The economy is about how wealth is created, distributed and consumed. It concerns the ways in which a country produces, distributes and consumes the tangible, material commodities of life. It is also about how the proceeds or income from these activities are distributed between those that contribute toward them: capitalist businesses, workers, the state and the whole of society. Every person affects the economy in some way and we are all affected by it.
Economics may appear to be the study of complicated tables and charts, statistics and numbers, but, more specifically, it is the study of what constitutes rational human behaviour in the endeavor to fulfil needs and wants. As an individual, for example, one can face the problem of having only limited resources with which to fulfil his/her wants and needs, as a result, he/she must make certain choices with his/her money.
One can probably spend part of his/her money on rent, electricity and food. Then he/she might use the rest to go to the movies and/or buy a new pair of jeans. Economists are interested in the choices he/she make, and inquire into why, for instance, he/she might choose to spend their money on a new DVD player instead of replacing his/her old TV. They would want to know whether he/she would still buy a carton of cigarettes if prices increased by 2 Birr per pack. The underlying essence of economics is trying to understand how both individuals and nations behave in response to certain material constraints.
While many excellent economists have shed light on a wide variety of subjects, many people still have only a sketchy grasp of how economies work. And what passes for economic “science” is often bunk. Fortunately, technological progress doesn’t depend on people’s economic understanding of why it occurs, although it can be stunted by bad policies.
The world economic history well recorded that fact that political economy, as it was then called, emerged in the eighteenth century, when the Scottish philosopher Adam Smith pursued “an inquiry into the nature and causes of the wealth of nations”. His key insight, that competition between selfish profit-seeking producers tends to advance the common good, is profound and often true.
At the time, political economy was descriptive, analytical and firmly anchored in a political and social context. In the nineteenth century, it was rebadged as the science of economics, akin to a branch of mechanical engineering. In keeping with the science of the time, economies were thought of as gigantic, self-equilibrating machines.
Philippe Legrain, in his book entitled “European Spring: Why Our Economies and Politics are in a Mess – and How to Put Them Right” argued that, increasingly, economics ran away with itself. Instead of trying to describe the world as it is, with the economy as a form of human interaction, it imagined a mathematical ideal detached from its social, political and historical context.
Assumptions that were not approximately right but completely wrong became doctrine: that people have known, stable, independent and well-ordered preferences; that based on those preferences, they “maximize” rather than operate by rules of thumb and make do.
According to Philippe Legrain, that they know how the economy works and have “rational expectations” about what the future holds, which conforms to a known probability distribution; and that as a result, markets, not least financial ones, are “efficient” and tend towards equilibrium.
On the basis of these false assumptions, economists created a fantasy world that’s fine, lots of people love Harry Potter – and then proceeded to give advice as if the real world was like their fantasy. And people believed them. Which is bonkers, as economist themselves called them.
Philippe Legrain noted that simplifying false assumptions allowed macroeconomists to model economies as if they consisted of an all-seeing, all-knowing single representative agent rather than as the complex interaction between many types of agent; to abstract from the financial system altogether, and to ignore the role of particular institutions. As a result, mainstream economics has very little to say about how new ideas come about and how they are deployed across the economy which is a pity considering they are the two main drivers of growth in advanced economies.
Because it has no coherent account of innovation, mainstream economics often misses the point. Immigrants are seen as generic drones who fit into vacancies in the labor market, rather than diverse sparks of new ideas. Free trade purportedly delivers a tiny one-off gain instead of being a stimulus for competitive improvement. Entrepreneurs don’t exist.
Likewise, mainstream macroeconomics has no coherent account of how the financial sector interacts with the economy. Standard models ignore it altogether; newer ones tack it on in an ad hoc way. Milton Friedman, a famous American economist, once countered that theories should be judged by their ability to predict events rather than by the realism of their assumptions.
On that basis, according to Philippe Legrain, orthodox economics is a flop. Physics is a wonderful science that told us how to send a man to the moon. Economics pretending to be physics is a disaster that led to the crash. The notion that economies are stable and predictable and tend towards a steady state, in effect, a linear forward projection of equilibrium over time, is nonsense.
Philippe Legrain, lashed that ironically, this neo-classical theory is often advanced by free-marketeers who don’t understand its implications. If this really was an accurate description of how an economy works, a central planner could do the job just as well as the market system.
Philippe Legrain acknowledged that economies are in fact complex systems that are forever changing in often unpredictable and non-linear ways as a result of the interaction between different economic agents with a limited grasp of how the economy works and little idea of what the future holds.
The operational mechanism of economies
Capitalism and political participation
For the first time in human history, a system that can be called capitalist is dominant over the entire globe. Such a system is conventionally defined as consisting of legally free labor, private ownership of capital, decentralized coordination and pursuit of profit.
One does not need to go far back into the past, or to have a great knowledge of history, to realize how unique and novel this is. Centrally planned socialism was only recently eliminated as a competitor. And nowhere in the world can be found un-free labor playing an important economic role, as it did until some 150 years ago. Such is the hegemony of capitalism as a worldwide system that even those who are unhappy with it and with rising inequality whether locally, nationally or globally have no realistic alternatives to propose.
“De-globalization” and a focus on the “local” is meaningless because it would do away with the division of labor, a key factor of economic growth. Surely, those who argue for “localism” do not wish to propose a major drop in living standards. Forms of state capitalism, as in Russia and China, do exist, but this is capitalism nevertheless in which private profit motive and private companies are dominant.
Increasing inequality of income, however, undercuts some of capitalism’s mainstream ideological dominance by showing its unpleasant sides which is the exclusive focus on materialism, a winner-take-all ideology, and disregard of non-pecuniary motives. But since no ideological alternatives currently exist and even less, political parties or groups to implement them, the hegemony of capitalism looks pretty unassailable. Of course, nothing guarantees that it would look like that to the coming generation, for new ideologies can be invented. But this is how it looks to a reasonable observer today.
One of the most basic principles of democracy is the notion that every citizen’s preferences should count equally in the realm of politics and government. A key characteristic of a democracy is the continued responsiveness of the government to the preferences of its citizens, considered as political equals. But there are a variety of good reasons to believe that citizens are not considered as political equals by policy-makers in real political systems.
Research findings shows that wealthier and better-educated citizens are more likely than the poor and less-educated to have well-formulated and well-informed preferences and significantly more likely to turn out to vote. They are much more likely to have direct contact with public officials, and much more likely to contribute money and energy to political campaigns. These disparities in political resources and action raise a profound question. In a political system where nearly every adult may vote but where knowledge, wealth, social position, access to officials, and other resources are unequally distributed, who actually governs?
One aspect of political inequality is the disparity between rich and poor citizens in political participation. Studies of participatory inequality seem to be inspired in significant part by the presumption that participation has important consequences for representation. Inequalities in activity are likely to be associated with inequalities in governmental responsiveness.
Meanwhile, statistical studies of political representation have found strong connections between constituents’ policy preferences and their representatives’ policy choices. However, those studies have almost invariably treated constituents in an undifferentiated way, using simple averages of opinions in a given district, on a given issues, or at a given time to account for representatives’ policy choices. Thus, they shed little or no light on the fundamental issue of political equality.
The sustainability of democratic capitalism is already a different question. Note first that these two words – democracy and capitalism – were not often combined in history. Capitalism in the absence of democracy has been a common feature throughout history. This was the case not only in Spain under Franco, Chile under Pinochet, or the Congo under Mobutu, but also in Germany, France and Japan. It even occurred in the United States via the exclusion of blacks from the body politic and in England with its severely limited franchise based on ownership of property at levels sufficient to include only the elite.
Thus, it does not take huge leaps of imagination to see that capitalism and democracy can be decoupled. And inequality can play an important role in that. It already does so by politically empowering the rich to a much greater extent than the middle class and the poor. The rich dictate the political agenda, finance the candidates who protect their interests, and make sure that the laws that are in their interest are voted in (not in our country).
The American political scientist Larry Bartels finds that United States Senators are five to six times more likely to listen to the interests of the rich than to the interests of the middle class. For the poor, there is no discernible evidence that the views of low-income constituents had any effect on their Senators’ voting behaviour. Both democracy and the middle class are being hollowed out.
In effect, it is not for nothing that since Aristotle, and more recently since Tocqueville, the middle class was seen as the bulwark against nondemocratic forms of government. It was not by some special moral virtue, embodied among the “middlemen,” that a person who has, for example, ceased to be rich and become middle-class would suddenly prefer democracy.
It is simply that the middle class had an interest in limiting the power of the rich so that they would not rule over them and of the poor so that they would not expropriate them. Large numbers of a middle class also meant that a lot of people shared similar material positions, developed similar tastes and tended to eschew extremism of both the left and the right. Thus, the middle class provided for both democracy and stability. All of this is under attack by rising inequality. The middle class in Western democracies is today both less numerous and economically weaker relative to the rich than it was 20 years ago.
Hilina Pawlos
Name: Hilina Pawlos
Education: Degree
Company name: Belle fashion
Title: Owner
Founded in: 2022
What it do: Women fashion
Hq: Addis Ababa
Number of Employees: 2
Startup capital: 500,000 birr
Current Capital:Growing
Reason for starting the Business: Passion
Biggest perk of ownership: Following my dream
Biggest strength: Creativity
Biggest challenge: Inflation
Plan: Open branches
First career: None
Most interested in meeting: Donatella Francesca Versace
Most admired person: My families
Stress reducer: Working
Favorite past time: Traveling
Favorite book: None
Favorite destination: Italy
Favorite automobile: Mercedes Benz
The Economic implications of the opening of the Ethiopian banking sector
These days, it is possible to listen to people discussing about the potential consequences of foreign investors in the banking industry following a draft proposal accepted by the Ethiopian Council of Ministers. One can come across business people, bank employees and others chatting and trying to make sense of the cons and pros, especially what there is for them of this first stage financial market opening. However, partly due to lack of detailed information and partly due to peoples’ tendency to see things in general terms, it is rare to find people with first-hand knowledge of the opening of the Ethiopian financial market to foreign investors. Factors like the degree of ownership, the number of branches they can open (if any), the type of financial services they provide, the nature of capital mobilization, more importantly the mode of factor payment (say in the form of dividend or expat salary) and the manners in which they will transfer best practices and technology-all these are important to know how much the Ethiopian economy benefits from this opening. At the same time the appetite of foreign investors is affected by how the regulatory framework addresses the above and related concerns. Though the immediate opening of the banking sector seems very limited, with the hope that the Ethiopian economy will soon experience a full-fledged financial liberalization (development and opening of forex market, equity market, security market and other sorts of financial markets), this article presents some of the views surrounding financial market liberalization. There is no question on the ever- increasing attractiveness of the Ethiopian economy to foreign investors, especially the service sector such as financing due to high rate of return, high proportion of youth population (hence, a growing market), the inevitable rise of a considerable middle class, more importantly the untapped financial potential due to limited access of financial services and to lack of various types of financial markets. Now let’s see about three perspectives about economic liberalization, especially the financial one while keeping in mind the opening of the Ethiopian banking sectors to foreign investors.
The debate on economic liberalization in developing countries which encompasses other related processes such as privatization and deregulation goes as far back, at least, to the 1980s. There has been fierce resistance at the intellectual and policy making level given that domestic private sectors were undeveloped as a result unbale to take over and efficiently run previously public owned businesses. Besides, the opening of the developing economies to foreign multinationals was (is still in some sectors and in many countries about four decades later) considered problematic since they are too big to compete with and too complex to be monitored by low-income countries’ existing institutional frameworks. In developing countries (when will they finish their development?) opening up the economy as a whole, especially opening institutions such as banks to foreign investors are seen in relation to political, security, and economic sovereignty (national interest) lenses. There are those who say that only the power of domestic financial institutions can slowly but sustainably help grow the economy. Among their claims, they argue that foreign bank entry is often accompanied by frequent -(1) financial crises, (2) currency market crises, and (3) market instability and general economic chaos. (4) In addition, foreign banks provide loans to those businesses which are large and have relations with the outside world or whose products are tradeable while small companies (usually in the non- tradeable sector) may rarely benefit directly from foreign financial institutions. (5) They bring about a kind of “brain drain” by luring experts from local banks. Later, the profits are distributed to their shareholders(abroad). (6) And one more important line of argument is that even if foreign investors pump in foreign currency in to the local economy around their entrance, over time, they have to transfer back the returns to their shareholders in hard currency. One may ask “well! where is their benefit in terms of foreign currency, then?”. One way of addressing this question is that foreign investors help businesses flourish (become productive) and generate hard currency via exports. However, isolating their impact in this regard requires cautious research as there are always many moving pieces in an economy and we don’t easily know what causes what.
In stark contrast to these arguments, there are groups that advocate for free flow of goods, services and capital within countries as well as across borders with minimal government intervention. They argue that life would be better off if producers and consumers met voluntarily without government interference. Their thoughts related to whether banks should enter or not are fetched from the same line of reasoning. In their view, free trade is the only way to wealth and prosperity. They argue that the source of market-induced financial crises, market shocks and general economic chaos is government intervention, not the market itself. Wounds and illnesses caused by the free market itself are treated and healed by its antibodies (supply and demand). According to these ivory-tower elites, we should not trust nearly anything the government prescribes for the reason that the medicines it prescribes cause worse harm than the original disease. From their point of view, when foreign banks come in, what follows is (1) the financial sector develops, (2) a country’s economy will grow because credit and savings will expand, making trade easier and production sustainable. (3) As competition between financial institutions heats up, consumers benefit (savers get high interest rates, borrowers pay low interest rates) and inefficient and unprofitable banks exit from the market, so the loss of resources is reduced. Since businesses can freely move and compete, it will increase their profitability too. (5) When foreign investors come in, they bring not only foreign currency but also FDI follows them as there may be organizations that have ties to or trust them. Usually, proponents of such unbridled free trade do not take the various contextual difference say between Ethiopia and Germany or the US and India. For them, it doesn’t matter whether you practiced free trade (hence developed appropriate regulatory frameworks) for centuries or you got your independence about seventy years ago. Hidden in their argument is the naked truth that companies in their countries are big and have been in the game for a long time. Thus, they can beat any newly coming competitor be it at home or abroad.
The right way in this regard seems the middle way. Those who favor this approach say that it is possible to increase the blessings and reduce the burdens of opening up an economy by using appropriate institutional restraints so that unbridled capitalism cannot destroy an economy at the same time by encouraging competition which will help avoid institutional(economic) stagnation. If governments, in countries like Ethiopia, cautiously put in place appropriate institutional frameworks, opening up the financial sector may help bring about financial deepening, economic growth and development. And in the short term they may help alleviate foreign currency shortages.
To sum it up, like every other policy action, the coming in or lack thereof foreign investors to the banking sector of Ethiopia by itself cannot be good or bad. It is what we really do with this policy that matters and determines the net benefits of these measures.
The writer can be reached at etsubdink08@gmail.com
