Egypt: Good Progress to Date, but Sustainabil- Ity Requires Deep, Transformational Change

Egypt: Good Progress to Date, but Sustainabil- ity Requires Deep, Transformational Change

February 20, 2019

George Abed, Distinguished Scholar in Residence, [email protected], +1 202 857 3310 Chun Jin, Research Intern, [email protected], +1 202 857 3337 Boban Markovic, Senior Research Analyst, [email protected], + 202 857 3632

KEY POINTS • Egypt is making good progress on economic reforms in the context of an IMF-supported program. This is re- Exhibit 1: GDP Per Capita, 1980-2018 flected in higher growth, reduced deficits, a reformed exchange regime and higher reserves. Current $, thousands 28 Korea 24 • Egypt is also making headway on the more pressing and long-debated structural reforms of fuel subsidies and is- 20 sues related to the business environment, thereby improving the immediate outlook. 16 Turkey 12 • However, to sustain the progress and to lift the growth trajectory durably over the long term, deeper and more 8 Malaysia fundamental reforms are urgently needed. EMs 4 Egypt • Prolonged neglect of deep-rooted structural distortions 0 1980-89 1990-99 2000-09 2010-18 has impeded Egypt’s ability to match its more successful EM peers in raising its standard of living and in reaping Source: IIF and IMF the full benefits of globalization (Exhibit 1).

• While the current policy of incremental reform could EGYPT’S IMF-SUPPORTED REFORMS continue to produce marginal, albeit often impermanent Once more the IMF moved the goal posts and allowed Egypt improvements, the urgent need is for a serious reconsid- to pass the fourth review of the program agreed in 2016 and eration of the country’s growth model and its state-led thereby receive the penultimate $2 billion disbursement of a development strategy. $12 billion loan. To be sure, the Egyptian authorities have in fact implemented much needed macroeconomic reforms, in- • The approach needs to transform the role of the private cluding a sharp devaluation of the pound, some belt-tighten- sector to become the leading engine of growth while re- ing and interest rate hikes to combat inflation, and a partial ducing the dominance of the state in the functioning of reform of fuel subsidies. The authorities were supposed to markets and in direct economic activity. The state should focus on securing a healthy business environment for complete the reform of fuel prices to include cost recovery sustainable and inclusive growth. targets and indexation to international prices, but the task was only partially executed, a reason why the fourth review of the program was not completed on time last October. But • Finally, the reform program needs to phase out, gradu- now Egypt promised to complete the promised reforms by ally and, hopefully, non-disruptively, the role of the military in economic policy setting and in all commercial ac- the end of the program later in the year. The IMF in turn al- tivity that is extraneous to its core mission. lowed the disbursement of the $2 billion installment.

But even if Egypt were to complete all the reforms written time, the state sector is comparatively large and is heavily into the program on time, that would have only scratched the weighed down by a bloated government bureaucracy and an surface. For beyond the long overdue and much debated unreformed public enterprise sector stuck in the past, state- macroeconomic reforms, there remain deep layers of struc- led development paradigm. Embedded in this sector is an in- tural inefficiencies and distortions that have plagued Egypt creasingly bold security establishment invested in its own economic performance for decades. The more obvious struc- sprawling economic and commercial dominion. Bolstered by tural impediments were identified in discussions with the the powers of emergency rule and determined to snuff out IMF, and a few of the these are being addressed by the au- any serious political challenge, the regime has also increas- thorities. These include completing work on new procure- ingly tightened its grip on the levers of economic power. The ment and competition laws, and the introduction of a new overriding objective of the Sisi regime appears to be to main- insolvency regime. Progress however, has been slow and if tain political stability at all costs and to prevent a fateful slide previous experience is any indication, it will be some time towards the ‘chaos’ of the Arab Spring rebellion. And given before such reforms produce the expected benefits. the imminent constitutional changes affecting Presidential term limits, the prevailing policy view could endure for many The deeper reforms needed to transform the Egyptian econ- years to come. omy, however, remain untreated. The overarching objective of the current program, as in the case of previous efforts at EGYPT HAS BEEN HERE BEFORE fundamental reform, has been to alter the structure of the In the past three decades, there have been at least two im- economy after decades of state-led development by gradu- portant episodes of attempted structural reform and both ally scaling back the overpowering role of the state in the ended with only modest and impermanent results. One was economy, and through an overhaul of the business environ- in the early 1990’s when Egypt was rewarded for its major ment, empowering the private sector to take the lead gener- role in the First Gulf War with considerable donor funds that ating high rates of inclusive and sustainable growth and were used to pay off debt and support a program of economic meaningful job creation. Reforming the social protection reform and privatization. Beyond a substantial reduction in program, including the decades-old system of consumption debt, and some temporary improvement in macroeconomic subsidies which was the focus of the current program, was to indicators, in large part because of aid inflows, actual results have been accomplished years ago. The failure to build a dy- of that program on structural reform were modest. namic, innovative and outward-oriented private sector to serve as Egypt’s growth engine has long been viewed as the The other, meaningful reform drive was undertaken by a main reason why Egypt has fallen short on matching its more pro-business government under President Mubarak in the successful emerging market peers in achieving high and sus- early 2000s. During that period, Mubarak’s own son, Gamal, tainable growth and in reaping the benefits of globalization. spearheaded the reform drive through his position in the rul- It was time therefore to reconsider the country’s growth ing National Democratic Party. The program again tackled model and development strategy. macroeconomic imbalances and addressed some non-fundamental structural issues. The reforms achieved positive To many observers, it is now becoming increasingly clear results, including higher growth rates and a notable rise in that Egypt’s inability to fully execute on structural reform is foreign direct investment, some of which funded some pri- due to the resistance of a powerful state economic sector and vatization of public enterprises. But both the structural re- its unwillingness to yield the power and the privileges it has forms and the privatization campaign faced stiff resistance long enjoyed to a revitalized private sector that could con- from the ‘deep state’ and to some extent, from the public. In ceivably develop into a competing power center. At the same the end, the program’s accomplishments, substantial in

Exhibit 2: Selected Macroeconomic Indicators, 1988-2020

2000-09 2010-16 2017 2018 2019f 2020f Real GDP growth, % 5.0 3.4 4.2 5.3 5.8 5.1 Unemployment rate, % 9.8 12.7 11.8 10.9 10.2 9.7 Inflation, average consumer prices, % 7.5 9.7 23.3 20.9 14.5 10.0 Current account balance, % of GDP 0.8 -3.1 -6.1 -2.4 -1.2 -0.8 Volume of exports of goods, % change 8.7 -3.8 12.5 9.3 9.0 7.0 Fiscal balance, % of GDP .. -11.1 -10.7 -9.5 -8.1 -7.0 Central gov’t domestic debt, % of GDP 64.0 69.4 77.4 70.3 62.5 56.8 Central gov’t external debt, % of GDP 20.7 23.6 30.0 30.0 32.7 34.2 Source: National Authorities, IIF and IIF Forecast for 2019, 2020

some respects, became tarnished by claims of high-level cor- Exhibit 3: Current Account Balance, 1991-2018 ruption and quickly began to fade. It was not long before the reforms were abandoned with the onset of the 2011 Arab % of GDP $, billion 10 5 Spring uprising and the turmoil that followed. 8 0 THE PROGRESS TO-DATE 6 It comes as no surprise, therefore, that Egypt’s performance under the current Fund-supported program is showing une- 4 -5 ven outcomes. There has been some progress on the ‘low 2 hanging fruit’ of macroeconomic imbalances, but little dis- 0 -10 cernible movement on the fundamental reforms that would -2 ultimately lead to a reduction in the bulk and influence of the -15 state in the economy and to reinvigorating the role of the pri- -4 % of GDP $ billion (rhs) vate sector. -6 -20 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 On the macroeconomic front, progress is notable (Exhibit 2): Source: IIF the currency has nearly stabilized at the new, sharply depre- ciated rate under a managed float regime with some positive impact on export receipts (especially tourism), growth has Exhibit 4: Fiscal Balance, 1991-2018 risen to 5.3%, unemployment is down but remains stub- % of GDP bornly high at 10%, global financial markets have responded 42 with strong inward capital flows, inflation has declined after a spike, to around 12%, while the current account and fiscal 32 deficits have narrowed, the former substantially so (Exhibits 22 3 and 4). Domestic public debt has declined sharply although Fiscal Balance foreign debt has risen dramatically (Exhibit 5). The IMF’s in- 12 Total Revenue itial support and Egypt’s commitment to an IMF program Total Expenditure that showed early progress also attracted an additional $19 2 billion from regional and other multilateral sources. This -8 and other factors helped Egypt triple its foreign exchange reserves to the equivalent of 6.5 months of imports. -18 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 Market assessment of Egypt’s performance under the program has been positive but tentative due to the fragility of Source: IIF the progress to date. For example, the fiscal deficit has declined but only to 9.5% in 2018, while capital inflows have been mostly in the form of volatile, non-resident purchases Exhibit 5: Total Public Debt, 2002-2018 of high-yielding government bonds, with only small amounts of non-energy related FDI (Exhibit 6). % of GDP % of exports 150 21 External Debt, % of GDP The reluctance of foreign investors to make long-term com- Domestic Debt, % of GDP 18 120 mitments to Egypt stems from a poor business environment Total Debt Service, % of exports (rhs) 15 including lack of competition in some important sectors, a 90 condition that is possibly aggravated by the influence and 12 reach of the military establishment in the economy more 60 9 generally. Indeed, since the ascent of President Sisi in 2013, economic growth has been fueled mainly by the state-owned 6 30 energy sector (the major Zohr gas find in the SE Mediterra- 3 nean) and by construction activity on large infrastructural 0 0 projects implemented by the armed forces. Being visible and 2002 2006 2010 2014 2018 proudly showcased by the military-led regime, such projects (e.g. the widening of the Suez Canal, construction of the New Source: IIF Capital), have tended to outshine the less visible rise in private sector activity.

THE ‘DEEP STATE’ AND THE ECONOMY Egypt’s perennial difficulties in achieving deep, structural Exhibit 6: Foreign Direct Investment, 1991-2018 reform intended to scale back the role of the state and revive % of GDP private sector investment are rooted in the early origins of 9 8 the authoritarian, military-led regime established under Egypt Nasser in the 1950’s. The newly installed military regime at 7 the time undertook massive land reform and redistribution 6 and nationalization of major industries and services, thus 5 creating a sizable public sector that played a leading role in 4 Emerging Markets economic development and policy formulation for decades. 3 In 2017, the public sector in Egypt employed 5.9 million 2 workers, or 22.5 percent of Egypt’s 26 million total work- 1 force, and this excludes the armed forces estimated at 1.3 0 million, about one-third of which are in reserves. In compar- 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 ison, available data on other EM countries indicate that, for Source: UNCTAD and IIF example, in Turkey which also had a powerful military for decades, the public sector’s share of employment is about Unusual as it may sound, the armed forces own businesses 13.3 percent while in South Korea, it is only 8.9 percent. In that produce, for example, cement, steel, vehicles, fertilizers, Egypt, state-owned enterprises are prominent in such im- home appliances while also owning and managing service portant sectors as infrastructure, construction, energy, stations, hotels, toll roads and travel facilities and services. mines and transportation. For years these sectors have been starved for capital and talent and subject to neglect due to Moreover, unlike their private sector counterparts and, tight fiscal conditions. In addition, the weakness of market- given that they operate under a military-led regime, the based pricing in the public sector dampened investment armed forces businesses enjoy special status and often a while lack of incentives subdued efforts at innovation and competitive cost advantage vis a vis the private sector while entrepreneurship. This has marked the public economic sec- being subject to less stringent accountability and oversight tor with low productivity, steady deterioration in structures standards. The cost advantages often include easier access to and services, and higher cost of doing business. land and credit, cheaper inputs such as energy, reductions or outright exemptions from some taxes and customs, and re- The public sector’s economic size was estimated by the Egyp- lief from the standard requirements of transparency and ci- tian authorities at 31% of GDP in 2016/17, which is large in vilian audit. comparison with EM peers. That is why the public sector has often been the object of reform seeking to scale it back, in The entry of the armed forces into economic activity in Egypt part through privatization but also via policies fostering has a long history, its deep roots going back to the early dec- more robust market competition and private sector invest- ades of the 19th century when the founder of the modern ment. Included in the current program is a commitment by Egyptian state, Muhammad Ali, established the very first the Egyptian authorities to take to market 15-30% of an ini- Egyptian armaments industry with the help of European in- tial four public enterprises out of a total planned partial ‘pri- dustrialists and engineers. But the contemporary phase of vatization’ of 23 state owned enterprises by 2020, with a to- the role of the military in Egypt’s economy began under Nas- tal market value of about 1.8% of GDP. In July 2018, the gov- ser in the 1950s with the launch of important military indus- ernment announced the first four state companies 10% of tries (under the Ministry of Military Production). This effort whose shares would be floated by year end, but delays have received a boost in the 1970s from President Sadat who col- plagued the program and so far, none of these companies laborated with Arab Gulf countries to create the Arab Organ- have been brought to market. ization for Industrialization. Following the Camp David Peace accords with Israel in 1978, President Sadat and, later, In parallel to the large public enterprise sector in Egypt, the President Mubarak sought to take some of the military armed forces have for decades operated in the business spending off budget and to reduce overall defense outlays. space, producing civilian goods and services and ‘competing’ To accomplish this, they allowed the armed forces to expand with the private sector in key segments of the economy. the scope of their economic activity into commercial areas and enlarged the associated tax and accountability privileges as an added sweetener.

As a result, the armed forces expanded the scope of exemp- IMPLICATIONS OF THE STATE’S PRIVILEGED PO- tions from transparency and relief from civilian audit, long SITION IN THE ECONOMY enjoyed only by the purely military activities, to cover all the Other emerging and developing countries have also had, or finances under the authority of the military. Even during the still have, strong military establishments with influential di- brief period of civilian rule under President Morsi (2012- rect or indirect roles in the management of the economy. In 2013), the budget and other financial operations of the mili- China, the People’s Liberation Army (PLA) for many years tary (at the time under the authority of the then Minister of exercised great influence through its own industrial activi- Defense and now President Sisi) were given exemption from ties in areas similar to the case of Egypt (e.g. mining, infra- civilian audit. structural projects and strategic industries). However, the reforms which began in the late 1970s cut deep into the role Since the ascent of President Sisi, the reach and influence of of the military in the purely economic domain to the point the armed forces in the purely economic sphere appear to where it is no longer considered material. The rise of a dy- have expanded while the associated privileges have been en- namic private sector in China of course helped speed up the larged and more boldly exercised. For example, legislation process. Similarly, in Latin America (Argentina, Brazil, was passed in 2014 placing all “public and vital facilities” un- Chile) and in Asia (Indonesia, Pakistan) the military did der military jurisdiction for two years, and in 2016 the law play, and to some extent does still play a role in controlling was extended to 2021. The role of the military in exploiting parts of the economy and more prominently in influencing public land, granted to it by the state, for commercial pur- economic policy. In all the countries where the military poses and in having the final say on the private sector’s use played a prominent role in economic activity, the arrange- of economically viable land in widely designated areas of the ment inevitably led to the spread of rent-seeking and high- country have been more assertively exercised. The involve- level corruption, and this ultimately spurred the reforms ment of the military in implementing public infrastructure that ended or constrained the practice. projects has expanded. Furthermore, given the continuation in effect and recent expansion of emergency laws in the con- A critical turning point in the reforms that led to the diminu- text of the fight against terrorism, the role of the military in tion of the role of the military in the economic sphere has the formulation of public policy in general and in setting been the establishment (or reconfirmation) of civilian au- limits on public discourse and activity has also strengthened thority over the military. In most EM countries with such ex- to the point where it has risen above any possible challenge. perience, the military eventually divested itself of all or most of its commercial interests and all military activities ulti- Finally, the security establishment wields strong influence mately came under civilian control. This important change, over important segments of the economy through a vast net- along with other structural reforms that became feasible as work of retired senior officers and other defense personnel. a result, often set the stage for the revitalization of the pri- These occupy high managerial positions or sit on company vate sector that attracted new investment and achieved high boards throughout the public enterprise sector and in a large rates of growth. In contrast, Egypt has remained under an number of private sector firms. Retired high-ranking officers authoritarian rule led by the military since the military coup are especially prominent as governors of provinces with ex- of 1952, except for the brief interlude of the Islamist Presi- tensive powers over local economic development, and as dent Morsi in 2012. The supremacy of civilian authority over heads of ‘strategic state agencies’ such as maritime the military ended with the military coup of 1952 and has transport, aviation, railways, industrial and agricultural de- never been reasserted since. As a result, the role of the armed velopment authorities, the Suez Canal Authority, and agen- forces and more broadly the state economic sector, have re- cies responsible for export and import policies. mained large and influential and, in recent years, may have even grown in importance. It is interesting that both the IMF and the World Bank have long been aware of this particular feature of the Egyptian Slow and Unevenly Shared Growth economy, and, in their own assessments, one occasionally For the past three decades, Egypt’s rates of growth, on aver- does find oblique references to the role of the military in the age, have lagged those of emerging markets countries. economy, but the issue has rarely been explicitly highlighted Whereas Egypt’s GDP per capita (at current exchange rates) much less confronted head-on. For example, in a recent re- between 1988 and 2018 increased by 50% to around $2,572, port highlighting the lack of progress on structural reforms, in Turkey and Malaysia per capita GDP rose by about four the World Bank emphasized the urgency of implementing ‘… and six times, respectively, during the same period to $8,716 business environment reforms that eliminate privilege, en- and $10,704, while for S. Korea, it rose sevenfold to about hance competition and ensure a level playing field” (italics $32,046. For the group of EMs tracked by the IIF, per capita are the authors’). income increased six times during the same period to an average of $5,242. The clear under-performance of Egypt’s iif.com © Copyright 2017. The Institute of International Finance, Inc. All rights reserved. Page 5

economy over this extended period must be due to a persis- tent deficiency in the structure of the economy adversely af- Exhibit 7: Unemployment by Gender, 1991-2018 fecting the country’s growth model and development strategy. Percent 30 Total Male Female Furthermore, Egypt’s growth has not been equitably shared among the different segments of the population while the in- 25 consistency of the growth rates suggests lack of sustainabil- 20 ity. For example, women and youth, and the poor more generally, have not shared equitably in the growth that has been 15 achieved. While the country’s overall unemployment is around 10%, female unemployment was reported at 25% and 10 youth unemployment at 34% in 2018 (Exhibit 7). Strikingly, 5 about 50% of unemployed women and 30% of unemployed men possess partial or full university education. As low-in- 0 come households missed out on the benefits of growth, pov- 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 erty rates remained relatively high in Egypt. The poverty rate is estimated at 16% of the total population at the interna- Source: ILO tional lower middle-income poverty line ($3.2 per day in 2011 PPP), compared to rates in such EMs as Brazil at 8.0%, China at 7.0%, Turkey at 2.7%, Thailand 0.5% at and Malay- Exhibit 8: Poverty Rates, 2015 sia at 0.2% (Exhibit 8). % of population $1.9/day $3.2/day $5.5/day Egypt 1.3 16.1 61.9 Outdated Development Strategy Brazil 3.4 8.0 19.4 The military-led regime that came into power in 1952 in China 0.7 7.0 27.2 Egypt, after some trial and error, eventually settled on an Turkey 0.3 2.7 11.5 ambitious, state-led development strategy with a strong pop- Thailand 0.0 0.5 7.1 ulist, nationalistic, and post-colonial flavor. The strategy was Malaysia 0.0 0.2 2.7 intended to achieve high rates of growth and a more equita- Source: Poverty and Equity Databank (World Bank) ble distribution of wealth and income than had been the case Note: All the poverty lines are in 2011 PPP. under the monarchy which, under the hegemony of Great itself has not undergone fundamental change and has con- Britain at the time, was associated with a Western-inspired, tinued to occupy policy makers’ attention because of its ten- private sector-led, liberal economic regime. The strategy dency to serve as a spark for social unrest when attempts are adopted by the new regime was marked by extensive land re- made at reducing its scope. form, the nationalization of major industries, and the build- ing of a large public economic sector and a strong military. In terms of employment, the public sector’s share of the total The strategy was further reinforced in the 1960s as Egypt de- has steadily decreased over time as the public sector began veloped closer military and economic relations with the So- to approach and then reach the limits of its absorptive capac- viet Union. ity (Exhibit 9). Nevertheless, the public sector remains large and has been frequently reinforced by a long-established The military regime also established an extensive system of practice (if not official policy) by which governments guar- social protection built on the principle of wide public access anteed jobs for all university graduates. While this practice to free health care and education, administered fuel and food declined with time, governments nonetheless often resorted prices and rent controls in urban areas. This top-down sys- to it when faced with high unemployment, especially at times tem of economic management and control was administered of political unrest (e.g. in 2012). Regardless, the practice did by a steadily expanding government bureaucracy and an en- inflate the size of the public sector, and equally importantly, larged public economic sector. The basic characteristics of it also helped direct university students towards the skills the economic system and the philosophy behind it have not and educational specialties required by government service been fundamentally challenged since then. To be sure, mar- rather than towards the entrepreneurial and market sensi- ginal improvements in the system of consumption subsidies tive skills needed in the private sector. The practice also cre- over time did help reduce their cost as a share of GDP from ated the expectation among university graduates that if they double digits to around 4%, but the social protection system waited long enough, they would eventually obtain a job in government and thereby secure life-time employment and

relatively generous (and practically irreducible) benefits. As Exhibti 9: Public Sector Employment, 2005-2017 a result, long term unemployment became a feature of the unemployed graduates as they await employment in the % of total employment Government Public Business Total public sector. Accordingly, 36 percent of unemployed young 2005 25.0 3.9 29.0 men and 51 percent of unemployed young women have been 2006 27.3 3.6 31.0 looking for a job for two years or more. 2007 26.1 3.2 29.3 2008 25.3 3.4 28.7 … and Ineffective Growth Model 2009 24.6 3.4 28.0 On purely technical grounds, the growth model deployed in 2010 23.5 3.3 26.8 2011 23.3 3.6 26.9 Egypt has also proved ineffective. This has to do with the 2012 23.0 3.6 26.6 poor quality of production inputs to some extent, but also 2013 23.1 3.6 26.7 with the choice of policy framework applied. The latter was 2014 23.7 3.6 27.3 rooted in the tradition of top-down state planning to the ne- 2015 23.6 3.4 27.0 glect of creating a business environment that would leverage 2016 22.8 3.3 26.1 market-based incentives for investment and growth. 2017 19.3 3.2 22.5 Source: Central Agency for Public Mobilization and Statistics In the first place, the quality and quantity of the production inputs have been below what would be required for high and sustainable growth. Private sector capital accumulation rates in Egypt have generally been low (Exhibit 10), while Exhibit 10: Private Sector Investment, 2004-2018 public investment (except possibly in the gas and oil sector % of GDP where the bulk of investment is financed by international 35 companies) did not rise to compensate for the shortfall. Ac- Indonesia cording to the IMF, total investment since 1991 has averaged 30 18.4%, a full 10 percentage points below the 28.6% average 25 Korea for emerging markets generally (Exhibit 11). 20 The labor input has also fallen short of the optimal quality Thailand needed for high rates of growth. On the most basic level, lit- 15 eracy rates in Egypt are lower than in EM peers, the national 10 average being 76% (83% for males and 67% for females) in Egypt Egypt, whereas in Malaysia, e.g. the rate is 93%, in China 5 95%, in Turkey 96% and in S. Korea 100%. Reform of the 2004 2006 2008 2010 2012 2014 2016 2018 Egyptian public education system has been exceedingly slow and the system lacks resources and modern methods, result- Source: IIF ing in widespread skill mismatches between the products of the system and the demands of a modern economy. The mis- match is one reason for the high and chronic unemployment Exhibit 11: Total Investment, 1988-2018 rates among university graduates. Students in Egypt generally perform below peers in emerging markets on standard- % of GDP 35 ized tests in science and math. According to most recent data, average scores for Egyptian students are 27 for science 30 and 25 for math, compared with world averages of 43 and 41, Emerging markets respectively (Exhibit 12). As a result, the quality of the labor 25 input has remained below potential causing a drag on 20 productivity and growth. Similarly, the quantity of the labor input as measured by the proportion of a country’s working- 15 age population that is employed has remained below poten- Egypt tial, most recently estimated at 42.2% (67.6% for males and 10 only a stunning 16.7% for females), compared with overall 5 ratios for the BRICS of 58.9% and the ASEAN countries of 1988 1993 1998 2003 2008 2013 2018 66.3%. Source: IIF and IMF

At the same time, the economy itself has also failed to mod- ernize sufficiently or to develop the technologically sophisti- Exhibit 12: 2015 TIMMS Science & Math Score (Grade 8) cated industries to attract the highly skilled and university % correct math science graduates produced by the educational system. These struc- Thailand tural imbalances in the labor market have led large numbers Malaysia of educated Egyptians to emigrate and remain abroad. Turkey Overall, the Egyptian educational system does not appear to Hong Kong be as integrated into the intense scientific and technological Korea activity at universities and research centers in the high-in- Chinese Taipei come countries to the same extent other emerging market countries have achieved. This is reflected in part by the rela- Singapore tively fewer numbers of university students that Egypt sends Egypt abroad for advanced studies compared to EM peers (Exhibit 0 20 40 60 80 13). Even Iran with a slightly smaller population and facing stringent restrictions on entry into the US for its nationals, Source: Trends in International Mathematics and Science Study sends more than three-times as many students for advanced studies to the US, who mostly focus on science and engineer- Exhibit 13: Students Enrolled in U.S. Universities ing, than does Egypt. Number % of population of 15-24 years old Indeed, the general scientific effort in Egypt is below that of Saudi Arabia 44000 0.91 EM peers. For example, while spending on Research and De- China 360000 0.22 velopment (R&D) in such technologically advanced coun- Iran 13000 0.12 India 196000 0.08 tries as Korea and Israel is a stunning 4.3% (the world’s high- Egypt 4000 0.02 est), it is 2.2% in Singapore, 2.0% in China, 1.3% in Malaysia, Source: Institute of International Education, ILO 1.3% in Brazil but only 0.6% in Egypt (Exhibit 14). Out of 137 countries, the World Economic Forum ranks Egypt 94th in ‘technological readiness’ and 109th in ‘innovation.’ There- Exhibit 14: Investment in Research and Development fore, it is not surprising that Egypt’s growth has not been as- % of GDP sociated with technologically leading industries or with ris- South Korea 4.3 ing productivity. Indeed, total factor productivity (TFP) in Israel 4.3 Egypt was especially low for many years, compared to EM Singapore 2.2 peers where TFPgains were a major source of growth. China 2.0 Malaysia 1.3 Weak Business Environment Brazil 1.3 The poor business environment has impeded both private Egypt 0.6 sector investment as noted above but, perhaps even more Source: UNESCO importantly, discouraged foreign investors and slowed the integration of Egypt’s economy into global cycles of production and trade. The Egyptian authorities have identified Exhibit 15: The Perception of Corruption Index, 2018 some of the factors underlying these unfavorable outcomes Score Rank/180 and they have made some efforts to address them. Progress, Singapore 85 3 however, remains slow. These include improving the com- Hong Kong SAR 76 14 petitive environment by creating a level playing field for both United Arab Emirates 70 23 public and private sector businesses, updating and simplify- Taiwan, China 63 31 ing the cumbersome solvency regime, reducing non-tariff South Korea 57 45 trade barriers, and improving transparency and governance Saudi Arabia 49 58 standards, especially in public sector enterprises. Malaysia 47 61 Turkey 41 78 Finally, the business environment in Egypt, despite succes- China 39 87 sive efforts at reform, remains sub-optimal. For example, on Egypt 35 105 such measures as the Transparency International’s Source: Transparency International

Perception of Corruption Index, Egypt ranked 105th out of Exhibit 16: World Bank Doing Business and WEF Global 180 countries in 2018 (Exhibit 15). According to the World Competitiveness Ranking Bank’s 2016 Enterprise Survey, fully 70% of the Egyptian Global Ranking ( 1 = the best) firms surveyed regarded corruption as a major hurdle to 0 EM Asia S. Korea their business expansion. On the ease of doing business, 20 Egypt ranks 120th out of 190 countries. In the WEF’s global MENA Thailand Malaysia competitiveness index, Egypt ranks 94th out of 140 coun- 40 Turkey tries vs. Korea 15th, Malaysia 25th and Turkey 61st (Exhibit 60 Morocco 16). 80 Indonesia Tunisia Egypt has also fallen behind other EM peers in integrating 100 Iran Lebanon Philippines

its economy into the global manufacturing value chain, and 120 Jordan WB Doing BusinessDoing WB impediments to global integration seem embedded in the 140 Egypt political system itself. Because of lack of transparency in much of its security influenced public enterprise sector and 160 140 120 100 80 60 40 20 0 the operation of military-controlled businesses in some sec- WEF Global Competitiveness tors, Egypt’s economy has not been sufficiently open to take Source: World Bank Doing Business Report 2018, WEF Global advantage of the massive wave of global industrial innova- Competitiveness Report. tion and integration during the 1980s and 1990s. Successful EM countries were able to hitch their economies to that wave, thereby generating high rates of growth and global in- Exhibit 17: Manufacturing Value Added Per Capita, 1992- tegration. Of course, also exposing their economies to the 2017 inevitable risks of such exposure to the external environ- 2010 constant $ ment. 1350 Emerging markets (incl. China) Even during the era of reform in the 2000s, and as global 1150 investors showed interest in Egypt as a destination for FDI, 950 several sectors in the economy, as the IMF has noted, remained closed to foreign investors (e.g. aviation, engineering 750 services, steel and aluminum, construction). Relying on substantial foreign exchange revenues mainly from its oil and 550 Emerging markets (excl. China) gas resources at the time, labor-intensive tourism, workers 350 Egypt remittances, Suez Canal fees and official aid (from the US and Gulf countries), it was as if Egypt lacked the urgency 150 and, in any event, chose not to prioritize the needed policies, 1992 1997 2002 2007 2012 2017 to compete globally. The country thus may have neglected Source: UNIDO the transformation of its traditional industrial structure to move up the value chain with all the resources and policy attention that such a task would have required. Exhibit 18: Merchandise Exports, 1988-2018 Thus, for example, Egypt’s manufacturing value added per 100 % of GDP capita over three decades rose by only 105%, whereas the 90 Vietnam comparable increase for EMs was 273% (Exhibit 17). Simi- 80 larly, Egypt’s merchandise exports as a ratio of GDP re- 70 mained virtually stagnant in the past thirty years, whereas 60 Thailand Korea’s increased by 36%, Thailand’s doubled and India’s 50 rose by 165% during this period. Vietnam also witnessed a 40 great leap in merchandise exports which increased by 3.5 30 Korea times from 1996 to 2018 (Exhibit 18). 20 India 10 Egypt 0 1988 1993 1998 2003 2008 2013 2018

Source: IIF

A POSSIBLE PATH TO FUNDAMENTAL REFORM Exhibit 19: Real GDP growth per capita It is clear that the type of reforms that would lift Egypt out Real GDP per capita (Index, 1972=100) of its low-middle-income trap onto a trajectory of high and 800 sustainable growth need to tackle fundamental questions 700 Emerging Asia about the nature of the country’s economic system and the 600 role of the state in the economy. Questions that are akin to 500 those faced by the former Soviet Republics in their experience of constructing a new market economy in the wake of 400 Egypt the collapse of the Soviet system. In Egypt, the change need 300 not be so extreme, but many features of the Egyptian econ- 200 omy resemble those of a command system and may there- 100 MENA Oil Importers fore require an equally drastic treatment. 0 At the same time, one must recognize that fundamental re- 1972 1981 1990 1999 2008 2017 forms of the type that would shrink the role of the state in Source: National Authorities, IIF. EM Asia: South Korea, Thailand, Indonesia, Malaysia, Philippines the economy, and especially if they are to extract the armed MENA: Lebanon, Jordan, Tunisia, Morocco forces from the domain of purely economic activity, would be wrenching and could be destabilizing. In the present po- Secondly, the authorities should focus on those structural re- litical environment, it is almost inconceivable that such reforms can be contemplated much less implemented. In this forms that have been endlessly debated and, for the most context, the example of the ‘transition economies’ in the late part, analyzed in terms of social and economic impact. Most 1980 and early 1990s could offer guidance. For diminishing of these reforms have been included in one or more of the the role of the military in economic activity the examples of reform programs undertaken in the past but rarely have they certain countries in Latin America and Asia may be relevant been completely fulfilled. The reforms should be at the cen- (Exhibit 19). ter of the Egyptian authorities’ policy attention until they are fully implemented within a well-defined medium-term In the case of Egypt, one has to assume that the ultimate ob- framework. jective of any restructuring of the Egyptian economy must be to build a viable economy operating according to market The third major area of policy focus should be on the long- forces (appropriately regulated to safeguard the public inter- overdue reform of the public enterprise sector. While the re- est), an economy that is closely integrated with and benefit- form of this sector often leads to a discussion of improving ing from a liberalized global system of exchange, one that efficiency and profitability in preparation for eventual pri- grows at or near its economic potential, able to create quality vatization, no presumption of a transfer of ownership need jobs in numbers sufficient to meet growing demand, and be necessarily indicated at this point because of the prevail- with a safety net that secures social peace and harmony. ing public sensitivity to privatization, judging by past expe- Such a program would require that the clusters of structural rience. Nonetheless, privatization should remain an option. reforms that have been frequently identified in the case of Finally, serious consideration would need to be given to the Egypt but rarely fully implemented, be taken up anew and role of the military in the purely economic activities in which finally be seriously tackled. Such a reform program, how- it is currently involved. However, given the long history of ever, needs to be pursued in a manner that is least disruptive the involvement of the military in this realm, there are no of prevailing social and political stability. clear signs of a national consensus in Egypt on this issue. In Assuming that there exists a broad political consensus on the any event, the issue should be addressed in the context of need for a fundamental change in the current economic sys- public sector reform, preferably to be undertaken in full tem, and assuming that there is a sufficiently powerful agent transparency and with the support of wide-ranging public to champion the change, and both assumptions remain sub- debate. One possible approach is for the military to start by ject to doubt, the question then turns on setting priorities. shedding those businesses that are least related to its core mission, such as travel services and the manufacture of con- First and foremost, the Egyptian authorities should press on sumer goods, then gradually move to other areas. with the macroeconomic reforms and keep them in effect so as to reap their longer-term benefits. These include perse- Clearly, a full debate on these issues would go beyond the verance with fiscal and exchange rate reforms to reduce the purely economic boundaries of discussion available in this deficit and to maintain a competitive exchange rate while space. But that does not detract from the supreme im- keeping inflation in check. portance or urgency of these issues for Egypt now, or perhaps more importantly, for the country’s future.