Leadstar College of Management

Chapter Five: Macroeconomics Aspect of Managerial Economics

 Macroeconomics is the study of the aggregates and averages of the entire economy.
 It's the part of economic theory which studies the economy in its totality or as a whole.
 In microeconomics, we study the individual economic units like a household, a firm, or an
industry.
 However, in macroeconomics we study the whole economic system like national income, total
savings and investment, total employment, total demand, total supply, general price level.
 We study how these aggregates and averages of economy as a whole are determined and
what causes fluctuations in them.
 The aim of the study is to understand the reason for the fluctuations and to ensure the
maximum level of employment and income in a country.
Macroeconomics…
Scope

 The scope of macroeconomics includes the following theories:

 National income
 Money
 Economic growth
 Employment
 Price levels
 The studies of problem of balance of payment, unemployment, general
price level are the parts of macroeconomics, as these relate to the
economy as a whole
Macroeconomics…
Importance

The Importance of Macroeconomics

Why is macroeconomics important? Here are a few crucial reasons:
 It helps us understand the functioning of a complicated modern economic system. It describes how
the economy as a whole functions and how the level of national income and employment is
determined on the basis of aggregate demand and aggregate supply.
 It helps to achieve the goal of economic growth, a higher GDP level, and higher level of employment.
It analyses the forces which determine economic growth of a country and explains how to reach the
highest state of economic growth and sustain it.
 It helps to bring stability in price level and analyses fluctuations in business activities. It suggests
policy measures to control inflation and deflation.
 It explains factors which determine balance of payments. At the same time, it identifies causes of
deficit in balance of payments and suggests remedial measures.
 It helps to solve economic problems like poverty, unemployment, inflation, deflation etc., whose
solution is possible at macro level only (in other words, at the level of the whole economy).
 With a detailed knowledge of the functioning of an economy at macro level, it has been possible to
formulate correct economic policies and also coordinate international economic policies.
Macroeconomics…

Case Study: Ethiopia’s Homegrown Economic Reform

Macroeconomic indicators…

GDP per capita (current US$), RHS Poverty headcount ratio at national
GDP growth (annual %) poverty lines (% of population)

39
15 1000
30
800
10 24
600
400
5
200
0 0

2015
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

2016
2017
2018
2004 2010 2015

Double digit growth and over six- … a 15 percentage points

fold increase per capita during decline in the rate of
2004-18 led to… poverty.
2
Growth has been driven primarily by public investment…

Contributions to real GDP Growth (In percent)

While the National

Investment Government consumption
Private consumption Net exports Accounts data show that
20
Real GDP aggregate investment
15
was the driver of growth,
10 evidences from fiscal and
5 financial accounts depict

0
that the public sector has
2012 2013 2014 2015 2016 2017
been on the driver’s seat
-5
of the investment boom.
-10

3
… which stimulated construction and service sectors.

Contributions to Real Gross Value Added Growth (In percent)

Agriculture 1/ Manufacturing 2/ Construction

14 Services 3/ Gross Value Added

12

10

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
4
Note: 1/Includes agriculture, fishery, hunting, and forestry; 2/Includes manufacturing, mining, and quarrying; 3/Includes all service-related activities.
The investment program that fuelled growth was financed through
mobilization of domestic savings and prioritization of credits…

Gross domestic savings

(in percent of GDP) Bank outstanding credit, by sector
30 35 (in percent of GDP)
25 30
Public and prority sectors
20 25
Private sector
20
15
15
10
10
5 5
0 0

2018
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017

2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Domestic savings was increased by
…and this was directed to finance
about 15 ppts of GDP to about 24
primarily public and priority sectors.
percent in 2018…
5
…along with significant mobilization of external resources…

External borrowing and grants (In percent of GDP)

14
Loan disbursement- net Grants
12

10

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
6
…and by keeping the cost of financing low.

Real interest rates (annual, in %)

T-bills, weighted average While negative real interest rates

50 CBE lending rate to SOEs
kept the cost of domestic
0 financing low, overvalued
-50 exchange rate facilitated cheap
-100
imports for public sector
projects.
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Parallel-official exchange rate spread Real exchange rate appreciation
(in % of official exchange rate)

200
30
150
20
10 100

0 50
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019

2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
7
While closing the education and health gap with lower middle income
economies…

 For the current 2020 fiscal year, low-income economies

are defined as those with a GNI per capita of $1,025 or less
in 2018; lower middle-income economies are those with a
GNI per capita between $1,026 and $3,995; upper middle-
income economies are those with a GNI per capita between
$3,996 and $12,375; high-income economies are those with
a GNI per capita of $12,376 or more.

8
… ethiopia have a long way to go to reach today’s lower middle income
level benchmarks in other development indicators.

GDP per capita (current US$), 2018 Poverty headcount ratio at $1.90 a day, 2015

2,219 27.3
Need to triple Need to cut
per capita GDP poverty in half
865 to reach 13.8 to achieve
today’s lower today’s lower
middle income middle income
level level
Ethiopia Lower middle Ethiopia Lower middle
income income

Access to electricity (2017) and basic drinking water (2015)

services
Ethiopia Lower middle income
86 85 Need to provide electricity and water
44 for additional 40-45 million to reach
39
current coverage rate of lower middle
income countries.
Access to electricity (% of population) People using at least basic drinking 9
water services (% of population)
At the same time, the economic progress has not been entirely successful
in inspiring structural transformation…

Employment in agriculture Manufactures exports

(percent of total employment) (% of merchandise exports)
60
80
50
60 40
40 30 Ethiopia Lower middle income
Ethiopia 20
20
Lower middle income 10
0 0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2010 2011 2012 2013 2014 2015 2016 2017 2018

10
… reflecting the fact that income growth was achieved primarily
through capital accumulation and less through productivity growth.

Contributions of Factors of
Production Growth (in %)

Capital While capital contributed half of

TFP 0.7 the growth during 2005-17, the
Labour 2.1 contribution of productivity (TFP)
Human capital
was not overwhelming…
2.6
• In particular taking into
0.5 account the potential
1.7
increase in inefficiency
5.2
1.7
associated with large
1.1
capital accumulation
1997-2004 2004-2017

Source: estimated based on data from Penn World Tables 9.1. 11

 Productivity growth is constrained by structural and institutional
bottlenecks ...
Constraints to doing business Constraints in the manufacturing sector, ranked by firms
(weighted rank) (0-4; not a constraint to a major constraint)
FX regulation FX shortage
Corruption Power outage
Access to financing Access to electricity
Shortage of raw materials
Inefficient gov. bureaucracy
Poor internet service
Inadequate infrastructure Access to credit
Inflation Weak market demand
Poor work ethic of workers Expensive land lease
Inadequate educated labor Excessive government control
Excessive tax
Tax rates
Customs
Policy instability Access to land
Tax regulations High interest rate
Restrictive labor regulation Transport logistics
Government instability Long bureaucracy
Road
Crime and theft
Labor shortage
0 5 10 15 20 0 1 2 3 4
Source: World Economic Forum, Global Competitiveness Source: UNDP, Growing Manufacturing Industry
Report, 2018. in Ethiopia, 2017.

FX shortages, access to and reliability of electricity, corruption and government inefficiency, poor internet service, 212
and access to finance are cited as the most problematic factors to doing business.
... and constraints specific to key productive sectors.

Insufficient yield growth due to inefficient provision of inputs and services,

Agriculture difficulty with respect land lease rights, limited investment on R&D and irrigation,
marketing and logistic related problems, and lack of agriculture-specific
financial services.

The manufacturing sector remains underdeveloped despite recent efforts

Manufacturing to stimulate the sector due to inefficient incentive structure, limited
backward and forward linkages, and insufficient incentives for production
of import competing activities.

Ethiopia’s vast and diverse mineral resources, with the potential to generate the much
needed FX, remain untapped due to a variety of constraints including institutional and
Mining
technical barriers against large-scale miners, absence of a legal framework to
manage the miners’ relationship with local communities, and informality and pricing
issues related to gold mining.

While maintaining historical and cultural assets for centuries, sufficient efforts have not yet
been made to leverage these assets for economic growth. Challenges include limited
Tourism
accessibility and attractiveness, insufficient marketing and branding, and weak
supporting institutions.

13
ICT penetration, which is crucial for productivity growth, is also
limited by various constraints, including:

Hard Limited access to reliable electricity, limited access to affordable

infrastructure and reliable high-speed internet, and high cost of IT equipment

Enabling Lack of digital ID and poor digital payments system

system

Applications Underdeveloped e-commerce systems

Finance Limited access to finance for entrepreneurs and start-ups

People Limited digital literacy and future-oriented advanced skills

Police and Public sector monopoly in telecom and energy, restrictive regulation for
Regulation new start-ups, and traditional Industrial Policy may be ill-suited to innovation
13
At the same time, the economy is facing headwinds from growing
macroeconomic imbalances.

• While achieving the intended objectives of building human capital and

infrastructure and reducing poverty,
• … efforts to finance public investment programs through,
o rapid accumulation of debt, and
o directing domestic financial resources to public and priority sectors,
• … coupled with poor project execution have brought to the fore macroeconomic
imbalances, including:

Foreign External Limited private High

exchange debt sector access inflation
imbalances burden to finance

14
High demand for imports and poor export performance resulted in
large CA deficits and significant FX shortages
Drivers of the current account deficit
(In percent of GDP)
30
20
10
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
-10
-20
-30
-40 Exports Imports
Service, net Transfers, net
Current account balance

As a result of persistent current account deficit, FX shortage has become one the main
binding constraints to business. 15
Rapid increases in external debt in the context of poor project execution
and export performance led to high risk of debt distress.

Public sector external debt

 While the stock of the external debt is

45
External debt (% of GDP)
not particularly high by international
40
standards…
35 External debt service (%
of exports of goods and  Poor project execution along with
30 services)
disappointing export performance…
25
20
 Prompted the IMF and World Bank to

15 rate Ethiopia’s external debt burden as

10 a high risk of distress

5  Undermining the country’s credit

0 standing and borrowing ability.

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
16
 Expansionary fiscal policy appears to have crowded-out private sector’s
access to finance…

Percent of firms identifying the following as Most problematic to doing business

the biggest obstacles to business
FX regulation
Access to finance 40.4 Corruption
Access to financing
Electricity 10.1
Inefficient gov.…
Trade regulations 9.9 Inadequate infrastructure
Tax rates 7.6 Inflation
Corruption Poor work ethic of…
7.1
Inadequate educated…
Tax administration 6.6 Tax rates
Informal sector 5.8 Policy instability
Access to land 4.6 Tax regulations
Restrictive labor…
Transportation 3.9
Government instability
Poorly educ. work force 1.7 Crime and theft
0 10 20 30 40 50 0 5 10 15 20
Source: The World Bank’s Enterprise Survey (2015). Source: Global Competitiveness Report (2018).
17
… and might have contributed to the high inflation.

Inflation
(in percent)
45 Inflation averaged about 15½% a year during

35 2005-19, with wide ranging economic

consequences such as:
25
 Dwindling purchasing power of consumers, in
15 Average
particular the poor and middle class
5  Negative saving rates, there by discouraging
financial saving
-5
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
 Appreciating real exchange, there by eroding
external competitiveness

At the same time, anticompetitive and hoarding practices are making it difficult to
stabilize prices 18
The current reform agenda aims to overcome the aforementioned
challenges through comprehensive and well-synchronized set of
measures

Correct FX imbalances

Macroeconomic Control inflation

Macroeconomic Build
Jobs,
reforms
reforms Improve access to finance
confidence
inclusive
growth,
Ensure debt sustainability
poverty
reduction,
Rebalance
creating a
Macroeconomic
Structural growth and
Ease business enhance path to
reforms
reforms constraints productivity prosperity

Address sector-specific
Macroeconomic
Sectoral institutional \and market
reforms
reforms failures

19
 End

THANK YOU!