Download The political economy of private sector

The political economy of private sector development in
the Middle East and North Africa:
Credible commitment, rent-seeking and
institutionalization
Philip Keefer, Development Research Group
Draft: 4 November 2007
Prepared for the Flagship Report on Private Sector Development in MENA
Summary
The policy problem: Long-term low investment and growth plague MENA countries. The
policy sources of slow growth have been difficult to decipher, however, since by many measures,
including widely-used measures of governance, MENA countries do not rate below, and
occasionally rate more highly, than fast growing comparator countries. This chapter examines
the challenge of attracting private investment in countries where leaders are not selected in
competitive elections.
The political roots of low investment: Successful non-democracies have attracted private
investment by encouraging the institutionalization of the ruling party, the bureaucracy, or the
military: allowing for transparent promotion and recruitment; delegating substantial authority to
low levels of the organization; and allowing intra-organization coordination. MENA countries
exhibit considerably less institutionalization than comparator countries because
institutionalization limits leader discretion and access to rents, and is less likely to be pursued in
countries with high natural resource rents and intra-leadership discord.
Reconciling reasonable aggregate governance and policy indicators and low investment: Lack
of institutionalization implies weak governance and policies that encourage rent-seeking, neither
of which show up in aggregate country indicators. Disaggregated data, however, indicates
substantial divergence from aggregate indicators and provides a reasonable basis for concluding
that low investment is, indeed, a consequence of the governance and policy environment, which
in turn follows from reluctance to allow institutionalization.
Recommendations: Though the obstacles to private investment identified here are deep-seated,
the analysis characterizes the types of reforms that can make a difference: those that offer
guarantees to investors without challenging leader aversion to institutionalization. These include
limited geographic jurisdictions, such as Export Processing Zones, where the civil service
overseeing regulatory activities can be transparently and meritocratically recruited; and
accelerated growth-oriented public investment, the benefits of which fall when leaders renege on
their commitments to investors.
The political economy of private sector development in MENA:
Credible commitment, rent-seeking and institutionalization
Dissatisfaction among the governments and citizens of MENA countries with the rate of
income and employment growth has motivated a search for policy solutions that would increase
both. The most important undisputed economic lesson of the last 20 years is that private
investment is essential to these goals. Country success in formulating policies that accelerate
private investment depends on a range of factors, including their economic circumstances,
technical capacity, agreement on which policies are appropriate, and political constraints on
policy selection. This analysis is concerned with the last of these, the incentives of political
leaders in MENA to adopt policies that promote private investment.
The starting point of the analysis is that growth and investment in MENA, whether oil or
non-oil, have lagged those in reasonable comparator countries. One possible explanation for this
that emerges from current research on institutions and growth is the absence of competitive
elections in most of MENA. However, MENA growth and investment lag considerably behind
even East Asian countries that similarly lack competitive elections. Another common
explanation is the influence of cronies and special interests on government policy. Here again,
though, the question is why the influence of cronies has a more negative effect on growth and
investment in MENA than in other countries. It is apparent that political leaders who are not
competitively elected face widely varying incentives to pursue policies that promote private
investment. This report outlines the sources of this variation and suggests explanations for the
reluctance of leaders in MENA to adopt policies favorable to private investment.
Such policies generally include low barriers to entry and competitive markets, equal
treatment of private investors by government policy and, especially, credible commitments to
private investors that their investments will not be expropriated. The central argument in the
analysis here is that countries without lack competitive elections can achieve these objectives
through the institutionalization of the ruling party, the bureaucracy or the military. In many nondemocracies, these organizations are not institutionalized: they do not exhibit such
characteristics as internal transparency regarding compensation and promotion, explicit rights to
coordinate internally, and considerable delegation of authority to lower levels of the
organization. The absence of these organizational attributes prevent leaders from making
credible promises to members of the organization, since members cannot easily contest reneging
by leaders.
Institutionalization, however, allows members to challenge leaders and limits leader
discretion. At the same time, it allows leaders to credibly promise the organization’s members
that they will not be expropriated if they invest, and that they will be rewarded if they accelerate
growth. These characteristics promote private investment, first, by giving confidence to those
inside the organization that they can invest without fear of expropriation and, second, by
encouraging these members from promoting growth rather than exploiting their official positions
to extract rents from private investors.
Only in some countries that lack competitive elections, however, do politicians have
incentives to create institutions that reduce barriers to entry and allow for credible commitments
to large numbers of private investors. When they do, private investment can flourish, as China
demonstrates. In other countries, leaders are reluctant to permit institutionalization: the losses in
rents and tenure security outweigh the gains from greater private investment. As the discussion
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below argues, lower rates of private investment in MENA countries can be traced to the lack of
institutionalization, which in turn responds to country characteristics that make
institutionalization less attractive to leaders than in many of the countries in East Asia. Country
characteristics that make institutionalization less attractive in MENA countries than in East Asia
range from high natural resource rents to high levels of intra-leadership conflict.
The next section outlines the contrast between growth and investment in MENA and
comparator countries, followed by an overview of various approaches to institutionalization and
the apparent absence of institutionalization in most MENA countries. The report then turns to an
explanation of reluctance to institutionalization, focusing most on natural resource rents and
intra-leadership conflict. The failure to institutionalize should be evident in the policy
environment; the section identifies policies that provide such evidence.
Finally, the report turns to policy implications. These are significant. First, the usual
benchmarks of economic liberalization, ranging from trade liberalization to the relaxation of
rules governing business entry, will have less of a sustained growth effect in the absence of
reforms that increase credibility. Second, reforms to increase credibility must take into account
the persistently weak incentives for slow institutionalization in the region. This means, in
particular, taking steps to make reforms credible to private investors outside of country elites.
Such steps could include significant increases in productive public infrastructure investment,
which benefits all entrepreneurs and not only the chosen few, and which is a costly signal of
government commitment not to expropriate (since the political value of the infrastructure is
degraded if it attracts little private investment); and limited institutionalization in the form of full
transparency and meritocracy in the civil service in selected jurisdictions, such as Export
Processing Zones, which are significant enough to support employment growth, but not enough
to challenge leader aversion to institutionalization.
Growth and investment in MENA
Over the 20 years from 1985-2005, MENA countries grew substantially more slowly
relative to plausible benchmark countries: East Asian countries, non-democracies, and other
middle income countries (see Figure 1). In the more recent decade, 1995-2005, growth has been
about the same across these groups (see Figure 2). However, MENA countries have not enjoyed
the rapid growth acceleration that has characterized some of these East Asian countries.
Moreover, poorer countries, all else equal, should offer a higher return to capital that would
drives faster growth than in richer countries. Non-oil MENA countries (Lebanon, Egypt, Jordan,
Morocco and Tunisia), with average per-capita incomes of $3,894, were 23 percent poorer in
1995 than seventeen East Asian comparators (not including Hong Kong), with average income
per capita of $5,056.1 Nevertheless, they grew only slightly faster (2.5 percent versus 2.4
percent).
1 Income numbers are ppp-adjusted, in constant 2000 US dollars.
3
Figure 1: Average yearly growth in per capita income, 1985-2005
(purchasing power parity, constant 2000 dollars)
0
.01
.02
.03
Average real per capita income growth, 1985-2005
MENA Oil
No competitive elections, 1984-2004
Middle Income
MENA Non-oil
East Asia
Source: World Development Indicators, author calculations. The MENA oil countries with data are Syria,
Saudi Arabia, Algeria, Yemen and Iran. The MENA non-oil countries with data are Tunisia, Egypt,
Jordan, Lebanon and Morocco. 45 countries are in the group of comparators characterized by noncompetitive elections, 70 among the middle-income comparators and 17 among the East Asian countries.
There are overlaps between the last three groups, but MENA countries are excluded from them.
The comparison is starker if one looks at the five largest East Asian countries, China,
Indonesia, the Philippines, Thailand and Vietnam. Their average incomes were slightly lower
than the non-oil MENA countries in 1995, $3,498. However, the average growth of these
countries from 1995 to 2005 was more than forty percent faster, at 3.6 percent per year.
The contrast between East Asia and the major oil producers is similar. The five major oil
producers with the largest populations, Algeria, Iran, Saudi Arabia, Syria and Yemen (all with
populations greater than 50,000,000), had average incomes approximately the same as the East
Asian comparators in 1995, $5,314. However, instead of growing at approximately the same rate
as the East Asian comparators, per capita incomes in these countries grew only 1.8 percent per
year in the succeeding 10 years, compared to 2.4 percent for the East Asian countries, and 3.6
percent for the five East Asian countries with populations greater than 50,000,000. This
represented continued slippage relative to the East Asian benchmark: in the previous decade per
capita incomes in East Asian countries had grown by 3.5 percent per year (5.4 percent for the
four largest), while, in contrast, Syria grew at a 1.6 percent annual rate, Saudi Arabia by 0.16
percent, Iran by 0.1 percent and in Algeria, suffering through internal conflict, incomes per
capita receded at a rate of 1.7 percent per year.
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Figure 2: Average yearly growth in per capita income, 1995-2005
(purchasing power parity, constant 2000 dollars)
0
.01
.02
.03
Average real per capita income growth, 1995-2005
MENA Oil
No competitive elections, 1994-2004
Middle Income
MENA Non-oil
East Asia
Source: World Development Indicators, author calculations. The MENA oil countries with data are Syria,
Saudi Arabia, Algeria, Yemen and Iran. The MENA non-oil countries with data are Tunisia, Egypt,
Jordan, Lebanon and Morocco. 45 countries are in the group of comparators characterized by noncompetitive elections, 70 among the middle-income comparators and 17 among the East Asian countries.
There are overlaps between the last three groups, but MENA countries are excluded from them.
A proximate explanation for the difference in growth rates between East Asia and MENA
is the low quality and quantity of investment. Although data coverage is less complete, there is a
several percentage point gap in investment/GDP between comparator countries and MENA.
Among thirteen East Asian comparators, private investment averaged 16.7 percent of GDP from
1995-2005, and among the four large East Asian countries, 18.5 percent (China’s average was
17.4 percent). The four oil producers with the largest populations averaged 14.8 percent, and the
five non-oil producers 14.7 percent.
There is little evidence that public investment can compensate for shortfalls in private
investment, but even if it could, public investment quantities did not offset shortfalls in private
investment: total investment was 22.4 percent in the non-oil MENA countries, compared to 26.4
in East Asia and 31.6 in China and Thailand. In the non-oil MENA countries where private
investment was highest, Morocco and Lebanon (where private investment averaged 19 percent of
GDP compared to 8.2 percent in Egypt), public investment averaged less than five percent of
GDP, resembling more closely the less successful Philippines model than the Chinese.
One measure of quality is the contribution of public investment to growth. This appears,
as well, to have been higher in East Asia. To get a rough sense of this, one can take the sample
of all countries, regress their growth over the period 1985-2005 on public and private investment
in the first half of this period, 1985-1995, and ask whether investment in East Asian and MENA
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countries is associated with higher or lower than average growth.2 As one would expect, given
the common incentives of private actors to profit maximize, in neither MENA nor East Asia is
private investment associated with different growth rates than in the average country (controlling
for initial income per capita). Public investment, however, is associated with substantially
different growth rates across regions. Public investment in either the non-oil MENA countries or
in the oil producers in MENA with the largest populations has a slightly smaller growth effect
than the average country, but significantly greater than average in the largest East Asian
countries.
Why would the effect of public investment differ across countries? One explanation is
the degree to which private investors are free to take enter new markets opened up by public
investment. Another is the degree to which governments use public investment to pursue growth
rather than other objectives. On both counts, the political environment in MENA countries
provides fewer incentives to target public investment to the pursuit of fast growth than do East
Asian comparators. This chapter therefore explores the politics of government policies towards
investment and growth in MENA.
Credible commitment and investment in non-democracies
In both democracies and non-democracies, political leaders pursue economic growth
when the policies underlying growth are politically attractive. Those policies insulate private
investors from arbitrary bureaucratic decision making and expropriatory behavior by
government; encourage innovation, and promote easy entry into new markets and competition.
It is not enough to embrace these policies, however. If investors do not believe that the policy
commitments are credible, or if civil servants do not believe government promises to reward
them in exchange for faithfully implementing the policies, the growth effects of policy reform
are limited.
In the past, scholars posited that competitive elections would both provide the essential
institutional foundation of credible commitment and motivate politicians to pursue growth.
However, countries with and without competitive elections exhibit no significant difference with
respect to either private or total investment as a percentage of GDP. This is because both
democracies and non-democracies differ significantly among themselves in the political
incentives that they offer politicians to pursue investment- and growth-promoting policies. As a
consequence, and as Table 1 illustrates, rates of private investment are almost identical in
countries with and without competitive elections, though private investment in MENA is less, on
average, than in both sets of comparators.
An important element of heterogeneity among countries with competitive elections is
political credibility. In many democracies, politicians are only able to make credible promises to
narrow groups of citizens, those from the same geographic area or with whom politicians have
had significant personal interaction. Under these circumstances, electoral competition does not
drive politicians to make policies that benefit all citizens, but instead gives them incentives to
pursue clientelist promises that benefit selected groups of citizens (Keefer and Vlaicu,
2 The illustration comes from variations on a regression such as the following: Growth (85-05) i = (private
investment, 85-95) i +(public investment, 85-95) i +(Large East Asia) i +(Large East Asia) i *(priv. inv.) i
+(Large East Asia) i *(pub. inv.) i + (MENA, no oil) i +(MENA, no oil) i *(priv. inv.) i +(MENA, no oil) i
*(pub. inv.) i +(MENA, non-oil) i +(GDP/capita 1985) i +  i
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forthcoming). Broad investor protections, low entry barriers into markets and laws and
regulations that open markets all suffer under these circumstances, since they all tend to deny
benefits to narrow interests and to favor broad social interests. This is one reason why the rule of
law and bureaucratic quality are lower in young democracies, and corruption higher: in young
democracies, politicians are less likely to have the ability to make credible promises to broad
groups of citizens (Keefer 2007).
Table 1: Elections and private investment/GDP, 2004
(in percentages; number of countries in parentheses)
Competitive Elections
No Competitive Elections
MENA
15.5 (56)
15.0 (47)
13.2 (9)
Notes: Countries with competitive elections exhibit Legislative Index of Electoral Competitiveness (LIEC) =7 and
an executive index (EIEC) =7. For EIEC=LIEC=5, elections have multiple candidates, but only candidates from one
party win seats. For EIEC=LIEC=6, elections have multiple candidates, but the winner receives more than 75% of
the vote. For EIEC=LIEC=7, no candidate receives more than 75% of the vote.
In non-democratic countries, politicians have three reasons to appeal to narrow interests,
and therefore to under-provide investor protections and government regulations that will attract
capital from investors broadly. First, although, as the foregoing discussion makes clear,
competitive elections are no guarantor of accountability, the absence of elections also means that
broad groups of citizens face high costs in holding politicians accountable for policy favors to
special interests (see, for example, Keefer 2006, demonstrating that special interest-driven
banking crises are worse in non-democracies). Second, whereas in democracies politicians need
special interests to finance their political campaigns, in non-democracies, special interests may
play a bigger role, to defend the regime against potential violent overthrow. In exchange for this
bigger role, however, special interests can demand greater rents and economic privileges, both of
which are antithetical to growth.
The third, as in democracies, is the difficulty of making credible promises to citizens. In
democracies, elections allow citizens, at relatively low cost, to expel politicians who break their
promises (though these promises may be clientelist rather than growth-promoting). In nondemocracies, leaders themselves choose how easily particular groups of citizens can expel them
and how large those groups can be. That circle can be quite small, restricted to family, or large,
as in the case of an institutionalized and large ruling party. The smaller the circle, the fewer are
the investors who enjoy protection from arbitrary or predatory government actions against them
and the less conducive are policies to growth. The remainder of this discussion focuses on the
degree to which unelected leaders make different choices regarding how credible they wish to
be, and how this helps explain substantial variation across autocracies in private investment and
growth.
How can unelected politicians make credible promises not to expropriate private investors?
Unelected leaders can use two broad sets of arrangements to remain in power. One is to
make themselves and their close relatives and associates the center of entrepreneurial activity in
the country. Since leaders have no reason to expropriate themselves, this approach solves the
credible commitment problem, but limits investment to a small group. The other choice leaders
have is to embrace greater institutionalization, of a ruling party, bureaucracy or of the armed
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forces, which reduces the costs to members of the institution (e.g., the ruling party) of expelling
the leader. MENA countries tend to rely more on the first set of arrangements; faster growing
democracies, such as China or Singapore, rely on the second.
La économie, c’est moi
Absent any institutional arrangements for constraining arbitrary or expropriatory
behavior by leaders, one source of investment is leaders themselves and close associates and
family members with whom personal relationships secure promises of non-expropriation. Faccio
(2006), using data on 20,000 firms from 47 countries, finds that political connections can have
high economic value (a new political connection increases firm value by one to four percent).
The country where these connections were most pervasive was Indonesia, where 22 percent of
firms had directors or owners who sit in the legislature; directors or owners who used to be
politicians; or directors or owners who are friends with ministers or legislators.
Systematic data on political connections are not available for the MENA countries
examined in Figures 1 and 2 and Faccio does not analyze them. However, anecdotal evidence
supports the conclusion that leaders and their close associates control large swaths of private
sector activity across the MENA region. Owen (p. 67) argues that, prior to coup attempts in
1971-72, rents were concentrated in an extremely narrow circle in Morocco; following these
attempts, it expanded to a circle of advisors drawn from 1,000, who were rewarded with
privileged business opportunities.
In Syria, the cousin of the president owns 55 percent of Syriatel, responsible for tax
revenues amounting to 1.7 percent of GDP (Heydemann 2007, p. 14). Entrepreneurs in Algeria
were categorical in stating that having a “name” (being from an elite family, and therefore
closely connected to other elite families) was essential to avoiding expropriatory actions by
officials. These arrangements are associated with high rents for the participants. Faccio (2006)
notes, for example, that connections are highly correlated with corruption. They are, at the same
time, a solution to the problem of credible commitment: leaders cannot expropriate themselves
and are unlikely to expropriate family members and close associates.
This solution limits investment and expertise to what leaders and close associates
themselves can offer, unless investments by the leader in a firm provide a credible commitment
to private co-investors that they will not be expropriated. If this is the case, leaders can leverage
their own capital to attract new capital. It is not necessarily the case, however, that politically
connected partners solve problems of credible commitment. Frequent disputes between private
(especially foreign) and well-connected local partners make clear that co-investment by leaders
and close associates is often a vehicle of rent extraction rather than protection.3
3 Under one circumstance, co-investments by leaders attract private investment that would otherwise not enter a
country: when the loss of reputation from expropriating partners results in larger rent losses to the leader than the
loss of reputation from expropriating investors generally. Future potential co-investors will be more reluctant to
deal with leaders who reneged on their agreements with prior co-investors, just as future investors are more reluctant
to enter a country when a ruler has expropriated earlier investors. Co-investment reduces the probability of
expropriation only if the rents that leaders can extract from the private sector are greater when they co-invest than
when they simply tax. This may be the case, however. For example, ownership gives rulers access to firm
information that they would not otherwise have, making it more difficult for private investors to hide rents from the
ruler.
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The reliance on personal ties between leaders and investors need not be inimicable to
economic growth. Haber, et al. (2003) document the utility of such ties in raising growth rates in
Mexico for a prolonged period of time at the turn of the last century. However, a key attribute of
the Mexican case was that state governors controlled their own militias, and therefore could
defend their interests against potential incursions by the leader, Porfírio Díaz. In the Mexican
case, therefore, close personal connections to governors or to Díaz himself were sufficient to
overcome credibility problems. In countries where the leader exerts unquestioned authority over
all citizens, the circle of potential investors tightens contracts accordingly.
In rare circumstances, rulers need investors more than investors need rulers. Moore
(2004) describes the history of business-state relations in Kuwait and writes that prior to the
discovery of oil, “Manpower and financial power gave Kuwaiti merchants and early sense of
equality with the ruling al-Sabahs. . . [P]olitics needed commerce.”(p. 31) Once oil was
discovered, however, the ruling family could independently finance its own defence, among
other things, and not rely on the labor force controlled by the merchants. This led to significant
institutional changes. “The elected municipality board, which had served as an asil merchant
enclave since 1932, was replaced with an appointed board of shaikhs. As royal family members
took control of government ministries, merchant committees within those bodies, designed to
provide policy input, were disbanded”(p. 42). Merchant leverage of the al-Sabah family was
directly linked, however, to their ability to finance their own defense and, because of the small
number of merchant families, their ability to coordinate a response to al-Sabah intrusions – a
crucial feature of institutionalization that is discussed below.
Jordan provides another example of this. Jordan exhibits little of the institutionalization
that is discussed in the next section, but at the same time it has relatively high governance scores.
Jordan’s ratings on the rule of law and corruption components of the World Bank’s Governance
Index are larger than those of all other non-oil MENA countries. As Table 4 below reports,
Jordanian firms are far less likely to report corruption as a major obstacle to doing business
compared to firms in other countries. What explains this? Similar to Moore’s (2004) description
of sheik-merchant relations in Kuwait, private enterprise in Jordan is to a large degree the
province of Jordanians of Palestinian descent, who both lack family connections to the
Hashemite ruling family and are outside the elite circles that control policy making (Moore
2004). This is unusual in the region. As in Kuwait, however, their interests are protected, at
least partially, by their capacity for coordinated action, their relatively small numbers, and by the
government’s interest in promoting employment in the Kingdom.
However, the government has no interest in granting this group special rents. As a
consequence, it is also the case that Jordanian firms report low access to bank financing (Table
4), and Jordanian manufacturing reports very low rates of firm concentration in manufacturing,
with Gini coefficients of less than .10 compared to over .55 in Morocco and Egypt (Sekkat
2005). Low access to bank financing is clearly negative for investment. While the high rates of
concentration in Morocco and Egypt may be undesirably high and a reflection of growth-stunting
market power of incumbent firms, Jordan’s rate of concentration is lower than even wellfunctioning competitive economies (Ginis of approximately .40 are common in Europe and
North America). The low Gini in Jordan may reflect a willingness of leaders to accept the
diseconomies of small scale manufacturing in order to hinder the emergence of large and wellfunded actors from outside the support base of the government.
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A related strategy is an affinity-based one, in which investors from the same background
as the leader believe that they are less likely to be expropriated than others. One manifestation of
this in MENA is the economic prominence of the Allawi in Syria. Affinity could imply that the
leader’s personal utility increases in the welfare of members of the group (e.g., as in Robinson
and Verdier 20XX). The leader therefore avoids behavior that hurts the group, while members
of the group support the leader because challengers are unlikely to share the leader’s affinity for
them. This is a fragile strategy. It requires easily observable cues that distinguish members of
the affinity group from all others, as well as the belief that the leader prefers the affinity group
above others. It also requires that the affinity group not be too large. If it is large, the leader
gains more from expropriating all members of the group and losing their political support than he
does from protecting their property rights and retaining their support. Finally, even if the
strategy works, it extends only to members of the affinity group; other private investors dare not
enter.
Institutionalizing restraints on the leader
Absent elections, citizens cannot easily contest actions by leaders against their interests.
They confront significant collective action costs in coordinating their response, including a lack
of information on whether a leader has in fact acted arbitrarily and against their interests and an
inability to make agreements with each other about participating in coordinated action against
the leader. Leaders themselves affect these costs, whether by placing prohibitions on citizen
assembly or restrictions on media access. The circle of investors willing to trust leader
commitments not to expropriate, and of civil servants willing to believe leader compensation
promises if they implement pro-growth policies, are both small.
Information, for example, is essential both for holding leaders accountable and for
coordination among citizens. Limits on citizen access to information are greater in countries
where investment depends more on personal connections between investors and politicians,
consistent with the idea that barriers to collective action by citizens are greater in such countries.
Faccio (2006) finds more restrictions on press freedom in countries where politically-connected
firms are more pervasive. Her evidence does not extend to the MENA region. However, the
market share of state-owned newspapers, a plausible proxy for restrictions on press freedom, is
much higher in MENA countries: in 2000, for all the countries for which there is data, the
market share was 74 percent in four large MENA oil countries, 60 percent in four non-oil MENA
countries, 60 percent in all non-democracies, but only 36 percent in four large East Asian
countries.
By reducing these collective action costs for some subset of citizens, allowing them to
coordinate freely, leaders simultaneously increase their own vulnerability to revolt and the
prospects for private investment. Where average citizens have little access to information and
are relatively unable to make agreements with other citizens to coordinate a response to ruler
actions, this subset of citizens has better access to information and the ability to make
agreements with other members of the group. Leaders must necessarily give all members of this
group greater scope for taking independent action without consulting the ruler, otherwise all
efforts to coordinate are instantly regarded with suspicion. In practice, an institutionalized ruling
party, such as the Chinese Communist Party; an institutionalized civil service, as in Singapore; or
an institutionalized military, as in Indonesia or Chile, all constitute subgroups of citizens with
superior ability to coordinate a response to arbitrary leader actions.
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These organizations have several key attributes that facilitate coordination by their
members. They include: a hierarchical structure that is intended to facilitate coordinated action
generally (e.g., to provide public services, mobilize political support, or to defend the country),
and therefore against the ruler in the event of arbitrary behavior; the ability to enforce intraorganizational agreements without the leader’s intervention, allowing group members to make
credible agreements with each other; stability of membership and career paths, leading to
frequent and long-term interactions among group members, further enhancing the capacity to
make credible agreements; transparent reward systems that quickly expose arbitrary treatment of
group members by the leader, without which the group could not easily coordinate a response to
arbitrary treatment; and decentralized responsibility for tasks, which gives scope for coordination
efforts to emerge throughout the organization, without which leaders could simply co-opt those
at the top of the organization, undermining the point of institutionalization.
The next three sections discuss institutionalization of bureaucracies, ruling parties and the
military as possible institutionalization strategies. The conclusion in each case is that there is
little evidence of institutionalization in MENA. The Syria case is typical: though he came to
power as the leader of an apparently ideologically- and class-oriented party with an institutional
identity separate from the leader, Hafiz al-Asad quickly asserted personal control over all three
major power institutions: the party as general secretary, and the government and military (as
pres). His personal Alawite clients dominated the military police, including several praetorian
guard units and intelligence organs. As Hinnebusch (p. 146) concludes, ideology faded as the
regime’s source of support, replaced by patronage and personal/tribal ties to the regime. 4
Institutionalized bureaucracies
The Singaporean civil service reflects all of the attributes of institutionalization. First, it
is structured to provide a high level of public services, requiring ample ability to coordinate
within and across ministries. Second, it has promotion and compensation standards tied to the
successful achievement of service provision, so that successful coordination is actually rewarded.
By 2006, 40 percent of average civil service and 50 percent of senior civil service total
compensation was performance-based.5 These ratios are higher not only than other public
sectors around the world, but also most private sector employment contracts.
Third, Singapore has extended substantial discretion to civil servants. For example, in
the early 1980s, community policing was introduced, one of the attributes of which is to generate
substantial police-community interaction and to endow police with substantial discretion to
tackle crime and crime prevention in their patrol areas. Workplace and food safety regulators
were also allowed to defer prosecution for firms in violation. By the 1990s, agency counter staff
were appraised on manners, job knowledge, and helpfulness to the public (Burns 15-16). More
4 The family-based governing systems of the Gulf states also generally do not exhibit institutionalization. However,
the families are so large and the consequences of conflict over succession so grave for the entire family, that they
have occasionally attempted to formalize certain aspects of family rule. In Saudi Arabia, for example, King Abd alAziz decreed in 1932 that only his own offspring and those of his brothers and of families related to his common
history and marriage were “royal” and given stipends. This list was edited twice by King Faisal after 1958 (Owen,
p. 58).
5 See the VOG (Vibrancy, Opportunities and Growth) website of the Public Service of Singapore and its
information on the variable component of civil service compensation:
https://app.vog.gov.sg/StaticContent/FAQ.aspx#5.
11
broadly, the Block Vote Budget Allocation system introduced in 1989 set a target of total
expenditure for each ministry is set as a percent of national income. Following budget approval,
each ministry could then spend according to stated objectives, but could freely shift funds and
manpower between programs and activities. In particular, the budgeting process allowed
ministries to use unexpected surpluses from one area to achieve objectives in other areas without
going back to the legislature or cabinet for approval.
Finally, performance standards are transparent, as a result of significant investments that
Singapore has made in its management information systems. The Singapore Government
Management Accounting System (SIGMA) was introduced in 1992. This computer-based
information and analytical system allowed exact costing of public sector activities. Resultsbased budgeting was then possible and was introduced in 1994, linking budgets – and
compensation – to precise performance and cost targets (Jones 1999).
These bureaucratic characteristics are associated with a high level of performance.
Looking only at non-democracies, the first two columns of Table 2 compare average values, over
the period 2000-2005, of the International Country Risk Guide measure of bureaucratic quality
and the World Bank Governance Index, for Singapore, two sets of MENA countries and China,
controlling for the 2000 values of other country characteristics that affect the costs of supplying
high quality bureaucratic performance in a country. 6 Singapore performs significantly above the
average non-democracy. The ICRG bureaucratic quality variable ranges from zero to six.
Singapore scores 1.1 points, almost one standard deviation, higher than the average nondemocracy, controlling for other country characteristics.
The institutional arrangements exhibited by the Singaporean civil service should
encourage investment for two reasons. The usual reason is that investor risks are lower when
they confront a predictable, high quality bureaucracy. The second reason, to which less attention
has been paid, is that the very characteristics of the Singaporean civil service make it difficult for
the government to renege on its promises to compensate the bureaucracy for treating investors
well. These characteristics (internal transparency and stability) endow the civil service with the
ability to coordinate a response to government should it renege on these promises. Column 3 of
Table 2 indicates that Singapore is, indeed, exceptional among non-democracies in its ability to
attract private investment, with private investment/GDP ten percentage points higher in
Singapore than the average non-democracy.7 Of course, the government needed a motivation to
make these promises in the first place – that is, it needed a political motivation to seek growth.
Such a rationale, and the reason why it is not common across all non-democracies, is explored in
the next section of this chapter.
Neither governance nor investment are different in the MENA oil countries than in the
average non-democracy. However, Table 2 highlights two puzzles with respect to the non-oil
MENA countries. First, governance is significantly better than average, approximately one-half
6 Table 2 results are robust to the use of period averages for all right hand side variables, as well. The use of initial
values mitigates feedback effects from governance and investment back to income and other right hand side
variables.
7 This regression controls for income/capita to take into account diminishing returns to investment in richer
countries with larger capital stocks. Consistent with this, higher income countries attract significantly less
investment, all else equal.
12
a standard deviation. However, there is little sign in the public sector organization of these
countries of the meritocracy and bureaucratic coordination that characterizes the Singaporean
public sector. Performance-based contracts are nearly unknown, promotions are largely
seniority-based, and recruitment is heavily clientelist. For example, the World Bank (2004)
report on governance in MENA reported that appointments to the civil service in Syria are based
on demonstrations of loyalty rather than on merit (p. 50). Loyalty to one’s immediate superiors
as a basis for recruitment leads to a personalized rather than institutionalized civil service. The
second puzzle is that, while governance is above average, private investment is slightly (though
not significantly) worse than average.
Table 2: Singapore, governance quality and investment across non-democracies, 2000-2005
Dependent variable:
Bureaucratic Quality
(ICRG), 2000-2005
World Bank
Governance Index,
2000-2005
Private
Investment/GDP,
2000-2005
GDP/capita, ppp-adjusted,
$US, 000s, 2000
.13
(.01)
.16
(.06)
-.65
(.01)
MENA, No Oil
.65
(.10)
1.11
(.00)
-.92
(.74)
MENA, Oil, Large
.23
(.42)
.15
(.56)
-.71
(.75)
China
-4.02
(.17)
3.95
(.07)
17.61
(.27)
Singapore
1.10
(.05)
1.95
(.07)
10.42
(.00)
Population (millions)
.004
(.09)
-.002
(.49)
-.053
(.08)
Land Area (millions)
-.14
(.56)
-.17
(.36)
1.61
(.25)
Percent population rural
.01
(.14)
-.005
(.68)
-.01
(.92)
Percent population under 14
yrs
-.04
(.05)
-.004
(.84)
-.46
(.00)
R-squared
.51
.59
.27
N, countries
41
63
54
Notes: Ordinary least squares, p-values based on robust standard errors reported in parentheses. Constant not
reported. Right hand side variables all measured in year 2000; ICRG Bureaucratic Quality, World Bank
Governance Index and Private Investment are averages over the period 2000-2005.
Sources: Data from World Development Indicators, World Bank Institute and International Country Risk Guide.
13
A potential explanation for these puzzles begins to emerge when one removes the control
for income per capita in the first two columns of Table 2. In this new specification, the
Singapore advantage grows; the non-oil MENA advantage disappears, however. Only compared
to other countries with their levels of income per capita, therefore, do non-oil MENA countries
do better with regard to governance; this is not enough to attract private investment.
Political stability explains why non-oil MENA countries exhibit a governance advantage
in Table 2, controlling for per capita income. Compared to all non-democratic countries, the
non-oil MENA countries (not including Lebanon) exhibit much greater political stability, a
difference that grows if one focuses on non-democratic countries with approximately the same
incomes as the non-oil MENA countries. The average tenure of leaders of the non-oil MENA
countries was approximately 15 years in 2000; it was approximately 10 years for all other nondemocracies, and just more than eight years for 12 non-democracies with similar incomes per
capita. Political stability, measured as the fraction of years in which a leader of a country was
replaced, was less than two percent from 1990 – 2004 for the non-oil MENA countries and more
than eight percent for other non-democracies. If one controls for these factors, the bureaucratic
quality advantage that non-oil MENA countries exhibit in column 1 falls from .65 to .12 and is
entirely insignificant.8
Political stability, therefore, allows leaders to build credible arrangements grounded in
personal relationships. The Table 2 governance advantage that MENA non-oil countries exhibit
may be better than in other countries with similar incomes not because they have more
institutionalized governments, but because they offer more propitious circumstances for building
the non-institutional basis of credibility.
Institutionalized ruling parties
Institutionalized political parties are another, more common, vehicle through which
leaders of non-democracies can limit their discretion and, correspondingly, encourage investment
by private actors lacking personal connections to them. The Chinese Communist Party is the
best example of such a party. Mao resolutely resisted institutionalization of the party and,
correspondingly, party members were exposed to, and actually experienced, frequent purges,
including those of the Cultural Revolution. Intra-party credible commitments were not possible.
Growth, not coincidentally, was slow.
8 These controls have no effect on the World Bank Governance Index, even when the index component,
Government Effectiveness, is used instead of the whole index. One likely explanation for this is that the criteria for
evaluating bureaucratic quality used by International Country Risk Guide differ from those used by other inputs into
the World Bank’s Government Effectiveness measure. ICRG emphasizes an “established mechanism for
recruitment and training”, a key element in the discussion here regarding bureaucratic institutionalization, but does
not mention the credibility of government commitment to its policies. However, Global Insight’s rating is weighted
five times more heavily than ICRG’s in the construction of the Governance Effectiveness measure. Its criteria are
not available on its website. However, the description of the World Bank’s measure of government effectiveness
does not mention recruitment and training, but does emphasize government credibility generally. See,
http://info.worldbank.org/governance/wgi2007/pdf/booklet_decade_of_measuring_governance.pdf. Political
stability could have little effect on policy credibility (if successive politicians have similar policy incentives) but a
considerable effect on bureaucratic quality (as new politicians bring in new bureaucrats whom they can trust or in
order to satisfy patronage obligations).
14
Following Mao’s death, as party leaders felt an increasing imperative to spur economic
growth, Deng Xiaoping introduced numerous reforms that increased the credibility of leader
commitments to party members. One of these was to disband the Red Guard. Others included, as
in Singapore, transparent promotion schemes, greater information dissemination among party
members, and performance-based promotion schemes. Significant authority was also delegated
to party members, particularly to pursue economic growth. At first, cadres were allowed to
promote township and village enterprises. Later, rules were changed to give them leeway to
promote private investment in their jurisdictions. Cadres were promoted based largely on their
achievement of employment and growth objectives (Gehlbach and Keefer 2007).
China itself is evidence of the importance that an institutionalized ruling party can have
in limiting the discretion of unelected leaders: private investment soared after party
institutionalization was introduced. Gehlbach and Keefer (2007) report more systematic
evidence from a cross-country comparison of democratic episodes. They argue that, in the
absence of data on party institutionalization itself, one can use the average age of ruling parties
as a proxy. On the one hand, more institutionalized ruling parties can better defend themselves
from regime challenges (since they can coordinate a more effective response to challenges, as in
Keefer 2007). On the other hand, institutionalization can take time to take root, so older ruling
parties are more likely to be institutionalized than younger ruling parties. Taking alternative
explanations for ruling party age into account, by controlling as well for the length of the nondemocratic episode and the tenure of the individual ruler, as well as numerous other country
characteristics, they identify a large, positive association between the age of the ruling party and
private investment. Consistent with the argument that institutionalization protects those inside
the organization better than those outside, party age has a smaller effect on foreign direct
investment. Table 3 reproduces these results.
Although in many MENA countries the political and economic elite are members of the
ruling party, and membership in the ruling party is an important criterion for bureaucratic
advancement, institutionalized ruling parties are not characteristic of the region. Whereas the
Chinese Communist Party is integrated into every aspect of the state and the party itself offers a
transparent career path for the ambitious, this is not the case in MENA. The leader of the party
remains the hub of decision making, delegating little and promoting and rewarding party
members at his discretion. Consistent with this, attracting private investment has not,
historically, been a priority for most countries in the region. Interlocutors in Algeria indicate that
economic growth is still not a major government concern.
Owen’s (1992) review of the evolution of parties in Tunisia and Algeria, and of the Ba’th
parties in Iraq and Syria indicates the absence of party institutionalization, even in situations
where the ruling party was apparently prominent. Tunisia’s Neo-Destour Party, founded in 1934
by Habib Bourguiba and associates, was indeed a well-organized party by 1955, the year before
independence, with a political bureau, national congress, 100 branches and a small army. In the
1960s, the party’s membership was 400,000, more than 10 percent of the population. The party
dominated five national organizations for students, women, agriculturalists, businessmen and
merchants (Owen p. 255). However, despite its breadth, party organization was fundamentally
weak; by the end of the 1960s, the central bureaucracy of the party had only 140 staff (Owen p.
257). Party institutions were gradually absorbed into the government administration and
subordinated to Bourguiba’s personal discretion. In 1974, Bourguiba has the party congress
15
declare him president for life, declares that he will appoint members to the political bureau,
rather than the party’s central committee (Owen p. 257).
Table 3: Party Institutionalization and Investment in Non-Democracies
Dependent variable:
Private Inv. /GDP
Base
sample
More
autocratic
FDI/GDP
Base
sample
More
autocratic
Age of ruling party
0.088
(0.01)
0.109
(0.00)
0.026
(0.15)
0.022
(0.26)
Years in office
0.072
(0.43)
-0.050
(0.70)
0.017
(0.78)
0.050
(0.62)
Political Instability
0.677
(0.90)
0.880
(0.89)
-3.144
(0.04)
-1.753
(0.14)
Length of Non-Dem. Episode
0.012
0.103
-0.090
-0.045
(0.92)
(0.53)
(0.27)
(0.71)
Frankel-Romer Trade index
-2.115
(0.04)
-2.381
(0.13)
1.415
(0.00)
0.766
(0.03)
Percent population young
-0.465
(0.00)
-0.431
(0.03)
-0.052
(0.33)
-0.013
(0.80)
Population, millions
-0.011
(0.01)
-0.011
(0.09)
-0.002
(0.24)
-0.003
(0.25)
Percent population rural
-0.011
(0.80)
-0.018
(0.75)
0.020
(0.27)
0.003
(0.88)
Land area, millions
0.086
(0.84)
-0.186
(0.85)
0.500
(0.10)
0.531
(0.20)
-0.027
(0.91)
107, 86
0.28
0.013
(0.96)
87, 76
0.27
-0.029
(0.78)
125,100
0.17
-0.058
(0.49)
105,90
0.1
GDP/capita, PPP, thousands USD
N, countries
R-squared
Note: Ordinary least squares, clustered and robust standard errors; p-values reported in parentheses. Units of
observation are non-democratic episodes, defined in the base sample, as continuous years in which countries exhibit
either a Legislative Index of Electoral Competitiveness (LIEC) <7 or an executive index (EIEC) <7. In the more
autocratic subsample, the criteria are LIEC<7 AND EIEC<7. See Table 1 notes (political data from Database of
Political Institutions, other data from World Development Indicators). Source: Gehlbach and Keefer (2007).
In Algeria, Houari Boumedienne took over in a 1965 coup, and began immediately to deconstruct the ruling Front de Liberation Nationale, giving control of it to veterans of the
independence war (Owen p. 258). In the mid-1970s, he made efforts to build up the party as a
vehicle of political mobilization. This late effort at institutionalization ended with his death in
16
1979, when his successor, Chadli Ben Jalid, assumed the power to appoint members of the
political bureau (abandoning internal party elections), and reduced the number of party
commissions from 11 to 5 (Owen, p. 259).
The Ba’th parties in Iraq and Syria had many of the trappings of institutionalization, but
their internal organization remained subject to the discretion of the rulers. Rulers were careful to
avoid party organization that would permit party members to threaten their rule. Key to this was
the establishment of competing organizations, particularly security forces, that also reported to
them (much as Mao had undermined the Communist Party by establishing the Red Guard,
outside the party and reporting to him). In Syria, the civilian Ba’th party was parallel to the Ba’th
apparatus in the army, dominated by General Hafiz al-Asad (Owen 261), who overthrew the
civilian party in a coup in 1970. He used the party as an instrument of government, but gave it
no role over internal security, predominantly Alawi, or the army. Recruitment to the party was
based on regional and sectarian considerations rather than on the ideological principles for which
the Ba’th Party was historically known (Owen 261-62).
Figure 3: Party institutionalization in MENA and non-democratic comparator countries
-20
0
20
40
60
Ruling Party Age - Leader Tenure, Non-democracies, 2004
MENA Oil
MENA Non-oil
Middle Income
Large East Asia
Large MENA Oil
No competitive elections
East Asia
Note: Each bar is the average of the difference between the age of the ruling party and the number of years that the
leader has been in power. In countries where there is no ruling party, as in some Gulf States, this number is
negative.
The Iraq Ba’th party came to power in July 1968. From then until Saddam Hussein
assumed power in 1979, the army and the Ba’th party were two separate and competing entities.
Hussein was in charge of the civilian party apparatus, building up a disciplined and secretive
civilian party apparatus, carefully recruiting members who then supervised the public
administration, from which it was independent. The party was present in every military unity,
school, university and neighborhood (Owen p. 262). However, again, key elements of
institutionalization, including transparent standards for party member advancement and low
barriers to intra-party communication and coordination were not present. Ideological bonds
among party members were diminished, as in Syria.
17
Figure 3 demonstrates that these qualitative comparisons are reflected in a systematic
quantitative difference between MENA countries and faster growing countries such as those in
East Asia. In 2004, all three subsets of MENA countries had parties more clearly dominated by
the party leader (in the sense that the leader’s tenure was close to or greater than the party’s age)
than middle-income non-democracies, all East Asian non-democracies, and the largest East
Asian non-democracies (China, Vietnam, etc.).
Transitions from one leader to another are another way to assess the level of ruling party
institutionalization. In the MENA region, transitions have generally followed the death, not
always natural, of the previous leader. This has often accompanied at least a change in the name
of the ruling party, if not its wholesale dismantling. In China and Vietnam, in contrast, party
institutionalization is reflected in the fact that leadership transitions have been regular and
undertaken prior to the death of incumbents.
Military institutionalization
The military plays an important role in the selection of leaders in many MENA countries;
its institutionalization would therefore be an important source of investor security. Comparative
information about military institutionalization is not widely available, however. Available
information, though, suggests that non-democratic countries exhibit substantial variation in this
regard, with some exhibiting substantially freer flows of information internally, more transparent
and meritocratic promotion and recruitment criteria and greater delegation of responsibility
throughout the organization.
Indonesia is an example of one such country. In 1968, Indonesia began to enjoy
continuous high rates of growth and investment, with a brief interruption in 1981, until the
Suharto regime collapsed in 1998 and national income shrank by 13 percent. At the same time,
significant changes were made in the institutionalization of the Indonesian military. In 1969,
President Suharto centralized control of a badly divided military under a commander in chief and
gave it a territorial structure – with regional commands subdivided into district and local
commands down to the village level (Callahan p. 11 and Global Security, Indonesia). The
reorganization seemed to delegate substantial discretion to low command levels, reflecting a
national security objective of preventing countervailing organizations from forming (Callahan p.
11). “ABRI’s military operations relied on a well-developed doctrine of national defense called
Total People’s Defense, based on experience during the struggle for independence. This doctrine
proclaimed that Indonesia could neither afford to maintain a large military apparatus nor would it
compromise its hard-won independence by sacrificing its nonaligned status and depending on
other nations to provide its defense. Instead, the nation would defend itself through a strategy of
territorial guerrilla warfare in which the armed forces, deployed throughout the nation, would
serve as a cadre force to rally and lead the entire population in a people’s war of defense. . .”
(Global Security, Indonesia). The success of this strategy required close bonds between citizen
and soldier to encourage support of entire population; in support of this objective, the army
mobilized for local development efforts.
Suharto leveraged military institutionalization by seconding active-duty military into
civilian jobs. “In 1977, more than 21,000 ABRI personnel were seconded to civilian jobs, with a
slow decline over the next two decades (16,0000 in 1980, and probably 14,000 in 1992).” In
1973, fully one-third of cabinet ministers, two thirds of provincial governors and half of
ambassadors were active-duty or retired ABRI officers. By 1995, these percentages had declined
18
to 24 percent, 40 percent and 17 percent, respectively” (Callahan, p. 11). Because the military
had relatively transparent internal promotion criteria that rewarded effective performance in
these positions and insulated officers from arbitrary removal, seconded officers had both the
incentive and capacity to make credible commitments to outsiders. This extended to retired
officers, who appeared as directors and senior managers of private firms. Their personal
relationships with investors ensured that they would not renege on agreements with those
investors; their position in an institutionalized military hierarchy secured their ability to protect
private investors from other expropriatory threats.
Of course, members of the Indonesian military, as with members of the institutionalized
parties and bureaucracies discussed earlier, received higher rents than non-members. These rents
helped cement loyalty to the regime, but because of institutionalization, the rents were not too
high to obstruct growth. It is noteworthy, however, that beginning in the 1990s, Suharto began
to dismantle military institutions. He more overtly “played powerful generals off one another,
probably resulting in multiple informal chains of command that led only to Suharto.” (Callahan
p. 13). Discipline broke down among the lower ranks of soldiers “and was non-existent in many
regions.”(Callahan p. 15).9 The effects of de-institutionalization were evident in May 1998,
when in the face of the popular uprisings that brought the regime down, the military could
neither save nor overthrow him (Callahan p. 15).
In MENA countries, the balance between meritocratic and personalistic organization of
the military appears to be more strongly weighted towards the latter. Sadaam Hussein’s
management of the Iraqi armed forces provides the most extreme example of this. Hashim
summarizes his discussion of Hussein’s policy throughout his rule to rotate officers, to replace
even successful officers with even incompetent loyalists, to establish competing armed forces,
even at substantial cost to military readiness. “Even though Iraq faced a higher threat
environment in the 1990s vis a vis both external and internal threats, in [Saddam Hussein’s]
mind it was the most proximate force to him, the Iraqi military, which continued to represent the
gravest threat” (p. 14).
Outside observers rate the Syrian army as one of the largest and best-trained in the
region. Nevertheless, in contrast to assessments of how the Indonesian armed forces are
organized, observers point to the unwillingness of staff officers or field commanders to show
initiative or to react independently to a crisis without the consent of the chain of command
(Bennett 2001). Ethnic identity plays a significant role in officer recruitment; Alawi and Druze
minorities, key support groups of the government, are dominant in the officer corps (Global
Security, Syria). The political importance of these limits on the institutionalization of the
military were made clear when a general who attempted to increase the level of
institutionalization, by increasing the emphasis on merit in major military appointments, was
replaced after disputes with the brother-in-law of the president, who was in charge of major
military appointments and dismissals (Gambill 2002).
Similarly, observers argue that commanders of the Egyptian army are reluctant to extend
operational flexibility to brigade and battalion commanders, noting that “Officers below brigade
9 The motivation for deinstitutionalization is not documented, but is plausibly one of the following: a decline in the
risk of insurgency (reducing the value of an institutionalized military); an increase in internal threats to the regime
from the military; and related to this a potential decline in the willingness of the regime to share rents with the
military.
19
level rarely made tactical decisions and required the approval of higher-ranking authorities
before they modified any operations.” (Global Security, Egypt). None of this implies a generally
casual attitude towards military readiness. For example, during the 1980s, the Egyptian armed
forces implemented a concerted effort to improve the quality and efficiency of the defense
system by introducing modern armaments and reducing the number of personnel (Global
Security, Egypt). Generally, though, organizational enhancements within the military that would
increase both delegation of authority downwards and the ability of units to coordinate joint
operations entail greater regime risk than leaders in the region are willing to countenance.
Available information therefore suggests that personal loyalty of officers to the leader
plays a greater role in promotion, at the expense of more transparent and meritocratic promotion
criteria. Responsibilities are not delegated to lower ranking officers as they are elsewhere;
information flows are truncated; and outside observers claim that greater mistrust exists between
officers and enlisted men and across units. These characteristics create obstacles to the ability of
the military to coordinate in opposition to the regime. This increases leader security, but because
the military provides no significant bulwark against arbitrary behavior by the leader, it
undermines leader ability to make credible commitments to investors.
Summarizing: The policy implications of institutionalization
Institutionalization enhances private investment in three ways. First, it enables leaders to
make credible agreements with civil servants to pursue actions that are only partially observable
by leaders and that are essential to promoting private investment. The performance contracts
that characterize the Singaporean civil service, or the reward system that the Chinese have put in
place for local officials, by conditioning promotion on growth, all require that civil servants or
party members believe that the promises of bonuses and promotions in exchange for
performance are credible. The institutionalization of the party or the bureaucracy allow those
promises to be made, such that rulers can implement growth-promoting policies (Keefer and
Gehlbach).
Second, institutionalization protects investors from expropriation. This is a direct
consequence of institutionalization, since those within the institutionalized organization, whether
party, bureaucracy or military, are at less risk of expropriation. It is also an indirect
consequence, since those within the institutionalized organization can leverage their personal
relationships to extend an umbrella of credibility over those outside of the organization, as with
joint ventures between private investors and party officials in China or between retired military
and private investors in Indonesia. Third, institutionalization necessarily curbs rent-seeking: it
does not make sense for leaders to institutionalize, making themselves more vulnerable to
overthrow, without a corresponding growth payoff. That payoff will not materialize if markets
that were closed prior to institutionalization remain closed afterwards.
Given the advantages of institutionalization, it remains, first, to ask why MENA countries
have been reluctant to institutionalize and, second, to establish whether the policy environment
in MENA mirrors what we expect in the absence of institutionalization. These are the subject of
the sections that follow.
Why the reluctance to institutionalize?
The willingness of leaders to choose institutionalization to boost investor confidence
depends on an essential tradeoff. Leaders can make broad promises to many investors only if
20
many investors believe that they can impose costs on the leader in the event that they are
expropriated. However, the easier it is for citizens to contest expropriation or the low rates of
job creation that are caused by expropriation, the easier it is for them to force leaders to reduce
the share of rents that they extract from the economy.
This tradeoff suggests several circumstances under which institutionalization might be
desirable. First, it is an attractive strategy when the returns to private investment are high and
when rents in the absence of private investment are low. In these cases, institutionalization
attracts investment, improving citizen incomes and reducing their incentive to revolt, and does so
at low cost in terms of natural resource or other rents that leaders must surrender to newly
organized citizens. In countries with large natural resource rents, incentives to institutionalize
are low. The returns to private investment are low (the exchange rate effects of resource exports
reduce the rate of return to the manufacture of tradeables), reducing the payoff to
institutionalization; leader incentives to expropriate are lower, since high natural resource rents
are, in and of themselves, a motivation for revolution that leaders seek not to exacerbate; and
institutionalization imposes higher costs on leaders in terms of natural resource rents that they
must surrender.10
Second, where the leadership group cannot make credible deals among themselves, it is
difficult for them to agree to institutionalize. They cannot be sure that, in the course of
institutionalization, other members of the group will not take advantage of them, or will make
specific decisions related to institutionalization that harm their interests. For example, in
Algeria, different each power center in the government (e.g., the heads of the military and secret
service) controls a different source of rents. Institutionalization requires that their control over
that source of rents be loosened; the order in which loosening proceeds, however, is one of many
details that is critical and difficult to manage.
The discussion that follows focuses on these two determinants of institutionalization, but
there is a third, the intrinsic dissatisfaction of citizens and their propensity to revolt, that also
affects leader decisions to institutionalize. Keefer and Gehlbach (2007) argue that a higher threat
of revolt (that is, a greater ability of citizens to undertake collective action) reduces leaders’
ability to extract rents from the members of the organization (e.g., the ruling party) to which they
grant greater information access. The easier is collective action by citizens, therefore, the less
inclined are leaders to institutionalize. Systematic comparative evidence makes it difficult to say
more about this issue in the case of MENA countries, but the prevalence of well-armed clans in,
for example, Yemen, or the extent to which sectarian groups are mobilized in many countries,
suggests that the costs of collective action in the MENA region may be lower than in East Asia,
and a deterrent to institutionalization.
The first argument suggests that where natural resource rents are large,
institutionalization is less likely. In fact, the oil-producers in the MENA region exhibit low rates
of institutionalization. As is well-known, the natural resource rents available to them are, by any
standard, large. One way to see this is to compare the rents extracted in MENA from energy,
forests or minerals, the variables energy, forest and mineral depletion as a fraction of Gross
10 This is similar to the arguments in Acemoglu and Robinson (2007) about the conditions under which nondemocratic leaders accede to democratization.
21
National Income with the rents extracted in comparator countries.11 Differences are slight with
regard to forest and mineral resources, but of course large with regard to energy. As Figure 4
makes clear, the ten MENA oil countries, including the five largest of these, derived 30 percent
of GNI from oil rents in 1995, rising (for the seven countries with data) to 54 percent by 2005
(with the run-up in crude oil prices).
Natural resources are not the only source of rents and some non-oil countries have had
access to non-oil-based rents. Egypt and Jordan, for example, have historically received large
amounts of foreign assistance that have been de-linked from development objectives. In Egypt,
prior to 1990, foreign aid was 8.7 percent of GNI and in Jordan more than 18 percent. In
contrast, in East Asian countries with populations greater than 2 million (excluding Pacific
Islands), aid was 2.1 percent of GNI; it was only 1.1 percent in the largest East Asian countries.
From 1990 to 2004, aid averaged half of its earlier level in both Jordan and Egypt. By 2004, it
had dropped to approximately 5 percent in Jordan and two percent in Egypt. In East Asia, thanks
to very large aid flows to Cambodia (10 percent of GNI), Laos (11 percent), Mongolia (16
percent), and Papua New Guinea (8 percent), aid flows in 2004 were 3.6 percent of GDP.
Figure 4: Rents from Energy Extraction in MENA and Comparator Countries
0
20
40
60
Energy Rents/GNI
1995 1996
1997
1998 1999 2000 2001 2002 2003
year
MENA Oil
MENA Non-oil
No competitive elections
2004 2005
MENA Oil, Large
East Asia
Middle Income
Note: GNI is Gross National Income. Energy rents are volumes of energy extracted times world prices (or relevant
market, for natural gas), less costs of extraction. Source: World Development Indicators and Hamilton and
Clemens 1999).
11 Depletion rates are calculated as the total volumes of resources extracted times their world price, less costs of
extraction, from World Bank staff estimates, in World Bank Development Indicators. See Hamilton and Clemens
(1999).
22
High levels of foreign aid, particularly when they are not conditioned on policies
consistent with development and growth, are essentially free resources that are an additional
disincentive for regime liberalization. Though Egypt’s rents from all sources – oil and foreign
aid – dropped by half in the 1990s compared to the 1980s, the recent run-up in oil prices has
substantially boosted them again. Energy rents/GNI rose from 3.2 percent to 17.4 percent over
the period 1995-2005.
The control of land also offers a source of rents when small investments to improve land
lead yield large returns. In Tunisia, returns to land ownership are high because of tourism and
investment from oil states in residential property. Consistent with land as a source of high rents,
observers report considerable involvement by the ruling family in land deals.
The process of institutionalization is also difficult when members of leadership groups
(those who enjoy personal or affinity relationships with the ruler) to make credible agreements
with each other that, in the process of institutionalization, their relative positions will be
preserved and their absolute rents not reduced. In China, for example, the key leaders who
needed to agree to party institutionalization under Deng Xiaoping had served together in the
Chinese Civil War and participated in the difficult Long March (ten percent of those who started
the March finished it). This gave them an ample basis on which to build credible intraleadership agreements. Not only did they have a long history of personal interaction, but
internecine conflict would have undermined the nation-building objectives for which they had
made great sacrifices.
The basis for credible intra-leadership agreements seems to be less present in MENA.
Ayubi points to the intensity of intra-familial conflict in the Gulf states, which he illustrates with
the cases of Abu Dhabi, where of the nine Amirs since 1818, five were murdered; two were
deposed; and two died natural deaths, and of Sharjah, where of the eight leaders from 1803, two
were murdered; three deposed; and three died natural deaths (Ayubi, p. 254). He also counts
three dozen actual and abortive coups in the Arab world over the period 1940-1969 (p. 258).
The importance of coup threats (essentially, threats from groups close to the leadership, not
revolutionary threats from citizens at large) also led the Jordanian leadership to deinstitutionalize. In 1957, coup threats against King Hussein led him to take command of the
army, to outlaw political parties, and tp allow only rare meetings of the parliament (once
between 1974-84). He limited his cabinet to only a small group of ministers, and the political
elite was a small group emanating from several hundred families (Owen, 1992, p. 65).
Owen (1992, p. 202) also argues that internal conflict and disagreement about key aspects
of public policy, such as how best to pursue pan-Arabism, have consistently challenged armies in
the MENA region. For example, prior to 1967, young officers (typically, radical nationalists) in
Syria, Egypt and Iraq overthrew their generals and attempted coups. While the military was reequipped and professionalized following the 1967 war, the dangers posed by increased
organization within the military were offset by the creation of new paramilitary organizations in
charge of internal security, the Central Security Police in Egypt, and the Defence Companies in
Syria controlled by the president’s brother. President Sadat repeatedly changed the minister of
defense and chief of staff. In Iraq, officials from the Ba’th party closely oversaw army
operations. Hinnebusch (p. 86) reports as well that by the early 1960s, the Syrian army was
divided on sectarian, geographic and ideological lines.
23
In Tunisia, interlocutors report the difficulties within the ruling family of controlling
corrupt behavior by members of the ruling family, such as the evasion of taxes. This is a
common problem, but again points to the fact that members of the ruling clique can have sharply
different attitudes towards institutionalization, making agreements about institutionalization
difficult to reach. Algerian respondents point out that key officials would countenance
institutional reforms, but are concerned that their accumulated rents would be jeopardized.
Reports by close observers reveal clear examples of the difficulties of credible intraleadership agreement in Algeria. The largest private bank, Khalifa, was founded by the son of
the secret service chief during the internal conflict of the 1990s. The bank engaged in massive
insider lending and 3 billion dollars were lost; these losses came at the expense of the other key
actors in Algeria. The inability to make credible deals among leaders regarding private banking
led to financial sector policies in which no domestically owned private banks are allowed (the
sale of the largest state-owned bank has gone to short-listing three times, and three times the
process has been halted), and the remaining foreign-owned banks are not allowed to lend or
receive financing from any shareholder, including the parent bank.
The financial sector provides other illustrations of intra-elite tensions. The biggest stateowned bank credit, equal to 4.5 times the equity of the bank, was to a company linked to the
army chief of staff. When the president dismissed him, the bank called this loan and the
company collapsed. However, in return, the president had to close down a large enterprise that
was controlled by individuals close to him and the secret service. Another well-placed observer
indicated that state-owned banks are reluctant to make private sector loans because of “tensions
with the generals.” Again, this can be explained by the mistrust among elites about how the
costs and benefits of rent-seeking will be shared among them.12 In all of these cases, the
inability to make credible agreements has led to policies that reduce the rents available to
everyone.
These same observers report that intra-elite disagreement extends to the issues of concern
here, such as democratization (or, more modestly, institutionalization). For example, although
the elections were considered a disappointment for the government, particularly the drop in
turnout from 46 percent in 2002 to 30 percent in 2007, in the post-election period no key actors
were replaced in any ministry. Elites cannot reach agreements that would improve even their
own aggregate welfare.
Defusing opposition and maintaining support in the absence of institutionalization
Another way to judge whether MENA governments are reluctant to institutionalize is to
examine whether they pursue alternative strategies to defusing opposition. One of these is to
undertake redistribution to some citizens, such that recipients of redistribution believe that revolt
will not leave them better off, while non-recipients believe that they will not succeed in staging a
revolt without the cooperation of those who receive the redistribution. One way in which this
strategy can manifest itself is the creation of a large civil service and military. Beneficiaries are
most likely to believe that they will lose them in the event of a fall in the regime and are
therefore least likely to support insurgency (see, for example, Robinson and Verdier XX). Non-
12 This same observer reports that every state-owned enterprise is controlled by a different center of power, so loans
from state-owned banks that go to the private sector divert resources away from SOEs.
24
recipients of these jobs, observing that all public sector workers, constituting a significant
fraction of the population, are supportive of the government, see their chances for successful
revolt correspondingly decline.
Although details on the public sector wage bill in MENA are harder to compile, the
available information points to much higher spending than in comparator countries. In 2001, in
the three non-oil MENA countries for which data are available from World Development
Indicators, public sector wages as a fraction of GDP were reported to be approximately 19
percent in Jordan, 10 percent in Lebanon and 11 percent in Tunisia. The oil countries with data
report roughly similar figures: Bahrain and Kuwait, at approximately 16 percent, and Iran at 9
percent. The contrast with East Asian countries (with data) is sharp: corresponding figures for
Indonesia, Cambodia and Singapore were 1 percent, 4 percent and 5 percent. Papua New Guinea
was the highest, at 7.4 percent of GDP, but demonstrates the lack of connection between
spending and performance, since its bureaucratic quality was below average in East Asia.
The 2005 Unified Survey has data for more recent years, though for fewer countries.
These show Algeria with a government wage bill of approximately 7.5 percent of GDP from
2001-05; Egypt with a bill of approximately 7.8 percent over that period; Iran starting with a
wage bill of almost 10 percent in 2001, plummeting to 5 percent by 2005; Morocco steady at
between 12 and 13 percent; Syria rising from 9.5 percent to 11 percent; and Tunisia steady at
approximately 12 percent.13 In contrast, in 2005 spending in East Asia averaged less than 6
percent for those countries with data: Indonesia spent 1.3 percent of GDP on public sector
wages, the Philippines 5.5 percent, Thailand 5.9 percent and Malaysia 5.2 percent.
More detailed and revealing data are also, unfortunately, older. Schiavo-Campo, et al.
(1997) collected thorough information on the wages, numbers and total wage bill associated with
public sector employment in a large number of countries. Their data reveal that, at least at that
time, MENA countries had much larger government workforces and offered more generous
compensation to government workers. In Algeria, Bahrain, Egypt, Jordan, Lebanon, Morocco,
Syria, Tunisia, West Bank-Gaza and Yemen, they found total government employment averaged
8.4 percent of the labor force (3.3 percent of the population); that the average government wage
was 3.4 times GDP/capita; and that the total government wage bill was 9.8 percent of GDP.
In contrast, figures for Latin America were 4.7 percent of the labor force (1.9 percent of
population); a lower average wage of 2.5 times GDP/capita, and a total wage bill of 4.9 percent
of GDP. Among East Asian countries, these numbers were lower still. In China, 2.8 percent of
the labor force, or 1.7 percent of the population, were employed by the government, for a total
wage bill amounting to 3.8 percent of GDP, with average wages amounting to 1.3 times
GDP/capita. In Singapore, with its much-vaunted and famously well-paid civil service, two
percent of the labor force, or .9 percent of the population, were government employees, and the
total wage bill was 4.6 percent of GDP. Although salaries in Singapore are high, though, they
are only 2.1 times GDP/capita. In Indonesia, finally, a fast-growing, poorer country with a lessadmired civil service, government employment is 2 percent of the labor force, 1 percent of the
population, earning average wages amounting to 1.6 times GDP/capita, amounting to a total
wage bill of 3 percent of GDP.
13 This alternative data source is largely consistent with the World Development Indicators (where the two overlap).
It is, however, dramatically and inexplicably lower in the case of Jordan. World Development Indicators reports that
in 2003, the government wage bill in Jordan was 20.5 percent; Unified Survey reports 5.8 percent.
25
Consistent with the idea that MENA governments have chosen to use public sector jobs
to defuse opposition, rather than institutionalization, militaries and military spending are also
larger. In the large oil countries, military spending was 5.8 percent of GDP in 2004 and military
personnel was 3.02 percent of the labor force, about the same as in the smaller oil countries.
Among the MENA countries with no oil, spending was 4.1 percent of GDP and military
personnel comprised 3.9 percent of the labor force. In East Asia, military personnel constituted a
similar fraction of the labor force (3.6 percent in East Asian countries generally, 3.1 percent in
the largest of them), but a much smaller fraction of spending (1.9 percent of GDP in all East
Asian countries, 1.3 percent in the largest ones). In Latin America, both spending and personnel
were low: 1.3 percent and .78 percent, respectively.
Privileged involvement by the military in the private sector is another device to build
regime support. For example, Syria’s military operates the largest construction business in the
country, according to Ayubi (p. 276). Military involvement in the economy is common, as well,
in East Asia, including Thailand, China and Indonesia. The difference in MENA is that, because
the military is less institutionalized, military involvement is more likely to be characterized by a
narrow investor base and higher barriers to entry for non-military investors.
As the evidence in Table 2 indicates, these larger expenditures do not translate into
greater efficiency, since bureaucratic quality is not higher in MENA countries than in comparator
countries that spend less. On the contrary, given a lack of institutionalization, leaders cannot
easily monitor or contract with the public sector to induce high performance. Shirking is easier
when institutionalization is low. As a consequence, in addition to the greater measured rewards
that governments offer to public sector employees to gain their support, they also offer greater
opportunities to shirk compared to countries in which governments opt for institutionalization
and smaller public sectors.
Two additional empirical regularities are consistent with the conclusion that
institutionalization lowers the public sector wage bill and raises bureaucratic quality. First, a
measure of bureaucratic quality from International Country Risk Guide is positively associated
with one measure of institutionalization, the age of the ruling party in non-democracies.
Gehlbach and Keefer (2007) report regressions showing that corruption is significantly lower,
across a variety of specifications, when the age of the ruling party is higher. Second, controlling
for income per capita, the correlation between the public sector wage bill and bureaucratic
quality is insignificant (since 2000) or significantly negative (in the period before 2000).
The contrast between Algeria and Indonesia provides a useful illustration of the dynamics
of institutionalization. In Algeria, as in Indonesia, the military played a large role during serious
episodes of civil unrest. This implies that leaders would place a high premium on a wellfunctioning military, and therefore on institutionalization of the military. However, set against
the rewards of increased security that institutionalization brings are the costs in terms of rents
foregone. Fuel exports as a fraction of GDP in Indonesia in 1968, just before a major
reorganization of the military took place, were only 4 percent of GDP, compared to 12 percent in
Algeria in 1966 and 15.3 percent in 1968. In Indonesia, fuel exports rose as high as 19.2 percent
of GDP in 1981, but in that same year were 32 percent of GDP in Algeria. Incentives to
institutionalize the military were persistently lower in Algeria than in Indonesia.
Given its reluctance to institutionalize, Algeria would be expected to engage in greater
public spending to defuse opposition. Patterns of government spending reflect this. From 1994 –
26
1998 (the last year of the Suharto regime), government expenditures in Algeria averaged 24
percent, compared to 15.5 percent in Indonesia. Most of these expenditures flowed to wages and
the military. Public sector wages were 9 percent of GDP in Algeria and 2.3 percent in Indonesia.
Military expenditures were 3.4 percent of GDP in Algeria and 1.4 percent in Indonesia. In
contrast, goods and services were 17.5 percent of government expenditures in Indonesia and only
6.3 percent in Algeria.14
Governance and barriers to entry in MENA vs. comparator countries
To the extent that MENA countries exhibit less institutionalization and a more
personalized basis for credible investor-politician or bureaucrat-politician interaction, we would
expect to see public policies towards investment that are associated with less institutionalization:
a greater risk of expropriation of investor assets, greater rent-seeking (since a lack of
institutionalization allows governments to extract greater rents from the economy), and more
barriers to entry and less competitive markets (reluctance to remove these barriers undermines
the rationale for institutionalization in the first place).
Figure 5: Governance in MENA and Comparators, 2004
-1.5
-1
-.5
0
World Bank Governance Index
MENA Oil
No competitive elections
Large East Asia
MENA Non-oil
East Asia
Middle Income
Source: World Bank Institute, World Bank Governance Index
Note: The index is the sum of only the rule of law and corruption indicators (omitting voice, regulatory
effectiveness, and policy stability). The MENA oil sample contains the United Arab Emirates, Bahrain,
Algeria, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia and Syria. The MENA non-oil sample
consists of Egypt, Lebanon, Morocco, Jordan and Tunisia. There are no MENA countries in the remaining
groups.
14 Although Algerian income per capita was slightly more than twice Indonesian income per capita, differences in
income per capita are not a good explanation for these differences. Government expenditures/GDP, for example, are
not significantly correlated with income/capita in 1994 and could, at most, explain 2 percentage points of the 15
percentage point difference between the two countries.
27
In her work looking at the political connections of private firms, Faccio (2006) finds
more cross-border restrictions on investment and security purchases in countries where
connections are more widespread. Surprisingly, though, along some dimensions, MENA rates as
well or better than comparator countries. These comparisons turn out to be misleading for
several reasons explored below, including the fact that governments need only one regulatory
instrument to deter private investment, even if all other regulations are highly favorable. In fact,
governance, finance and trade barriers all seem to constitute more serious obstacles to firm entry
in MENA than in comparator countries.
According the World Bank’s Governance Index, MENA countries, whether oil or nonoil, have higher governance scores than other groups (Figure 5). The difference with comparator
groups is significant, amounting to almost one standard deviation by 2004 (results are similar for
2005, when data do not allow non-democratic countries to be identified). Some de jure barriers
to entry also seem to be lower in MENA countries. Figure 6 compares MENA values for the
costs of starting a business as a fraction of income per capita with those of other countries.
These costs are taken for 2004; results are again the same for 2005, for which it is not possible to
identify countries lacking competitive elections. They indicate that, compared to the average
country lacking competitive elections, the costs in MENA are more than 20 percentage points
less as a fraction of GDP. They are also lower than middle income countries and only slightly
higher than East Asian or large East Asian countries.
Figure 6: The costs of starting a business in MENA and comparator countries, 2004
0
20
40
60
80
Costs of Starting a Business as Percent of GDP/capita
MENA Oil
No competitive elections
Large East Asia
MENA Non-oil
East Asia
Middle Income
Source: World Bank Doing Business Indicators
Note: The MENA oil sample contains 12 countries, United Arab Emirates, Bahrain, Algeria, Iran, Iraq,
Kuwait, Libya, Oman, Qatar, Saudi Arabia and Syria. The MENA non-oil sample contains Egypt, Lebanon,
Morocco, Jordan and Tunisia. There are no MENA countries in the remaining groups.
28
Access to finance is another key issue in development and, once again, according to some
measures of financial development, such as liquid liabilities of the banking sector as a fraction of
GDP, the financial sector in non-oil MENA countries is much larger than in other regions.
Although an unusually large fraction of these liabilities are funneled to the public sector, Figure
7 illustrates that the quantity of domestic credit that goes to the private sector is also larger in
non-oil MENA countries.
The conclusions that emerge from Figures 5-7 are inconsistent with interviews with
entrepreneurs, however, who throughout the region report that members of elite families have
significantly greater protection from unwelcome government interference than others and that
entry into markets controlled by elite interests is not easy. Interviews and detailed firm surveys
in countries across the region suggest significant barriers to entry and political influence on
firms; comparing similar responses in East Asia suggests that the influence of regime “insiders”
on the economic prospects of “outsiders” either through outright expropriatory activity, or
through arbitrary regulatory or constract dispute resolutions, or through regulatory barriers to
entry, including those related to access to premises (land), is worse in MENA, not better, as the
figures suggest.
Figure 7: Private sector access to credit in MENA and comparators
0
20
40
60
80
Domestic Credit to the Private Sector/GDP, 2005
MENA Oil
No competitive elections, 2004
East Asia
MENA Non-oil
Middle Income
Source: World Development Indicators.
Note: The MENA Oil countries for which this data are available are Yemen, Qatar, Iran, Kuwait, Saudi Arabia,
Libya, Bahrain, Algeria, and United Arab Emirates. The MENA non-oil countries are Tunisia, Jordan, Morocco,
Egypt and Lebanon. 69 countries are in the Middle Income group, 48 in the no competitive elections group, and 21
in the East Asia group. There are no MENA countries in the remaining groups.
For three reasons, aggregate indicators and the assessments of outside observers may not
accurately depict the differences in barriers to entry between MENA and comparator countries.
First, officials may not respect de jure rules and regulations in practice. For example, even if
overall de jure obstacles are low, enforcement may differ across classes of firms, creating a
competitive advantage that, de facto, prevents entry. In Tunisia, for example, many barriers to
29
trade have fallen, highlighted by the rapid inclusion of Tunisia in a free trade zone with the
European Union. In the midst of this friendly de jure environment, however, entrepreneurs
complain that prominent individuals are increasingly bringing goods into the country without
paying value-added taxes. While tariffs are low and the VAT is quite average, by evading the
VAT, these importers gain a 15 percent cost advantage over others.
There is also considerable variation between the hypothetical (de jure) costs of business
start up in Figure 6 and firm assessments of those costs in the surveys.15 The de jure costs of
starting a business (in percent of per capita income) were 30 for Algeria, 63 for Egypt, 52 for
Jordan, 12.2 for Morocco and 34.2 for Syria. They were 450 for Cambodia, 57.4 for Vietnam
and 15.8 for China, no better or slightly worse than the MENA countries. In contrast, in their
survey responses, a lower percentage of firms in the three East Asian countries reported business
licensing and permits (not necessarily for starting up) as a severe or major obstacle to the
operation and growth of their business than in any of the MENA countries. In Algeria, 24
percent of medium-sized respondents reported business permitting as a considerable obstacle.
The percentages were 23 percent for Egypt, 22 percent for Jordan, 19 percent for Morocco, and
48 percent for Syria. In contrast, only 6 percent of Cambodian respondents, 2 percent of
Vietnamese respondents, and 18 percent of Chinese respondents classified permitting as a
substantial obstacle.
A second explanation for the divergence of firm-level and aggregate assessments appears
to be that governance evaluations focus on the representative or median potential investor,
though across countries, it is the position of non-representative investor that may differ
substantially. The World Bank Doing Business Indicators, for example, explicitly evaluates the
de jure obstacles to entrepreneurial activity for a representative firm of a particular size and in a
particular business. This is valuable information. However, as the foregoing discussion implies,
the median potential investor may be untouched by institutionalization.
Fast-growing countries that have institutionalized extend the direct benefits of
institutionalization to far less than one-half of the population (60,000,000, in the case of the
Chinese Communist Party). For this fraction, the security of property rights and the reliability of
regulatory and contract dispute resolutions are both high. In countries that have not
institutionalized, such as MENA countries, the fraction of citizens that benefit from the strong
protections of institutionalized restraints on the executive is smaller. Even if it is the case that
the median citizen confronts no worse, or even a somewhat better governance environment than
the median citizen in comparator countries, the fraction that enjoys great security is likely to be
the driver of growth.
Aggregate indicators of governance also do not distinguish the types of rents that officials
extract. For example, in one country where entrants confront severe barriers to entry and favored
incumbents are well-treated, observers would see little expropriatory behavior and could rate
country governance more positively. In another country where incumbents are less protected,
but where officials extract rents from most enterprises, but those rents are capped and made
15 Both the de jure assessments and survey responses are informative about effects on firms. It is not possible to
use either of these indicators to say anything about the broader social welfare implications of business regulation,
since this depends on the content of the regulations and whether they respond to market inefficiencies, neither of
which are observable.
30
predictable by institutionalization, governance might be viewed as poor, though investment
would be high.
Third, aggregate depictions may be inaccurate because it only takes one onerous
regulation to block firm entry, even if all other regulations are favorable. Finance and trade
barriers may be the source of those barriers in MENA. There is evidence that all three
distortions affect broad comparisons of governance and other barriers to entry between MENA
and other countries.
Table 4 indicates substantial difference between individual firm perceptions of
governance and other barriers to firm entry than those in Figures 5-7. For example, the last
columns of Table 4 summarize the fraction of firms that regard corruption as a “major or severe”
obstacle.16 These results do not mirror the governance assessments in Figure 5. Rather than
having a distinctly better governance environment for firms, MENA exhibits significant
heterogeneity and, on average, little difference compared to East Asia. Firms in Egypt and Syria
are significantly more likely than firms in the other countries to identify corruption as an
obstacle, and Morocco and Jordan the least, with China and Algeria in the middle.17
The extent to which corrupt payments are an obstacle need not correlate with the quantity
of bribes that they pay. Where bribes are payments to officials for exclusive access to lucrative
markets, or for permission to impose large costs on the country at large (e.g., pollution beyond
statutory norms or tax payments below legal obligations), individual firms would not regard
them as an obstacle. On the other hand, where bribes are payments to avoid expropriation of
firm assets (e.g., having premises shut down, workers declared illegal, goods released from
customs), or to avoid selective enforcement of laws that are generally unenforced (creating a
competitive disadvantage for the target firm), firms are more likely to regard corruption as an
obstacle.18 While one cannot say that corruption is less of a problem for society as a whole for
countries where firms do not cite corruption as a major obstacle, one can say that in countries
where they do, as in MENA, corruption is both a problem for firms and for society.
The evidence that finance is a significant barrier to entry is even more compelling, both
for its breadth and objectivity. Nee and Opper (2006) confirm that political access matters for
credit access in China: among 66 firms listed on the Shanghai Stock Exchange, firms with CEOs
who are politically active are more likely to have access to bank credits than firms that do not.
Despite this, however, as Table 4 makes clear, firms are more likely to use bank financing in
China and less likely to rank it as a severe or major obstacle, than they are in those MENA
countries for which data are available.
16 The World Bank governance indicators for the countries represented in Table 4 are similar to the regional
averages reported in Figure 6.
17 Note that firm responses for Lao PDR almost certainly reflect the sensitivity of the question and respondent
reluctance to answer negatively. Lao PDR has the lowest World Bank Governance scores of the countries in Table
4.
18 This means, of course, that it is not necessarily good for a country as a whole if firm respondents to this question
report that corruption is not an obstacle for them; however, if firms report that corruption is an obstacle, this is likely
to signal a lack of credible commitment in firm-state relations.
31
Table 4: Bank finance and corruption in MENA and East Asia
Percent of firms that list
access to and cost of
financing as a “major or
severe” obstacle
Percent of working
capital financed with
bank credits
Percent of firms that list
corruption as a “major or
severe” obstacle
Medium
firms
(20-99
employees)
Large firms
(100+
employees)
Medium
firms
Large
firms
Medium
firms
Large firms
Algeria
(2002)
62.08
(199)
54.34
(66)
14.02
(184)
15.58
(59)
31.91
(193)
18.05
(65)
Egypt
(2004)
35.97
(262)
41.54
(142)
5.46
(351)
10.84
(169)
50.44
(346)
50.49
(167)
Jordan
(2006)
7.31
(184)
5.64
(88)
9.72
(185)
11.53
(88)
9.77
(184)
3.90
(88)
Morocco
(2004)
85.36
(321)
86.36
(242)
1.79
(321)
6.31
(242)
14.64
(321)
21.49
(242)
Syria
(2003)
30.25
(224)
22.84
(43)
3.27
(206)
3.55
(38)
62.82
(226)
56.73
(42)
Cambodia
(2003)
13.97
(56)
3.48
(25)
3.19
(69)
2.8
(25)
43.76
(68)
31.74
(25)
China
(2003)
27.30
(370)
33.83
(541)
19.79
(657)
37.71
(746)
28.38
(370)
25.32
(541)
Lao PDR
(2005)
15.87
(63)
14.29
(28)
9.00
(60)
4.18
(28)
1.59
(63)
0
(28)
Vietnam
(2005)
44.9
(374)
41.02
(527)
20.37
(385)
36.85
(528)
11.50
(340)
10.33
(471)
Source: The World Bank, Investment Climate Surveys (various years). Countries with competitively elected
leaders are omitted (e.g., Indonesia). http://www.enterprisesurveys.org.
The key indicator that bank financing is problematic for firms is whether firms rank bank
financing as an obstacle and exhibit low levels of bank financing, relative to firms in other
countries. Firms in Jordan, Cambodia, and Lao PDR tended not to regard finance as an obstacle,
but also tended not to use bank financing for working capital. However, the difference between
the fraction of firms in Algeria, Egypt, Morocco and Syria that described bank financing as an
important obstacle and did not report using bank financing for working capital was as much as
three times higher than in China. The fraction of firms that reported using bank financing for
32
working capital was much lower in these countries than in China (as much as 10 times less,
comparing Chinese and Syrian medium-sized firms).19 Table 4 suggests a substantial mismatch
between the bank credit that Figure 7 reports is flowing to the private sector and firm reports of
whether that credit is actually reaching them.
Further evidence that total domestic credits to the private sector (Figure 7) are a
misleading indicator of the costs of access to finance comes from a recent report on the financial
sector in Egypt illustrates this (World Bank 2006). Using data from the Central Bank of Egypt,
the study concludes that 565 borrowers (approximately 0.2 percent of total borrowers) receive
more than 50 percent of total credits issued by Egyptian banks to the private sector (Table 2.1, p.
22). The importance of large deposits also suggests that access to credit is a barrier to entry.
When it is costly for banks to verify the liquidity position condition of firms, as when accounting
systems and audit standards are poor, or when banks face few competitive pressures, banks can
demand that potential borrowers place significant funds on deposit as a condition for lending. In
Egypt, competitive pressures on banks are few: most loans (more than 50 percent) and most
branches (85 percent) are held by state-owned or state-controlled banks (p. 24).20 Extremely
large deposits (greater than 5,000,000 Egyptian pounds) constitute 22 percent of total deposits at
state-owned banks (and much less than five percent at all other banks).
In these same situations, demands for collateral can be larger than in more efficient and
competitive financial systems (e.g., exceeding the value of the loans). In fact, firm responses to
the surveys used in Table 4 indicate that MENA firms are more likely to report that access to
land is a “major or severe” obstacle: 35 percent of medium-sized firms in Algeria, 26 percent in
Egypt; 42 percent in Morocco; 38 percent in Syria; but only 3 percent in Cambodia and 12
percent in China. Of course, barriers to land access are a problem beyond their impact on credit
markets and can also reflect official efforts to set up barriers to market entry to potential
competitors of favored incumbents.
One final piece of evidence that barriers to entry are significant in MENA countries,
despite apparently favorable aggregate governance and business climate indicators, is the
comparison of trade policies in Figure 8. It is notoriously difficult to provide “apples to apples”
19 Moroccan and Algerian firms report significantly higher rates of bank access to capital for new investment (e.g.,
31 percent of large firms in Algeria compared to 28 percent of firms in China use bank capital for new investment).
It is easier to interpret answers to the working capital question, however: working capital refers to percent of total
financing from banks, while the investment question refers to any bank financing, no matter how small; answers are
less likely to refer to bank access in years past; the use of banks for working capital is less likely to be influenced by
access to bond and equity markets; directed credit by governments is more likely to target investment than working
capital; and the question about working capital was less likely to be viewed as hypothetical by respondents.
20 This is typical of the region: in Algeria, state-owned banks control approximately 91 percent of assets and
liabilities in the financial sector while in the Kingdoms of Jordan and Morocco, although state-ownership is less
important (zero and 23 percent of all lending, respectively), private banks have close links to the ruling families.
State-owned banks may be an important vehicle for solving commitment problems in non-institutionalized
countries, at least between leaders and large private enterprises. By authorizing large loans from state-owned banks
to these enterprises, leaders confront the risk that if they expropriate the rents of the firm, they will render large
liabilities of the firm unpayable. The losses to the state-owned bank must then be absorbed either by the rulers
themselves or by depositors (including citizens generally, as well as the other large enterprises that have large sums
on deposit). To the extent that citizens bear the costs of the default, revolt risk is more likely; to the extent that
rulers or other enterprises bear the cost, rulers lose rents.
33
comparisons of trade policies.21 Figure 8 describes the results of the most sophisticated effort to
do so. It shows that trade barriers are only low in those MENA countries with no comparative
advantage in manufacturing (Oman, Saudi Arabia, Bahrain). However, in countries such as
Morocco, Egypt and Algeria, all with substantial unemployment, larger markets, and excellent
access to EU markets, trade barriers are high. There are, of course, well-known examples from
East Asia that suggest trade protection is not inimicable to growth. Korea, for example,
combined high trade barriers, fast growth and large manufacturing exports. The difference,
however, is in degrees of institutionalization: Korean governments were able to credibly
condition trade protection on export growth. MENA governments do not, and perhaps cannot.22
Figure 8: Trade Restrictiveness, selected MENA countries and comparators
Overall Trade Restrictiveness, Manufacturing
(Tariff and NT Barriers)
Malaysia
Indonesia
China
Tunisia
Morocco
Jordan
Egypt
Algeria
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Source: Source: Kee, Nicita and Olarreaga 2006
Low investment rates are not the only consequence of the trade, finance and governance
barriers identified here. Another is enterprise structure. In particular, there is some, at least
anecdotal evidence that MENA firms are more likely to be vertically integrated than their
counterparts in more “institutionalized” countries. Under some special circumstances, vertical
integration constitutes a barrier to entry, one that benefits even those incumbents that do not
21The mix of non-tariff and tariff barriers varies from country to country and the trade weights used in weighting
trade barriers on specific goods depend on the barriers themselves.
22 Egypt has recently undertaken trade reforms (over the period 2004-06). Recent economic developments
(significant accelerations in reported FDI and economic growth) appear to have been very positive, underlining the
role that trade barriers play in keeping out growth-promoting entry. It is possible that investment and growth
improvements reflect the formalization of pre-existing informal and unreported activity; they are, however,
nonetheless striking.
34
benefit from special rent-seeking arrangements with governments. Box 1 describes the apparent
role of vertical integration in MENA countries.
Box 1: Vertical Integration, institutionalization and barriers to entry in MENA
Successful firms in the MENA region appear to be more vertically integrated, from raw
material processing through to the manufacture of final outputs, than their counterparts in the
same industries in more institutionalized countries. In conversation, the owner of at least one
vertically integrated firm indicated explicitly that vertical integration was an important tool to
deter competition. Sekkat reports that vertical integration in the rebar (steel) industry is
associated with market domination in Egypt. The owner of one firm in North Africa, with a
large market share in the manufacture of window frames, described his firm’s steady progression
upstream, going from purchasing finished polyvinyl chloride (PVC) inputs to buying PVC
powder and producing the PVC needed to build window frames entirely in-house; and going
from buying glass to manufacturing it in-house. A large cable manufacturer in Egypt made the
same upstream move into the manufacture of PVC inputs into cable.
Vertical integration is an obstacle to competition only under narrow conditions. In
particular, it deters entry only if a) vertically integrated firms are more efficient (otherwise, two
non-integrated upstream and downstream firms could do business to produce final output at
equal or lower cost and drive out the vertically integrated firm) and b) costs of entry (e.g., of
capital or of finding managerial talent) are high for potential entrants (so that they cannot enter
with sufficient scale to compete with the vertically-integrated incumbent). The industries
mentioned above, such as window frames, are far less vertically integrated in institutionalized
countries, where one or both of these conditions does not hold.
However, in non-institutionalized countries, as in MENA, imports of inputs are costly
(e.g., because of port functioning and other trade barriers); contracts are harder to enforce (e.g.,
when property rights weak); and especially when hold-up is possible (when specific assets are
required to produce for downstream firm); and financial markets heavily favor incumbents. The
market for managerial talent is also known to be thin in MENA. If starting a verticallyintegrated enterprise is more technically and organizationally demanding, and the market for
managerial talent is thin, then incumbents (who already have mastered the complexities of one
stage of production) can vertically integrate more cheaply than entrants can start a verticallyintegrated competing firm.
Note that these particular firms do not necessarily benefit from regime largesse. Their only
advantage is perhaps to have owners from elite families, with names sufficient to shield them from
expropriation by government officials, but not to extract substantial subsidies or entry protection.
Unfortunately, although such firms are likely to thrive in the face of business environment
improvements, they are unlikely to support improvements in the business environment that would
make entry cheaper, not least because the value of their investments in vertical integration would
fall.
In sum, although the portrait of the business environment painted by Figures 4, 5 and 6
paint a positive picture of the MENA business environment, there are numerous reasons to
believe that this picture is not entirely accurate. Incumbents seeking to preserve rents, and
political decision makers seeking to aid incumbents, need only one policy instrument to keep out
entrants. No matter how liberal a country’s policy environment might appear in general, a mere
handful of restrictive policies could nevertheless successfully deter most entry, as could the
35
ability of a handful of firms to receive favorable, ad hoc exceptions to even generally liberal
business regulations and taxes. This appears to be the case in MENA.
Policy Implications for MENA
Some of the underlying issues identified here that undermine political incentives to
promote private investment are not susceptible to simple policy fixes, such as the reluctance to
institutionalize because natural resource rents are high or social unrest is simmering or the
leadership group is not cohesive. In all of these cases, however, governments desire faster
growth, they are simply unwilling to make the institutional concessions necessary to achieve it.
The policy challenge is to find ways to provide investor guarantees that do not require
institutional changes that leaders oppose.
Two reforms in particular may improve the investment climate and the credibility of
government commitments without challenging leader reluctance to institutionalize. The first is
Special Export Zones, with dedicated regulatory oversight, meritocratically and transparently
chosen, that is compensated based on the success of the zones. Ideally, of course, such standards
would be applied to the entire civil service, but this would involve excessive institutionalization
from the point of view of leader political calculations. For example, a Chinese-style system of
compensating governors and mayors based on local economic growth would require sacrificing
other, more clientelist and personalist criteria in the selection and compensation of these
officials.
The second possible reform is substantially increased investment in growth-oriented
infrastructure. Governments have more to lose by reneging on commitments to private investors
if the political payoffs to large infrastructure investments are low in the absence of a private
investor response. Infrastructure thus has a double payoff in terms of attracting private
investment: it directly lowers costs of doing business, and it raises government costs of reneging
on commitments not to expropriate. Public investment has played a large role in Chinese
growth, and exceeds, as a percent of GDP, public investment in any other country.
Such reforms are not easy to implement in a broadly unsympathetic political
environment. For example, it is difficult for governments to credibly promise bonuses in
exchange for success. In EPZs this can be addressed by arranging for compensation to be paid
directly by zone occupants. It is also difficult for governments to withstand pressures to avoid
spending resources on investments with a more distant payoff when the leadership group cannot
make credible promises among each other regarding the distribution of future benefits to that
investment. Nevertheless, in difficult political environments, where leaders are reluctant to
allow institutionalization, partial reforms such as these offer a strategic direction for considering
how to accelerate private investment without challenging non-negotiable political arrangements
that undermine stronger support for private sector-led economic growth.
36
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