In June, the International Monetary Fund completed the Second Review under the Stand-By Arrangement (SBA) for the Arab Republic of Egypt, which is a report issued periodically whenever it is time to disburse a new tranche of a loan borrowed by the Egyptian government from the IMF.
The latest review praised the government’s financial and economic performance, in general, in the face of the COVID-19 crisis, considering that the Egyptian economy is one of the few economies in the world that continued to achieve positive growth rates. Perhaps this is logical because, in fact, Egypt did not have a lockdown, which is something many forget when they talk about an Egyptian economic miracle in the face of an international pandemic and crisis.
The review report carried a repeated recommendation to the Egyptian government that it should exit the economic sectors allowing the private sector to take the place of the government in them, with a repeated reference from the fund to the military-owned companies in that context. According to the review report, which is based on the data of the Egyptian government, state-owned companies and the military are widespread in almost all economic sectors. There are approximately 300 state-owned entities via the Ministry of Public Business Sector and the military, in addition to approximately 645 investment partnerships, in which the state or the military are located, and 53 public economic agencies operating in key sectors such as agriculture, transportation, petroleum and natural gas. The fund argues, as usual, that the profitability indicators of these public companies are lower than those of the private sector companies.
Indeed, the report is based on a survey conducted in 2018 on the indicators of the profitability of the public business sector other than the banking sector and military-owned companies. This survey concluded that the productivity of the private sector is four times the productivity of the public one in Egypt. The fund also argues that approximately 107 public sector companies burdened annual losses, and those losses were concentrated in the industrial sector, especially the textile, food, iron, steel and plastic industries, while the profitable public companies, according to the fund, tend to be companies that have monopolies over natural resources such as oil and gas, or major bodies such as the Suez Canal Authority and the Urban Communities Authority.
The fund’s report continues to present its same argument about the need for the state to exit some economic sectors and focus on sectors without others. This argument is that investment in the public sector, including economic bodies, is currently estimated at approximately 18.4 per cent of the Egyptian GDP in 2020, so it consumes the state’s spending. What the fund ignores is that the industrial sector suffers from weak investment, and the main bulk of such an investment goes to the public service sector and the infrastructure investments, which witnessed a steady growth in spending over the past years. The expenditure of the Urban Communities Authority, the Roads, Bridges and Metro Authorities, has increased due to the national projects undertaken by the government.
Public or private sector?
The public-private sectors dichotomy appears to be very superficial in regard to the Egyptian case. The public sector in Egypt is not a traditional model of the public sector nor does the private sector in Egypt have the latent productive capacities, especially in the manufacturing industries necessary for the sustainable operation of the workforce in Egypt.
The Egyptian public sector is currently very complex. While the state continues to expand spending on infrastructure through the public sector and economic bodies, it does not invest sufficiently in the industrial public sector, which needs development. We can clearly see the numbers from the sustainable development plan, in which the government estimates that government investments in the current fiscal year amount to EGP 933 billion, most of which directed to the new national projects related to infrastructure.
The Ministry of Planning’s investment allocations reach about EGP 86 billion, while the Ministry of Housing, without the Urban Communities Authority, acquires EGP 62 billion, meaning that the Ministry of Planning, which is currently investing in the Egyptian rural development project, in addition to the Ministry of Housing, acquire approximately 41 per cent of the investment allocations of ministries in Egypt. At the same time, investment allocations for public business sector companies are about EGP 80 billion, with an EGP 9 billion decrease from the previous year.
As for the private sector investments, which amount to only 25 per cent of the total investments estimated at EGP 1.25 trillion, the situation is not much different, as the state itself has been encouraging investments in infrastructure, whether in the real estate sector, the construction and building sector, or in the transport and road sector. The private sector is behind the state. While private investments in the current fiscal year amount to EGP 317 billion, the real estate sector accounts for 25 per cent of those investments, which reflects a distortion of the economy increasing day by day due to the state-motivated investment in rentier sectors such as real estate.
These current trends of the state towards intensive investment in rentier sectors such as real estate and construction and building affect the flow of private investments to more important sectors such as manufacturing industries, whose shares amount to only 13.3 per cent of private investments. Of course, this structural distortion affects the quality of jobs in the economy. The more investments in the real estate and construction activities sector, whether from the public or private sectors, the less quality and sustainable jobs are produced because wage rates are lower in the two sectors, and they depend on irregular employment. The Egyptian industrial sector, despite all its problems, is still producing better quality and sustainable jobs from the construction and real estate sectors.
From the above, we can see that the underlying distortions in the economy are the real problem in the Egyptian economy, and not the state’s competition with the private sector, which we cannot deny, of course, in recent years. The annual private sector investment share has fallen from more than 50 per cent before the flotation to 25 per cent currently. But, as it is said, the devil is always in the details. This decline is mainly caused by the state’s competition with the private sector in the process of extracting rents from the real estate and construction sectors, which explains the decline in private sector investments, but the state, as well as the army, did not crowd out the private sector in the industrial sector significantly. Rather, it keeps the Egyptian industrial sector with great growth potential and latent capabilities that can withstand the expansion of the state and the private sector due to the size of the large Egyptian market.
The situation, then, appears as follows, a state crowding out the private sector in rentier activities, and an industrial sector far from the supposed investment targets a large market such as the Egyptian market, and therefore when the IMF talks about the need for the state to identify specific sectors to direct investments to it, this necessarily means the exit of the state from the construction, building and real estate sectors, which is currently impossible for the state to get out of. The sales of the administrative capital’s lands and the participation of the Urban Communities Authority and the Ministry of Housing in these investments are very large and generate a lot of important revenue to finance other investments for the state in the same sectors, especially with new national projects every day.
Elephant in the room
In Egypt, we do not have a private sector that wants to invest heavily in industry. This is a structural distortion that has been going on in the Egyptian economy for a long time. Its roots can be traced back to the period of economic openness in the seventies and the way the state changed the economic compass from an economy oriented towards a free one. Since 2014 until now, the contribution of the industrial sector to the GDP has not exceeded one per cent. That contribution was around 16 per cent in 2014 and is currently only 17.1 per cent. In spite of the state’s expansion in the economy, especially in the rentier sectors, as mentioned above, the relative weight of the private sector has increased as a percentage of GDP in recent years. In 2014, the private sector represented nearly 64 per cent of GDP, and it has now increased to about 70 per cent in 2020, but the increase was linked to a greater transformation at the sectorial level. The private sector’s interest in investing in agriculture and manufacturing industries has decreased in favour of the real estate and construction sectors, in which the state has also expanded.
The problem for the private sector in Egypt appears to be its ability to obtain financing from banks and financial institutions. The high rates of domestic borrowing raised the cost of borrowing, especially with the flotation, after which interest rates were raised to 16-20 per cent levels to address the inflationary shock resulting from the flotation. Therefore, the government acted as an important future for bank deposits and savings, which private and government banks pumped into local debt instruments in order to obtain very high interests without entering into the risk of providing credit to high-risk projects, especially in the industrial sector.
The credit provided by local banks in Egypt has shifted significantly towards the state, as the private sector currently obtains only 30 per cent of domestic credit, after that percentage was close to 55 per cent in 2010. With the significant shifts in sectorial interests of the Egyptian private sector after 2010 towards the real estate sector the majority of the credit that was directed in the period from 2010-2020 was directed mainly towards real estate sector projects, and in recent years it has been directed towards the participation of the private sector in infrastructure projects undertaken by the state.
The state’s private sector has the right to invest in infrastructure and real estate, because it is simply the secured sectors at that stage. The presence of the army in the market encouraged or forced the private sector to enter the real estate sector, and with the continuous boom of the sector since 2007 in particular, that entry was a lifeline, instead of being subject to risks of industrial investment in a country that still suffers from structural problems in supply chains, especially those related to the import of intermediate goods from abroad, after the increase in the import cost due to flotation.
That deal was a win-win for both sides, as the army and the Engineering Authority of the Armed Forces will work under the new legal and institutional arrangements that the government has introduced as supervisors of hundreds of major companies and thousands of subcontractors in infrastructure projects. The president will receive repeated praises as the owner of major national projects and the owner of the modern Egypt renaissance, in which he is currently building huge urban complexes from the administrative capital and the new city of Galala and Al Alamein to all the small new cities that the state creates on the borders of the old cities. In return, the private sector will guarantee itself a share of the bloated real estate pie without a major crowding out in financing from the army and the state. On the contrary, it will facilitate the processes of obtaining land from the state and the partnerships that the large private sector in the real estate sector undertakes with the state in obtaining credit from government banks.
Thus, over time, almost all domestic savings in Egypt in the last five years have been directed towards two types of lending: first, consumer lending directed to individuals, and secondly, lending directed to investment in sectors related to the state’s investment orientations in the infrastructure and real estate sector. This continuous state of intensive investment in the real estate sector reproduces the structural distortion in the Egyptian economy, which is basically summed up in the fact that the large private sector and the state both compete with each other in the sectors related to rent extraction. We find the two are present in the oil and gas sectors, the real estate sector, contracting activity and other rentier sectors. The two do not contribute to the production of real added value in the economy, but rather fragile growth rates of up to five per cent annually, but they do not generate good jobs in quantity or quality. Therefore, economic surpluses are not even reflected on the largest groups of workers in the economy.
The state as the origin of the market
Contrary to the prevailing neoliberal theory, the Egyptian state played a very important role in the presence of the private sector in its current form and structure that is addicted to investing in real estate and infrastructure, such as iron, steel and ceramics. Since the stage of economic openness, the state has played the role of the originator of the market, as it determines the limits of investment in a particular sector, and its entry into the sector in many cases means the entry of the private sector behind it. Egypt, like other developing countries, witnessed the expansion of this sector historically with the support of the Egyptian government, especially in light of the population increase, which put great pressure on the infrastructure in Egypt and thus accelerated the process of private and government investment in this sector. But in a country that often suffers from economic difficulties related to public financial management, the construction boom is a cause for thought.
There are specific features of the nature of the political economy and of the relationship of contractors with the state in the developing world. Investment in infrastructure largely determines the nature of public investments in countries that have always suffered from deficits in managing the balance sheet. We find here the paradox that despite Egypt’s adoption of a policy of reducing public spending since stabilisation and structural adjustment programmes in the nineties, often those plans were to reduce public spending mainly because of the expansion of infrastructure projects.
In order to explain this contradiction, James O’Connor puts forward his famous theory in his book, The Fiscal Crisis of the State. According to O’Connor, governmental budget deficit is not a contingency connected with certain conditions or certain states, but rather an organic result of the state functions per se. O’Connor explains that the state has two functions, the first is to provide the appropriate climate and suitable soil for private capitalism to flourish, or in more explicit words, to provide formal and informal protection for private capitalism in order to grow and prosper. This is achieved through infrastructure projects such as planning and construction of new residential and industrial cities and other infrastructure projects that work as a permanent provider of finance for the prosperity of sectors such as construction and construction and related heavy industries such as iron and steel industries, cement, sanitary ware and others.
As for the second function, it is to legitimise the social system in the country by means of the continuous redistribution of income in favour of the working class. In most cases, this second function was not fulfilled in the Egyptian case, or at least it was not as efficient as the first one, and perhaps the absence of that function can be explained. The second is the rentier nature of the Egyptian state, which, in the absence of natural resources such as oil, meant that the state had a single path to an efficient redistribution of income in society, which is through an efficient tax system, which was not achieved in the Egyptian case due to problems in the nature of the economy and the efficiency of the bureaucratic apparatus of the Egyptian state.
So, the Egyptian state, like other developing countries, had a natural tendency to finance large expenditures on infrastructure through resources that are not available through the natural ways of resources. We mean here taxes. Since the eighties, the share of taxes from the Egyptian GDP has gradually decreased from 1981 to 2010 from 26.4 per cent to 14.1 per cent, respectively. This continuous deterioration of the tax proceeds did not prevent the state from financing intensive investments in infrastructure, especially in the sectors of transportation, communications, and electricity.
The large private sector associated with spending on infrastructure in Egypt has developed to be monopolistic centres in the Egyptian economy since the nineties. Perhaps the later manifestation of the role of business groups in politics in Nazif’s government is the best expression of the rise of economic power and, by extension, the political power of the private sector. So, now, after the state’s return to investing heavily in infrastructure after a pause between 2010-2015 due to political turmoil, the private sector came again behind the state for this sector. However, because the nature of the state’s current investment is characterised by a large degree of exploitation of the influence of the army as a large social and economic force, and thus forcing businessmen to enter into partnerships that may be unfeasible for them, calls for the state’s exit have been increasing recently.
The private economic elites in Egypt want other conditions for managing the economic relationship with the state that allow them to limit the army’s economic role, especially in the vital sectors of the economy. The IMF also wants the army to get out of these sectors and provide an opportunity, or in other words, a better share of the pie for the private sector. But all this will not address the basic problem in the economy, which is that we are in an economy that depends on rentier sectors mainly, and therefore neither growth in domestic product is able to generate good jobs nor is the added value of the economy as a whole good.
The private sector does not invest in industry sufficiently, and the state does not want to encourage it, while the International Monetary Fund and international institutions continue to talk about the need to give a greater opportunity to the private sector, although this sector has obtained all possible opportunities since the mid-seventies, but other objective determinants distorted it. It is tarnished with the Egyptian economy as a whole. We are all chasing after real estate and national projects, so there is no difference between a public or private sector, an army or a state. Everyone wants to share the profits of a bloated real estate bubble in a low-productivity developing economy.