73009 September 2012 – Number 73 EGYPTIAN PRIVATE ENTERPRISES IN THE AFTERMATH OF THE REVOLUTION: AN INVESTMENT CLIMATE UPDATE Andrew Stone with Lina Badawy and Hooman Dabidian1 regime, a number of investigations were launched, which included prosecutions of some prominent Introduction: The January 25th Revolution is an entrepreneurs; reversal of select land allocations enormously important political event for Egypt, but and licensing approvals, and reversal of at least one attention to its economic consequences is also vital. major enterprise privatization. The Egyptian revolution reflected a popular movement in favor of dramatic changes in the way Initially, the events of the Revolution and its citizens were governed and the way resources and aftermath imposed a substantial shock to the opportunities were distributed in society. economy. Private firms reported significant Expectations were extremely high, especially among setbacks in terms of sales and exports. Given that the youth, for a new era of a more responsive their use of capital and labor has shifted less than government and an economy that offered sales, productivity (output/inputs) sharply employment, more inclusive growth and stability. declined. Smaller firms suffered especially badly, Prior to the revolution, Egypt had high reporting larger declines in sales and slower unemployment rates. The unemployment rate for 15 recovery. to 24-year-olds in particular was estimated at 33%. Firms’ own identification of constraints place Along with profound changes resulting from the uncertainty at the top of their problems – revolution there were accompanying substantial uncertainty about the macroeconomic situation, economic disruptions. Unemployment has been including aggregate demand and prices, uncertainty sharply exacerbated by the estimated loss of almost about the unstable political situation and two million jobs in tourism and the crash in uncertainty about the regulatory policies they face – remittances resulting in part from the return of over including potential changes and arbitrary 80,000 Egyptian workers from Libya. Tales of administration. By 2012, concern about corruption disruptions, supply interruptions, property crimes, had risen to the top 3 constraints, and concern with and financing problems abound. In addition, in crime and theft rose to the top five for the first time, response to a public outcry over excesses of the prior suggesting an overall decline in the state of crime prevention, security and legal observance. 1 Andrew Stone, Lead Evaluation Officer, The World Bank; Lina Transport, which had not been a leading constraint Tarek Badawy, Consultant, The World Bank, Hooman Dabidian, before 2011, now rose to the seventh most Private Sector Development Specialist, The World Bank. This commonly identified serious constraint. Quick Note was cleared by Simon Bell, Sector Manager, Finance and Private Sector Development Department, The Middle East and North Africa Region (MNSFP), the World Bank and by the The “bad news� of the aftermath of the revolution Egyptian counterpart for the ICA Update, the General Authority was a period of economic disruption, where private for Investment (GAFI). The field research was carried out by the demand sharply contracted and the output of firms Social Research Center, at the American University in Cairo, under the direction of Prof. Ramadan Hamed. The authors thank fell substantially. Given that most firms tried to Sahar Nasr and GAFI counterparts for their inputs and support. maintain their levels of capital and labor, this meant a sharp decline in productivity. By 2012, sales and Private Enterprises in April 2012: In March and productivity had recovered part way to their former April, 2012, at the request of General Authority for levels, but firms had clearly made some labor force Investment (GAFI) for an update on the reductions and continued to confront lower performance of firms in the latter part of 2012, the demand. The decline in growth expectations and a World Bank surveyed 295 of the respondents to the pervasive sense of uncertainty suggests a strong 2011 Rapid Assessment by telephone. The sample, need for a new Government to encourage private- distributed across the same six cities, comprised 14% led growth and to take key actions to signal credible microenterprises, 39.7% small enterprises, 33.5% commitment to this strategy. medium enterprises and 22.9% large enterprises. 66% of firms were in manufacturing, while 34% Private enterprises in June 2011: In June, 2011, a were in services and construction. Rapid Assessment survey of 360 enterprises found that firms confronted a significant worsening of If the first half of 2011 was a story of decline, the certain constraints to their operation, led by second half was, for all categories of firms, a period macroeconomic uncertainty (especially reduced of recovery (figure 1). Driven by a strong demand, but also inflation), political instability, and improvement among large firms with large sales regulatory policy uncertainty. Firms in tourism value, sales for the entire sample was 14% higher in were especially likely to report a worsening of the second half of 2011 than in the first half. For the uncertainty and instability. Many firms had lost entire year of 2011, large firms sampled actually substantial days of business to civil disorder, and experienced a small, nominal increase in sales (2%), 14% had experienced a significant loss due to crime. but the average micro, small and medium firms Some firms experienced disruptions in supply reported a substantial decline in their sales (figure 1, logistics, while many experienced a higher cost of “unweighted�). This overall trend was marked by finance. Sales for the sample of firms were down by substantial losses in the first half of the year, and an average of 20%, although SMEs reported Firm Sales Experience for Second Half versus First Half of 2011 suffering a considerably higher sales decline than did large firms and the average tourism firm 20 unweighted weighted by sales 16.0 reported losing the great majority of its sales. 14.4 Exports for the sample of firms had declined by an 10 5.2 estimated 45%, with firms of all sizes experiencing a 1.8 1.2 substantial decline. Firms had only adjusted their 0 investments modestly, yielding a weighted estimate Overall -3.9 Micro Small Medium Large of about a 5 to 8% decline, although again smaller -10 -6.1 firms reported sharper reductions. Finally, with -12.2 -16.1 regard to employment, the total number of people -20 employed by sampled firms had remained remarkably steady, although smaller firms reported -30 small reductions.2 Sectorally, firms in construction -40 -36.1 and tourism reported the greatest reductions in employment. However, with regard to sales, exports and investment, firms were quite optimistic Figure 1: Weighted firm sales increased in the second about recovery and predicted rapid growth within half of 2011 compared to the first half. modest gains in the second half of the year. two years. Regarding employment, firms responded that the general economic situation in Egypt and Expectations for 2012, already shaped by the first wage inflation would have the strongest impact on quarter’s experience during the April survey, had their hiring of additional workers. moderated but were positive with a return to positive sales growth overall, a recovery of exports to their pre-revolution level and a modest upturn in investment. However, the picture for employment 2 Surveys do not reflect exit’s impact on employment and was less positive – firms reported that, for the year, oversample certain rarer types of firms, so the experience of the the total number of jobs in the sampled firms sample cannot be directly extrapolated to the macroeconomy. September 2012 · Number 73 · 2 declined 9.4%. This reflected a 9% decline among analysis shows this pattern throughout, although a large firms, 11% for medium firms, 21% for small weaker rebound in the chemicals/pharmaceuticals firms and 23% for the microenterprises surveyed. sector and a strong rebound in metal industries. The Expectations for job growth for 2012 were low, overall picture is one of recovering but not fully except among small firms, which expected a recovered productivity. Egypt has not yet reached significant rebound. even its level of four year ago, much less resumed its trajectory of productivity growth. This places added By the time of the 2012 Rapid Assessment (in a urgency on an agenda of investment climate reform period with numerous uncertainties about the and strengthened market support institutions and Parliament, Presidential elections, the Constitution services. and the interim Government), political instability had risen in rank to a dead tie with macroeconomic Expanding Access to Finance Egypt stood out for uncertainty. Each were identified by an the unusually low rate of access to bank loans extraordinarily 95% of respondents as major or experienced by private enterprises. Overall, the severe constraints to their operation. Corruption percentage of firms with a loan in both rapid was now identified by 85% of firms as a serious problem, a huge increase.3 A substantially higher proportion of firms also identified “regulatory policy uncertainty�, “crime, theft and disorder�, “informal sector competition� and “transport� as serious. One quarter of responding firms had now experienced a significant crime, resulting in a substantial average loss. For the first time, transport problems emerged among the top 7 constraints identified by firms. Addressing these priority constraints poses a critical challenge. Productivity in Egypt after the Revolution: Private-led growth is critically related to the ability of private firms to increase productivity. The immediate effect of the dramatic fall in demand in the aftermath of the Egyptian Revolution was a Figure 2: Access to Finance precipitous fall in productivity. As firms kept investment and labor force as stable as they could, assessment surveys was higher than that measured sharply reduced sales meant that less output was in 2008. In the April 2012 survey, 24.5% of firms being realized per unit of input. Thus total-factor reported having a loan or line of credit, including productivity (TFP) in sampled enterprises in June 13% of microenterprises, 16% of small enterprises, 2011, after having shown encouraging growth in 22% of medium enterprises and 48% of large ones. 2008, showed a dramatic decline. TFP could not be In the earlier 2011 survey, 21% of firms reported tracked in 2012, but evidence on labor productivity having a loan or line of credit. This reflects a is encouraging. Overall, labor productivity for the substantial increase in access since 2008 when 13.4% cross-section of surveyed enterprises, which had of firms reported having a loan or line of credit. fallen dramatically as measured by the 2011 survey, Why has financial access broadened recently? Part had recovered to above its rate in 2004 and 2006, of the explanation is continued policy and although not to its level measured in 2008. 4 Sectoral programmatic reforms to expand MSME access to finance, such as the expansion and extension of credit information and launch of an SME database in 3 Respondents’ evaluation of constraints to their operation is all governorates, and the Central Bank of Egypt’s understood to relate directly to the marginal shadow cost of the clear strategic priority on SME finance. Another lies constraint to the firm. An increase in severity would indicate the cost imposed by the constraint – either directly or through foregone opportunities -- has grown. 4 The data does not specify why productivity rebounded, half of the year. Cost-cutting and a reduction in production although the most likely explanation is better sales in the second disruptions may also have contributed. September 2012 · Number 73 · 3 in counter-cyclical strategy pursued by some state- Since innovation is closely associated with owned banks in order to build market share. They productivity growth and competitiveness, the have consciously expanded SME lending at a time of analysis also explored the characteristics of firms economic hardship and Government crowding out that innovate. Two significant features were a in financial markets. higher likelihood of offering employees formal training exports of at least 10% of sales value. An Nonetheless, the reported average amount of bank earlier multilinear regression analysis also found finance received remains small, amounting to 2.6% three strong correlates of innovation: domestic of working capital and 1% of investment capital. Of competition, international competition, and informal firms that didn’t have a loan in 2012, the competition. overwhelming majority reported they had never These findings point to key areas for a medium-term applied for one. In 2011, high interest rates deterred agenda encouraging employment growth and 11% of firms without loans from applying, but by innovation led by SMEs. These include: 2012 only 1.4% reported this was the main reason for not having a loan. In 2011, 48% of firms expected  Strengthening higher education and worker interest rate to fall, but in 2012, only 6% expected training, and the link of skills supply to private this. Instead, in 2012, 80% of firms expected interest demand. rates to hold steady. Finally, although in 2011 about  Assuring easy access to foreign technology and 30% of firms faced some restrictions on their access a legal environment conducive to technological to foreign exchange, by 2012 this was at only 5%. licensing. New Insights on SMEs - Breeding “Gazelles�:  Investing in international standards of Unemployment is MENA’s central challenge and at corporate governance. the heart of the discontent associated with the “Ara b  Policies encouraging ICT investment and Spring�. To face the challenge of unemployment, competitive provision of internet services. conditions are needed that promote innovation and  Further efforts to remove barriers to entry and encourage fast-growing SMEs that research points to encourage market dynamism through legal and as the most significant job creators. An expanding regulatory reforms and an active competition literature on “gazelles�, finds that “5 to 10 % of firms policy, involving a combination of trade, deliver 50 to 80 % of employment generation�. This investment and regulatory policies that minority of firms achieves rapid growth over a encourage flexible operation and ease of entry sustained period. and exit, with an active competition authority empowered to address anti-competitive A unique analysis of panel manufacturing data from behavior. 2008, 2006 and 2004 explores the characteristics of fast growing manufacturing SMEs in Egypt, defined It also points to the need for improved competition by job growth. In this work, the probability of a firm in financial services, and competitive forces more being a “gazelle� 5 and the probability of a firm generally, to address the needs of fast-growing being an innovator was predicted through a variety SMEs. of firm characteristics. Generally, gazelle firms in were characterized by higher levels of employee Contact MNA K&L: education and training, more foreign technology, Laura Tuck, Director, Strategy and Operations. external auditing, using email or a website, being MENA Region, The World Bank less than 10 years old, being small, and with reliable Regional Quick Notes Team: power supplies. However, gazelle firms were also Omer Karasapan, and Roby Fields more likely to have received a high number of Tel #: (202) 473 8177 inspections and were actually less likely to have received a bank loan than non-gazelles. The MNA Quick Notes are intended to summarize lessons learned from MNA and other Bank Knowledge and Learning activities. The Notes do not necessarily reflect the views of 5 Gazelles are generally defined in terms of sustained growth of the World Bank, its board or its member countries. 20% or more over a period of four years. In the case of Egypt, employment growth was used as the metric to judge “Gazelle� status. September 2012 · Number 73 · 4