Download Economic Growth in Egypt: Constraints and

Economic Growth in Egypt:
Constraints and Determinants
Anton Dobronogov
(based on a paper co-authored
with Farrukh Iqbal)
Summary
• Econometric analysis: trends in
government consumption, credit to the
private sector and the average growth rate
of OECD countries have been significant
determinants of growth in 1986-2003
• Growth diagnostic technique: in the early
2000s inefficient financial intermediation
was a significant constraint on growth
Plan of the presentation
• Egypt’s growth performance in 1960-2003:
phases and trends
• Econometric analysis of growth
performance in 1986-2003
• Growth diagnostic for the early 2000s
• Experience with growth diagnostic
approach: some lessons and questions
Divergence, convergence,
divergence, convergence…
percentage points
GFP per capita growth
5 year moving average
8
7
6
5
4
3
2
1
0
1960
1965
1970
1975
1980
Egypt
1985
OECD
1990
1995
2000
Increased correlation with OECD
growth after 1985…
Egypt and OECD growth rates:
moving 5-year correlation
1
Correlation coefficient
0.8
0.6
0.4
0.2
0
-0.21960
1965
1970
1975
1980
-0.4
-0.6
-0.8
-1
Year
1985
1990
1995
2000
… but there has been also
convergence in volatility levels
GDP per capita grow th
5 year moving standard deviation
7
6
% GDP
5
4
3
2
1
0
1960
1965 1970
1975
1980
Egypt
1985
1990 1995
OECD
2000
Phases of growth
Phase 1: 1961 – 1973
•
•
•
•
•
Low growth and divergence from OECD
The state dominated the economy
Import substitution policies
Low share of private sector in the GDP
Large military expenditures, two wars
Phases of growth
Phase 2: 1974 – 1985
• High growth and convergence with OECD
• The government launched the “Open Door
Policy”
• Dramatic increase in windfall revenues from the
Suez Canal and from petroleum exports
• Deterioration of fiscal institutions: government’s
current expenditures rose even faster than
revenues
Phases of growth
Phase 3: 1986 – 1991
• Low growth and divergence from OECD
• Collapse in windfall revenues following the
1985-86 oil price crash
• Fiscal deficits averaged about 15% of GDP
throughout this phase, accommodated through
expansionary fiscal policy
• Current account deficits up to 8% of GDP
• Lower oil prices – lower implicit energy subsidies
– lower effective protection
Phases of growth
Phase 4: 1992 – 1998
• High growth and convergence with OECD
• Successful macroeconomic stabilization, the
fiscal deficit fell from 15% to 1.3% of GDP in four
years;
• About one third of all state-owned enterprise
assets privatized between 1991 and 1998;
• Establishment of a free foreign exchange market
for current account transactions and some
easing of capital account restrictions.
Gross Fixed Domestic Investment In Egypt and the Best
Performing
Lower-Middle Income Countries
40
35
% GDP
30
25
20
15
10
5
0
1980
1985
Egypt
1990
Top ten LMIC (mean)
1995
2000
Top 10 LMIC (median)
Current Expenditure, Capital Expenditure, and Budget Surplus
in Egypt, 1991-2003
30
20
10
0
1991
1994
1997
2000
2003
-10
-20
Capital expenditure
Current expenditure
Budget surplus
Working Age Population As Share of Total Population
in Egypt, 1960-2040
Population ages 15-64 (share of total)
0.70
0.65
0.60
0.55
0.50
0.45
0.40
1960
1980
2000
2020
2040
Phases of growth
Phase 5: 1999 – 2003
• Lower growth and slowdown in convergence
• Several shocks including the Luxor terrorist
attack in 1997, the global financial crisis of 199799, and a domestic financial scandal in 1998-99,
September 11 (2001), war in Iraq (2003);
Current Expenditure, Capital Expenditure, and Budget Surplus
in Egypt, 1991-2003
30
20
10
0
1991
1994
1997
2000
2003
-10
-20
Capital expenditure
Current expenditure
Budget surplus
Money supply in Egypt
Money and quasi money (M2)
100
% GDP
80
60
40
20
0
1986
1989
1992 Year 1995
1998
2001
30
25
20
15
10
5
0
Claims on government
Claims on private sector
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
-5
1987
Annual growth as % of M2
Growth of Domestic Credit in Egypt
Banking Deposits and External Capital Account
Balance in Egypt
70
10
60
5
50
0
40
-5
30
20
-10
1991
1996
Banking deposits, % of M2
2001
External capital account balance, % GDP
Major Stock Market Indicators In
Egypt
40
35
% GDP
30
25
20
15
10
5
0
1986
1988
1990
1992
1994
1996
1998
2000
2002
Year
Market capitalization of listed companies, % GDP
Stocks trades, % GDP
Econometric analysis: variables
Dependent variable: GDP per capita growth
Independent variables (correlations with GDP per
capita growth are in parentheses): growth of
• OECD GDP (0.36);
• Government consumption (share in GDP; -0.40);
• Credit to the private sector (share in M2, 0.62);
• Credit to the government (share in M2, -0.08);
• Share of working-age population in the total
population (0.37).
Results of the Econometric Analysis
Specification
1
2
4
3
5
6
Growth rate
0.556**
(2.39)
0.480*
(2.17)
0.566**
(2.59)
0.563***
(3.40)
0.500**
(2.60)
0.558***
(3.48)
-0.161***
(-3.14)
-0.145**
(-2.95)
-0.163***
(-3.41)
-0.157***
(-4.08)
-0.202***
(-4.67)
-0.167***
(-5.00)
Credit to private sector, % M2
0.145*
(2.13)
0.141*
(2.07)
0.147**
(2.29)
0.137**
(2.63)
0.154**
(2.91)
0.151***
(3.47)
Credit to the government, % M2
-0.008
(-0.15)
0.029
(0.74)
-0.000
(-0.47)
-0.000
(-0.07)
-0.039
(-1.40)
-0.017
(-0.76)
Population 15-64, % total
0.381
(0.22)
2.090***
(3.43)
-
0.735
(0.54)
0.202***
(4.66)
-
0.001
(1.03)
-0.028**
(-2.83)
-0.021**
(-2.73)
0.002 ***
(3.73)
-0.029***
(-3.28)
0.001
(1.04)
-0.025***
(-4.28)
-0.830***
(-4.68)
0.001***
(6.00)
-0.026***
(-5.28)
-
-
-
-0.497**
(-2.97)
-0.519**
(-2.68)
-0.472**
(-3.09)
R-squared
0.80
0.79
0.80
0.90
0.84
0.90
Adjusted R-squared
0.70
0.70
0.72
0.83
0.76
0.84
OECD GDP, %
Government consumption, % GDP
T
C
AR(1)
Robustly statistically significant
variables
• trends in government consumption (-)
• credit to the private sector (+)
• the average growth rate of OECD
countries (+)
Growth diagnostic approach
Growth diagnostic decision tree
Growth
problem
Low social returns
Low appropriability
High cost of finance
Bad international
finance
Poor geography,
bad infrastructure
Coordination
and
information
failures
Poor tax
system
Bad local finance
Expropriation
risks
Macro risks
Low
domestic
saving
Poor intermediation
Searching for a binding constraint in
Egypt
• Macro instability appears to have been
binding on growth in the beginning of
1990s
• After stabilization growth resumed, but hit
another constraint in about 1997
Is it social returns? Physical capital
1986-91
GDP pc growth
1.3
GDP growth
3.7
Private I/GDP
12.3
Public I/GDP
18.1
1994-99
3.0
5.0
8.6
14.6
Investment Rates in Egypt
25
20
15
10
5
0
1986
1991
Private I/GDP
1996
Public I/GDP
2001
Is it social returns? Human capital
Basic
Read
Write
and
vs.
and
Basic
Illiterate
1999/2000
13.2
*
-3.4
Gross primary school enrollment in
Egypt
120
-0.1
100
80
%
Read
Write
1995/96
vs
4.2
5.7
60
40
20
0
1980
1985
Total
Secondary
-0.7
2
University
7.1
8
1990
Female
1995
Male
2000
Is it insufficient private appropriation? Rule of law
Is it insufficient private appropriation?
Is it insufficient private appropriation? Taxes
• ICA: “high taxes” and “tax administration” as
important problems from business perspective
• High degree of informality: about 84% of SME’s
(not including micro) found to be (partly) informal
in1998
BUT …
Is it insufficient private appropriation? Taxes
• The average tax to GDP ratio for top 10 LMIC for
the latest available year is 15.8%. In Egypt it
was 13.9% in 2003, down from 16.5% in 1997.
• We also have data for 6 out of top 10 LMIC for
1998 on the marginal tax rates (corporate and
individual). The average corporate one is 35.8%;
the average individual one is 41.2%. In Egypt
they were 40% and 32% respectively in 2003.
Then it is finance
• But not international one: Egypt has
comfortable access to lending from the
IFIs as well as to foreign capital markets
• Domestic savings rate remained low (more
on this later) but constant throughout
1990s and is likely to be increasing in the
course of demographic transition
• So we have to look into quality of domestic
financial intermediation
Upward trend in real interest rates and
lending margins
15
10
5
0
-5
1986
1991
1996
2001
-10
-15
-20
-25
Deposit interest rate (%)
Lending interest rate (%)
Finance: access
Low access and “insider problem”, hence higher shadow
price of finance.
Firms having an outstanding loan from a financial
institution
40
36
35
30
%
25
17.4
20
15
13
10
5
0
Small
Large
All
Share of debt in the working capital of the firms which have
an outstanding loan is 46%, whereas for firms which do not
have an outstanding loan, this share is 0.
Finance: supply-side problems
• Financial system strongly pro-cyclical, low
resilience to shocks (especially capital markets,
but also banks)
• Public banks dominate banking system
• Large domestic public debt (60% of GDP), shortterm instruments -> crowding out private credit,
no incentives for the banks to search for new
clients, amplified risk-aversion during bad times
• From 16% to 30% of all loans are nonperforming, in part because of politicized lending
practices
Finance: problems (continued)
• Collateral-based lending is dominant (92%
of transactions)
• Credit registry is underdeveloped
• Property rights are poorly defined, notably
for land
• Collateral is scarce
• Some 40% of firms not having outstanding
loan reported to have applied but were
rejected
Why growth in Egypt
accelerated in the first half of 1990s, but slowed down
in the end of the decade
• Macroeconomic stabilization cut off unsustainable
expansion of banking credit to the government
• This suddenly left the banking system with extra
resources to lend to the private sector.
• Private credit went up and so did the economic growth
rate, but because of insufficient assessment capacity of
the banking system and politicization of the credit
allocation process, the quality of lending stayed poor.
• When hit by the financial scandal of 1998-99, the system
became even more dysfunctional. The harsh reaction of
the government increased the risk-aversion of the banks,
a tendency reinforced by rising levels of non-performing
loans, scarcity of collateral and external shocks.
Why growth in Egypt… (continued)
• After the CBE eased monetary policy, banking deposits
started to grow as a percentage of GDP (though falling as a
percentage of M2), but so did the lending-deposit interest
spread (from 360 basis points in 1998 to 530 in 2003).
• Increased financial intermediation margin slowed down
lending to the private sector.
• Furthermore, during the growth slowdown, the government
carried out expansionary fiscal policies which led to higher
budget deficits and higher borrowing by the public sector.
• This increased the probability of “forced” roll-over of
government securities, hence further reducing the banks’
willingness to lend.
• A combination of these factors resulted in excess liquidity of
the banking system instead of higher private investment.
• It is in this sense that the financial system posed a
constraint to economic growth after 1999.
Some lessons from experience with
application of growth diagnostic
approach
Why distinction is made between social
and private returns to investment, but not
between social and private costs of
finance?
If the financial system seriously misallocates
resources, this would affect social costs of finance
through high opportunity costs and possibly high
fiscal costs (e.g. if the government uses the
taxpayers' money to bail out poorly performing
public banks), yet private costs for those who have
access to finance may remain low
Why only insufficient private appropriation may
adversely affect growth, but not unequal
private appropriation?
• Think of an economy with pervasive rent-seeking and "insideroutsider" problem; e.g. with high barriers to entry and/or large badly
targeted subsidies
• In this economy private returns for insiders are likely to exceed
social returns (e.g. appropriation will be excessive) and could be
quite high, whereas for outsiders appropriation will be very low
• There is no guarantee whatsoever that the insiders are
talented entrepreneurs
• If they are not, this will push private investment and growth
down;
• This situation may surely could and does persist in some
countries for quite prolonged time periods
• Similarly, private costs of finance for some economic agents
could be lower than social costs, e.g. because of subsidies, and
higher for others, e.g. because of bribes needed to get access to
credit.
Some criticisms are not justified
• - "GD approach looks for silver bullets" - not if you view it
as a tool for prioritization of policies and reforms;
• - "GD approach does not take into account policy
complementarities" - not really: if the constraint binds on
growth, it will not be a "stand-alone" thing, rather it will be
connected to a number of policy areas
• - "binding constraints bind because they are politically
difficult or impossible to remove, so it is less useful to
identify them" - even if the first part of this statement is true,
it is still possible to think about politically feasible ways to
shift the constraint out somewhat if not removing it
completely;
• Furthermore, the most relevant costs could be financial
rather than political; if the constraint binds on growth, expost financial costs of its removal are likely to be low
(welfare gains produced by growth acceleration will almost
certainly outweigh them), but these costs may loom large
ex-ante - and that's exactly when the Bank can help a
country the most.
Economic Growth in Egypt:
Constraints and Determinants
Anton Dobronogov
(based on a paper co-authored
with Farrukh Iqbal)