How political favours hinder economic growth

The majority of working-age people in MENA face a choice: they can be unemployed; or they can work in low-productivity, subsistence activities often in the informal economy. In particular, only 19% of the working age people in MENA have formal jobs.

The main reason is that the private sector does not create enough jobs. Between 42% and 72% of all jobs are in micro firms in MENA, but these micro firms do not grow. In Tunisia, the probability that a micro firm grows beyond 10 employees five years later is 3%.

Why has private sector job creation been so weak?

Given the jobless growth in the region, one might suspect that the determinants of job creation are different in the Middle East and North Africa. They are not! The types of firms that create most jobs in the region are the same as in other faster growing regions.

1. Startups create the most jobs. Micro startups accounted for 92% of total net job creation in Tunisia between 1996 and 2010 and 177% of total net job creation in Lebanon between 2005 and 2010.
2. More productive firms create more jobs. Firms with higher initial productivity create more jobs in the subsequent five years in all countries in the region with data.

The problem is that there are not enough startups and productivity growth has been weak. For instance, for every 10,000 working-age persons, only six new limited liability firms are created annually in MENA countries compared to an average of 26 new firms among all developing countries worldwide. Moreover, firms in Egypt and Tunisia barely increase their productivity in the first 35 years after entry, while firms in Mexico, India or Turkey increase their productivity 2-3 fold over the same period.

Why have firm startup and productivity growth been so low?

Jobs or Privileges shows that the reason is policies that privilege a few dominant firms by insulating them from competition. Four examples of such policies that stifle fair competition in the region:

1. Restrictions on foreign firms to enter service sectors are among the highest in the world. Removing the restrictions on foreign direct investment into service sectors in Jordan would create more jobs in domestic service firms: a 1% increase in the industry share of employment in foreign service firms would increase employment growth among domestic service firms by 1 %-point over a five years period.
2. Red tape in Morocco reduces job creation. In particular, unequal and unpredictable treatment by tax administrations, corruption and obstacles in the judicial system, and high cost of finance limit the growth of startups which are the engine of job creation.
3. The generous energy subsidies to industry in Egypt undermine competition and cost jobs. As a result, despite lower wages in Egypt relative to Turkey, labor-intensive manufacturing firms in Egypt employ 320,000 fewer workers.
4. Discriminatory policy implementation in the Middle East and North Africa crates an uneven playing field reducing competition among firms. For instance, firms with deep political connections in Egypt receive fewer tax inspections by government officials.

Given that these policies cost jobs, why are they still in place?

Policies in the region have often been captured by a handful of politically connected firms which created privileges rather than jobs. While the problem is regional, we focus on Egypt and Tunisia. In both countries, politically connected firms are firms that are managed or owned by businessmen either controlling a high political post in the government or ruling party, or whose assets have been confiscated in 2011 because they were owned by the (former) ruling family.

Jobs or Privileges finds that the activities of the 469 politically connected firms in Egypt and 215 connected firms in Tunisia are widespread across economic sectors. And these were the sectors that obtained generous policy privileges.

For instance, 45% of connected firms in Egypt operate in high-energy-intensive industries compared to only 8% of all manufacturing firms. Energy subsidies lead to privileges rather than jobs!

Moreover, 43% of sectors with at least one connected firm in Tunisia are protected from foreign entry into service sectors compared to only 14% of non-connected sectors.

When tariffs started to decline in Egypt, non-tariff technical barriers to import increased. These barriers were not imposed randomly: 71% of politically connected firms but only 4% of all firms sell goods that are protected from foreign competition by non-tariff barriers (The Economist: Friends in high places).

Privileges suppress the firm dynamics associated with job creation. In Egypt there are fewer startups in sectors dominated by politically connected firms despite the generous privileges in these sectors. The bottom line is that, when a politically connected firm enters a non-connected sector in Egypt, job growth declines by 1.4 percentage points annually.

Where do we go from here?

The simple answer is: reform the policies that privilege a few connected firms at the expense of the millions of workers and non-connected entrepreneurs. But how can such policies be reformed against the interest of few influential beneficiaries? What does it take to create institutions that safeguard competition? What is the role of citizens in institutions that are supposed to safeguard competition?

This post first appeared on The World Bank Future Development Blog

Author: Marc Schiffbauer is an economist in the Poverty Reduction and Economic Management unit within the Middle East and North Africa region. Abdoulaye Sy is an Economist in the Macro and Fiscal Management Global Practice at the World Bank. Sahar Hussain joined the World Bank as an Economist in February 2013. Hania Sahnoun is an Economist – consultant.

Image: People walk past clocks at Reuters Plaza in London. REUTERS/Jon Jones.