The 2016 International Monetary Fund’s annual report on the Ethiopian economy calls for the Addis Ababa government to boost economic growth through investing in infrastructure.While the IMF is right to make this point, Ethiopia must ensure it does not once again become bogged down in the simplified debate around austerity vs stimulus that has dominated policy discussion in recent months. Economic growth will only return through what is known as investment spending on planes, trains and other projects with a strong multiplier effect.Here’s how the argument works. If the Ethiopian government decides to build a new rail link like it did early this year, or a new runway at Bole airport, then construction workers are employed, and their suppliers increase production to provide the goods needed during the building. There is a boost to employment in both construction and manufacturing. These workers then go out and spend their earnings, further boosting income and employment.This ripple effect through the economy continues, boosting output and jobs still further. Economists call this positive spill over effect the multiplier. For every dollar of spending, Ethiopian will get back several times more, since the extra income and employment generates higher tax revenues. And this reduces the government’s deficit.Construction projects in infrastructure have particularly high multipliers as, in the longer term, they also help the economy work better. Better transport links, for instance, reduce costs to businesses and commuting times for individuals.The boost to manufacturing is also important. Despite the growth of the service sector over the past ten years, manufacturing is still Ethiopia’s engine of growth. So boosting manufacturing is important in securing long term growth.
This tells that Addis Ababa government spending on investment can reduce the deficit and have positive short- and long-run effects on employment and income.Examples of investment spending might include the proposed Bole Airport expansion, investment in rail, the expansion of urban light rail systems, and the construction of road schemes that cut congestion and link major cities together effectively.But before Ethiopia can get carried away, not all government spending has the same beneficial effects. Government spending that is consumption rather than investment has a much smaller multiplier effect. So increasing transfer payments, such as welfare benefits, would not have anything like the positive economic effect generated by investment projects.Spending on local construction projects, such as cosmetic regeneration schemes in run-down areas and traffic calming measures, would also not be capable of generating large multiplier effects, since these don’t have the longer term benefits of large investment projects.Government spending that distorts the economy can also have negative effects. Addis Ababa’s energy policy that offers subsidies to renewable energy providers and artificially increases costs to individuals and businesses fall in to this category. These “green” policies are arguably holding back Ethiopia economic growth.The take away message that cutting the public deficit and boosting growth is not as simple as it is made out to be. Neither cutting public spending, as advocated by some, nor increasing public spending, as advocated by IMF, provides us with a complete solution.It is about spending more on projects which have a strong investment component. Projects which boost construction and manufacturing to begin with but also yield a longer term benefit to the infrastructure of the economy, giving it the room to grow in future.Bole International Airport expansion and Addis Ababa rail services are good examples of projects that would deliver exactly these investment benefits which brings strong multiplier effects, a boost to Ethiopia manufacturing, and long term infrastructure improvements to build future capacity for growth.A focus on infrastructure spending means making tough decisions on welfare spending. And it means reversing current thinking on energy policy. None of this is easy or uncontroversial, but Ethiopian government investments are the key to growth and the IMF appear to have realised this.