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The Role of the State: the Case of Egypt

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The Role of the State: the Case of Egypt E ROLE OF THE STATE: THE CASE OF EGYPT Heba Handoussa Working Paper 9404 t E_CON(DMIC ARC HIV RESEARCH FORUM FOR THE ARAB COUNTRIES, IRAN & TURKEY P 940'4 The Economic Research Forum for the Arab Countries, Iran and Turkey (ERF) was established in June 1993 as an independent, non-profit regional networking organization. Its mission is to pro- mote policy-relevant economic research with a broad representation of views to help activate the policy-formulation debate in the region, by encouraging and funding quality research, and by disseminating results of research activities to economists and policy-makers. The ERF Working Papers Series disseminates the findings of research work in progress to promote the exchange of ideas and encourage discussion and comment among researchers for timely revi- sion by the authors. The Working Papers are intended to make preliminary research results available with the least possible delay. They have therefore not been edited nor made subject to formal peer review by ERF staff and ERF accepts no responsibility for errors. The views expressed in the Working Papers are those of the author(s) and not those of ERF. Unless otherwise stated, copyright is held by the author(s). Requests for permission to quote their contents should be addressed directly to the author(s). IDRC - Lib. THE ROLE OF THE STATE: THE CASE OF EGYPT Heba Handoussa Working Paper 9404 Please address correspondence to: Heba Handoussa, Economic Research Forum, 7 Boulos Hanna St., Dokki, Cairo, Egypt, Fax: (202) 3616042. The Role of the State: The Case of Egypt Heba Handoussa` Department of Economics The American University in Cairo An earlier version of this paper was presented to the Cairo Conference, Initiative For Promoting Economic Research in the Middle East ` I am deeply indebted to Sahar Tohami for providing me with much of the recent literature on the New Institutional Economics and for her many useful comments on my research outline. I am also grateful to Ismail Shoukry, Dalia Khalifa and Ahmad Ghoneim. Ismail Shoukri was responsible for collecting the necessary detailed information on a large sample of public sector enterprises and for calculating measures of allocative efficiency for the group. Dalia Khalifa prepared a short appraisal of the public sector hotel industry and Ahmad Ghoneim made a thorough search of the local press for articles on the new public sector law and collected and adjusted data on wages. Abstract This paper adopts a neoinstitutional approach to analyse the changing economic role of the state under liberalization, taking Egypt as a case study. Part I provides an analytical framework that establishes the boundaries of the state in a less developed economy. The conclusion is that state intervention should embrace - in addition to stabilization, regulation, correcting for market failure and redistribution-the process of "catching up" by manipulating industrial policy and building up institutions that reduce uncertainty and promote the acquistion of knowledge. Part II tests four hypotheses concerning the weaknesses in Egypt's process of liberalization: (1) Under-regulation of product and factor markets has resulted in increased misallocation and monopoly behaviour; (2) Over-regulation of the institutional structure has raised transaction costs and created agency problems; (3) The persistence of centralized controls over public enterprises is responsible for deteriorating performance;(4) Divestiture is necessary for efficiency only if the state is unable to break the link between the bureaucracy and state-owned enterprises. The evidence is consistent with each hypothesis and highlights the importance of legislative reform as a necessary complement to comprehensive liberalization. Part III summarizes the achievements of the recent stabilization and liberalization programme and stresses the need for the state to play a new role in the context of poverty alleviation and in the integration of the informal sector into the modern economy. 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In Egypt, after three decades characterized by central planning and regulation, the dominance of public enterprise activity in the productive and tradables sectors and the operation of an elaborate system of welfare, the scope and degree of state intervention is now being questioned. The problems of delineating the economic boundaries of the state and of analyzing the structure of incentives and organization with which it guides economic activity are common to many of those countries in the Middle East region which had opted since the 1960s for a similar configuration of policies and regulations to govern the process of economic growth and development and which have more recently begun to make the transition towards a market economy. Egypt represents a consistent model of development which has attempted to blend the neoclassical precepts of a market economy with those of a highly socialist orientation. This model was adopted to a considerable extent by many of its neighboring countries, with similar repercussions on performance. Halfway through the period under study, Egypt inaugurated its Open Door Policy (October 1973), with a partial liberalization of the incentive and institutional structure. However, the three underlying themes characterizing the Egyptian model have persisted throughout the period: an import substituting strategy imposed through central planning and macroeconomic policies; a dominant state-owned sector in key sectors of economic activity, itself dominated by a top-heavy bureaucratic structure; and an extensive institutionalized system of welfare transfers operating mostly via implicit and explicit subsidies and guaranteed employment. An important distinction is made throughout this paper between the instruments wielded by the state in providing an optimal incentive structure for efficient performance of the economy and those used in providing an enabling institutional environment. The first concerns the package of macroeconomic policies and corrective measures that affect the operation of markets and resource allocation and the second addresses the system of laws and regulations which govern the operation of economic agents in the society. Together, these two sets of tools have to a large extent determined the pace and direction of economic growth. Yet neoclassical economics is mostly concerned with the manipulation of the incentive set of instruments, and tends to take for granted the institutional setting of the economy as 'given' and determined by the configuration of social and political circumstances over which the economist has little to say. The analytical approach adopted here is therefore based on the neoinstitutional view of economic theory whereby the state and its institutions play a pivotal role in determining the performance of the economy. The standard neoclassical model - with its focus on market orientation as the essential ingredient to the efficient allocation of resources - ignores the major role which institutions play in reducing (raising) uncertainty and promoting (impeding) the acquisition of knowledge. Just as efficient institutions can provide an enabling environment which enhances competitive behavior and 1 an efficient growth path, inefficient institutions may persist over time because of the symbiotic relationship between them and the organizations that have evolved in response to their suboptimal structure. Organizations - firms, trade unions and other economic, political, social and educational bodies - come into being and develop to take advantage of the opportunity set as determined by institutions and by the standard constraints of economic choice theory. These organizations are therefore likely to maintain and reinforce an inefficient institutional system and can be seen as the major source of resistance to its evolution along a path that improves economic welfare. The first part of this paper provides an analytical framework which links the nature of the state's intervention in the economy with the performance of that economy over time, based on the approach of the new institutional economics which recognizes both the theoretical framework of neoclassical economics as well as the limitations of its assumptions.' The main questions that we seek to answer are why the neoclassical model of growth has failed to explain the differential growth performance of developing countries and how the institutional approach can help remedy the weaknesses of the neoclassical model, and what are the boundaries of the state that are implied by the proposed theoretical framework.
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