The Fallacy of Ethiopian Debt

"There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen". -  Bastiat, Frédéric

It wasn't a while ago, we met a lady that just came back from a vacation. After courteously asking how her vacation was, we immediately shifted to a question that concern us the most. How did you find the change in Ethiopia? As always we expected the usual rant of Ethiopian politics, or how the rich is getting richer, and the poor is poorer. Of course we did hear that, but not to be rude, we just nodded our head, silently telling ourselves, trying to figure out which country is perfect anyway. One thing stood out though, which was, “Yes there are new roads, huge projects, railways, etc., but all this government is going to leave us is debt". We couldn't disagree of the borrowing binge, especially after hearing the lady, few days after, some pundits, and experts on the media were mentioning the issue of debt, Ethiopia is accumulating. 

You may be wondering why we are trying to bore you with another article. We promise, if you give us your undivided attention, our advice may save you some fortune in the future.

What is debt?

An amount of money borrowed by one party from another. Debt can be used to make large purchases that could not be afforded under normal circumstances. A debt arrangement gives the borrowing party permission to borrow under the condition that is to be paid back at a later date, usually with interest. Of course we knew you know, what a debt is, if you may allow us to break it into two categories, it might help to clarify few things.

What is bad debt?

Bad debt is when you borrow to consume or invest in liabilities. From a personal perspective consuming or using materialistic items today, and do not further bring any positive gain, maybe personal satisfaction, besides that, the debt is still owed. On a governmental level, borrowing money to spend on military, food stamps, unemployment benefits, subsidies, and the like, usually bring in negative returns.

What is good debt?

Good debt is when you borrow capital to invest in assets that are expected to bring in cash flow. On a personal level, either one opens his or her own business or invests in other business. From a government perspective, borrowing to build infrastructure, railways, hydro power, schools and the like are some examples of assets a government can borrow to invest.

We also understand that debt has a limit, be it a good or bad. Even though, we don't claim to be doctors, or in this case someone with a P.H.D in economics, we will try to diagnose the Ethiopian economy. The monetary value of all finished goods and services (GDP) in Ethiopia in the year 2000, stood at $8.18 billion. Today in 2014, it is estimated to be approximately $50 billion. In other words, the size of the economy grew six times larger in 14 years. We also know that today the national debt stands at $22 billion. What does this all mean? We are confused as well dear reader, give us a break, we can’t find our calculators.

To make matters simple, let’s assume (isn't that what every economist does, assume), the borrowing binge of the Ethiopian government began in the year 2000. Therefore if we divide, the outstanding public debt, which is $22 billion and divide it by 14 years, it gives us $1.58 billion. Which means, every year, the government borrowed approximately $1.58 billion on behalf of you and me. If the Ethiopian economy is truly where it is today, which is approximately $50 billion, then we need to figure out, how many billions were added every year, since the year 2000. To do so, we simply divide $50 billion by 14 years, which gives us $3.58 billion. In other words for the past 14 years, the Ethiopian economy has added approximately $2 billion per year.

We aren't sure if this is considered good or bad debt. But recent history has shown us, when governments borrow and spend on unproductive deals, usually the amount of borrowed money is greater than GDP. For instance the United States borrows $1 trillion per year, taking the year 2013 as an example, despite borrowing $1 trillion, GDP only grew by $350 billion. We wonder where the money goes, but that's for another day. We did promise, we might be able to save you a fortune, even though we don't possess any crystal ball, history often rhymes, and these are some key issues that rise before a debt or a currency crisis.

·         Debt to GDP ratio reaches 90% historically this is when things start going bad. Today according to CIA fact page it's 50.1%

·         Banks reporting high level of debts going bad, or more than one bank declaring bankruptcy

·         Government corporations not being able to pay their debt.

·         The government begins paying for nanny's, as the French government does, or pays you to stay home as the Greece government did.

Till we see any of the above, you shouldn't lose any sleep at night. 

Regards,

Eskinder Haile