Cotton factory, Mahalla, Sept. 21, 2010. Shawn Baldwin/Bloomberg/Getty Images
July 11, 2013
Much has been written about the lack of political
liberty during the thirty-year reign of former Egyptian President Hosni
Mubarak. But those three decades were also characterized by a lack of economic
equity, and deteriorating standards of living. Historically, Egypt has enjoyed
a diverse portfolio of resources—plentiful agriculture, hydroelectric power,
petroleum and natural gas deposits, and an educated and available labor force.
But management of such resources during the Mubarak era was plagued by
political favoritism, financial corruption, and a failure to institute innovation-based policies or, for that matter, any system-based policies.
The Mubarak regime touted the relatively high growth
rates in Egypt in the years before the 2011 revolution—even after the
international recession occurred in 2008, Egypt’s GDP still reached a growth
rate of 4.1 percent—but it was a mirage. The growth did not trickle down to the
middle and lower classes, where social conditions actually worsened. This is
what economists call “unbalanced development.” As Egypt neared the brink of
revolution, more than half of all Egyptians were failing to attain the minimum
level of sustained livelihood. Unemployment and inflation rates had continued
to hit the poor harshly, with persistent double-digit levels in both economic
indicators for more than three consecutive years. Moreover, wages lagged due to
high levels of informal workers and child labor, ineffective mapping of skills
to work requirements in the labor market, and a legal minimum wage of two
Egyptian pounds ($0.35) per day, one-fifth the standard set by the United
Nations Development Programme. By the beginning of 2011 it was clear that in
Egypt, the rich were getting richer, the poor were getting poorer, and the
middle class seemed to be disappearing altogether.
Conditions
have only worsened since the revolution; including after the election of
President Mohammed Morsi in 2012. People had high hopes for any indication of
economic recovery, or an announced plan for a new economic system. However, the
same economic problems persisted, and some indicators have even worsened.
Unemployment remains in double digits, inflation has climbed further still due
to the declining value of the Egyptian currency in the international foreign
exchange market, and tourism receipts were at record low levels because of
severe political instability. Egypt’s central bank has made repeated
announcements about alarming—and ever decreasing—levels of its reserves,
causing financial and economic ratings for Egypt to fall. Also, more critical
economic problems emerged after the 2011 revolution, such as fuel shortages and
electricity outages, and consequently interruptions in the water supply. In
addition, political favoritism continued under Morsi’s rule.
It is imperative that Egypt now embarks on a new
economic course. The need to rebuild is reason enough for the political
factions to put their squabbles aside and unite in the greater interest of the
country. Egypt does not need reform; it requires transformational change toward
a completely new system. Reforming a system that has failed will not work.
Understandably, many Egyptians from the political, social, and economic spheres
are calling for reform, but the January 25 revolution clearly highlighted a
system failure in the old regime. Thus, there must be new methods of governance,
economic management, and political order, based on the principles of
accountability and transparency.
What
is needed is a bottom-up approach in accordance with the theories of Michael E.
Porter of Harvard University. This would start with an examination of Egypt’s
economic structure, and an analysis of past performance in the various sectors.
In the belief that macro-economic management is critical for economic
development, the model would then construct a new system based on a vision and
plan for a brighter economic future. Porter’s method is based on looking at the
“critical forces” that govern the sectoral structure of the economy. It builds
on the market mechanism (micro-economy) yet does not deny the importance of
macro-economic management through effective government regulation of such
markets. Porter’s sufficiency condition to the achievement of both economic
prosperity and social equity simultaneously is to look at the situation on the
ground—not only on paper—and to cultivate the forces of the market with
efficiency-driven government regulation mechanisms to dictate growth and
innovation outcomes, and not vice versa.
Agriculture, Industry, and Services
The central role of agriculture in Egypt’s political,
economic, and cultural heritage dates back to ancient times. Modern Egyptians
remain faithful to agrarian traditions. In recent years, the agriculture sector
has achieved steady growth rates of 3 to
4 percent per year. Yet, the sector continues to decline as an overall
percentage of GDP. Agriculture, while employing 32 percent of Egypt’s labor
force, contributes only 13 percent of GDP.
The agriculture sector is afflicted by numerous
problems. It currently behaves according to the “low cost-low quality output
trap” hypothesis. Land holdings are relatively small per investor, which works
against economies of scale. Thus, the sector utilizes reduced expenditure
measures to attain target profit margins, and this has been happening without
enough technological mechanization due to a lack of funds in the sector. And
consequently, the forces of low cost, low quality, and low output characterize
the sector. But perhaps the most pressing problem is low labor productivity, as
measured by international benchmarks as well as against other domestic sectors.
Many factors contribute to the problem. One of them is the sheer size of
Egypt’s homogeneous labor force (nearly seven million workers with similar
skills, work ethics, and family culture). Another reason is the sector’s
relative low wages, which are lagging behind the already low wage level in the
Egyptian economy. This is a result of low levels of agricultural education and
training, as well as severe land fragmentation; the subdivision of land parcels
that hinders efficiency and productivity.
Another problem for the sector is inefficient water
use. Low levels of investment in infrastructure, an old and inconsistent legal
framework, and user subsidies have plagued Egypt’s water system. The sector
experiences decreasing returns to scale given the high saturation of land—with
farmsteads as well as real estate developments—in areas in close proximity to
water sources notably the Nile River. Land reclamation for agricultural
purposes seems to be the only means for so-called “horizontal land expansion”—in
either direction from the Nile—but the high cost of reclaimed land, driven by
competition from other sectors, poses a challenge.
Industry contributes to about 35 percent of Egypt’s
GDP and to nearly one-fifth of its growth rate. About 17 percent of the labor
force is employed in this sector. While the industrial sector does enjoy a
higher labor productivity level compared to other Egyptian economic sectors, it
nonetheless suffers from low labor productivity levels as measured against
international benchmarks.
Low labor quality is a major problem, whether we are
talking about skilled or unskilled workers. The reasons for this include
Egypt’s poor overall educational system, the lack of practical training for skilled and
unskilled workers, and an inadequate matching of skills with the needs of
employers. Another problem is that industry faces technical constraints due to
severely low levels of innovation. Egypt spends little on Research &
Development (R&D), and there is an absence of the type of university-industry
collaboration in R&D that is necessary for industrial competitiveness.
Egypt’s dependency on imported technologies is another obstacle to industrial
development. Factors such as ministerial decrees, sudden policy shifts, lack of
transparency, and corruption combine to discourage technological upgrading and
industrial innovation.
A fundamental problem hindering industrial development
is state control and influence over the sector. The government’s power over the
sector began back in 1961 during an era of nationalization under Egypt’s then
leader, Gamal Abdel Nasser, but has maintained its influence to this day,
despite many attempts for privatization. Nasser’s endeavors in
industrialization were based on the public sector with economies of scale, given
the size of the Egyptian population at the time. It worked well for at least a
decade, but was not sustainable due to a lack of technological progress and
over-employment in public sector industries, such as textiles, iron and steel,
home appliances, scientific research, and pharmaceuticals. Anwar Sadat’s open
door policies in the 1970s were mostly geared towards open trade in
consumption, rather than creating new industrial markets locally.
The efforts at privatization undertaken by the Mubarak
regime resulted in crony capitalism—monopolies in industrial enterprises
shifted from the state to a private sector with close political ties to
Mubarak’s ruling National Democratic Party. The powerful monopolies of these
tycoons, combined with historically weak supply-chain infrastructure,
undermined any potential contribution to innovation from the private sector.
Factors such as political favoritism, high levels of country risk, and a lack
of information transparency encouraged the private sector to pursue short-term
gains at the expense of long-term prospects. Consequently, local innovation has
been geared toward reducing expenditures on total delivered cost reaching the
consumer. Yet it generally overlooked the potential of high quality
technological attributes for industrial production, the latter being a risky
strategy due to insufficient local demand for high-priced industrial goods.
Egypt’s services sector contributes to 57 percent of
the country’s GDP. The sector is dominated by three services, all of which are
foreign dependent: tourism, which relies on visitors from abroad; telecom,
which is largely foreign owned and depends on outside technology; and financial
services, which rely on technology outside Egypt’s borders.
Foreign dependency is a potential problem because the
sector’s investment funds and proceeds are not locally based. Nobel laureate
Robert Solow’s growth theory argument states that local technological
innovation, through capital investments, is the key to sustainable development.
When such funds are foreign dependent, a lack of sustainability could be a
problem.
Yet, foreign dependency provides a host of direct
benefits and positive externalities to the economy as well. For example, the
sector employs more than half of the Egyptian work force, making it the
country’s leading job market. Services contribute to neutralizing the trade
deficit via net exports. The sector is a main source of Foreign Direct
Investment (FDI), and an engine for driving business generally. And it is a
means for spreading technology, efficiency, quality, and growth to other
sectors of the economy.
A New Economic Vision
Competitive economies tend to produce higher levels of
income for their citizens. Egypt, however, has not fared well in
competitiveness studies. The World Economic Forum’s Global Competitiveness
Index (GCI) defines competitiveness as the set of institutions, policies, and
factors that determine the level of productivity of a certain country relative
to its peers. The level of productivity, in turn, sets the sustainable level of
prosperity that can be earned by any economy. The productivity level also
determines the rates of return obtained by investments (physical, human, and
technological). Because the rates of return are the fundamental drivers of the
growth rates of an economy, a more competitive economy is one that is likely to
grow faster in the medium- and long-term.
Egypt’s GCI has been weak and erratic. It ranked 81
out of 139 countries in 2010 on the eve of the revolution, down from 70 the preceding
year. The fall in rank indicated the persistence of an inefficient and stagnant
economic system. The economy experienced an artificial growth trajectory due to
the high financial profitability of a relatively few elite enterprises—there
was though a lack of notable local innovation and no trickle-down (spillover)
effects. This meant such economic activities had little impact on the masses.
The relatively high reported GDP growth rate in 2010
certainly did not reflect national productivity. Once again, growth rates alone
turned out to be a poor indicator of economic development. Egypt’s lowest
competitiveness rankings have been in the areas of corruption, macroeconomic
environment, R&D spending, effectiveness of higher education and training, and
labor market efficiency (the latter category scoring next to last in the
rankings of all nations). Egypt received its lowest rankings in precisely the
areas required for any sustainable level of competitiveness.
A brighter economic future is within Egypt’s grasp.
There are a variety of solutions to some of the basic problems. For example,
significant “scale and stretch” opportunities exist that can help the
agricultural sector reach another level. There is strong potential for Egypt to
expand into new markets, such as food processing and retail food chains and
franchising. Better education and skills upgrading can help the sector’s
abundance of low-cost labor achieve a value-added advantage. Egyptian farmers
stand to make substantial gains by moving from traditional to mechanized
agricultural techniques. Egypt has an opportunity to exploit its comparative
strengths, including favorable weather conditions that allow for year-round
cultivation, and the potential that land reclamation could increase crop outputs
by 3.5 percent per year, thus exceeding its own population growth.
Egypt’s water subsidy has historically encouraged
over-consumption. Coupled with a fixed Nile-basin water quota, Egypt now needs
to reconsider its water policy. Re-allocating water subsidies and introducing
fair water pricing formula to eliminate excess water demand is necessary. This
will create an “equilibrium water usage” in the country, rather than
over-consumption of a potentially scarce resource. Egypt must reach
satisfactory understandings on water use with Africa’s Nile Basin countries,
and partner with them to maximize agricultural efficiency. The goal should be
growth in agriculture that will exceed growth in the population rate, an
essential factor for achieving food security.
In order to reverse Egypt’s poor industrial
performance, improving standards of quality, expanding R&D, creating
university-industry partnerships, and upgrading the supply chain are all
important pillars for success. Incentives to deepen existing investments and
create new innovative industrial ventures are equally important. Another step
is enforcing anti-monopolistic fair pricing practices. Egypt may have much to
learn from the economies of the so-called BRICS nations—Brazil, Russia, India,
China, and South Africa—in terms of their industrial capacity, economies of
scale and stretch, “Creating Shared Value” projects, industrial innovation, and
locally-based multinational enterprises. The concept of Creating Shared Value
using private investment for public interest, first introduced by Michael E.
Porter and his colleague Mark R. Kramer, has been very successful in the BRICS
economies. Egypt can borrow from such experiences, such as profit-seeking
investments tackling public goods and services related to environmental
pollution, infrastructure development, education scholarships, health-based
research, and other national-based targets.
The future of Egyptian services could be quite
promising if certain criteria are met. Exploiting the advantages of foreign dependency
will be one of the key practices. For example, the foreign demand dependence in
tourism can be turned into an intangible asset in the form of branding Egypt on
a global scale. Dependency on foreign financing can be turned to an advantage
by fostering partnerships with local entrepreneurs, and shifting FDI from
capital-intensive to labor-intensive enterprises to reduce unemployment.
Additionally, Egypt should promote value-added investments in the services
sector, with the aim of yielding significant positive externality to other
sectors of the economy.
To truly move forward, however, Egypt must adopt a
vision to create an efficiency-driven competitive market in the short to medium
term, and an innovation-driven society in the long term. Such a vision must be
pursued in keeping with the January 25 revolution’s demands for equity and
economic justice, more jobs and higher living standards. The economy needs to
gradually shift from the extreme neo-classical liberal approach of the Mubarak
era to a welfare state that also provides an open environment for investment
and entrepreneurship. Three stages of implementation are required:
Short-Term Recommendations
The first stage—over a span of one to two years—is
immediate intervention, with the objective of establishing the prerequisites
for a systemized economy. To begin with, political unrest must cease or be
reduced significantly. Public management systems must be restructured, and
training programs to upgrade labor productivity upgraded. Transparency-driven
regulations and mechanisms must be enacted to reduce corruption. Also, the
application of “labor matching schemes” to operational performance in public
enterprises should be mandatory, such that efficiency is the core criteria for
job security. Public jobs must be mapped to the education skills required for
work tasks, and in essence the whole labor market and the education sector
should be mapped together in order to feed each other with operational skills,
knowledge, and talent. Consideration should be given to revising the minimum
wage structure to adjust for inflation, and index it to achieved educational
levels.
Medium-Term Recommendations
The second and most challenging stage—over a span of
three to five years—should be aimed at achieving an efficiency-driven economy
with distributional equity among the masses. This stage requires
transformational changes in the structure of the Egyptian economy, starting
with the establishment of a national planning commission. Regulations must be
implemented to enforce local quality standards in line with regional
competition. An effort must be undertaken to radically improve and update the
educational system across all levels, which would abandon a pedagogy based on
rote memorization in favor of one that inculcates critical thinking skills.
Meanwhile, a private education system as an alternative to free tertiary
education should be created with links to public R&D and industry practice.
The Egyptian government should undertake a major
overhaul of national infrastructure in this stage; among the aims would be
tackling agricultural land fragmentation, improving supply chains for industry,
and maximizing positive externalities in services. Policymakers should promote
the concept of Creating Shared Value, thus igniting investment through an
understanding of the interdependence of business and society. This would
require the enactment of national mechanisms for cost-benefit analysis using
economic and social-environmental evaluation of new investments, and abandoning
sole reliance on financial cost-benefit assessments. In other words, economic
value-added should receive priority in evaluating financial projects even under
private sector investment. The government should allow subsidies for essential
goods only when they remain in line with national competitiveness goals. It is
no use for citizens to receive entitlements of subsidized goods and services if
such goods and services fail to function properly. This doctrine concerning
economic subsidies espoused by the Indian economist Amartya Sen, must be
implemented to have a sustainable growth path based on efficiency.
Long-Term Recommendations
The third stage, spanning five to twenty years, is
aimed at creating a sustainable, innovation-driven society based on
international standards. Numerous critical elements must be achieved. One of
them is a cultural transformation to develop a world-class educational
system—not unlike the enlightenment that occurred in Egypt through the
educational expeditions to Europe during the reign of Mohammed Ali. Another
vital element is to spend a minimum of 5 percent of GDP (compared to the
current expenditure of 0.5 percent) on R&D, with strong connections to the
agriculture, industrial, and services sectors. Egypt must also undergo a radical
shift toward an institutional culture as it relates to work ethics, corruption,
and information transparency; a policy of zero-tolerance for corruption should
be pursued. Finally, policymakers should seek to make Egypt an entrepreneurship
hub for the region by promoting local and regional investments through a
differentiated competitive advantage. Tourism is an obvious but by no means the
only area ripe for a “branding Egypt” strategy.
Egypt needs a new manifesto, as demanded by the
people, in the slogan Bread, Freedom, and Social Justice! Egyptians can unite
around such a vision, whatever their ideology or religion, to achieve the dream
of a better future. Leaders and policymakers must create the environment for
making this happen.
Tarek Selim is a professor of
economics and the chair of the Department of Economics at the American
University in Cairo and an affiliate of the Microeconomics of Competitiveness
Network at Harvard Business School. He is a research fellow at the Economic
Research Forum for the Arab Countries. He previously served as a senior
economic advisor for the Egyptian Competition Authority, and is a founding
member of the Alfred P. Sloan Industry Studies Association at the University of
Pittsburgh. He is the author of Egypt, Energy, and the Environment: Critical
Sustainability Perspectives.