Chapter 2: The State and Its Involvement in Economic Activities

Introduction

Can you imagine what it would be like to live in nation without government where there would
be no system of courts to administer justice; no provision of national defense; and no police and
fire protection services provided to the public? Driving on the roads could also be a problem
because virtually all the streets and public transportation facilities are supplied and maintained
by the government. Therefore it would not be difficult to imagine what life would be like without
government. However; you may also ask how much government is enough? Hence, this chapter
will discuss the state and its involvement in economic activities.

Chapter Objectives:

At the end of this chapter, students are expected to be able to:

 Understand the need of a government,

 Distinguish between public and private goods,
 Discuss economic activities of the state,
 Discuss the basic economic objectives of the state, and
 Understand the legal framework of the Ethiopian government.
2.1 The Need for Government

We need a government in any country to promote development by providing fundamental legal

and social framework for a free market economy. With regard to the involvement of the
government in the free market economy there are at least three reasons: to establish the
preconditions for markets to operate efficiently, to correct market failures, and to improve social
welfare and promote equity.

First, governments need to set up the preconditions for markets to operate efficiently by creating
the necessary institutions, laws, and regulations that will facilitate their functioning. Where
government intervention in areas such as property rights and competition laws is lacking, some
market activities may not develop at all, or they may develop in an inefficient manner with
impossibly high entry costs or administrative and legal barriers.

A second reason for governments to intervene is to correct market failures. In a general sense,
these failures refer to a set of conditions under which a market economy does not allocate
resources efficiently. Correcting such a situation requires that the government assist the invisible
hand to approximate what the market would have done in the absence of market failure. There
are various types of market failures, each requiring different forms of government intervention.
In the case of public goods, for example, the market usually fails to define the charge that
individual consumers should pay for their use. Here the function of the government to overcome
that failure would be revealing the citizens’ preferences for public goods—preferences often
expressed and channeled through the political process.

Closely related to public goods is the concept of externality—the recognition that consumption
or production of some goods may generate positive or negative external effects for the society
that are not reflected in their price. This argument has often been used to justify a government’s
role on the grounds that, without such intervention, the market would overproduce or under
produce those goods, depending on whether the externalities were positive or negative. In
addition, market failures often are associated with incomplete markets and imperfect or
asymmetric information among consumers and suppliers. Markets may not provide goods or
services whose costs are less than what consumers are willing to pay. Similarly, imperfect and
asymmetric information may lead to an erroneous valuation of goods and services, and therefore
to inadequate supply or demand. Finally, market failures are related to problems of adverse
selection and moral hazard when buyers or sellers act exclusively on the basis of their own
benefit and to the detriment of the general interest.

The third and equally important rationale justifying government intervention refers to the
concern for distributive justice or equity. Even if markets could function efficiently, by their
nature they would not ensure that growth and income are distributed in a fair or just manner.
Government thus should play a role in income distribution, without compromising the efficiency
of the markets to allocate resources. Welfare economics considers the function of the
government as going beyond the provision of public goods and focusing on the distribution of
income.

Although the concern for equity is typically associated with the role of government, this does not
mean that only the government should or could contribute to reducing poverty. If one thinks of
poverty as resulting from a lack of opportunities, empowerment, and social protection, it is clear
that the government is not solely responsible for filling that lack. In fact, the private sector does
play an active role in creating economic opportunities (employment, credit), promoting inclusion
of all members of the civil society (associations of private sector producers, workers, parents of
students, and the like), and protecting citizens (education, health care, and social protection, with
or without public sector involvement in financing or delivery), thus contributing to reducing
poverty either through its independent actions or by association and partnership with government
activities.

2.2 Public Goods vs. Private Goods

a) Public Goods

Public goods are those goods which cannot be priced in the market in order to deprive those
members of the society from its use or its benefits who do not pay for it. In other words, a section
of the society cannot be excluded from its consumption. The term public good does not
necessarily refer to a good that is made available by the government. Instead, any commodity
which is comprised of two features, namely non-rival consumption and non-exclusion is said to
be a public good.

A good is non-rival in consumption when with a given level of production; consumption by one
person need not diminish the quantity consumed by anyone else. In other words, a number of
people may simultaneously consume the same good. The second characteristic of a public good
is non-exclusion. Non-exclusion means that it is impossible, or prohibitively costly, to confine
the benefits of the good (once produced) to selected persons. A person will benefit from the
production of the good, regardless of whether or not he or she pays for it. Although non-rivalry
and non-exclusion often occur simultaneously, there is a distinction between the two concepts.

Thus, the indivisible goods, whose benefits cannot be priced, and therefore, to which the
principle of exclusion does not apply, are called pure public goods.

a) Private Goods

Private goods are those goods which are priced in the market and only those consumers are
allowed to consume these goods who pay their stipulated price. In other words, these are the
goods which are priced and the principle of exclusion applies on their use. Those who do not
agree to pay their market price, or those who cannot pay for them, are excluded from the use of
these good. Thus, the ability to price a good, the divisibility of a good and the exclusion principle
are the main features of private goods.

A product becomes divisible if it can be priced. Its indivisibility characteristic may also imply
that each individual has an access to its entire amount so that his/her use of it does not reduce its
availability to other. Therefore, private goods and services are divisible so for the use is
concerned while public goods and services are indivisible. The second issue that can be seen
with divisibility is the principle of exclusion. Private goods are subject to the principle of
exclusions. It can be priced and those who do not pay for can be deprived of it. In contrast, a
public good is indivisible and the principle of exclusion does not apply to it. Consequently, there
is a risk of beneficiaries not paying for it voluntarily. The main criterion of indivisibility is that
the good question should be equally available to all member of the society irrespective of their
ability or willingness to pay for it. However, note that indivisibility of good does not necessarily
imply that every citizen of the society has actually an equal share in its benefit
Regarding financing, the provision of public goods and services has to be financed through
compulsory contribution (like taxation). The financing of such goods cannot leave to market
mechanism while the financing of private goods is left to market mechanism.

Externalities

Sometimes in the processes of production, distribution or consumption of certain goods, there are
harmful or beneficial side effects called externalities that are borne by people who are not
directly involved in the market exchanges. These side effects of ordinary economic activities are
called external benefits when the effects are beneficial and external costs when they are harmful.
For example, pollution caused by factories, power houses, railways, transport vehicles, etc is a
cost to the society but not to the individual undertakings. Similarly, beneficial externalities of
social overheads like roads, etc cause a divergence between private and social marginal benefits.
The term externality stems from the fact that these effects are outside, or external to, the price
system, so their impact is not determined through mutual agreement among all those affected.

These externalities are of two types: market-external effect and non-market-external effect. In
the case of non-market external effects, individual economic units cannot be identified and
compensated for loss, nor can they be identified and charged for economic gains. In contrast, in
the case of market-external effects, the losers (beneficiaries) can be identified and compensated
(charged) for the same. Hence, pure public goods are characterized by the existence of
externalities, i.e., economic effects which flow from their production or use to other parties of
economic units such economic effect may also be called spillover effects, or neighborhood
effects or third party effects. They arise on account of interdependence of economic units via
input/ output relationship and may be in the form of gain or lose.

By implication, provision of public goods with non-market external effect should be preferably
in the hands of the public authorities since they can do so irrespective of their commercial
profitability. In contrast, pure public goods with market external effects may be left in the hands
of the private sector. A pure private good is supposed not to have any externalities. In this case,
there is no difference between private and social marginal costs of supply. Therefore its market
price represents its serial supply cost also. This implies that, even in the hands of private sector,
its supply would be at the socially optimum level. Ordinarily, therefore, the provision of pure
private goods should be entrusted to the private sector. But on account of various reasons this
may not be adhered to in every case. The government might decide to step in where merit wants
are concerned or for other relevant considerations like the cost conditions, resource availability,
social and political philosophy, and so on.

One remarkable characteristic of a pure public good is that an additional member of the society
can be benefited by its use without appreciably adding to its total cost. This implies that the use
of a pure public good by one more member of the society does not reduce its availability to the
others. A good example of it is the tuning in of your radio set. Still another example is that of a
bridge, over which an additional vehicle may pass without any additional cost to the society.
Note, however, that mostly this principle applies, in reality, only to a limited extent. We cannot
keep adding to the number of vehicles that may use the same bridge; we cannot have the same
defense budget if our population keeps increasing, and so on. Also it may be added that a large
number of members of the society may not be able to enjoy the benefits of a public good without
adding to the cost of its supply. Similarly, the provision of a public good may be increased or
decreased for budgetary reasons or due to extraneous factors. Pure public goods which possess
this characteristic have a strong case for inclusion in the public since public goods are indivisible
also. On the other hand in the case of private goods, the argument is basically in favor of large-
scale production for which either the society should agree to monopolistic type of private
enterprise or should go in for public sector.

It would be noticed that it is highly difficult to come across goods which fully satisfy all the
characteristics of pure public goods. Similarly, it is highly difficult to come across pure private
goods. In general, most goods possess elements of both publicness and privateness. The
difference between goods is mostly of degree and not of kind. Such goods which are neither
pure public goods nor pure private goods are called impure public goods also called quasi-public
goods or quasi-private goods. If the elements of publicness are predominant in the mixture of
characteristics of a good, then it may be termed a public good; in the opposite case, a private
good.
2.3 Economic Activities of the State

The role of the state in the economy may be approached from two perspectives:

 Historical angle
 Theoretical angle

2.3.1 Historical angle

The role of the state in the economy may depend on the particular economic theory that a certain
country adopts. To be precise the scope of activities undertaken by any particular state depends
upon its political and social ideology, resource availability, and the administrative and other
facilities at its command.
In the early days before the emergency of modern capitalism, the interference of the state in the
economic activities of the society used to be substantial. In those days, the society was not aware
of the advantages of market mechanism. Later as capitalism grew, the ill effects of control were
evident. As a result of this, they developed a philosophy, which advocated that, the interference
of the state in the economy should be confined to the minimum possible. This economic
philosophy is termed as the laissez faire (which means leave us alone) economic philosophy.

Adam Smith was the promoter of this philosophy. He was advocating for unregulated market
structure. He provided that, to the extent possible, the provision of the goods should be left in the
hands of the market-guided private sector. Adam Smith believed that the market was capable of
generating efficient signals for the economic units. He provided that there is an “invisible hand”
which guides every economic unit. However, even he recognized that there were certain goods
the provision of which could not be left to the market forces. The market would not provide them
either due to the lack of commercial profitability or some other reasons. But all the same
economy needed these goods for its own efficiency. These included social overheads, defense,
and maintenance of law and order, and the maintenance of the state itself was also to be there.

In the wealth of nations, Adam Smith enumerated four justifiable categories of government
allocative activity. These were: the duty of protecting the society from violence and invasion by
other independent societies, the duty of protecting every member of a society from the injustice
of oppression of every other member of the society (this reflects the obligation of establishing an
administration of justice which provides law and other within the society so that the market
economy may function), the duty of establishing and maintaining highly beneficial public
institutions and public works which are of such a nature that the profit they could earn would
never repay the expense to any individual or small number of individuals to provide them, and
the duty of meeting the expenses necessary for support of the sovereign, which vary depending
on the form of political structure.

The free market economic theory requires that the role of the state on the economy has to be
minimal. Proponents of this theory argue that the market would best function if it is left to
operate on its own. It should be the demand and supply forces that have to regulate the market. In
such a system the state has to engage itself in limited activities. Accordingly, in a capitalist
economy the main task of providing goods and services is assigned to the private sector in which
individual economic units are motivated by economic rationality and guided by the market
mechanism in their decision-making. The owners of factors of production are guided by income
which they can earn in alternative employments: the investors are guided by the profitability of
alternative investments; the consumers try to maximize their consumers’ surplus, and so on. In
this arrangement, the government has only a limited role to play.

There is yet another economic theory which is situating at the other end of the free market
economic theory. This is called the command or socialist economic theory. In the command
economic system, the role of the state in the economy is substantial. Such an economy is
basically dominated by the state sector. In such a system economic activities and decisions of the
state are expected to be guided not by commercial profitability but by the totality of objectives of
the society. Market mechanism is assigned, if at all, a very marginal role. In a command
economic system, it is the state that determines what goods and services are to be supplied and
how much. Proponents of this theory advocate that the economy will function effectively if the
role of the state in the economy is substantial.

Third, there is the mixed economic theory which is a mid way between the free market and the
command economic systems. In this system, both private and public sectors are assigned
significant roles. The concept of a mixed economy implies that the decision-making processes
concerning economic activities (and more particularly those relating to allocation of productive
resources) are shared between private and public sectors. Resource allocation through market
forces is supplemented by non-market ones and in practice the state economic activities tend to
be all pervading in the economies of both developed and underdeveloped countries. Most market
economies have witnessed a general upward trend in public expenditure as a proportion of
national income. This is turn implies growing pubic revenue (taxes, revenue from public
undertakings, borrowings, and creation of currency.)

These days, it is a usual practice with the governments to borrow huge amounts from the market.
This causes shifting of resources from the private sector to the public one. And if the borrowings
happen to be from the central banks, then the additional effect is that of adding to the total
money supply also. Later on, when the authorities pay interest charges on public loans or repay
the principal, shifting of resources takes place in the reverse direction. However, the government
may be raising the resources for debt servicing (interest and principal repayments) by taxation or
by additional borrowing. With different policies and practices different economic effects are
experienced in the society. The authorities have an effective tool in their hands in the form of
public debt and its operations. It can be theoretically shown that the growth of public debt is
helpful, rather essential, for the growth of the financial institutions and therefore for the growth
of the economy.

Furthermore, it is not just the aggregate of revenue and expenditure which affects the working of
the economy. Public revenue and public expenditure are powerful tools in the hands of the
government through various taxation policies the government may try to mould the working of
the economy in a particular manner.

It must be realized that the field of the government activity is extending not only in terms of
participation in the economy, but also in terms of regulating it. In this respect, some authors
provide that there are three basic objectives that a state needs to follow. These are the allocative,
distributive and stabilization functions. When it comes to providing and pricing the goods, the
government divides its activities into various categories some of the public goods like defense,
law and order are not subject to the principle of exclusion. Every member of the society enjoys
the benefit of these goods in question in equal amount and their financing is done through
budgetary provision. Some other goods, which are considered merit goods, are provided to the
society on a subsidized basis because under free market mechanism they are generally under
consumed. Still others are subjected to the full-fledged principle of exclusion and the provision
of such goods is made on the basis of commercial profitability.

But the activities of the government do not stop only at having a proper and effective public
sector. It also tries to regulate the working of the private sector so as to help achieve the goals of
the society. For this purpose, the government adopts various budgetary measures, price controls
and other direct physical measures including licensing, quotas, and so on.

A modern government finds that the need to intervene in the economy is constantly increasing.
Even when the economy is not a centrally planned one and depends to a large extent upon the
price mechanism, there is a need to regulate its working. Left to itself, a free market mechanism
is likely to generate patterns of income and wealth distribution which violate social and
economic justice. Production and trade may get concentrated in the hands of firms resorting to
various monopolistic and restrictive trade practices. A free market economy is subject to violent
cyclical fluctuations from which it should be protected by ensuring stability of employment,
production, and prices. It is also contended that with the growth of industrialization and
urbanization, a lot of social security problems emerge: the problems of health, sanitation,
housing, pollution and social crimes increase. A number of other similar fields for state
intervention include provision of social overheads, contribution to capital formation, labor-
employer relationships, industrial security, balance of payments, and so on. In other words, there
are internal economic and social problems and there are the problems arising out of the fact that
the economy is subject to much stronger impacts of foreign economic and political contacts.

Accordingly, the role of the state expands not only in terms of its participation in economic
activities but also in terms of its protection and regulation in various ways. This, therefore, calls
for a set of carefully planned monetary and fiscal policies and a proper coordination between
them.

The states are seized of the problems of economic stability, economic growth, employment,
inflation, balance of payments, regional imbalances, and so on. Provision of more and more
social and economic services is being taken over by the state, including education, social security
and administration of labor welfare measures, etc. In some countries, this trend had been
reinforced by nationalization and regulation of existing industries.
2.3.2 Theoretical angle

There are a number of theoretical basis for the involvement of the state in the economy. Based
up on the considerations discussed earlier it is possible to make out a case for the co-existence
between the public and private sectors. This may be approached from a point of view of i) pure
public and pure private goods; and ii) impure public goods.

It can be contended that so far as providing the pure public goods is concerned, we should entrust
the public sector with this job. If the task is left in the hands of the private sector, then the system
would suffer from inefficiency on account of the following reasons.

1) a) Left to the market mechanism, even a pure public good would have to be priced. This
would automatically involve the enforcement of the principle of exclusion to its use. As a result
either the good would not be supplied at all, or the suppliers would try to deprive a section of the
society from its use. Such an enforcing of the principle of exclusion will either be impossible or
will be very costly to enforce.

b) To the extent that some of the external effects of the public goods cannot be priced (the non-
market-external effects), there will be a divergence between the private and social marginal costs
of the products. The supply of goods, therefore, would not be at an optimum level. Thus, suppose
that a particular public goods under consideration has external economies which cannot be
measured and, therefore, cannot be priced. The spill-over gains are there in the society, but the
supplier of goods cannot charge for them. To him, therefore, the market price is much lower than
the social marginal benefit and he determines his supply on the basis of the price which he gets.
It means that he would produce less than what would be the optimum quantity from the society’s
point of view. Similarly, when a public goods has external diseconomies (such as the smoke
nuisance), the social marginal cost is higher than the private marginal cost. The private producer,
however, would determine his supply on the basis of the marginal cost to himself and not to the
society. Thus, in this case, the supply will be more than the socially optimum quantity. On the
other hand, if the public goods are supplied by the state then the state can bring output to socially
optimum level by either foregoing profits or by suffering losses.
c) The market mechanism fails in the case of pure public goods and the users cannot be forced to
reveal their demand preferences. The suppliers are faced with the problem of free riders.

2) Quasi Public Goods: as regards the quasi-public goods, it should appear that here the role of
the state should be limited to those goods which have more of publicness in them while
predominantly private ones should be left to the private sector and the market mechanism. The
precise field of the state activity has to be decided not only on the basis of efficiency of the
public sector but also on the basis of the political and social ideology of the state.

3) Merit Goods: In the society, there are certain wants which almost all members of the society
should be able to satisfy. Examples of such wants include educational and health needs of the
society. Musgrave calls them merit wants on account of their overriding importance. Provision of
such goods helps the economy in attaining a high level of efficiency and contributes to the
achieving of basic objectives of the society. Thus, if the provision of education is left to the
market as such, the cost of educating the children will have to be borne by their guardians. This
would deprive many brilliant students of educational opportunities. Such a state of affairs would
be bad both for the deprived persons and for the society as a whole. It would also lead to a
general lowering of the standards of efficiency in the economy. Similarly, precious lives may be
lost if health services are left to the forces of market only. It needs no arguing that the state
should either take up the supply of merit goods or should at least supplement their availability.

4) Market Failure: We notice that market tends to operate inefficiently, amongst other things, on
account of the existence of public goods and the absence of law of constant returns. Market
failure is a commonly observed feature, not only when an economy is riddled with monopolies
but even under competitive conditions. The problem is compounded on account of uncertainty of
future, incomplete information (both technical and economic); and deliberate attempts on the
part of sellers to influence demand forces through selling techniques. Theoretically therefore, we
can provide economic arguments not for the existence of state, but also for its corrective role.
One dimension of this corrective role is what Musgrave calls the allocative role and comprises
of policies and actions of the government designed to counteract the “inefficient” outcomes of
market functioning. Another dimension of the corrective role is the distributive one through
which the state tries to bring income and wealth distribution as also concentration of economic
power in line with what it considers proper. Similarly, an unregulated market economy tends to
exhibit instability (cyclical or otherwise) in terms of important macro variables like income,
employment, prices and output and it is considered a legitimate function of the state to protect
the economy against these destabilizing forces.

If the state plans to restrict itself to the provision of public goods only, there would not be much
scope for government activities and for studying public finance, since pure public goods are
extremely scarce. A greater area of justification for the state lies in the field of mixed or impure
public goods. However, in actual practice, a state does not come into existence or stay alive on
the basis of above-mentioned theoretical reasons. For ages, it has been simply there and has
played allocative and corrective roles in varying degrees on transitory considerations. The need
for an active participation of government in the economic functioning of the society has come to
be recognized quite slowly. The theoretical developments concerning state activities are also not
old. For a long period, the theory of public finance consisted of the best way to raise tax revenue
for financing given state activities. The analysis regarding choice of level and composition of the
state activities did not find place in it.

5) Infrastructure: The role of state in providing infrastructure (social overheads) was recognized
even in early economic literature. The arguments in favor of this dictum were that infrastructural
facilities are commercially non-viable and require huge resources beyond the capacity of private
sector. These days, the argument of commercial non-viability is supplemented by that of the
contribution which infrastructure makes to the productive potential of an economy. Theoreticians
show that growth of an economy is sum of contributions made by productive resources,
technology, institutional framework and infrastructural facilities. The contribution of
infrastructural facilities is termed total factor productivity. The provision of such facilities is
considered a primary responsibility of the state, particularly because its spill-over effects are
non-marketable.

However, though desirable, the state may not be able to provide all those goods which have
predominantly public elements in them for the following reasons:
i) The state may not have enough resources particularly in an underdeveloped economy to
undertake the supply of all the goods which, theoretically, it should be providing to the economy
on grounds of publicness. This means that there is a need to have a large number of goods in the
public sector but the state cannot afford to undertake all these activities.

ii) The administrative machinery of the state may not be efficient enough to undertake the
provision of all the goods which are predominantly public in nature. This limitation is also
stronger in the case of underdeveloped countries, since the administrative machinery of such
countries generally lacks in skill, statistical information, and so on.

iii) The efficiency in public undertakings is notoriously low. There is a lack of initiative and a
proper system of incentives. Also the public undertakings are expected not to follow the
principle of commercial profitability in every case and the state may not be able to bear the
additional losses on account of expansion of its activities.

iv) The boundaries of government activities depend upon political and social acceptability of its
policies. In some countries, social traditions and attitudes may not allow the government to
expand its activities in certain directions. In some other cases, the political atmosphere may be
against certain state activities.

Generally, we see that no economy is there without a public sector. Each is a mixed economy
with varying proportions of private and public sectors. If any society decides to completely forgo
the provision of public goods including the state existence itself, it would mean anarchy. And if
the activities of the state were confined only to its own maintenance, provision of social
overheads and the protection against foreign aggression and internal disorders, then also there
would be a lot of inefficiency in the provision of those goods which have more of publicness in
them.

2.4 The Legal Framework of the Ethiopian Government

The Federal Democratic Republic of Ethiopia (FDRE) has a parliamentary form of government.
The Republic comprises the Federal Government and nine National Regional States established
on the basis of settlement patterns, language, identity and the consent of the people concerned.
The National Regional States are entitled to equal rights and powers. There are two self-
governing city administrations: Addis Ababa and Dire Dawa.

The Federal Government and the Regional States have legislative, executive, and judicial
powers. The powers of federal and regional governments are defined by the Constitution. It is
incumbent upon Regional States to respect the power of the Federal Government which likewise
is bound to respect the powers of regional states. All powers not given expressly to the federal
government alone or concurrently to the Federal Government and the states are reserved to the
states.

The federal arrangement, under the Constitution, has guaranteed the rights of Regional States to
administer their own affairs. The Regional States have their own constitutions. They are
empowered to formulate policies that are appropriate for their respective development, to lay the
foundation for economic and social infrastructures, to directly participate in sectors that are
critical for their economic development and to safeguard law and order in their own areas.

FDRE has two Federal Houses: the House of peoples' Representatives (HPR) and the House of
Federation (HOF). The HPR is the highest authority of the Federal Government. The House has
legislative powers in all matters assigned to federal jurisdiction by the Constitution. Members of
the HPR are elected by the people for a term of five years. The members of the HPR, who shall
not exceed 550, represent the people as a whole. In order to discharge appropriately the duties
entrusted to it by the Constitution, the House has organized 12 standing committees. The
committees are formed in accordance with the organizational set-up of the federal government
organs. The committees enable the House to have effective legislative procedures. Since the
State is a multi-party democracy, people belonging to various political parties, coalitions and
independents make up representatives in the House. The working procedure of the Parliament is
determined jointly by agreement of representatives belonging to all groups in HPR. In addition to
the usual consultation with opposition parties in enacting legislations, there is a day in a month
identified as a day for the opposition to set the agenda for HPR. This affords the opportunity for
the minority in the parliament to be heard. Reports presented by the Prime Minister and other
executive officials and the debates are aired live to the public.

The House of Federation (HOF) is composed of representatives of Nations, Nationalities and

Peoples. Each Nation, Nationality and People has at least one representative in the HOF. One
additional member shall represent every nation or nationality for every one million people. The
state councils elect members of the HOF. The state councils may themselves elect
representatives to the HOF or hold elections to elect representatives by the people directly.

As to the FDRE Constitution, the HOF has the power, inter alia, to interpret the Constitution,
decide on the basis of the Constitution on issues relating to the right of Nations, Nationalities and
Peoples' to self-determination including secession, to promote and consolidate the unity and
equality of peoples and find solution to dispute or misunderstanding that might arise between
regional states. However, the HOF does not have any legislative power.
The President of the FDRE is the Head of the State. The HPR nominates the candidates for
presidency. The President is elected by a joint session of both Houses with the approval of a two
third majority vote. The President's term of office is six years. A president can only be elected
for two consecutive terms. The President's powers and functions include opening the joint
session of the two Houses, appointing ambassadors and other envoys, conferring high military
titles upon the recommendation of the prime Minister and granting pardon in accordance with the
law.

A political party or a coalition of political parties that has the greatest number of seats in the
HPR forms and leads the executive. The highest executive powers of the Federal Government
are vested in the Prime Minister and in the Council of Ministers that are responsible to the HPR.
In the exercise of state functions, members of the Council of Ministers are collectively
responsible for all decisions they make as a body.

The Prime Minister is elected from among members of the HPR and his/her term of office is the
duration of the mandate of the HPR. The Prime Minister is the Chief Executive, the Chairman of
the Council of Ministers and the Commander-in-Chief of the national armed forces. The Prime
Minister follows up and ensures the implementation of laws, policies, directives and other
decisions adopted by the HPR. The Prime Minister submits nominees for ministerial posts, for
posts of commissioners, the president and vice-president of the Federal Supreme Court and the
Auditor General to HPR for approval. He further submits to the HPR periodic reports on the
work accomplished by the Executive as well as on its plans and proposals.

Council of Ministers comprises the Prime Minister, the Deputy Prime Minister, Ministers and
other members as may be determined by the law. The Council is accountable to the Prime
Minister. In all its decisions, the Council is responsible to the HPR. The Council, inter alia,
ensures the implementation of laws and decisions adopted by HPR, draws up the annual federal
budget and implements the same when approved by the HPR, formulates the country's foreign
policy and exercises overall supervision over its implementation and submits draft laws to the
HPR on any matter falling within its competence. It has the power to declare a state of
emergency. In doing so, it submits, within the time limit prescribed by the Constitution, the
proclamation declaring a state of emergency for approval by the HPR.

An independent judiciary is established by the Constitution. Supreme Federal judicial authority

is vested in the Federal Supreme Court. Judicial powers both at the Federal and state level are
vested in the Courts. Courts at all levels are free from any interference or influence of any
governmental body, government official or from any other source. Judges exercise their
functions in full independence and are directed solely by the law.

The HPR has the power to establish the Federal High Court and First-Instance Courts nation-
wide or in some parts of the country as it deems necessary. Unless arranged in this manner, the
jurisdiction of the Federal High Court and the First-Instance Courts are delegated to Courts of
Regional States.

The Federal Supreme Court is the highest and final judicial power in federal matters. The Federal
Supreme Court has also the power of cassation over any final court decision from federal and
regional courts containing a basic error of law. While regional courts have jurisdiction over cases
arising under regional laws, federal courts have jurisdiction over cases arising under the
Constitution, federal laws and international treaties.

The judiciary is able to discharge powers independently and serves as a balancing power to the
executive, by providing the "checks and balances" which are decisive for the observance of the
rule of law, good governance and democratization.
Chapter Summary

We need government to provide the fundamental legal and social framework for a free market
economy. This framework implies necessary laws that define the property and other rights,
enforce contracts, and describe the status and form of various business organizations.

In the modern economic system, the government is a very important unit having a circular flow
of economic activity in relation to households and private sector firms. The private sector
produces private goods and charges price on the basis of price mechanism. The government
sector, on the other hand, produces public or social goods to satisfy the public or collective
wants. Public wants cannot be satisfied through the process of market mechanism because their
satisfaction cannot be accounted for price mechanism. Hence, public goods are not charged as
private good are charged.

The state has a role to play in the economy. This role may, however, differ with the economic
policy that a particular state adopts. In this regard, there are three economic theories regarding
the role of the state in the economy. These are the command, the free market and the mixed
economic systems.

A state structure could be a federal one where there are two government layers. Currently the
Ethiopian state structure is of a federal type where there is a federal government and nine states.
Addis Ababa and Diredawa are not states but chartered cities.