Biofuels, Economic Growth, and the External Sector in Ethiopia: A Computable General Equilibrium Analysis

In this study, we assess the economy-wide effects of biofuel investment in Ethiopia, with a focus on the external sector. The Government of Ethiopia has been revising its energy policy to switch from imported fossil oil to domestically produced biofuels, partly in response to climate change and partly in response to rising world oil prices, which leave oil-importing countries such as Ethiopia vulnerable to external oil price shocks. In Ethiopia, the value of oil imports relative to export earnings has increased over time, which has negatively impacted its balance of payments. Specifically, this paper assesses the implications of biofuels investment for growth and the external sector in Ethiopia using a dynamic recursive computable general equilibrium (CGE) model. The study is based on primary data collected from biofuel firms in Ethiopia and assumes that the amount of land is fixed in a given period. The results indicate that the macroeconomic and sectoral effects of biofuel investment in the context of Ethiopia are mixed. Biofuel expansion can help to improve economic growth if such expansion generates spillover effects, with jatropha and castor bean found to have the strongest positive impact on the economy. Without spillovers, the effect of biofuel investment on economic growth is negligible, indicating the importance of technology transfers. The impact on the external sector, especially on exports and imports, is negative, as biofuels expansion affects both the real exchange rate and production of export commodities. This negative effect might be mitigated by policies encouraging biofuels investment to move in a direction that does not compete with the use of land for traditional export crops.