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Egypt’s Rent Curse

by | February 22nd, 2011 | 11:52 am
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The recent overthrow of President Mubarak offers great hope for Egypt’s future political development. But the challenge of economic transformation will be no less important, and arguably as difficult. This challenge is viewed as one of achieving greater globalization and a greater role for markets inside Egypt. The more fundamental challenge, however, is different.

Some countries create wealth, while others live off unearned wealth, or rents. Egypt is not typically associated with the latter. Yet it should be because Egypt’s economic problems stem from reliance on rents, which are broadly defined as benefits that flow to the economy irrespective of any efforts by the government to encourage work, entrepreneurship, investment, or creation of wealth. These have stymied the incentives for its government to create economic institutions that might support the creation of wealth. Egypt, in short, has suffered from the rent curse. Consider how and its implications.

Egypt is unique in the multiplicity of ways that its government and economy have earned rents over several decades. It generates rents from below the ground, from allies, from geography and location, from history, and from its disaffected emigrants. First, Egypt, while not a large oil and gas exporter, does produce reasonable quantities, which generate substantial revenues for the government. Second, Egypt has been a beneficiary of vast amounts of foreign aid, especially from the United States, amounting on average to about 2–3 percent of GDP since the late 1970s. In most cases, countries have received either military or economic aid. Egypt, like and because of Israel, has had generous helpings of both.

Third, Egypt is one of those few countries in the world that has reaped huge rents from geography and location: The Suez Canal, built in 1869, earns the economy foreign exchange and generates revenues for the government. These revenues are rents because there is relatively minimal effort on the part of the government to maintain the canal and keep the tanker traffic flowing through the waterway. Fourth, Egypt generates substantial revenues from tourism. Some portion of tourism is genuine wealth creation, but a substantial portion is related to the legacy of history. Tourists come in no small measure because the Pyramids, King Tut’s tomb, Luxor, and Abu Simbel are there.

A final source of rents is the remittances of Egyptian workers who live in nearby oil-exporting countries, performing skilled and semi-skilled activities. Strictly speaking, remittances do not flow directly into government coffers. But these remittances constitute rents not just because the government has had done little to generate them. Worse, remittances represent an indictment of the Egyptian government and economy because, by voting with their feet, Egyptian migrants have signaled that conditions for income generation and economic advancement outside Egypt are vastly superior to those within it. 

Together these various sources of rents account for about two-thirds of foreign exchange earnings and, directly or indirectly, generate at least a third of government revenues.

Why are rents so important? The history of economic development suggests that in rent-ridden countries, governments have little incentive to create strong institutions. The state is relieved of the pressure to tax its citizens and has no incentive to promote the protection of property rights as a way of creating wealth. As for the citizens themselves, because they are not taxed, they have little incentive and no effective mechanism by which to hold government accountable.

In Egypt, rents and weak economic institutions have taken a heavy toll on the economy. Weak delivery of essential services, such as education and skill creation, has limited the pool of entrepreneurial talent. A bloated bureaucracy, weak legal institutions, and obstacles for starting businesses—especially for outsiders—have led to an insufficiently enabling environment for entrepreneurs to flourish. Even Egypt’s private sector has tended to thrive more by virtue of its connections to the state than because it possesses any of the raw dynamism and hustling found in those of many Asian countries.

On this reading, Egypt’s long-term economic prospects appear gloomy. The Egyptian economy has relied for too long on rents that have stymied the development of the economic institutions and limited the economic opportunities for a young, unemployed and restive population. Can Egypt break decisively with its past—of living off nature, allies, history, and geography—and learn to create wealth itself?

This posting is based on an op-ed that appeared in the Financial Times.

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