical Analysis of the Experiences in Ethiopia

 

Jesiah Selvam[*]

Abstract

 

This paper examines the influence of privatization on deficits. Deficits—budget deficit, current account deficit and trade balance deficit —are the determining, but haunting issues in all economies, particularly in the Least Developed Economies (LDCs). Ethiopia is one of the LDCs that strive to control these deficits while implementing all possible measures of economic reform.  Privatization as one of the measures was implemented in 1994 which resulted in privatizing about 60 percent of State Owned Enterprises (SOEs) in the country. It is, therefore, expected that it has had direct and indirect influence on these deficit variables. The study used data over ten years, 1994/95-2003/04, and simple econometrics models to test whether there is any bearing on deficit variables in connection to privatization. The empirical results show that the connectivity of privatization in relation to these variables in general is fragile and weak because of the small sized and slow paced privatization programme. The study also reveals that the weak export orientation and openness were other causes which may lock the policies like privatization in successfully managing deficits. This study, therefore, suggests that the government should ensure that the privatization programme should proceed hand in hand with the practical economic reforms and liberalization, coupled with creating a real outward and open economy to reduce these increasing deficits.   

 

Keywords: Privatization, budget deficit, current account deficit, trade balance deficit and open economy.

JEL Classification:  L33, F14, F32, H62

 

 

 

PRIVATIZATION AND ITS INFLUENCE ON DEFICITS:

AN EMPIRICAL ANALYSIS OF THE EXPERIENCES IN ETHIOPIA

I. INTRODUCTION

 

The term “deficit” means a havoc transaction in any economic activities undertaken by either individuals or organizations. It is because of the common notion that it reflects a kind of negative sign in terms of their efficiency and effectiveness. Deficit in the macroeconomic view is, however, not considered a surprising phenomenon when applied to economies level as it occurs every year irrespective of their economic status. There is little evidence about any economy resulting in a steady surplus for long. Budgetary, trade balance and current account deficits—called deficits hereafter—are more prevalent phenomena which have lavishly been discussed theoretically and empirically, leaving ample suggestions and implications as to how to prevent economies from being affected by the severe blow of these deficits. 

            There are many factors and reasons behind to say that why deficits are unavoidable. The most important of these are the pace of economic development, economic dependency, lack of (trade) openness, tax system, uncontrolled expenditure, inflation and so on. In spite of these causes—being justified or unjustified for many reasons, the recent economic theories are less digestive towards deficits, pronouncing a new fashion that deficits could be reduced if appropriate macroeconomic reforms, and adjustment programs were implemented. These programs included reforms to: deregulate the economy, reduce the state intervention in SOEs (State Owned Enterprises), establish a market-determined exchange rate, bring fiscal deficit under control, rationalize public investment and liberalize trade (Faruqee and Hussain, 1994). 

            The urgency behind implementation of these reforms owes to the accumulation of deficits-led-debts by governments all over the world in the 1970s and 1980s. While considering many options to lessen severance of this issue, reconsideration of state’s dominance, particularly on SOEs came into the limelight in policies of many governments. The rationality was that many state owned enterprises (SOEs) had shown their robust contribution to these deficits owing to their weak operation and continuous losses  (Winter, 1999) which would have been avoided in the assumption of these SOEs if they were private ones (New African, 1999). Privatization is one among these programs—developing an efficient private sector to substitute the weak SOEs—with one of the objectives of scaling down deficits in many developing and transition economies since 1980s. Privatisation, in many cases, has been considered an attractive way to help cope with budget deficit through sales proceeds not only in those developing ones (Agénor and Montiel, 1999; Abu Shair, 1997)), but also in developed ones (Munday, 1996).  It is also believed that any reduction in budget deficit may bring improvement in the balances of current account (Cordon, 2001:15) and trade.  But, no extensive and highly verifiable evidences are consistently available whether it has done its task as expected on these deficits, particularly in the African economies. 

            The purpose of this paper is, therefore, to examine the influence of privatization on deficits in Ethiopia. Ethiopia, one of the least developed as well as centrally planned economies in Africa  for seventeen years, has adopted privatization in the same fashion as much as other developing countries since 1994. As the country suffered from a long lasting decline of growth and productivity and increasing lag of technical progress compared with the West, budgetary deficits and external imbalances, it was quite obvious that the issue of stabilization and adjustment of the balance of payments received priority on the way of transition. Privatization as one of the structural adjustment reform was expected to approach these issues in such a way that a reasonable reduction of deficits in their budget, balance of payments and current account could be accomplished.  The paper is divided into four sections: the next section provides a brief note about the data and methods used for this study. Specification for the econometric models is also given in this section. Section III discusses the magnitude of deficits in relation to privatization through a descriptive analysis, followed by empirical estimations and interpretation to examine whether or not the Ethiopian privatization influenced the selected deficits.  Section IV ends the study with a summary and conclusions.           

II. DATA AND METHODOLOGY

Data was collected from the Ethiopian Privatisation Agency (EPA), Ministry of Finance and Economic Development (MoFED), Central Statistical Authority (CSA) and also from the development reports of the World Bank. The data used for this study covers a period of over eighteen years, 1986-87-2003/04, but OLS(Ordinary Least Squares) for the empirical testing has used the data of time series over ten years, 1994/1995¹ EFY (Ethiopian Fiscal Year)-2003/2004 EFY which is however, carefully interpreted, because of its lack of time coverage2. Regression Models are used to accomplish the objective of the study, based on heterodox model.  The models, which are explained with more details in the latter part of results and discussion of section III, are developed using the perspectives of the heterodox model which does not conclude that the non-significant variables necessarily imply that the hypothesized causal links are invalid. The privatisation, the explanatory variable, for this study implies only the privatisation of state owned enterprise (SOEs).

 

 

Model Specifications

Three different econometric models are constructed to find out the effect of privatization respectively for budget deficit, trade balance and current account deficits. The equation in all the models is fitted with privatization, an explanatory variable, with other required exogenous regressors. The model (1) is fitted with an equation of four independent variables. These variables are the growth rate, inflation, interest rate and privatization. Privatization, the explanatory variable, is inducted to measure to what extent budget deficit has captured the effect of privatisation. The main hypotheses in this model is that  the economic growth is expected to have an influence on the budgetary deficit since the higher rate of economic growth results in an increase in tax revenues for the year. The size of the budgetary deficit is also sensitive to inflation and the level of interest rates in the country. Ceteris Paribus, inflation tends to increase federal receipts more than federal outlays. As a result, an increase in the rate of inflation tends to reduce the nominal size of deficit. Other things being equal, increases in interest rate increases the size of the federal deficit because federal outlays for interest payments on the national debt go up (Hyman, 1997: 404-5). The hypothesis for the function of privatization in this model is that the privatisation proceeds, and minimization of opportunities losses and costs involved in those privatized SOEs contribute to reduction of budgetary deficit. For empirical analysis, the model has been expressed as:

 

[Df/Y]t =  β0 + β2 [ y]t-1 + β3 [p]t+ β4 [r]t+ β5 [PRIV/Y]t + ut                     (1)

 

            The equation (2) is fitted with an equation in such a way that it embraces the growth rate, budget deficit, inflation, trade balance, terms of trade, foreign financing and privatization. The hypotheses are that the economic growth rate improves current account whereas budget deficit, inflation and foreign financing worsen it. The variables of Budget deficit and inflation need to be interpreted as there have been plenty of cases where these two problems have co-existed (Cordon, 2001:29-30). The inclusion of trade balance can be justified in the sense that it correlates directly with current account on the assumption that the exchange rate is constant.          

[CA]t = β0 + β2 [ y]t-1 + β3 [Df/Y]t + β4[p]t+ β5 [X/Y-N/Y]t + β6 [FF]t

                                        + β7 [PRIV/Y]t + ut                                                                 (2)

            The equation (3) includes growth rate, openness and terms of trade which improves the balance of trade, where as foreign financing diminishes the balance. Terms of trade also holds good for trade balance where any improvement in the terms of trade may be advantageous to its account balance. Privatisation is expected to increase the trade balance as it is believed that the export capacity and efficiency of private enterprises is well-off as compared to SOEs.

 

[B]t = β0 + β2 [ y]t + β3 [Open]t + β5 [T/T]t+ β6 [PRIV/Y]t + ut             (3)

           

Where t = 1……….,10 and ut= the error terms, which are independently and identically distributed with zero mean and finite variance.  Each variable in the above mentioned three equations is empirically measured as follows:

[Df/Y]t =   Budget Deficit as a percentage of GDP.

[CA]t =     Current Account Deficit as a percentage of GDP

[B]t = Trade Balance Deficit as a percentage of GDP

[y]t = GDP Growth (Real) rate, lagged by one period for budget and current account deficits with the assumption that the effects of GDP growth is not contemporarily related.

 [Open]t  =  Openness3 as a percentage of GDP; [TT]t = Terms of Trade4

[FF]t = Foreign Financing as a percentage of GDP, and

[PRIV/Y]t = Privatisation proceeds as a percentage of GDP

 

III. PRIVATIZATION AND DEFICITS: RESULTS AND DISCUSSIONS

In the Ethiopian context, privatisation is conceived as an important ingredient of the transformation from a command to a market oriented economy, reduction of alarming budget deficit and external debt, injection of openness into economy and development of private sector at macro level, and alleviation of problems such as managerial inefficiency and poor performance of SOEs at the micro level. Among all, budget deficit has perennially been at the centre of economic policy debates in the country because the operation of SOEs is a significant component of the government budget.  For long in the past, the role of SOEs was perceived to be important both for ideological reasons as well as owing to the alleged productivity of public goods.  However, SOEs had have become a drain on the budget, partly as a result of poor investment, the collapse in terms of trade and various structural problems.

            Ethiopia was no exception to this theory of other developing countries. Many SOEs in the country were found working at the poor growth rate in the pre-reform period (Selvam, 2005). The annual report of MoFED (2004) indicates that the annual production performance and sales performance of SOEs accounted for 2.05 and negative 0.13 percent respectively in 1991/92, showing their dismaying performance. MoI (1992) also reveals that as of the same fiscal year, 33 percent of a total number of SOEs including small sized enterprises were under the category of loss-making enterprises, in which industries accounted for 55 percent and whereas, agriculture constituted 27 percent (MoI, 1992) resulted in widening the deficit in federal budgets which in fact severed other deficits of the country. Not in all the times, but budget deficit may even worsen the current account if the balance of payments is not supportive. These indications confirm that the SOEs contributed its share negatively to deficits which is strongly considered as one of the reasons for the government in privatizing its SOEs.  The country privatized about 220 SOEs in which many of them were small sized enterprises. Consequently, the sales proceeds were very meager that the programme has yielded only USD 433.7 millions to the exchequer (see Appendix 1A). 

            Table 1 provides the data set for deficits over the pre-privatization period. Budget deficit recorded at 6.9 percent in 1986/87 that was surged to 11.1 percent in 1993/94 with the annual average of 10.05 percent over the period before privatization, 1996/87-1993/94. Miles et al.(2005) in the executive summary of 2005 Index of Economic Freedom confirms that the fiscal burden caused the economic freedom in Ethiopia to decline more than any other country in the world. Current account deficit was decreased by a meager of 0.08 percentage points over the period, but the annual average rate accounted for 4.79 percent. Trade Balance deficit surged from 8.57 percent in 1986/87 to 10.64 percent in 1993/94 with the annual average rate of 8.65 percent. Current account improvement is normally brought about by a reduction in budget deficit. But the observed budget deficit seemed to be uncorrelated with current account deficit which might have been attributed to an excess of savings over private investment.

 

Table 1

Deficits, 1986/87-1993/94

Year

Deficits

Budget Deficit*

Current
Account Deficit

Trade Balance Deficit

1986/87

-6.9

-5.8

-8.57

1987/88

-8.8

-6.6

-8.80

1988/89

-11.2

-3.6

-6.53

1989/90

-13.8

-2.8

-5.40

1990/91

-11.3

-5.2

-7.90

1991/92

-9.7

-2.4

-9.58

1992/93

-7.6

-6.9

-11.76

1993/94

-11.1

-5.0

-10.64

Annual Average

-10.05

-4.79

-8.65

              Note: Deficits are given in percentage of GDP *excluding grants

              Source: World Bank (1997) 

            Budget deficit was observed to have been a serious and prolonged issue in the pre-privatization period. It should also be noted that the surged deficits over the period occurred in spite of high export taxes. If this extra government revenue were not spent, the budget and current account deficits would have been minimized. Furthermore, with more of inward orientation and less of openness, the revenues from exports would also be less attractive to prevent the country from rising deficits. 

            Table 2 shows that the budget deficit to GDP, which stood at 3.7 percent in the first fiscal year of the privatisation period, 1994/95, was raised to 7.13 percent in 2003/04, the last fiscal year of the study period. It grew at an annual average of 5.48 percent over the period. The deficit was very low only in the fiscal years of 1996/97 and 1997/98. But the post war effect on budgetary deficit was observed in the fiscal year 1998/99 and 1999/00 which recorded 6.54 and 10.25 percents respectively. The observed rising phenomenon in the budgetary deficit, particularly after the war continued throughout the study period. Furthermore, the deficit fluctuated rapidly over the period (s = 2.29 percent).

Table 2

Budget Deficit and its Share in GDP

   Year

Budget Deficit

(USD Million)

Budget Deficit/GDP

(In %)

1994/95

214

3.7

1995/96

333

5.21

1996/97

98

1.46

1997/98

194

2.92

1998/99

462

6.54

1999/00

764

10.25

2000/01

350

4.32

2001/02

555

6.67

2002/03

435

6.55

2003/04

528

7.13

Annual Average

393

5.48

              Source:  World Bank (2004) and MoFED (2004)

            For the preliminary analysis, the effects of privatisation variables are linked to the size of the government budget deficit since privatisation may have been implemented as a quick solution to a budgetary problem in the country. In order to examine this effect, a simple correlation is applied. The result shows that there is a weak correlation (correlation coefficient is -0.268) found between privatisation and budget deficit.

            There may be two reasons which justify this no effect phenomenon: first, the privatization proceeds brought by the size of privatization were too small to effect the budgetary deficit and second, the retaining of major SOEs by the government may leave the budgetary deficit no link to the privatisation. However, the tendency of the government’s budget deficit reduces investment spending which is otherwise called a crowding effect.  Reduced investment spending implies a slower capital formation and lower economic growth. This adverse effect of budget deficit on economic growth is probably the most important cost deficit and a major reason why economists strongly advise governments to minimise this deficit.        

Current and Trade Account Deficits Issues

 

Trade and current account balances are the direct outcomes of these openness and export orientation, Ceteris Paribus. These balances are found to be negative in most of the developing countries, particularly in Africa. The reasons are: dominantly pastoral economy, inward oriented and less openness, weak industrialization, poor exim(export and import) policies, high degree of international dependability even on basic raw materials and so on.  Ethiopia is more prevalent to these economic debacles.

Table 3

Trade and Current Account Balances

 Year

Trade Balance to GDP(%)

Current Account
Balance to GDP(%)

1994/95

-9.25

-1.5

1995/96

-14.60

-7.4

1996/97

-5.74

-6.5

1997/98

-9.38

-5.1

1998/99

-14.90

-7.8

1999/00

-15.27

-5.1

2000/01

-16.31

-4.0

2001/02

-18.20

-6.0

2002/03

-19.45

-4.7

2003/04

-19.8

-13.24

Annual Average

        (%)

                -14.29

                   -7.6

         Source: World Bank (2004), NBE (2003) and NBE (2004)

            Table 3 illustrates the trade balance and current account deficits over the privatisation period. It indicates that the trade deficit increased slowly over the period, whereas the current deficit increased but with a little fluctuation. This trend of increase in the export to GDP was expected to have smoothened the trade and current account balance over the period, but the analysis over export to import prevented the expectation from yielding a positive effect on these two deficits. It can be verified in many instances that openness and export orientation (export to import and export to GDP) are the main policy variables affecting deficits. Many developed countries have made extensive use of privatisation as a policy tool in support of openness (Sadar, 1995: 33) which, in turn, inculcated in them a high degree of export orientation in their economies, ending up either as a less debit or credit balance in current and trade balances. Not only are these positive effects, but also a positive relation was found between openness and economic growth (Thirwall, 2004:640).  

Table 4

Openness and Export Orientation

Year

                       

Openness

 

Export to    Import

Export to GDP

1994/95

18.74

59.54

13.61

1995/96

19.97

47.54

13.23

1996/97

17.77

73.36

15.80

1997/98

20.23

62.73

15.80

1998/99

19.73

48.80

14.19

1999/00

19.76

50.20

15.40

2000/01

18.2

48.04

15.08

2001/02

17.51

45.51

15.20

2002/03

29.91

46.89

17.10

2003/04

28.9