# **6. Scenario Analysis: What Might the Future Hold for Ethiopia?**

In this section, we use our model to gain further insights about the future of Ethiopia’s growth. Specifically, we articulate three illustrative policy scenarios and assess their growth implications. Compared with benchmarking, this approach has the advantage of incorporating trade-offs involved in changing multiple policy variables simultaneously. The exercise has important methodological limitations implying that great care must be taken when interpreting results. Still, the simulations offer sufficiently meaningful insights about the future path of Ethiopia’s growth and the sources of growth under alternative policies.

The three policy scenarios share a number of key background characteristics. We use Early 2010s data as the base values and project one decade ahead for the Early 2020s. This is done to facilitate an evaluation of Ethiopia’s goal of reaching middle-income status by 2025. For the external sector, we assume unchanged commodity export prices and terms of trade. Similarly, we do not expect institutional changes or the occurrence of a banking crises. Note that these baseline assumptions, together with the persistence effect of previous-period reforms, lead to a per capita growth rate of 3.1 percent. The individual scenarios are described below and summarized in Table 4 while Table 5 offer detailed results.

Scenario A: ‘If it ain’t broken why fix it?’ This question is legitimate since Ethiopia’s growth strategy has delivered an unprecedented growth acceleration over the past decade. This is the spirit behind scenario A: ‘Business as usual’. To sketch this scenario, we assume continued public infrastructure investments and improvements in education that are in line with developments observed over the last decade. Public investment projects come at the cost of private sector crowding-out in the credit market, the buildup of inflationary pressures due to supply constraints, and, a policy of continued real exchange rate appreciation (to keep capital imports cheap). Public consumption increases in this scenario for the purpose of (imperfectly) capturing the growth drag of accumulating public debt to finance infrastructure investments (see Loayza _et al_ . 2005).

Scenario B: ‘The strategy of the past may not bring growth in the future’. It is equally legitimate to ask whether the current growth strategy needs to be adjusted today to enable it to deliver tomorrow. Scenario B simulates a reform which aims to promote accelerated private sector investment and reduce macroeconomic imbalances. Specifically, the pace of public infrastructure investment slows down but is partially substituted by private sector involvement, reflected in a modest increase in infrastructure and unchanged government consumption (implying no additional growth drag from public debt). Increased fiscal space is used to finance an expansion in secondary education, which would then approach current average LMIC secondary enrollment rates in the Early 2020s.<sup>24</sup> Increased private sector development is facilitated by an increase in private credit to GDP, which would then be slightly below the current LMIC average in the Early 2020s. Macroeconomic stabilization leads to a decline of inflation, a realignment of the exchange rate,<sup>25</sup>

> 24 World Bank (2013) identifies additional resources as a key determinant of expansion of secondary education.  The assumed values for education expansion in the 3 scenarios benefitted from input from Bank education specialists. 25 We assume an unchanged exchange rate in this scenario, as the exchange rate is currently overvalued but due to a Balassa-Samuelson effect (assumed in all scenarios), an appreciation of the exchange rate is expected in developing economies. The scenario thus assumes that those two effects cancel each other out.

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