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What Macroeconomics Factors Explain Algeria’s Poor Economic Growth Performance Mohamed Abdelbasset Chemingui1 email@example.com Background Paper for the GDN Global Research Project on explaining Growth in Developing Countries: The Case of Algeria (Revised version January 2003) Abstract The central focus of this paper is to identify the structure, magnitude, composition and determinants of Algeria’s economic growth during the past four decades, since it’s independence. The findings of this study indicate that the poor economic growth in Algeria is mainly due to internal economic policies and not due to external international economic shocks. This poor performance can be blamed on the country’s inability to properly utilize its natural resources. In addition, the country has suffered from macro-economic mismanagement, specifically price deregulation and reforms in order to increase investment rates. Moreover, structural impediments have blocked the private sector and hindered economic takeoff. The dominance of the public sector, the non-transparent privatization process, and weaknesses in the financial sector are among other factors that limited the progress of economic reforms. I. Introduction. 1 Mohamed A. Chemingui is a Research Scientist in the Techno-Economic Division of the Kuwaiti Institute for Scientific Research and Researche Associate with ERF. The author are gratuful to Magdy Mashaly , M. Zafar and one anonemous referee for their comments. Most of data used in this paper are extracted from the Global Research Project Database produced by the Worldbank. 1 Economic growth2 is probably one of the most important research topics in modern economics. Looking for the reasons why in 1992, output per capita was 48 times higher in the United-States than in Chad, or why average annual growth of GDP per capita in Singapore was 3.6 per cent during the period from 1960-1992 but -2.1 per cent in Madagascar in the same period, is an intriguing research task. How can countries go from rags to riches, or vice versa, and what part does economic policy play in this are also interesting questions? Or does it all boil down to whether countries have been blessed with abundant natural resources, a good geographical location, and favorable climate-factors outside the scope of economics? As underlined by De Gregorio and Lee (1999), the growth performances during the last three decades are very diverse among the countries in the world. The four East Asian tigers grew extremely rapidly at an average of over 6.0 percent per year in per capita terms between 1965 and 1995. On the other hand, many countries in the Sub-Saharan Africa and the Latin America regions recorded less than 1.0 percent average per capita income growth during the same period. The high growth of the four East Asian countries, compared to the poor performance of African and Latin American economies leads directly to the question of what can be done to improve growth. In some cases, economists tried to understand the sources of good growth performances in some countries and in other cases, studies have the objective to understand the causes of poor growth observed in other countries. There was a long time when we had a rather simple design about growth in the developing countries. It was usually enough, in the Fifties and Sixties, to invest massively to obtain a fast growth. But in the Seventies, several economies which had been profited from a massive external capital flows, had not realized a fast economic growth as they expected, while the accumulation of the loans in foreign currencies led them to a serious financial crisis at the beginning of the Eighties. Relevance of the report according to which investment is not obligatorily, an engine of economic growth was at the origin of a debate on the various determinants of the growth according to the level of development of the countries. This debate which faced during last years an exceptional width as by the high number of theoretical and empirical studies to which it gave place, as well as by the importance practical implications in terms of decisions of economic policy in the industrialized and developing countries. In addition to the debates relating to the search of the determinants and sources of the growth realized in certain countries, the known crises which touched some developing economies, especially in the middle of the eighties, were at the origin of the emergence of other kind of growth analysis. This analysis is relative to the causes of the economic recession observed in some countries, especially those laying out an important energy revenues. In this paper we revisit Algeria growth. There are two main purposes of this paper. The first is to examine past evolution of growth and the search for explanation for its poor performance. Secondly, to discuss potential growth for Algeria and to present the methodological approach to address this question. For these purposes we examined the issue of total factor productivity (TFP) growth, based on the Solow growth model, to examine the performance in Algeria and to examine how poor performance in Algeria can be explained. 2 Economic Growth is the growth at the level of national income. There are various measures of national income, but the one used is the gross domestic product. We measure growth as the percentage change in GDP. However, it is very important that we only take the percentage change of the real GDP. Economic growth tends to follow a cyclical pattern. There are may be boom periods when economic growth is faster, but these may well be followed later by periods when the economy slows soon down. This pattern is known as the trade cycle. 2 This document is composed of four sections in addition to introduction. In the second section, we will expose a history on the various phases of economic growth carried out in Algeria since it’s independence. In the third section, we will present a growth accounting exercise in order to estimate the primary sources of economic growth that were carried out in Algeria according to what proportion it comes from physical capital, labor or the TFP. The fourth section will present some main structural obstacles behind the fall in economic growth and TFP in Algeria observed since the middle of the 1980s. The last section will draw up, in the form of a conclusion, an assessment of Algerian’s experience in terms of economic growth through presenting the achievements, the determinants and the insufficiencies. II. Overview of the Economic Growth in Algeria. Algeria is a particular case in the MENA region. Whereas this country is vast and very rich in natural resources, it has not managed to benefit from it’s potential to secure a better living standard of it’s population and an economic takeoff. On the contrary, data show that in addition to low growth and the subject to international prices fluctuations of the energy products, the rate of unemployment has continued to increase. Compared with other Arab countries, especially Tunisia, in 1960 Algeria had an income per capita that was 60% higher than that of Tunisia. Thirty years later, Tunisia exceeded Algeria by 7%, which represents an increase of 67%. Contrary to Algeria, Tunisia is a small country endowed with little natural resources, but where the economic performances exceeded those of Algeria. Although Algeria profited extremely well from significant oil’s revenues since the middle of the sixties, Algerian economic experience often is regarded as a spectacular failure despite the exceptional investment effort in infrastructures and heavy industries since its independence. This significant variation in the economic performances between the two countries proves well the characteristics of Algerian experience, which deserves a historical background. The purpose of this section is to provide detailed accounts during the period from 1962-2000, of change in policies and environments in Algeria that are potentially crucial to the understanding of the growth process. We will do so by dividing Algerian’s economic history into four sub-periods, namely: A) 1962-1985: this is the period that Algeria laid foundations for the subsequent high and stable economic growth. B) 1986-1988: this is the period of macroeconomic instability, difficult adjustments and poor economic growth. C) 1989-1994: this corresponds with the first implantation of a structural adjustment programs and a reduction of economic declining. D) Since 1995: this is the period of implementation of the second new economic reforms and improvement of economic growth. The section begins with a brief account of growth experiences of the past forty years, followed by the discussions of the economic changes and turning events of each sub-period. For each sub-period, attention will be paid to the major changes in environment and policies that are likely to affect economic performance in the country. II.1. Growth Experiences in Algeria. Overall, Algeria can be regarded as one of the fastest growing economies among MENA countries. The average annual growth rate between 1962 and 1999 is a respectable 5.0 percent. Of course, this relative high growth rates were not achieved yearly. In fact, since its independence, economic growth in Algeria is marked by a 3 succession of ruptures. The period from 1962 till 1985 is clearly the time when Algeria enjoyed its highest economic growth, averaging 7% annually. This high growth was led principally by the growths in manufacturing sector who benefited by intensive public investment. On the other hand, the period from 1986 till 1988 is no doubt the most difficult period in Algerian’s economic growth history, declining on an average of 0.7% annually. The third period from 1989 till 1994 is the period of implantation of the first adjustment program and during which economic growth remained in declining period with nearly 0.1% annually. In the last period (1995 till 2000), Algerian’s economic growth re-started its improvement with an annual growth rate of 3.4% which will be explained mostly by the results of the adoption of the second economic reform supported by the World Bank and IMF. II.2. The First Period from 1962 to 1985: High Stable Economic Growth. Since independence in 1962, Algeria undertook the construction of a socialist economy supported by heavy industrialization and substantial investment in human capital. By the end of the 70’s, Algeria was on a strong path of high and fast growing income per-capita, and was investing about 45% of national income. Hydrocarbon export revenues provided the finance for these efforts, which created a large network for modern public enterprises and helped building extensive infrastructures, and yielded important social progress by reducing illiteracy, increasing life expectancy, and ensuring a high level of education for its population. Then, the choice of the Algerian State in this period was in favor of the institution of the state monopolies within the framework of a system marked by the centralized economic planning. An important public sector in advanced activities (foreign trade, Banks, insurance, main productive sectors) was constituted gradually. This sector is defined as a group of firms of which legal property returns to the State. The orientation of investments is decided at the level of the state power, and the leaders are named by political decision of the state power. The development system adopted in Algeria was centered on a strong industrialization, which is considered the way by which other sectors of the Algerian’s economy will be developed. Consequently, large investments had to be granted to this sector. During the first quadrennial plan (1970-1973), 54% of the total public investments were centered in the fields of industries, mining, energy and hydrocarbons, while agriculture shared only 10% of the same total. The part of investments intended for the industrial sector increased during the second quadrennial plan (1974-1977), reaching more than 56% against only 6% for the agricultural sector. The heavy industry, notably of hydrocarbons3, had to assure an energy function, an industrial function as well as a capital accumulation function. It had to assure accumulation -with the help of the oil’s revenue, contribute to the construction of the industrial sector by endowing it with raw materials, provide agriculture in inputs and in energy, and finally fill a social objective, namely to improve the level of population income and living’s standards. Macro-economics objective was also assigned to the public firms. The criteria of performance in the micro-economic sense were relegated to the second raw for the benefit of often-contradictory political, ideological, economic and social objectives. Indeed, it had to execute the objectives of the economic plans, namely: to give concrete expression to the programs of strategic investments often without real relation with the necessities of the firm to maximize the rates of use of the installed capacities. In addition, public firms had other 3 Whose tax system, only, exceeded by far food exports, the latter being considered a source of currencies in that period. 4 objectives mainly to help in reducing regional disparities, to absorb the demand of the population for more employment supply, and to take care of the social necessities of the employees (consumer goods with low costs, habitation, health, transportation,). On the other hand, the state had to assure various obligations towards public firms, notably both assistance and support: the Treasury grants public firms advances while the administration grants them subsidies and supplies them with loans or pawns their outside loans. There is no doubt that the public firm supports an organic and functional subordination. Moreover, the managerial initiative was being suffocated. Not much encouraged, the private sector sees itself scattering and evolving outside a strongly concentrated and centralized public sector. In a context where credits and financial support almost do not exist, the private sector nevertheless survived by drawing profits offered indirectly by state’s sector. Consequently, Liabes (1984) estimated that in all levels, the state’s sector lived and contributed to the reproduction of the private capital, by distributing salaries, protecting the market, offering subsidized products and taking the social expenses. The state participates in an important way in the expansion of the inner market, by the creation of social layers, which serve as customers of the private production. In summary, the key success of Algeria’s early modern economic development owed to the combination of (a) a vision to promote economic growth through high public investment and productive activities and human capital financed by an increasing energy production and a high international prices for oil products, and (b) a high development for local production realized both by public direct support and commercial protection. During this period, Algeria accounted the higher economic growth rate realized after its independence. II.3. The Second Period from 1986 till 1988: Declined Oil Prices, Economic Crisis, and the Implementation of the First Structural Reform Program. By the late seventies, the drawbacks of centralized planning were becoming apparent, most clearly in the case of state farms, which accounted for the major part of Algeria’s agricultural potential. Despite large government investments in the state-farm sector, production and yields were not improving. The time lag required for completing large public investment projects also became unduly long, which meant that capital was immobilized for long periods without generating any return. Moreover, most of the new industrial plants were running substantially below capacity as result of low domestic foreign demand, which can be explained by the deterioration of income for the most Algerian’s population and the low international competitiveness of it’s products. For all these reasons, the incremental capital-output ratio became abnormally high (Table 1.1), indicating the inefficiency of investment. With investment reaching nearly 50% of GDP according to national accounts figures, real per capita output would have been expected to grow rapidly. In fact, the average annual growth rate of per capita GDP declined from over 3% during the seventies to about 2% during the first half of the 1980s. Table 1. The Drawbacks of Centralized Planning System in Algeria 1975-76 1977-1978 1979-80 1981-82 1983 1984 1985 Gross Investment/GDP (%) 44 49.5 41 37 38 35 33 Capital-Output Ratio 3.5 4.5 5.5 7 8 8 6 Per Capita GDP growth (%) 3.5 3.85 1.25 1.55 1.9 2.2 2.3 Source: Authors’ calculations on the basis of data from World Bank (1994). 5 After the decade of the 1980s, Algeria’s macro-economic situation worsened, in large part because oil prices declined steeply. After 1986, in particular, the situation worsened rapidly as export revenues collapsed under the twin assaults of a Saudi-inspired lowering of world prices and a dramatic decline in the value of the dollar, the currency in which the energy trade was transacted (ICG, 2001). This shock caused a 50% drop in Algeria’s terms of trade. Although the Government borrowed heavily from abroad to maintain consumption levels, imports were cut by almost one-third in volume terms from 1985 to 1987. This reduction not only adversely affected investment and the consumption of imported consumer goods, but also reduced the level of activity of domestic industries, which started of imported inputs and spare parts. As a result, output stagnated, with the exception of the hydrocarbon and agriculture sectors. In parallel, unemployment and inflation rates increased, and per capita consumption declined. This precipitated an acute social and political crisis. In response to the crisis, the authorities initiated a broad-ranging program of macro-economic stabilization and structural reform. The steam of the national boom came to a halt in 1986, as oil prices were almost halved compared to 1985, and since then the Algerian economy has kept struggling to recover, as the Government initially borrowed heavily to compensate for the oil price drop. Real GDP growth averaged less than 1% per year in 1986-1998, compared to 5.4% per year in 1978- 1985. The adoption of the structural adjustment program become necessary and was initiated in Algeria in 1987. The program of macro-economic stabilization and structural reform that was initiated in 1987 was must be deepened in order to establish the conditions for sustainable long-term growth. The over-riding objectives of the macro-economic stabilization program are to restore growth, correct macro-economic imbalances and price distortions, and contain inflation. The priority objectives of structural reform included: (1) Promoting private sector development; (2) Reforming and restructuring public enterprises; (3) Deepening agricultural reform; (4) Developing a competitive financial sector, and a well-functioning labor market; (5) Strengthening the social safety net, and adapting it to the needs for a market economy; and (6) Integrating the economy into world markets. Since its inception, the fundamental objective of the structural reform program has been to improve economic efficiency and generate a supply response. Reform has transformed the legal and institutional framework of the productive sector and the factor markets. To stimulate the supply response and provide a source of competition for public enterprises (PEs), the reform program has included a broad range of institutional measures to promote the private sector and ensure a level playing field. A program to restructure the PE and banking sectors has been initiated to complement legal and institutional reforms. While the institutional framework for the financial and labor markets has been modernized, the reforms adopted have had a limited impact on financial intermediation and labor mobility. The main causes of the limited reform progress were the prolonged recession, and the structural rigidities and non-competitive business practices ingrained during 25 years of centralized planning. II.4. The Third Period from 1989 till 1994: The New Economic Crisis and the Adoption of the Second Economic Reform Program. Despite the progress achieved in implementing adjustment, the economic crisis has persisted. Weak economic growth has lowered per capita 6 consumption and exacerbated unemployment. Over the 1985-1992 period, aggregate GDP growth averaged only 0.4% annually. This recession continued in 1993 and 19944. Agriculture has been the bright spot of the economy, averaging an encouraging 5.4% growth rate per year. In contrast, the value added by the core “enterprise sector” (i.e., industry, construction, and services) has declined by an average of about 3.2% annually. Limited output growth translated into a decline in per capita private consumption of some 3% annually on average over the 1985-1992 period. The enterprise sector, particularly industry, continued to be dominated by large, heavily protected PEs, whose managers had no direct stake in improving the performance of their firms. Barriers to entry persist, notably in the form of the monopoly power of many PEs, and their de facto better access to official foreign exchange and domestic credit at subsidized rates. The barriers to exist of non-viable PEs constitute another important obstacle to more rapid structural change. The recession has worsened unemployment. The number of unemployed workers tripled over that period, and the official open unemployment rate reached an estimated 21%. Structural reforms have encompassed an overhaul of the incentive framework, including price, tax, and trade reforms. In January 1992, a major tax reform was enacted; a VAT was introduced to simplify the indirect tax structure, while unified corporate and individual income taxes replaced a series of scheduler taxes and special tax regimes. The tax reform included a significant tariff reform component, including a reduction in the maximum tariff from 120% to 60%, and a unification of the compensation tax rates on imports and domestically produced goods. Nevertheless, the incentive framework has suffered from significant distortions, which have limited the benefits derived from the reforms. The key distortions have been the overvalued exchange rate and negative real interest rates. While the tariff structure has been made more neutral, it continues to distort border prices and accord a relatively high rate of protection to domestic producers. With the implementation of the 1994 reform program supported by the World Bank and the IMF, Algeria marked a solid departure from the past, in terms of both macro- economics policy and results. The program was put in place following a severe external payments crisis, in the wake of the oil price drop throughout 1993. The Government introduced swift stabilization and adjustment measures, including a strong fiscal adjustment; tight monetary policy; an active exchange rate policy; and price liberalization. The program was accompanied by a debt rescheduling agreement with the Paris and London clubs, and the initiation of structural reforms, including privatization. To date, the main parameters of the reform program have remained in place. II. 5. The Fourth Period from 1995 till 2000: The New Departure of Economic Growth in Algeria. The reform program that was supported by the World Bank and IMF and lunched in Algeria in 1994 has been highly successful in bringing about macro-economic stability. Inflation dropped from 39% in 1994 to around 5% by the end of the 1990’s and is currently at about 3%. The fiscal deficit, at 8.7% of GDP in 1993, was initially halved and subsequently kept at low levels, and turned into surpluses of around 2.5% by 1997. The oil price drop of 1998 weakened the fiscal performance as the decline in oil revenues prompted a deficit of 4% of GDP, but the fiscal stance was reversed following the oil price recovery and expenditure curtailments in 1999, yielding a close-to balanced budget. However, the supply response failed to materialize, and the economy remains vulnerable to oil price and climatic changes. 4 During the 1990-1994 period, annual real growth was negative, averaging -0.9 percent (IMF, 2000). 7 The reform program succeeded in reversing the long past decline in GDP growth, but the recovery is still slow and subject to large fluctuations provoked by weather and oil price variability. Real GDP growth rate in 1995-1996 averaged 4% (mostly driven by the hydrocarbons sector), followed by a sharp slow down in 1997 to around 1%, reflecting the drought induced drop in agricultural production and a continued decline in the State-owned industrial sector. Manufacturing value added fell continuously by 2% in 1995, 13% in 1996, and 7% in 1997, implying a cumulative loss between 1990-1997 of around 40% in real terms and prompted some industrial restructuring. Economic performance in 1998, with a real GDP growth rate of 5.1%, was exceptionally high despite the oil price shock, principally due to an exceptionally good harvesting year by good rainfalls, and some recovery in manufacturing resulting from the restructuring efforts of the previous 4 years. In 1999, real GDP growth dropped again to 3.5%, mainly due to a substantial slow-down of the non-hydrocarbon sector, which grew at only 2.7% in real terms due to the budgetary impact of the sharp drop in oil prices. This was due to the deceleration of the construction and services sectors, compounded by a severe slow-down in agriculture due to an important late-season drought that mostly affected the cereal sector. Prompted by the oil price recovery in the second part of the year, the hydrocarbon sector grew at 6%, once again compensating for the slow down in the non-hydrocarbon sectors. Figure 1: GDP per Capita Growth Rate 40 30 20 per cent 10 Series1 0 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 -10 -20 -30 Year Source: World Bank Data III. Understanding the Economic Growth Fluctuations in Algeria: a Growth Accounting Exercise. Countries grow by accumulating labor, capital and human capital and by using resources more efficiently. There is a substantial recent literature that advances evidence across countries on the relative contribution of these three basic inputs and of efficiency gains - total factor productivity (TFP) - to output growth (J. Page and J. Underwood, 1996). Growth accounting exercises decomposes the growth of output into growth due to capital, employment and total factor productivity (TFP). Our interest in this exercise is to explore how Algeria’s overall growth has improved or declined since its independence and the successive periods of economic reforms, to better understand what has prevented the country from achieving the rates of economic growth needed and realized by other countries in the MENA region with less endowment of natural resources. As explained by Keller and Nabli (2002), in Algeria as MENA region, accumulation and productivity have often gone in opposite 8 directions, such as during the period of massive public sector investments. Examining growth alone will mask these very different effects and the somewhat anemic growth that has characterized the country, since reform may be more a reflection of significantly lower investments than a continuing poor productivity performance. Our methodological approach is then to perform a growth accounting exercise based on the assumption that the production function follows a Cobb-Douglas specification with constant returns to scale between capital and labor. Yt t = AK tα Lα −1 Where Y is output, A is an index of total factor productivity, and K and L are the stocks of physical capital and labor, respectively. We start our estimates of growth sources in Algeria by the decomposition of the growth for the period 1962-1999. We fixed the year 1962 as starting year of our estimation because this notes the independence year of Algeria. In the absence of a time series of employment, we used a series for total labor force growth. Human capital was not used in the calculation of TFP growth, the idea being that human capital contributes to TFP growth; i.e. that in a more general analysis human capital should be used to explain the path of TFP growth. 9 Table 2. Contribution to growth5 1962-99 GDP Capital Stock Labor force TFP Annual Growth Rate (in %) 5.00 4.87 2.37 Capital Share = 0,3 1.49 1.72 1.78 Capital Share = 0,35 1.74 1.60 1.66 Capital Share = 0,4 1.99 1.48 1.53 1962-85 GDP Capital Stock Labor Force TFP Annual Growth Rate (in %) 7.05 5.86 2.34 Capital Share = 0,3 1.85 1.24 3.96 Capital Share = 0,35 1.59 1.34 4.12 Capital Share = 0,4 2.12 1.15 3.79 1986-88 GDP Capital Stock Labor Force TFP Annual Growth Rate (in %) -0.74 2.67 3.24 Capital Share = 0,3 0.9 2.02 -3.66 Capital Share = 0,35 0.77 2.17 -3.69 Capital Share = 0,4 1.03 1.86 -3.63 1989-94 GDP Capital Stock Labor Force TFP Annual Growt Rate (in %) -0.08 4.54 1.88 Capital Share = 0,3 1.4 1.09 -2.58 Capital Share = 0,35 1.2 1.18 -2.46 Capital Share = 0,4 1.6 1.01 -2.69 1995-99 GDP Capital Stock Labor Force TFP Annual Growth Rate (in %) 3.36 1.52 2.22 Capital Share = 0,3 0.52 1.45 1.38 Capital Share = 0,35 0.45 1.57 1.34 Capital Share = 0,4 0.60 1.34 1.42 Source: Our Estimations III.1. Labor and Capital Productivity. Between 1962-99, the real GDP increased by 5% annually requiring an increase in labor and capital at respective average annual rates of 2.4% and 4.9%. For a value of 0.3 of the elasticity of capital, the growth rate of labor productivity is about 1.7% annually whereas that of the capital reached 1.5% during the same period. Respective contributions of the primary factors labor and capital, in growth, were established to 34.5% for the first and 29.8% for the second. This evolution hides significant variations between the periods by which Algerian’s economy passed. Thus, during the strong growth carried out during the period 1962-85, the volume of labor increased annually at a rate of 2.3% for a contribution to the growth of almost 17.6% whereas the stock of physical capital increased by 5.9% annually during the same period for a contribution to the growth of around 26.3%. Thus the annual productivity of the capital increased at the rate of 1.2% annually for labor and 1.9% for the capital. These results show that during the period 1962-85, Algerian’s economy was much more powerful compared to that of 1962-99 owing to the fact that for the 5 We have calculated the TFP using three distinct calculation of capital share (0.3, 0.35, and 0.4) to check the sensitivity of the region’s growth performance to the assumption made on the output elasticities. These shares are based on estimated coefficient from previous research using World Bank data (Nehru and Dhareshwar, 1993 ; and Keller and Nabli, 2002). 10 same volume of labor and an additional stock of capital of 1%, Algerian’s economy gained more than 2 points of economic growth. In other words, for an increase of n% in the primary factors used for the production, Algerian economy gained more in growth rate (n+m). This is explained especially by a strong improvement of the growth of the TFP. It is important to say that during this period, Algeria began a two-decade period of massive public investment in infrastructure, health and education, which in this early period of development was translated into high growth both by increasing the contribution of capital and labor and also by the improvement of the TFP. Large-scale public investment in critical infrastructure during this period has helped to get a significant growth response. However, compared to the volume of investment during this period, the contribution of capital to growth seems low than expectations for the country. This poor contribution of capital in economic growth confirms that not all the investments undertaken in Algeria in this period were productive. In fact, Algeria invested in large infrastructure projects and protected state industries with low competition and poor resources allocation. This was encouraged by the publicly subsidized energy, water, and other inputs. By 1986, as international oil prices slumped in the wake of global overproduction, Algeria marked a rupture in the growth of capital and labor productivity and in general began a long period characterized by a decline in the economic growth. With eroding macro- economic balances and growing external debt pressures, investments declined dramatically. The productivity of the capital thus showed a fall of 1% compared to the period from 1962 till 1985. Indeed, the annual growth rate of the productivity of capital passed from 1.9 to 0.9%. This tendency was relatively rectified during the period from 1989 to 1994, where the productivity of the capital accused an annual growth rate of 1.4%. As for Labor factor, it’s productivity was not affected by the crisis observed since 1986. Indeed, for an annual rise of the volume of labor used at the rate of 3.2%, its productivity increases at an annual rate of 2%, which corresponds more or less to a quasi efficiency stability of the use of labor factor. Over the period from 1989 to 1994 which corresponds to the installation of the structural adjustment program of Algerian’s economy, the crisis touched more the labor market. Indeed, the total occupied labor force increased at the rate 1.9% annually for an annual growth of the productivity at about 1.1%. III.2. Total Factor Productivity. This indicator, calculated as being the share of the growth not allotted to the contribution of the two factors capital and labor, constitutes a synthetic measure of the productivity. TFP growth is often thought of as “technical progress”, but in fact, it is the residual of a growth accounting estimation, it does not only embody the differences across countries in their progress in the adoption of better technology, but also reflects a host of non-technological differences; including changes in the utilization of both capital and labor; changes in schooling quality; and changes in the overall efficiency with which factors are allocated in the production process (Keller, J. and M. K. Nabli, 2002). For the calculation of the total factors productivity (TFP) for Algeria, we initially retained a value of 0.3 for the elasticity of the capital in accordance with the value most retained in similar analyses. Its evolution since 1962, date of independence of Algeria, is characterized by significant variations from one period to another. Between 1962 and 1999, this indicator realized a moderated performance with an increase by 1.8% annually, thus carrying its contribution to 35.7% of the growth carried out during the same period. However, during the period of sustained high growth of Algerian’s economy between 1962 and 1985 and before the first spectacular drop in international prices of oil, this indicator recorded a remarkable 11 performance with an increase of almost 4% on average annually, or a contribution of 56.1% of the growth carried out during this period. These performances hide periods of heavy falls of the annual growth rate of the TFP. Indeed, over the periods 1986-88 and 1989-94, the annual growth rate passes from -3.7% for the first period to rectify itself by reaching -2.6% annually on average. The situation was rectified again to find positive values of TFP as from 1995. Thus, the annual growth rate of the TFP reached 1.4% for a contribution of nearly 42% of the growth carried out between 1995 and 1999 and which accounted for 3.4% after a long period of economic crisis. As for labor and capital factors and in a preoccupation with a measurement of robustness of our results, we measured the TFP for two alternative values of capital elasticity (0.35 and 0.40). The results showed that the change of the value of the capital elasticity (from 0.3 to 0.35 or 0.4) has not affected significantly the value of the PGF for the period of sustained high growth (between 1962-95). Results are shown in table 2. For the other periods, the change of capital elasticity has not affected the annual growth rate of the PGF. The utility of TFP analysis is proven by a comparison between the two periods of 1962-99 and 1995-99. If we appreciated the performances of a given economy according to the only growth rate observed, it would be concluded that the results are better during the second period than the first period. However, this conclusion appears insufficient knowing that in the second period, the Algerian’s economy only used 1% of additional investment to release 2% of additional economic growth. Thus, the utility of the identification of exact sources of this additional gain knowing that it could not be the only result of investment. The growth rate of labor used being almost the same one lasting the two periods; the search of other sources of growth except those of capital and labor is therefore justified. This is why we estimated the growth of the TFP per period and which represented the part of the growth not allotted to the two primary factors of production. It is appropriate in a following part to identify the sources at the origin of the values of TFP estimated in the present part. In comparison, and over the long-term period, Algeria achieved economic growth mainly through labor force at the first place and capital accumulation at the second. In East Asia, TFP and capital accumulation are the main determinants of growth. In Tunisia and Morocco, capital accumulation appears the main determinant of growth. After a period of deterioration of the contribution of capital accumulation and the negative level of TFP (from 1986 to 1994), Algeria has achieved since 1995 better results in terms of TFP. Between 1995 and 1999, TFP growth is estimated at about 1.4%. It is likely that this improvement can be linked to the structural adjustment program adopted in Algeria at the middle of the 1980s, which reduced the share of public investment in total investment and mainly in non- competitive activities (the contribution of capital accumulation in economic growth did not exceed 0.5%. However, this recent efficiency gains in Algeria remain insufficient to achieve the high rates growth required to improve the needs of the high population growth rate. 12 Table 2. Determinants of Long-Term Growth in Algeria and Other Comparative Countries Morocco Tunisia East Asia Algeria(1) GDP annual growth rate (1960-94) 4.6 5.3 6.1 4.9 Contribution to Growth (%) * Capital Accumulation 2.6 2.3 3 1.5 * Labor Force 0.9 0.9 0.6 1.7 * Total Factor Productivity 1.1 2.1 2.5 1.8 (Human Capital Included) Source: J. Page and J. Underwood (1996) and our calculations. (1): data for Algeria are related to the period 1962-1999 IV. The Structural Weakness of the Algeria’s economy. Growth is not an automatic birthright for an economy. For an economy to grow, the right conditions have to be created. Growth depends to a significant extent on the resources that a country has. The better the quantity and the quality of the resources the more potential it is to grow. In Algeria and during the first period (1962-85) of its economic development which was characterized by a high level of economic growth realized through a high public investment rate (nearly 50% of government current expenditures) financed by its important natural resource exports mainly oil and gas. In fact, the hydrocarbons sector still the backbone of the Algeria’s economy, accounting for approximately 57% of government revenues, 25% of GDP, and almost all export earnings. Algeria has the fifth-largest reserves of natural gas in the world and is the second-largest gas exporter; it ranks 14th for oil reserves. However, the oil price crash of 1986 forced the government to revise the budget to bring the hydrocarbon revenues dropping from 44 percent in the 1985 budget to 32 in 1986 and to 23 in the following three years. In addition, Algeria implemented a stringent macro-economic program which has been considered modestly successful with an average rate of economic growth of 3.4% realized since 1995. However, this economic growth remains below expectations to improve the additional needs for the Algeria’s population which grew at an average rate of 2.3% and still very correlated to the international oil’s price. Achieving growth target in Algeria and reducing its dependency for oil’s price has been overshadowed by some structural barriers which reduced the success of the economic policy reforms implemented in the country in the middle of the 1980s. In the following sub-sections we will present the main structural obstacles to achieving high economic growth in Algeria. IV. 1. High External Debt and Payments. According to Were (2001), the channels through which indebtedness work against growth are identified as: current stock of external debt as a ratio of GDP, which may stimulate growth; past debt accumulation, which captures the debt overhang and therefore deters growth; and debt service ratio to capture the crowding out effects. Debt service payments reduce exports earnings and other resources and therefore retard growth. According to Elbadawi, et al. (1996), these debt burden indicators also affect growth indirectly through their impact on public sector expenditures. As economic conditions worsen, governments find themselves with fewer resources and public expenditure is cut. Part of this expenditure destined for social programs has severe effects on the very poor. Most studies confirm debt overhang/crowding out effects. Algeria’s substantial debt dated back to the 1970s, when the government borrowed heavily to finance development projects and meet rising consumer needs. Because payments 13 came under pressure starting in 1985, however, the debt-service ratio more than doubled between 1985 and 1988, increasing from 35 percent to 80 percent. By the end of 1990, the country’s external debt slightly exceeded US$ 26 billion, of which almost US$2 billion was in short-term loans. To reduce the debt-servicing burden, the government subsequently concentrated on obtaining medium and long-term loans to replay its financial obligations as soon as they became due. Also, to augment its efforts to obtain more financing, such as bilateral lines of credit, the government has discouraged importers from borrowing from suppliers; such as loans are usually of short duration and hence are more expensive than long- term lines of credit. S Figure 2. Exteral Debt as % of GDP 80.00 70.00 60.00 Percent 50.00 40.00 Series1 30.00 20.00 10.00 0.00 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 Year Source: World Bank Data IV.2. High Inflation Rate. The negative effects of inflation have been studies in a paper by Andres and Hernando (1997). According to the authors, the uncertainly associated to a high and volatile unanticipated inflation has been found to be one of the main determinants for the rate of return of capital and investment. In addition, inflation undermines the confidence of domestic and foreign investors about the future course of monetary policy. Inflation also affects the accumulation of other determinants of growth such as human capital or investment in R+D; this channel of influence is known as the accumulation or investment effects of inflation on growth. However, over and above these effects, inflation also worsens the long-run macro-economic performance of market economies by reducing total factor productivity. This channel, also known as the efficiency channel, nonetheless its importance in the transmission mechanism from inflation towards lower growth cannot be denied. A high level of inflation induces a frequent change in prices which may be costly for firms. It also generates larger forecast errors by distorting the information contents of prices, encouraging economic agents to spend more time and resources in gathering information and protecting themselves against the damages caused by price instability, hence endangering the efficient allocation of resources (cf. Andres and Hernando, 1997). 14 Figure 3: Inflation Rate Trends in Algeria 35.00 30.00 25.00 Inflation Rate 20.00 Series1 15.00 10.00 5.00 0.00 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year Source: World Bank Data The annual inflation rate increased during the period 1976 and 1981 with a level varying from 10 to 17 percent. In 1989 and after the economic crisis affecting the Algeria’s economy, inflation rate increased highly from 10 percent in 1989 to more than 30 percent in 1992 and 1995. The adoption of the adjustment program supported by the IMF and the World Bank consequently reduced the inflation rate. In fact, since 1995, annual inflation rate decreased from 33 per cent to 22 per cent in 1996 and 4 percent in 1997 (see Figure 3). IV.3. Poor Labor Productivity. Despite a significant increase in the labor productivity in Algeria since the 1960s (see figure 4), Algeria’s labor market’s outcomes still was very poor if was compared to other regions in the world like East Asia. The real difference between the two regions, is that East Asia’s labor force growth was accompanied by enormous increases in real output, which is not the case for Algeria. Real GDP growth in Eats Asia according to Keller and Nabli (2002) averaged 7.6% a year between 1970-80 - more than doubled its labor force growth rate for the same period. As for Algeria, economic growth during the 1990’s has only averaged 1.9% -only half less than the growth of its labor force, implying a strong deterioration in productivity per potential laborer in the country6. Many reasons are behind the poor labor market outcomes in Algeria. Firstly, and since the reduction in public expenditures allocated to education sector in the middle of the 1980s, human capital losses in terms of its quality which adversely affected the competitiveness of the Algerian economy. Secondly, the waste of human capital is another source of inefficiency in Algeria. This waste was encouraged by the incentives offered by the public sector to the workers and the importance of rent seeking in this sector. Serious challenges are facing the Algeria’s economy in order to turn the human capital as a growth factor and not as an impediment which reduces the efficiency of its productive resources. 6 More explication on the poor contribution of labor market in economic growth in Algeria is given by Chemingui (2002). 15 Figure 4: Output Per Worker Trends 14,000 Output (Algerian Dinars) 12,000 10,000 8,000 Series1 6,000 4,000 2,000 0 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 Year Source: World Bank IV.4. Poor Development of the Banking Sector and it’s Contribution to Private Investment Financing. The banking sector was a major facilitator of investment. Unless the 1990 law on money and credit was established and allowed for the operation of private banks, banking sector would have remained relatively undeveloped in Algeria. The public sector (government and public enterprises) absorbed an inordinate share of the credit available. During the period from 1996 to 2000, public sector absorbed 80% of domestic credit (IMF, 2001), which affected negatively the private investment. In this context, credit available for private investment financing was insufficient (only 20% of the available credit) and further liberalization of the Algerian economy was needed in order to facilitate access of private operators to credit and then to reduce the interest rates applied now which still very high compared with other countries in MENA region. The privatization of the six-state owned banks will more improve competition among them and by the way their efficiency in investment financing. V. Conclusion and Policy Options. The central focus of this paper was to identify the structure, magnitude, composition and determinants of Algeria’s economic growth during the past four decades since it’s independence. The poor economic growth in Algeria during the last fifteen years can be blamed on internal policies, more than on exogenous factors. In fact, Algeria has not succeed to take profit from it’s natural resources to undertake a proper macro-economic management of the economy. In addition, Algeria did not succeed in improving its economic policy clearly, deregulate its economy and increasing investment rate; which explains the weakness of it’s economic performances. Though it’s economic dynamics is well directed, and this in spite of insufficiencies in the system and the Algerian’s economic environment. Indeed, in addition to a difficult political context (civil war), and of a strong corruption practices which continues to slow down the economic takeoff of the country (rigging of public markets and imports licenses granted exclusively to special interest groups in the Algeria’s government). Other structural factors continued to block all initiatives of reforms and economic takeoff in Algeria. In this context, the weakness of the private initiative, the prevalence of the public sector and the non- 16 transparency in privatization process, the weakness of the financial system and other factors, may only accentuated the crisis and limited the range of any policy of economic reform. Many policies have to be implemented in Algeria in order to generate a high, steady rate of economic growth. In general, policies to boost growth split into two types: Demand- side policies and Supply-side policies. But in Algeria, the needs is to implement supply-side policies to boost the potential of the economy to grow by increasing the competitiveness of the existing activities and promoting investment in other sectors in order to diversify the economy and to reduce the dependency of the Algeria’s economy to the energy sector. The main supply-side policies can include a better promotion of education and training, promotion of research and development and labor flexibility. In addition, three policies can be implemented in the country in order to improve growth by supply-side. First, Algeria can accelerate trade liberalization. Delays in liberalization can send perverse signals to potential investors and may delay or prevent domestic and foreign investment in export oriented industries. Second, Algeria can move aggressively to improve its investment climate. Actions under this option can be grouped under three broad headings: (i) deepening of financial markets; (ii) improvements in the judicial and administrative systems governing private activity; and (iii) further privatization. Third, Algeria can adopt policies intended to accelerate the rate of productivity by adopting an “export push” strategy consisting of three essential elements: (i) accelerating trade liberalization to reduce anti-export bias; (ii) institutional reforms for trade liberalization; and (iii) targeted investments in trade related infrastructure. References 17 1. Andrés, J. and I. Hernando (1997), “Does Inflation Harm Economic Growth? Evidence For The OECD”, Paper Presented at the NBER conference on "The Costs and Benefits of Achieving Price Stability", Federal Reserve Bank of New York (February 20-21, 1997). 2. Bassanini, S. S. Scarpetta and P. Hemmings (2001), “Economic Growth: The Role of Policies and Institutions. Panel Data Evidence From OECD Countries”, OECD Economics Department Working Papers N°283, Paris. 3. Berthélemy, J. C., L. Soderling, J-M. Salmon and H-B. Solignac Lecomte (2001), “L’Afrique Emergente”, OECD Development Centre Studies, Paris. 4. Bruno, M. 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IMF (2001), “Algeria: Statistical Appendix”, IMF country report No. 01/163, Washington. 11. Nehru, V. and A. Dhareshwar (1993). “A new database on physical capital stock: Sources, methodology, and results”, Revista de Analisis Economico v8 n1: 37-59. 12. Keller, J. and M. K., Nabli (2002), “The Macroeconomics of Labor Market Outcomes in MENA over the 1990s: How Growth Has Failed to Keep Pace With A Burgeoning Labor Market”, Paper Presented at the MDF4, Amman, October 2002. 13. Liabes (1984), “Capital and bosses of industry in Algeria 1962-1982”, CREA, 650p. 14. Morrisson, C. and B. Talbi (1996), «La Croissance de l’Economie Tunisienne en Longue Période», OECD Development Centre Studies, Paris. 15. Page, J. and J. Underwood (1996), “Growth, the Maghreb and Free Trade with the European Union”, The Egyptian Center for Economic Studies, Working Paper Series N 07. 16. Pindyck, R. and Solimano, A. (1993): "Economic instability and aggregate investment", NBER working paper 4380. 17. Were, M. (2001), “The Impact of External Debt on Economic Growth and Private Investment in Kenya: an Empirical Assessment”, a paper presented at the wider conference on Debt Relief, August, Helsinki. 18. World Bank (1994), “The Democratic and Popular Republic of Algeria Country Economic Memorandum: The Transition to a Market Economy”, Volume I (In two volumes), Country Operations Division, Whashington. 19. World bank (2001), “Algeria in Brief”, world bank web site. 20. World Bank. Global Research Project Data base. 18
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