Global Economic Crisis: Short and Long-term Prospects for Egypt

Navtej Dhillon and
Navtej Dhillon Former Brookings Expert
Ragui Assaad
Ragui Assaad Former Brookings Expert, Regional Director, West Asia and North Africa at Population Council

October 29, 2008

Editor’s Note: In the second in a series of analyses, “Food, Fuel, and Finance: How Will the Middle East Weather the Global Economic Crisis?”
Navtej Dhillon speaks with Dr. Ragui Assaad, Professor at the University of Minnesota and former Regional Director for West Asia and North Africa at the Population Council in Egypt, on short-term and long-term prospects for the Egyptian economy. The full audio recording and an edited transcript of the interview follow.

Listen to the audio of the interview »

Egyptian Economy: Protected or Exposed?

Navtej Dhillon : As the global economy faces a slowdown, Egypt will continue to have above global average GDP growth. What will be the impact, if any, of the global economic downturn on the Egyptian economy? Is it protected or is it somewhat exposed?

Ragui Assaad: It is a complex set of questions, because there are a number of variables changing at the same time. In general, Egypt has been exposed to real shocks in the economy and protected from financial shocks. Egypt’s financial system is poorly integrated into the world’s financial system. While there are increasing capital flows, these flows have been fairly limited. The amount of portfolio investments has also been fairly small, and Egyptian banks are not very strongly integrated into the international system. So, in that sense, Egypt has been fairly insulated. However, it is not insulated from real shocks that may come from a drop in tourism revenues, volatility in oil prices, or shifts in foreign direct investment (FDI). Here, I am making a distinction between financial exposures versus real exposure. On one side we are not very exposed—on the financial end—but we are quite exposed on the real end.

Dhillon: OK, let’s dig a little bit deeper on the real shocks. To what extent have tourism, FDI, and petro-investment been driving the recent growth, and do some of these engines of growth look more vulnerable in the current economic climate?

Assaad: Yes, actually they have been quite important drivers of growth, all three of them have been very important. As you may know, 70% of Egypt’s foreign exchange earnings come from services, which mean tourism and the Suez Canal. To the extent that tourism is going to be hit hard by the slowdown in the Western, and even Eastern, European economies, then those flows are going to be affected quite strongly. The Suez Canal will be affected if activity of world trade declines and there are fewer revenues from the Suez Canal. The last service import is remittances from Egyptian workers abroad, and that really will depend on what happens to oil prices—whether they go down even further from their current level, or if they stabilize at that level. Foreign direct investment, which has grown significantly over the past few years, has been quite important in terms of investment in actual industries. And if FDI is affected by the economic slowdown it is going to have a real effect on the Egyptian economy.

There has been some growth in exports that has driven the current economic expansion. If demand for Egyptian exports is affected by the slow down, it will also slow the Egyptian economy down. On top of all of this, there has been what I would consider to be speculative capital flows being invested in the real estate sector coming primarily from oil-rich countries; and, again, to the extent that oil prices are falling and fewer of these speculative flows are coming in, there is going to be a slowdown of the real estate sector in Egypt, which has been an important part of the current boom in the economy. So, with all of these factors, I think there is clearly going to be a hit to the growth rate in Egypt.

Leaving the Poor and the Young Behind?

Dhillon: Let’s transition to more long-term prospects. As we now know, for the last five or six years, Egypt has been enjoying sound growth. When growth was uninterrupted and quite strong, there has been a rigorous debate on whether it has actually been pro-poor growth and, additionally, whether it has created job opportunities for young citizens. In your recent paper you argue that informal labor and non-wage labor are on the rise. Could you talk a little bit about the impact of economic expansion on both low-income families and the young in the country?

Assaad: I think that very few people would be able to argue that growth in Egypt lately has been “pro-poor.” It has been very much the theory that it is a “trickle down” sort of growth, and that it is eventually going to trickle down to the poor, which actually has not happened. A lot of the growth in income has been felt by those who own assets and property, and clearly the poor are excluded from that. What the poor and the lower to middle classes have actually been feeling is the inflationary impact of this growth, which has hit their consumption quite strongly. They have been getting inflation, but not so much of the benefits of growth in terms of jobs.

This is not to say that jobs are not growing in the private sector. In fact, the private sector employment growth rate has been quite rapid. The problem is that the modern private sector in Egypt is still very small. So even if it is growing fast, it is not receiving a lot of labor. What you are seeing instead is the transformation of one sort of surplus labor – invisible underemployment in the government sector. A lot of people employed in the government were actually being underemployed. That is now no longer happening as the government is no longer hiring, and instead that is being transformed into more visible underemployment in the form of unemployed graduates and in the form of non-wage labor in small family enterprises. The country has a large stock of underutilized labor, which in the past was “stored” in the public sector, so to speak, and now is increasingly more visible in the informal part of the private sector.

Dhillon: Right, and I guess the challenge that accompanies this is that, on the one hand, I think the Egyptian economy has been more successful at maybe raising levels of human capital through growing enrollment rates and education, but not quite as successful at increasing the productivity of human capital in the labor market.

Assaad: I don’t know if I would call it “human capital.” I would call it increasing levels of schooling. A lot of people are getting schooled and are getting credentialed in schools, but whether it is actual human capital in the sense that it has returns in economic terms is still a question because of the quality of human capital. There has been a tremendous focus on quantity of schooling often at the expense of the quality of that schooling. So we have a lot of people with schooling credentials that are brining very little return in the private economy. So these people are stuck with worthless capital and with the expectations that come with it, but not with the rewards.

Dhillon: What do you think are the long-term impacts of the growth of informal employment and non-wage employment on young people’s transitions and their economic welfare? Should we be concerned with huge welfare losses—that these young people are going into informal employment and non-wage employment?

Assaad: I think basically what you have is this current generation of young people as victims of a changing economic structure in which they are no longer obtaining the jobs that their peers in older generations were obtaining in the public sector, but where the private sector economy has not grown sufficiently to provide them productive jobs. They are the people who are being caught in this transition, and in addition they have acquired schooling credentials that are responding to the public sector needs, or at least the public sector demands, but with very little value in the new private sector economy. So they are being hit doubly: one, simply, by change in the economic structure and in labor demand in the economy away from public sector employment, and two, by the fact that their human capital is no longer considered to be valuable. Therefore, I do think that the impact on this generation is going to be long-term, in the sense that this cohort of young people who are going through the system right now are going to have a disadvantage probably throughout their lives. Hopefully, as the transition occurs, and the educational system starts responding more efficiently, and the private sector starts growing, the next generation of young people is going to have a slightly better time.

A Crisis in Globalization: Can the Egyptian Government Still Sell Private Sector Reforms to People?

Dhillon: I think that you are making an excellent point, which is a perfect segue to my next question. In terms of ensuring that the next generation fares well and the adverse impact and the effects on this generation are minimized, let’s talk a little bit about this issue. On the one hand, the necessity for the Egyptian economy to become more private sector oriented and to try to adapt and change the expectations of young citizens away from the security and stability of public sector. However, on the other hand, as the Egyptian economy integrates more with the global economy and has a more dynamic private sector, it also comes with inherent risks, and uncertainty and volatility for which, at the moment, perhaps individuals do not have sufficient instruments and protection. Where does that debate currently stand in Egypt? At a time when there is a global crisis of confidence in globalization and markets, does this make it hard for the Egyptian government to sell these reforms to people?

Assaad: Yes, I think that on the first question, the private sector clearly needs to be pushed towards greater formalization, i.e. to provide greater social security and job stability by becoming more formal. That can happen through labor legislation that reduces the cost of formality to private sector employers—and I think this has already happened with a labor law that was passed in 2004—so there are incentives for them to provide formal employment. On the other hand, they can do that only if they are formal themselves as firms …Now, again there has to be an incentive for [informal] firms to become more formal by reducing the cost of being formal: in the form of lower taxes, in the form of lower cost of regulation in general. I think nobody in Egypt is harking back to the state becoming the employer of first and last resort. People have accepted the idea that it is the private sector that is going to provide the main engine of employment growth. However, how to get the private sector to provide good jobs will depend on the regulatory framework that does not force most of the private sector to stay outside the radar screen in the form of very small, informal firms.

Now, one of the risks brought by globalization into this picture is that, yes, there is going to be more vulnerability to shock. But, Egyptians will have to be able to move away from the idea that you protect people’s jobs to the idea of protecting people themselves and providing the social insurance mechanisms that help people. So, there is a discussion now of unemployment insurance—something that has never really been functional in Egypt—there is a discussion of improved social insurance mechanisms so that the safety net is not connected to having a job or not having a job, but you can have a safety net that goes beyond your job security. The job security safety net has never really been very protective except for those who have those few, formal jobs in the economy. The vast majority of people in the Egyptian labor market have always been unprotected. So for them, the situation can only get better in terms of job protection, not worse.

Dhillon: Excellent. I think we will end here. Thank you so much for those great insights into the Egyptian economy. Thank you so much, Ragui, for your time.

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