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Republic of Djibouti Country Economic Memorandum

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Republic of Djibouti Country Economic Memorandum Report No. 33115-DJ II Volume Economic Memorandum Republic ofDjibouti Country Report No. 33115-DJ Republic of Djibouti Country Economic Memorandum UnlockingPublic Disclosure Authorized Public Disclosure Authorized Djibouti’s Growth Potential: The Road Ahead (In Three Volumes) Volume II: Main Report August 10, 2006 Social and Economic Development Group Middle East and North Africa Region Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of the World Bank Public Disclosure Authorized Public Disclosure Authorized REPUBLIC OF DJIBOUTI Country Economic Memorandum Table of Contents PART I. GROWTH ANALYSIS .................................................................................................. 1 CHAPTER 1: GROWTH PATTERNS. SOURCES. AND CONSTRAINTS ........................... 2 1.1 Growth Patterns ............................................................................................................................... 2 1.1.1. Overall Growth Performance: Stylized Trends ............................................................................ 2 1. 1. 2. Volatility of Growth .................................................................................................................... 3 1.1.3. Patterns of Growth and Recent Developments ............................................................................ 5 1.2. Sectoral composition of GDP growth: the supply side ................................................................... 8 13 .Demand composition of real GDP growth..................................................................................... 10 1.4. Sources of and constraints on economic growth ........................................................................... 11 1.4.1. The roles of capital accumulation, labor and total factor productivity ...................................... 11 1.4.2. Long-run sources of growth: incorporating a cross-country perspective ................................... 13 1.5. Bottlenecks to growth and private investment: a closer look ...................................................... 17 1.6. Conclusion and policy implications ................................................................................................ 26 PART I1. DJIBOUTI’S GROWTH REFORM AGENDA: THE ROAD AHEAD ................ 27 CHAPTER 2 .MACROECONOMIC AND FISCAL STRATEGY ......................................... 28 2.1. Medium-term economic outlook .................................................................................................... 28 2.1.1. What growth can be expected in the coming decade? ............................................................... 29 2.2. Reforming government pay and employment policies: evaluating options for reform............. 32 2.2.1. The Public Sector Wage Bill: The Magnitude ofthe Problem .................................................. 33 2.2.3. Policy instruments for reducing the wage bill ........................................................................... 39 2.2.4. Reforming government pay and employment policies: options for reform ............................... 41 2.3. Conclusion and policy implications ................................................................................................ 58 CHAPTER 3. MAKING THE LABOR MARKET AND THE INVESTMENT CLIMATE WORK FOR GROWTH AND JOBS ......................................................................................... 59 3.1. Main features of Djibouti’s labor market...................................................................................... 59 3.2. Labor market outcomes: stylized facts and recent trends ........................................................... 63 3.3. Explaining poor labor outcomes .................................................................................................... 73 3.3.1. Wage Distortions in the Labor Market: Do Public Sector Employees Earn a Rent? .................73 3.3.2. Investment climate and job creation .......................................................................................... 81 3.3.3. Labor market regulations ........................... ............................................................................... 88 3.3.4. Weak role ofpassive and active labor programs for the unemployed ....................................... 93 3.3.5. The supply-side: the poor quality of labor ................................................................................. 96 3.4. Conclusion and policy implications ................................................................................................ 98 CHAPTER 4 . MOBILIZING FINANCE FOR INVESTMENT ........................................... 101 4.1. The currency board arrangement ................................................................................................ 101 4.2. Djibouti’s financial sector ............................................................................................................. 105 4.2.1. Main features ofthe banlung sector ......................................................................................... 105 4.2.2. Bank lending trends ................................................................................................................. 108 4.2.3. Overall soundness ofthe banking system ................................................................................ 110 4.2.4. The money changers ................................................................................................................ 111 4.2.5. Informal finance mechanisms .................................................................................................. 112 4.2.6. Microfinance ............................................................................................................................ 113 i 4.3. Financial sector reforms ............................................................................................................... 115 4.4. Monetary and banking developments ......................................................................................... 1 18 4.5. Conclusion and Policy Implications ............................................................................................. 123 CHAPTER 5 .TOWARD AN EFFICIENT INFRASTRUCTURE ........................................ 125 5.1. Transport Sector ......................... .............................................................................................. 125 5.1.1. The Port ................................ .............................................................................................. 126 5.1.2. Railway ................................. .............................................................................................. 138 5.1.3. Djibouti International Airport .................................................................................................. 141 5.1.4. Roads ....................................................................................................................................... 143 5.2. Power and Water Sectors .............................................................................................................. 151 5.2.1. Electricity ................................................................................................................................. 15 1 5.2.2. Water ....................................................................................................................................... 153 5.3. Telecommunications ...................................................................................................................... 156 5.4. Conclusion and policy Implications ............................................................................................. 158 LISTOF FIGURES Figure 1.1 Djibouti vs Comparators: Real GDP Growth Rate .................................................................. 2 Figure 1.2 Djibouti vs Comparators: Real GDP per Capita in constant 2000US$. 1980-2004 .................3 Figure 1.3 Djibouti vs Comparators: Real GDP per Capita Ratios. 1980-2003 ........................................ 3 Figure 1.4 Djibouti vs Comparators: Growth Volatility. 1981-2004 .................................... Figure 1.5 Real GDP Growth Rate vs Volatility. 1986-2004 .................................................................... 3 Figure 1.6 Real GDP Growth in Djibouti and Yemen .............................................................................. 4 Figure 1.7 Response ofDjibouti’s real growth rate to a one std. dev shock in Yemen’s growth rate....... 4 Figure 1.8 Response ofYemen’s real growth rate to a one std . dev shock in Djibouti’s growth rate....... 4 Figure 1.9 Actual vs . Potential Real GDP Growth. 1981-2004 ............................................................... 4 Figure 1.10 Sectoral Shares in Real GDP. 1990-2004 .............................................................................. 8 Figure 1.11 Average Annual Expenditure Growth. 1990-2004 ............................................................. 10 Figure 1.12 Savings vs Investment as Share ofGDP .............................................................................. 10 Figure 1.13 Labor and Capital Productivity Growth. 1990-2002 ........................................................... 12 Figure 1.14 Evolution of Total Factor Productivity. 1990-2002 ............................................................. 12 Figure
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