IEMed Mediterranean Yearbook 2003


Panorama : The Mediterranean Year

Mediterranean Politics

Economy and territory

Culture and Society


Deterrents to Private Investment in North Africa

Theodore Ahlers

Director, Maghreb Department
Middle East and North Africa Region
The World Bank

There are two fundamental pillars to a successful development strategy in a globalised world. Firstly, countries need to have a good investment climate, in order to will encourage private firms to make investments, create jobs, and produce increasing added value. And secondly, countries need to empower and invest in the poorer populations, through health, education, and social protection, so that they may participate in the development decisions being taken, and which affect their livelihoods.

I will focus here on what drives private investment in an increasingly globalised world, namely the ability to maintain competitiveness – to find untapped markets, to invent products, to adopt new technologies, and to respond to changes in market conditions at home and abroad. While there are many features of a climate that is conducive to private investment, I will limit my discussion to the three features that I believe are particularly important in the case of North Africa. The first of these features that is important for creating a climate in which private investment can be competitive is the management of the exchange rate. Countries that have been successful in maintaining competitiveness of exports have achieved this by avoiding exchange rate overvaluation. Overvaluation is damaging to competitiveness, and therefore damaging to private investment, because it artificially alters the price ratio between tradable products and non-tradable products, thus weakening the ability of the producers of tradable goods to compete with either imported goods or with other countries’ exports.

What has been the experience of the North African region with respect to exchange rate management? In a recent study, we examined this issue by looking at the degree of exchange rate misalignment in the region. For North Africa, the results are mixed. During the late 1970s and early 1980s, exchange rate misalignment was a significant problem in some of the economies of North Africa. For example, between 1975 and 1984, overvaluation averaged eighty-two percent in Algeria and thirty-six percent in Morocco, which compares to average levels of misalignment of twenty percent in Latin America, twenty-nine percent in non-CFA Africa, ten percent in South East Asia, and forty-three in South Asia.

Since the mid 1980s, however, some countries have been more successful in their control of exchange rate misalignment than others. Between 1985 and 1994, Algeria’s exchange rate was overvalued by an average of twentyeight percent, but between 1995 and 1999, that figure was reduced to an average of only five percent. Morocco and Tunisia, on the other hand, have both experienced significant overvaluation of their exchange rates, averaging sixteen to seventeen percent for both countries over the 1995 to 1999 period. This continued overvaluation that has prevailed in certain North African economies can be traced in part to their reliance on fixed or managed exchange rate regimes. Prior to the late 1980s and early 1990s, most economies in North Africa opted for a fixed exchange rate regime as the most effective strategy for combating high inflation. This adoption of fixed exchange rates, either de facto or de jure, was successful in contributing to macroeconomic stability. However, once the immediate threat that inflation may run out of control had been averted, only Algeria and Tunisia shifted their policies to a more flexible exchange rate arrangement, while Egypt, Libya, and Morocco maintained fixed regimes. Recently, of course, Egypt has adopted a floating exchange rate regime. A central piece of evidence has emerged from the battery of empirical investigations looking into the subject: exchange rates are overwhelmingly more likely to become overvalued under fixed systems than under more flexible ones, which for North Africa has resulted in a substantial loss of competitiveness.

A second valuable feature for private investment which I think is particularly important for the North African economies is the health of the financial sector. An efficient financial sector, which is able to mobilise resources and allocate them efficiently to productive uses, is essential to the development of a competitive private sector. In North Africa, however, the financial sector serves as a major deterrent to that private sector development. Throughout North Africa, a principal deterrent to firms for investing and expanding is the lack of access to credit at competitive interest rates. Moroccan manufacturing firms are overwhelmingly financed from owner equity and retained earnings, and lending interest rates are double what businesses pay for credit in Thailand and China. The situation reflects inefficiency and lack of competition in the banking industry. In Algeria, a random sample of firms found that only eleven percent of working capital financing needs was financed by bank credit.

The large banks are still state-owned, and banking remains bureaucratic, non-businessfriendly, and poorly equipped. Private and foreign banks and other financial institutions are still weak and only play a minor role in financing enterprises. And in addition, export financing facilities are extremely limited.1 In Egypt, the financial system suffers from both inefficiency and lack of competitiveness. The four state-owned banks continue to dominate the field and the banking system still suffers from a low level of technology and poor financial innovation. Credit is granted overwhelmingly to big corporations, leaving small businesses with little access to formal credit. A 1997 survey of small and medium enterprises, which represent over ninety-eight of firms in Egypt, found that total banking sector loans to SMEs only accounted for about five to six percent of loans extended.

Even in Tunisia, access to credit by SMEs is limited. According to a survey in 2000, fifty-three percent of firms finance more than fifty percent of their investment from their own funds. Some of the major reasons for this low level of financial system funding are the collateral requirements for lending, which though applied equally to large and small firms, have a more deterring impact on small firms, accounting standards, and capitalisation and financing plans. The examples discussed above present the case for urgent and much needed reform of the financial sectors in North Africa. Finally, a third vital element in a successful climate for private investment, and one which in my mind is of highest importance for the North Africa region, is related to the overall governance framework. Governance is a highly implicative expression.

It encompasses how well the public are made aware of laws and regulations, as well as the general clarity of laws, how consistently and fairly laws are applied, how well the systems function in making public agencies accountable for their behaviour, and the degree to which the population are able to participate in government decisions. The Middle East and North Africa Region of the World Bank recently launched a report on governance in the region. In North African countries the governance challenges that are particularly relevant derive from weaknesses in inclusiveness and public accountability. Inclusiveness reflects the notion that everyone who has a stake in governance processes and wishes to participate in them can do so on an equal basis with all others. Accountability draws on the principle of proper representation, which means that those selected to act in the name of the population are credited for their successes as well as answerable for their failures. Limited public accountability in North Africa has resulted in private investment being hindered by a bureaucratic environment that is cumbersome and inefficient. An example of this can be seen in the level of bureaucracy and red tape that is necessary to go through in order to set up a business.

In Morocco in 1999, firms needed an average of ten different permits to initiate their activity, and half of all firms surveyed maintained full-time employees just to deal with the bureaucracy. In Algeria, entrepreneurs report an impenetrable degree of bureaucracy and red tape, with cumbersome and unclear regulations, and endless delays in obtaining clearances and authorisations. But the second governance issue that affects private sector investment is the lack of inclusiveness, which emanates from a lack of fair and consistent application of regulations and policies. The form in which this lack of consistency occurs varies between the different countries. In Algeria, businesses have identified the unfair access to public contracts as significantly deterring their activities. In Egypt, on the other hand, businesses have consistently identified informal competition as a major constraint to their activities. As some firms escape both duties and taxes, the ability for formal activities to be in a position to compete is undermined.

This is also a prevalent situation in Morocco, where firms cite unfair competition emanating from firms evading taxes and having undeclared workers. Smaller firms are often the most disadvantaged in North Africa, both as a result of the lack of inclusiveness and by the inefficient regulatory environment. While larger firms can alleviate some of the administrative obstacles to carrying out business by providing the required services internally, smaller ones have neither the organisational capacity nor the resources to cope with such extras. And more directly, evidence relating to business perceptions suggests that large private businesses and individuals throughout the Middle East and North Africa Region play a disproportionately large role in manipulating the systems for personal gain. This may range from the persistent awarding of large public sector contracts to effecting actual change in laws and regulations to lower costs or increase profitability. Such state capture of government regulations discourages the development of small enterprises, since they are less able to afford to buy decisions. At the same time, it has also deterred new investors, including those from abroad, from entering the economies, as the rules of the game are both unclear and biased. Private investment is driven by many factors, but there are three preconditions that are fundamental issues the countries of North Africa will need to address if they are to successfully promote a stronger private investment response:

  • A flexible exchange rate in line with fundamental levels
  • A financial system geared to business development
  • A governance system that ensures a business and investment-friendly climate effectively regulated to promote competition.