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Executive Summary

Ethiopia suffers from a chronic shortage of foreign exchange (forex).^[1] The resulting lack of access to imports prevents firms from accessing imported inputs required for production. This creates a vicious cycle as exporters are constrained by this same problem, which further reduces overall supply of foreign exchange in the Ethiopian economy. The inability to reliably access foreign exchange for imports affects firm decisions on sourcing, capacity, and output. While the cost of this constraint is known to be high on the Ethiopian economy and firms are known to use a range of measures to attempt to bypass this constraint, quantitative assessments of the problem and response actions by firms are limited. It is in this context that an importer survey was conducted with the goal of informing policy decisions. A total of 202 firms with an active importing license were interviewed in March-April 2022. These firms were randomly sampled from firms registered with an importer license.

All firms interviewed reported that they were operating below capacity, often well below capacity. Foreign exchange shortages were the main reason respondent firms cited for not operating at full capacity (63% of firms reporting this as their biggest constraint). Forex shortages far surpass the second and third reasons cited for not operating at full capacity — constraints due to the conflict (13%) and COVID-19 restrictions (11%). Firms operating below capacity cited forex shortages as the main constraint, regardless of whether they imported or not in the previous year. This was the most pressing constraint reported by firms of all sizes and sectors surveyed. It was the most pressing constraint faced by exporters and by foreign-owned firms as well as non-exporters and domestic firms. Amongst the total sample of firms with a renewed importer license, more than one-third of respondent firms (37%) had not imported in FY2020-21.

Overall, 74% of firms reported experiencing challenges in accessing forex. Access to forex was reported as most challenging for manufacturing firms and smaller firms but impacted all sectors and firm sizes. The losses attributed to forex scarcity at the firm level were largest for agricultural firms, for micro-firms, and for firms that did not import at all in the previous year. In general, the larger the firm sales, the higher the likelihood that they were able import. The survey found different types of imports for different sectors. Manufacturing firms imported a large share semi-finished goods as imports as compared to agricultural firms that primarily imported finished goods. The survey results find that foreign exchange shortages and an inability to import are most severe for the manufacturing and agriculture sectors, small and micro-sized firms, and all non-exporters. However, the constraint is also the top problem facing all firm types in the survey, including exporters and foreign-owned firms.

The primary means of accessing foreign exchange where it did occur was through specialized forex accounts or ‘diaspora’ accounts. The second most common means of accessing foreign exchange was through retention accounts available to exporters. The black market featured in many responses, but questions across the survey suggest that self-reported use of the black market by survey participants is underreported versus actual usage. The ability to source foreign exchange differed significantly by firm size. Exporting firms primarily used retention account earnings, as compared to non-exporters, which relied more on forex accounts. For faster access to forex, most firms reported that they approach banks, followed by turning to the black market. Friends and family abroad also served as a source of forex for one-quarter of firm respondents, and that foreign exchange was often used immediately. Foreign exchange access from banks is nevertheless a major pain point for firms. Most firms (55%) requested forex from a bank in the past year. On average, fulfilled forex requests took three months to be processed when they were fulfilled, but many firms reported that they have an unfulfilled request that has been in the system for more than a year. These firms are especially likely to report foreign exchange access as their top challenge.

The survey finds that individual firms do not tend to use both official and black-market foreign exchange sources but rather tend to access all their forex at the (lower) official rate or all at the (higher) black-market. Large firms import most of their products at the official rate. By contrast, most small and micro firms import through other means. Manufacturing firms are also more likely to import all their production through other means and outside of the banking system. Non-exporting firms tended to import through other means than the official rate and outside of the banking system at a higher prevalence than exporting firms. The survey gleaned new insights on the implicit exchange rate that firms face as they navigate official and black-market channels of foreign exchange access. The survey does not allow for a precise estimate of the transaction-weighted exchange rate facing the economy but finds firm-level estimates align with previous macro-level estimates. The implicit exchange rate was higher for non-exporting firms, which show a greater willingness to pay a higher exchange rate to access imports. This signals the importance of the retention account for exporters to guarantee an import price closer to the official exchange rate.

When asked about the maximum rate firms would pay to guarantee access to forex, some groups of firms were willing to pay higher amounts, including all non-exporters, firms that imported in the past year, and those that declared forex access a challenge. When compared to the implied rate they paid in the past year, many firms are willing to pay more than the implied rate to guarantee access to forex. Firm perspectives on policy changes to the exchange rate underscored challenges faced by policymakers. Current policy has been one of a crawling peg, with changes within the last several years to increase the rate of devaluation. The survey asked respondents about their support for faster devaluation, for a one-off movement to unify the official rate with the black-market rate, or about alternative exchange rate systems such as a floating exchange rate. Most respondents (71%) opposed maintaining the current regime, yet no option received majority support. Most firms appear to want both a stronger exchange rate and easier access to foreign exchange despite a tradeoff between these two priorities. The largest share of support for policy change was to adjust the exchange rate such that the official rate matches the black-market rate.

[1] See "Development in a Complex World: The Case of Ethiopia” ­– the Growth Lab’s compendium of project research from its Advancing Economic Diversification in Ethiopia project.

South Africa’s labor market exhibits a unique equilibrium with one of the highest unemployment rates in the world and yet a low level of informal employment. The unemployment rate has remained high and persistent over recent decades, in spite of the formal demise of the apartheid regime and subsequent transition to democracy in 1994. This paper uses a matching model of the labor market to argue that spatial considerations combined with low productivity of informal work may be responsible for such an outcome. Spatial dispersion inherited from the apartheid regime thins the labor market, creating exclusion and perpetuating spatial segregation. In most developing countries, the result would be higher employment in informal or own account employment. However, with low productivity in the informal sector, the high rate of exclusion shows itself in higher unemployment rates instead. Transportation costs and housing deregulation may become key factors in improving the working of the labor market in South Africa especially if it is not possible to raise informal productivity.

Related project: Growth Through Inclusion in South Africa

Can South Africa’s segregation policies explain, at least partially, its current poor employment outcomes? To explore this question, we study the long-term impact of the forced resettlement of around 3.5 million black South Africans from their communities to the so-called “homelands” or “Bantustans”, between 1960 and 1991. Our empirical strategy exploits the variability in the magnitude of resettlements between communities. Two main findings. First, the magnitude of outgoing internal migrations was largest for districts close to former homelands. Second, districts close to former homelands have higher rates of non-employed population in 2011. Together the evidence suggests that districts that experienced racial segregation policies most intensely, as measured by outgoing forced resettlements, have worse current employment outcomes.

Related project: Growth Through Inclusion in South Africa

We added a multi-sectoral economic framework to a SVEIR epidemiological model, combining the economic rationale of the DAEDALUS model with a detailed treatment of lockdown fatigue and declining compliance with Public Health and Social Measures reported in recent empirical work, to quantify the epidemic and economic benefits and costs of alternative lockdown and PHSM policies, both in terms of intensity and length. Our calibration replicates key features of the case and death-curves and economic cost for Argentina in 2021. The model allows us to quantify the short-term policy trade-off between lives and livelihoods and show that it can be significantly improved with targeted pharmaceutical policies such as vaccine rollout to reduce mainly severe disease and the death toll from COVID-19, as has been highlighted by previous studies.

Geo-political tensions and disruptions to global value chains have led policymakers to reevaluate their approach to globalisation. Many countries are considering regionalisation and friend-shoring – trading primarily with countries sharing similar values – as a way of minimising exposure to weaponisation of trade and securing access to critical inputs. If followed through, this process has the potential to reverse global economic integration of recent decades. This paper estimates the economic costs of friend-shoring using a quantitative model incorporating inter-country inter-industry linkages. The results suggest that friend-shoring may lead to real GDP losses of up to 4.6% of global GDP. Thus, although friend-shoring may provide insurance against extreme disruptions and increase the security of supply of vital inputs, it would come at a significant cost.

Notwithstanding announcements of progress, "international original sin" (the denomination of external debt in foreign currency) remains a persistent phenomenon in emerging markets. Although some middle-income countries have succeeded in developing markets in local-currency sovereign debt and attracting foreign investors, they continue to hedge their currency exposures through transactions with local pension funds and other resident investors. The result is to shift the locus of currency mismatches within emerging economies but not to eliminate them. Other countries have limited original sin by limiting external borrowing, passing up valuable investment opportunities in pursuit of stability. We document these trends, analyzing regional and global aggregates and national case studies. Our conclusion is that there remains a case for an international initiative to address currency risk in low- and middle-income economies so they can more fully exploit economic development opportunities.

This report analyzes the economic legacy of spatial exclusion in South Africa, focusing on the long-term effects of the former Bantustan policy. Through quantitative analysis, the report explores the spatial dimension of economic activity in South Africa and specifically how this particular spatial institution has continued to shape current economic outcomes, despite past and present attempts to reverse the effect. The report also identifies areas for further research and potential intervention to enable more effective economic inclusion of the former homeland areas of the country.

Related project: Accelerating Growth Through Inclusion in South Africa

The report aims to inform the government’s strategic approach towards manufacturing by analyzing the potential and limits for job creation within the sector. To meet that goal, we analyze the sector’s main features and recent trajectory through the lens of global deindustrialization and South Africa’s particular industrial dynamics. Secondly, we provide evidence of how, when, and why South Africa has deviated from the global deindustrialization trends. Lastly, we provide a policy framework to address the bottlenecks that are preventing South Africa from getting back on a better track of industrial performance.

Related project: Accelerating Growth Through Inclusion in South Africa

This report analyzes the causes and consequences of South Africa’s high rates of unemployment and the unique nature of labor market exclusion in the country. It leverages a combination of new quantitative analysis using South African datasets and international datasets for benchmarking, together with synthesis of existing literature and case studies. The goal is to: (1) characterize the challenge of labor market exclusion in South Africa, (2) identify ways in which this is similar and different to other countries, (3) understand what drives the unique challenges of the labor market in South Africa, and (4) narrow down what policy areas are most important to address the underlying drivers. This report takes a diagnostic approach to understand the causes of South Africa’s unique pattern of low informality.

Related project: Accelerating Growth Through Inclusion in South Africa

This paper explores franchising in South Africa, and its potential to help resolve the economy’s challenges of low entrepreneurship and concentrated ownership. South Africa features a large franchising sector, with half a million formal workers and a large number of small businesses owners competing directly with vertically integrated chains. Traditional franchising may not have much space for further growth as a percentage of the economy, but it can be made more inclusive with innovations in franchise finance that broaden the base of potential franchisees, as well as enforcement of consumer protections to ensure franchisee-franchisor relationships are balanced. The expansion of the franchising model to less capital-intensive business concepts and serving lower-income consumers (micro-franchising) is one area with expanding growth potential for the country, while the application of the franchising model to public services and socially driven organizations is less promising. Finally, while the franchising model is only directly applicable to particular sectors, there are features of franchising and the capabilities built up around the franchising that could be applied to other priority areas of the economy, in particular to smallholder agriculture. The success of traditional franchising shows the power of a menu of standardized proposals and contracts in a marketplace with a range of franchisors (in this case, up- and downstream agriculture corporates) offering different opportunities to potential franchisees (in this case, smallholder farming communities), along with training and technology transfer at scale.

Related project: Accelerating Growth Through Inclusion in South Africa

In this case study, we introduce a user-centered design process for developing Metroverse, a narrative visualization platform that communicates urban economic composition and growth opportunities for cities. The primary challenge in making Metroverse stems from the complexity of the underlying research and data, both of which need to be effectively communicated to a wide range of end-users with different backgrounds. To unravel the complexity of the research, and to design the platform, we followed a user-centered design process. Our design process brought together researchers, designers, and various end-users, who collectively guided the design of the narrative visualization. Engaging end-users in the early phases of the project allowed us to identify the valuable insights in the data and subsequently design effective visualizations that convey those insights. We believe findings from our process can provide a template for similar projects that require translating complex research data and methodologies into user-friendly story structures.

Watch Paper Presentation at CHI 2023: The ACM CHI Conference on Human Factors in Computing Systems

Picture yourself as finance minister of a developing economy. An eager environmentalist tries to convince you of the moral imperative of cutting your country's greenhouse gas emissions. You soon become bored because you’ve heard it all before, and your mind moves to more pressing matters. Your country is full of problems, from economic instability and inflation to challenges funding public services. Reducing emissions is not a priority.

Even if you were to succeed, your impact on the climate would be minuscule. Countries as populous as Pakistan, Nigeria, and Egypt each represent less than 1 percent of the world‘s emissions. Your country’s emissions—even cumulative since the industrial revolution—are infinitesimally small. Eliminating them all would have no material impact on the climate: you would have incurred costs and forgone opportunities to deliver economic prosperity with little to show for it.

Yet it would be a grave mistake not to consider climate change as an important aspect of your job. Change is sweeping across the global economy as countries recognize that the world must slash emissions to prevent a climate catastrophe. Decarbonization will reduce demand for dirty goods and services and increase demand for those that are cleaner and greener. The question is not what you can do to reduce your country’s emissions but how you can supercharge your country’s development by breaking into fast-growing industries that will help the world reduce its emissions and reach net zero.

Your country‘s history has been fundamentally shaped by the development of the few products it is able to make at home and sell abroad. Successful economies in east Asia and eastern Europe have sustained decades of high growth by upgrading their areas of comparative advantage, from garments to electronics to machinery and chemicals. They did not remain stuck in industries bequeathed by the past. If your country is to create jobs that pay higher wages, it will have to find new industries that can grow and export competitively even with higher wages.

Pessimists say that opportunities may have been there in the past for countries like Japan, Korea, or China, but those paths to development are now closed. Decarbonization will, however, create new opportunities—especially for those that move fast. The paths that are opening up have not been trod by many predecessors. Some are still virgin. Decarbonization will require significant greenfield investments, and plants will have to find new places to locate. This could be a great opportunity for your country, but to assess it, you must understand the changing landscape.

We do not know what technologies will power the low-carbon global economy or what materials and manufacturing capabilities they will need—nor what regulatory regimes the world will adopt, let alone what kind of cooperation or conflict will characterize relations between the largest emitters. These uncertainties will be resolved by those countries that play an active role and master the capabilities that will underpin their future comparative advantage. Keep in mind these six themes as you explore and exploit the opportunities and threats.

For a sample of emerging economies, we estimate the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabilization motive (appreciating the exchange rate as a nominal anchor) but are rather small when interventions follow a countercyclical, leaning-against-the-wind (LAW) pattern to contain exchange rate volatility. We document that under LAW, central banks outperform a constant size carry trade, as they additionally benefit from buying against cyclical deviations, and that the cost of reserves under the carry-trade view is generally lower than the one obtained from the credit-risk view (which equals the marginal cost to the country´s sovereign spread).

Is there a tradeoff between environmental sustainability and economic development? If there is a place where that question can be approximated, that is Loreto. Located on the western flank of the Amazon jungle, Loreto is Peru’s largest state and the one with the lowest population density. Its capital, Iquitos, is the largest city without road access in the world. For three decades, the region’s income and development has diverged from that of Peru and its other Amazonian peers by orders of magnitude. And yet, despite plummeting contributions from natural resources – that predominate in the policy discussion in and on the state – Loreto has developed a more complex productive ecosystem than one would expect, given its geographical isolation. As a result, it has a stock of productive capabilities that can be redeployed in economic activities with higher value-added, able to sustain higher wages and better living standards.

We deployed a thorough Growth Diagnostic of Loreto to identify the most binding constraints preventing private investment and development in sustainable economic activities. In the process, we relied on domestic databases available to the public in Peru and international datasets, combining and validating our analytical insights with extensive field visits to the Peruvian Amazonia and lengthy interviews with policymakers, private businesses, and academia. Improving fluvial connectivity, developing the capacity to sort out coordination failures associated with the process of self-discovery, and substituting oil for solar energy, are the three policy goals that would deliver the largest bang for the reform buck. The latter presents an opportunity for environmental organizations – subsidizing solar – to move away from their status quo of preventing bad things from happening, to a more constructive one that entails enabling good things and sustainable industries to happen.

Project page: Economic Growth and Structural Transformation in Loreto, Peru

We analyze the effects of bans on exports at the level of 5,000 products and show how our results can inform economic sanctions against Russia after its invasion of Ukraine. We begin with characterizing export restrictions imposed by the EU and the US until mid May 2022. We then propose a theoretically-grounded criterion for targeting export bans at the 6-digit HS level. Our results show that the cost to Russia are highly convex in the market share of the sanctioning parties, i.e., there are large benefits from coordinating export bans among a broad coalition of countries. Applying our results to Russia, we find that sanctions imposed by the EU and the US are not systematically related to our arguments once we condition on Russia’s total imports of a product from participating countries. Quantitative evaluations of the export bans show (i) that they are very effective with the welfare loss typically ∼100 times larger for Russia than for the sanctioners. (ii) Improved coordination of the sanctions and targeting sanctions based on our criterion allows to increase the costs to Russia by about 60% with little to no extra cost to the sanctioners. (iii) There is scope for increasing the cost to Russia further by expanding the set of sanctioned products.

Wall Street Journal: Sanctions Against Russia Could Be Better, These Harvard Economists Say

Video summary: How can sanctions against Russia be more effective?

This paper presents a structural ranking of countries by their distance to frontier. The ranking is based on comparative advantage. Hence, it reveals information on the productive capabilities of countries that is fundamentally different from GDP per capita. The ranking is centered on the assumption that countries’ capabilities across products are similar to those of other countries with comparable distance to frontier. It can be micro-founded using standard trade models. The estimation strategy provides a general, non-parametric approach to uncovering a log-supermodular structure from the data, and I use it to also derive a structural ranking of products by their complexity. The underlying theory provides a flexible micro-foundation for the Economic Complexity Index (Hidalgo and Hausmann, 2009).

We revisit the well-known fact that richer countries tend to produce a larger variety of goods and analyze economic development through (export) diversifcation. We show that countries are more likely to enter ‘nearby’ industries, i.e., industries that require fewer new occupations. To rationalize this finding, we develop a small open economy (SOE) model of economic development at the extensive industry margin. In our model, industries differ in their input requirements of non-tradeable occupations or tasks. The SOE grows if profit maximizing frms decide to enter new, more advanced industries, which requires training workers in all occupations that are new to the economy. As a consequence, the SOE is more likely to enter nearby industries in line with our motivating fact. We provide indirect evidence in support of our main mechanism and then discuss implications: We show that there may be multiple equilibria along the development path, with some equilibria leading on a pathway to prosperity while others resulting in an income trap, and discuss implications for industrial policy. We finally show that the rise of China has a non-monotonic effect on the growth prospects of other developing countries, and provide suggestive evidence for this theoretical prediction.

We study the impact of the Covid-19 pandemic on Euro Area inflation and how it compares to the experiences of other countries, such as the United States, over the two-year period 2020-21. Our model-based calibration exercises deliver four key results: 1) Compositional effects – the switch from services to goods consumption – are amplified through global input-output linkages, affecting both trade and inflation. 2) Inflation can be higher under sector-specific labor shortages relative to a scenario with no such supply shocks. 3) Foreign shocks and global supply chain bottlenecks played an outsized role relative to domestic aggregate demand shocks in explaining Euro Area inflation over 2020-21. 4) International trade did not respond to changes in GDP as strongly as it did during the 2008-09 crisis despite strong demand for goods. These lower trade elasticities in part reflect supply chain bottlenecks. These four results imply that policies aimed at stimulating aggregate demand would not have produced as high an inflation as the one observed in the data without the negative sectoral supply shocks.

Based on the criteria of the factor endowment structure of state-owned enterprise (SOE) sectors in China between 1980 and 2018, this paper rationalizes the classified reforming of China's state sectors by constructing a Nash bargaining model to capture the dynamics of ownership restructuring, and the reduction process of policy burden on SOEs. We reveal that the interplay between policy burden bared by SOEs and the ownership restructuring process largely depends upon their factor intensities since the reform period in the 1980s. Our model identifies two Ownership Reform Irrelevance Points (ORIP), which serve as the benchmark for the dynamics of the ownership restructuring process of China's large SOEs, which saw them move from ‘mixed-ownership’ to ‘privatization’. ORIPs demonstrate the need for a reduction in social policy burdens with regards to the state sector's comparative advantage of factor endowment structure through SOE ownership restructuring. This study theoretically analyzes existing literatures on the classified reforms of China's state sectors from 1978 to 2018. This study is the first to base such an analysis on the criteria of factor endowment structure focusing on the connection between the policy burdens bared by SOEs and their ownership restructuring process.

Following the Russian aggression against Ukraine, major sanctions have been imposed by Western countries, most notably with the aim of limiting Russia’s access to hard international currency. However, Russia remains the world’s first exporter of oil and gas, and at current energy prices this provides large hard currency revenues. As the war continues, European governments are under increased pressure to scale-up their energy sanctions, following measures taken by the United States, the United Kingdom, Canada and Australia. This piece argues that given the inelasticity of Russia’s oil and gas supply, for Europe the most efficient way to sanction Russian energy would not be an embargo, but the introduction of an import tariff that can be used flexibly to control the degree of economic pressure on Russia.

E-Letter in Science: How to weaken Russian oil and gas strength