90151 May 2014 – Number 124 X1` All in the Family: State Capture in Tunisia Bob Rijkers, Caroline Freund, and Antonio Nucifora1 authorization requirements and restrictions on foreign direct investment. Introduction and summary: Understanding state- business relationships and how they have shaped Figure 1: Business Interests of the Ben Ali Family 2 the institutional architecture of countries in the Middle East and Northern Africa is crucial for the identification of systemic vulnerabilities and reform priorities. In a new paper “All in the Family: State Capture in Tunisia”, we examine the relationship between regulation and the business interests of President Ben Ali and his family, using unique firm- level data from Tunisia for 1994 –2010, and document how Tunisia’s investment policy was abused to serve the president’s family’s private interests. Since the regulatory infrastructure instituted under Ben Ali has remained largely intact, our results underscore the urgent need for reforms equalizing opportunities for all. In spite of widespread recognition of its importance, empirical evidence on state capture has been limited by a lack of data. To redress this lacuna, we merge data on investment regulations with balance sheet and firm-level census data in which 220 firms owned by the Ben Ali family are identified. These connected firms outperform their competitors in terms of employment, output, market share, profits, and growth and sectors in which they are active are disproportionately subject to 2 The diagram from PRWP #6810 indicates the Ben Ali clan’s 1 Bob Rijkers and Antonio Nucifora work at the World Bank. alleged ownership of confiscated firms using information on the Caroline Freund is at the Petersen Institute of International website of the Ministry of Finance. The diagram is confined to Economics. This MENA K&L Quick Note was cleared by firms for whom we obtained information from the Tunisian Bermard Funck, Sector Manager, Economic Policy, Poverty and authorities and is not exhaustive. The diagram merely indicates Gender Units in the Middle East and North Africa Region alleged ownership relations without implying improper conduct (MNSED) of the World Bank. The Quick Note is based on Policy on the part of the listed individuals. Note that some of the listed Research Working Paper (PRWP) #6810 “All in the Family: State individuals are currently contesting the confiscation of their Capture in Tunisia”, World Bank, 2014, Washington DC available assets. at http://econ.worldbank.org. The authors may be contacted at Sources:http://www.finances.gov.tn/index.php?option=com_content&vi brijkers@worldbank.org. ew=article&id=201:gestion-des-biens- confisques&catid=28&Itemid=577&lang, Journal Officiel de la République Tunisienne, 18 mars 2011, No 18, 337-342. Consistent with theories of capture, performance Methodology: To characterize the Ben Ali family’s differences between connected firms and their peers business interests and their relation to regulation, are significantly larger in highly regulated sectors. In we identify in the Tunisian firm census 220 firms addition, the introduction of new foreign direct owned by the Ben Ali family that were confiscated investment restrictions and authorization in the aftermath of the Jasmin revolution. We merge requirements in narrowly defined five-digit sectors these data with administrative data from the tax is correlated with the presence of connected firms authorities, containing balance sheet information, and with their startup, suggesting that regulation is and create a database of the evolution of the endogenous to state capture. The evidence thus Tunisian investment law from 1993 until 2010, the implies that Tunisia’s industrial policy was used as a last full year of Ben Ali’s tenure. vehicle for rent creation for the president and his family. The data set we assembled3 allows us to identify the relationship between investment policies and the After the revolution, the same rules that benefitted business interests of Tunisia’s politicians. First, we the family have remained, as Tunisian investment pinpoint the sectors in which Ben Ali firms were laws have not changed substantially. As a result, active. Second, the data allow us to document rent seeking at the expense of the public and performance differentials between firms owned by repression of economic freedoms remain a reality. the Ben Ali family and their competitors, and to Reforms that open up opportunities for Tunisian examine to what extent these are explained by entrepreneurs to grow their businesses and create regulatory restrictions limiting entry. Finally, the jobs are essential to ensure that the revolution data set allows us to examine whether sectors in results in shared prosperity for all, instead of an elite which Ben Ali firms were active were significantly few. more likely to be subjected to new restrictions, effectively testing the endogeneity of regulations, i.e. This Quick Note summarizes the findings of the state capture. Decision-making authority over longer paper with the same title (details in footnote investment laws can be confidently attributed to Ben 1). Ali since changes to the Investment Code were made by decrees signed by the President himself. Thus, we The Risk of Regulatory Abuse: The potential for not only examine whether excessive regulations regulatory abuse is well known. Countries with invite rent seeking, but also whether rent seeking is more elaborate business regulations have higher associated with the proliferation of regulation. levels of corruption and lower levels of development, yet do not have better public goods The Tunisian Context: Tunisia provides a relevant (Djankov et al., 2001, Aedes and di Tella, 2007). context to examine who reaps the rents from While these patterns may in part be explained by regulation. It resembles many other developing limited administrative capacity in developing countries in having a development model based on countries (Harrison and Rodriguez-Clare, 2010), rather extensive state intervention. The Ben Ali they might also be the product of political processes family’s involvement in the economy was by no susceptible to capture by special interests. means secret, and Tunisia’s investment promotion Consistent with this conjecture, political connections agency advertised his close interactions with the account for significant market value in traded firms business community as enhancing public welfare. In (Fisman, 2001) and are especially prevalent in part because Tunisia registered stable positive countries with weak rule of law (Faccio et al., 2006). growth rates hovering around 4–5% per annum, Ben Nonetheless, direct empirical testing of the Ali also had a fairly favorable external image. The hypothesis that capture and manipulation of World Economic Forum repeatedly ranked Tunisia investment laws is a mechanism for rent creation as the most competitive economy in Africa and the remains elusive in spite of in-depth theoretical IMF as well as the World Bank heralded Tunisia as a analysis of the nexus between corruption, rents, and role model for other developing countries. Yet, the regulation (see e.g. Stigler 1971, Shleifer and Vishny, Tunisian model had serious flaws; unemployment 1993, 1994, Bliss and Di Tella, 1997, Ades and Di Tella, 1999, Acemoglu and Verdier, 2000). 3 The dataset is accessible at the Tunisian Institut National de la Statistique. May 2014 · Number 124 2 and corruption were high over the period studied, Entry Regulation and Connections: Second, sectors and contributed to Ben Ali’s downfall. Last but not in which Ben Ali firms are active are significantly least, Tunisia has a high-quality firm census, and more likely to be subject to prior authorization by authorities willing to grant access to data on both the government and to FDI restrictions. Ben Ali firm performance and political connections. firms dominate the telecommunications and air transport sectors and were also important players in Exorbitant Profits: We find evidence that entry other transport sectors, and real estate, all sectors in regulation was captured and to some extent dictated which entry is highly regulated. by the Ben Ali clan’s private business interests. To start with, Ben Ali family’s entrepreneurship was Entry Regulation and Performance Differences: both extremely lucrative and significant from a Third and related, Ben Ali firms outperform their macro-economic perspective. The ensemble of 220 competitors in terms of employment, output, market confiscated Ben Ali firms appropriated 21% of all net share, and profits, as well as growth in these private sector profits even though they accounted variables and do so especially in sectors that are for only approximately 3% of private sector output regulated. Performance differentials between and less than 1% of employment 4. Since we identify connected firms and their competitors are only firms with direct links to the Ben Ali family, as significantly larger in sectors subject to opposed to all firms with cultivated connections, authorization requirements and FDI restrictions. The this number is probably best interpreted as a lower effects are economically meaningful. Even after bound on the importance of political connections. controlling for its superior size, the market share of a typical Ben Ali firm is 6.3 percentage points higher Table 1 than the average firm, and this conditional differential is entirely due to Ben Ali firms sorting Macroeconomic Significance of into the regulated sectors. Consistent with theories Connected Firms of capture (Stigler, 1971), the superior performance (Ben Ali share of Total) of connected firms is thus to a large extent explained 21.30% by entry regulation, which is perhaps our most important finding. Table 2 Cronyism and Regulation in 2010 (at the 5 digit level) Sectors with BA firms (45 out of 332) Sectors without BA Firms (287 out of 332) 3.20% 42.86% 0.80% 39.29% Jobs Output Net Profits 24.28% Source: PRWP #6810 (See footnote 1) 14.13% 4 These estimates are in line with previous studies of the economic significance of connected firms. For example, in his Authorization FDI Restriction study of firms with connections to the Suharto regime, Fisman (2001) observes that the 25 business groups he identifies account for approximately a third of Indonesian GDP. Similarly, Ferguson and Voth (2008) argue that firms with ties to the Nazi regime accounted for three quarters of stock market capitalization in Source: PRWP #6810 (See footnote 1) Nazi Germany. A key difference with these studies, which have focused on publicly listed firms, is that we focus on the universe Manipulating Investment Laws: Finally, we present of firms and exclusively on firms with family ties to the Ben Ali evidence that the Ben Ali clan manipulated regime. investment laws to further its own business May 2014 · Number 124 3 interests. Although the number of observations is our understanding of the emergence and persistence limited, the correlation between the presence of of suboptimal policies (see the discussion in Rodrik, connected firms, entry restrictions and 1996), and suggest these may be endogenous to protectionism was present in the original Investment cronyism. Incentives Code enacted in December 1993. In addition, the probability of reforms to investment What has happened since the Revolution? While laws promulgating in additional regulations is Ben Ali and most of his entourage have been ousted, significantly higher when Ben Ali firms are present the institutional infrastructure that was put in place and the null hypothesis of no correlation between under his reign remains. Tunisians today literally Ben Ali presence and the introduction of continue to pay the price of privileges extended to authorization requirements and FDI restrictions is an elite group of entrepreneurs. Reform efforts have strongly rejected. Moreover, the start-up of new Ben not yet resulted in an opening up of economic Ali firms is significantly correlated with the opportunities for all, which is unfortunate since this imposition of new authorization requirements and was one of the central demands of those who took FDI restrictions. the streets a little over three years ago. Table 3 Contact MNA K&L: New Regulations by Presence of Ben Ali Gerard A. Byam, Director, Strategy and Operations. Firms MENA Region, The World Bank. (at the 5 digit level - 1994-2010) Preeti Ahuja, Manager, MNADE Regional Quick Notes Team: 2.00% Omer Karasapan, and Mark Volk Tel #: (202) 473 8177 The MNA Quick Notes are intended to summarize 1.55% lessons learned from MNA and other Bank Knowledge and Learning activities. The Notes do not necessarily reflect the views of the World Bank, its board or its member countries. 0.75% 0.38% Authorization FDI Restriction Sectors with BA firms Sectors without BA Firms Source: PRWP #6810 (See footnote 1) Political Connections and Industrial Policy: These findings illustrate how industrial policies can be abused as a vehicle for state capture (Schleifer and Vishny 1993, 1998, Helmann et al., 2000). By demonstrating how regulatory abuse can culminate in excessive market power benefitting an elite few, they help explain why political connections have been so highly valued (see e.g. Fisman, 2001, Ferguson et al, 2008).5 These findings also further 5 Connected firms have been demonstrated to benefit from privileged access to finance (Claesens et al., 2008) including bailouts (Faccio et al, 2006), as well as capital controls (Johnson and Mitton, 2001) and licensing arrangements (Mobaraq and Pursubasi, 2006) limiting competition. May 2014 · Number 124 4