Excerpt from Chapter 1 for Cleft Capitalism

Chapter One

SUCCESSFUL TRANSITION TO FAILED CAPITALISM

THIS IS A BOOK ABOUT THE SOCIAL AND POLITICAL CONDITIONS for economic development. Why does market-based development work in some societies and fail in others? Although it focuses on Egypt, it is not intended solely for those specialized in Egypt or the Middle East and North Africa (MENA). Egypt is a country in the Global South that has undergone significant economic liberalization under the auspices of the International Monetary Fund (IMF), the World Bank, the US Agency for International Development (USAID), and the European Commission. However, four decades of economic reform have failed to meet popular expectations for inclusive growth, better standards of living, and high-quality employment.

The mainstream political economy literature, informed by neoclassical institutionalism, has assigned blame to crony capitalism, rent seeking, and corruption. These critics have held that the regime of Egypt’s longstanding dictator, Ḥosni Mubārak (1981–2011), stifled the liberalization and privatization processes in favor of its cronies, raising the barriers to entry for other businesses, and thus sacrificing competition and efficiency. However, this argument does not fully explain the failure of Egypt’s attempted market making. Indeed, many other countries in the Global South have delivered development to significant segments of their populations despite the prevalence of cronyism and corruption. Even in the absence of formal market institutions such as the universal rule of law and secured property rights, these economies have developed other institutional rules that have brought about a vibrant, dynamic, and broad private sector that has led to wider engagement of the population in the production and exchange of economic value. The question is why Egypt has not followed suit, and specifically why its four-decade effort to develop a private sector–based economy has failed.

In pursuit of an answer, this book adopts an interdisciplinary approach that combines economic sociology with political economy. It establishes a detailed account of the institutional features of capitalism in Egypt—formal, informal, and semiformal, as well as public and private. This is done through developing, theoretically and empirically, the concept of cleft capitalism as an institutional explanation for Egypt’s failed market making and then offers a political-economic explanation of the factors that led to the rise of cleft capitalism. Although the focus is on Egypt’s transformation into a market economy since the mid-1970s, its central concept of cleft capitalism may prove to be beneficial in explaining other cases of arrested development in the Global South, with a special focus on MENA.

Egypt’s transformation has been part and parcel of a general change in the Global South since the 1970s, and the country’s recent political economic history bears considerable resemblance to other parts of the world, including South Asia, Latin America, and non-oil economies in North Africa like Tunisia and Morocco.

A PRIVATE SECTOR–DOMINATED ECONOMY

After two decades of adopting state-led development policies under GamālʿAbdel-Nāṣer (1954–1970), President Anwar al-Sadāt (1970–1981) launched an economic liberalization initiative in 1974 that inaugurated Egypt’s market-making process and transformation toward a private sector–dominated economy. In the following decades, an undeniable shift toward greater economic liberalization, deregulation, and privatization took place. These changes were part of the global transformation that was occurring under the ideological hegemony of neoliberalism, especially the Washington consensus after the end of the Cold War. Although these changes were part of the global neoliberal turn, domestic forces and influences also shaped Egypt’s institutional path.

Using the Heritage Foundation’s economic freedom index, a conservative source that refers to the ability to enter and operate a private business with the least amount of state regulation, Egypt showed continuous progression from the middle of 1995, jumping from 55 percent to 60.2 and 64.5 percent in 2008 and 2010, respectively.¹ Freedom of trade showed a more dramatic increase, from 25 percent in 1995 to 57.2 percent in 2002 and 74 percent in 2010, which tracked with the world average. This was largely a result of Egypt’s compliance with the IMF and World Bank conditions in return for funding, as well as its growing relationship with its principal trade partner since the 1980s: the European Union (EU). The two economies signed an association agreement in 2001 that went into effect in 2004 and included the gradual phasing out of tariff and nontariff barriers with the aim of mutual trade liberalization and, eventually, the establishment of a free trade area by 2020.

This trade liberalization and deregulation opened new areas for the development of private enterprises. At the same time, the state provided direct and indirect subsidies to private enterprises, especially in the sectors of manufacturing, tourism, financial services, telecommunications, agricultural exports, and real estate and construction. These took the form of tax rebates, investment incentives, below-market rate land allocation, and generous energy subsidies.

Private sector expansion proceeded concurrently with the contraction of state-owned enterprises (SOEs), particularly in their share in output and employment, due to chronic financial problems and lack of investment along with privatization and divestiture (Adly, 2012a). Overall, the share of private sector enterprises of all sizes underwent continuous expansion in terms of total output, investment, and employment, assuming the largest share in most productive sectors by the early 2000s. This trend was accelerated further as of 2004 when Mubārak appointed a neoliberally inclined cabinet that was committed to intensifying the liberalization of trade and capital movement, as well as further privatizing SOEs and supporting foreign direct investment (FDI).

Throughout this period, private sector enterprises expanded their shares in key sectors. According to the World Bank (2009, 26), the private sector held around 75 percent of Egypt’s nonhydrocarbon GDP. In the manufacturing sector, privately owned enterprises pushed their share from 58 percent in 1991 to 79 percent in 1995/1996, and eventually to 85 percent by 2001(Central Bank of Egypt, 2017, cited in Adly, 2017, 6). This large share remained constant through 2010.

The story is not much different in the construction sector, where the share of the private sector grew from 71 percent in 1991 to 88.4 and 89.1 percent in 2006 and 2010, respectively. The private sector also dominated retail and wholesale trade, as well as tourism, with shares growing from 85 percent in the 1990s to 99 percent in 2010 (Central Bank of Egypt, 2017, cited in Adly, 2017, 6).

On the investment front, the private sector’s share also exceeded that of the public sector in terms of gross capital formation as a percentage of GDP—increases in the fixed assets of an economy, including land improvement; the purchase of machinery, plants, and equipment; the construction of transportation infrastructure and facilities; and increases in inventories of goods used for production. Gross capital formation from the private sector rose from 7 percent between 1990 and 2000, to 10.3 percent from 2001 to 2010, whereas in the public sector, it declined from an average of 14.7 percent in the 1990s to 8.7 percent in the next decade (World Bank, 2017a).

The same trend applies to employment. By 2007, the overall share of the private sector, including wage laborers, the self-employed, and employers, stood at 65.3 percent versus 34 percent in the public sector (CAPMAS, 2007, cited in al-Merghani, 2010,144–146). Furthermore, the vast majority of state employees (5.4 million) worked for the bureaucracy rather than for SOEs (a mere 3.6 percent of the total labor force), rendering productive sectors in the hands of privately owned enterprises.

Capitalist Transformation

These transformations in Egypt were indeed part of the global neoliberal turn. Neoliberal influences found their way to the Egyptian economy through three principal linkages (Stallings, Haggard, and Kaufman, 19921):

1. Hierarchical, through conditionality by international creditors and sponsors such as the IMF, the World Bank, and USAID and Arab Gulf development funds

2. Market, primarily by the integration of the Egyptian economy into global trade and capital flows via foreign direct investments and commercial credit

3. Ideational, especially in the 2000s when a coherent collection of neoliberally oriented teams of technocrats and businessmen came to dominate economic policymaking for the first time (Hanieh, 2013, 52; Roccu, 2013, 65)

These neoliberal transformations were neither uniform nor local implementations of some universal agenda. In contrast, the domestic political economy weighed heavily as to the scale, pace, and scope of such changes, as well as to the definition of the final outcome of such market-making processes. The Egyptian state was by no means a mere transmission belt (Cox, 1992), with domestic factors shaping the reforms as much as any external linkages or influences (Roccu, 2013, 111). Therefore, it would be more accurate to say that the Egyptian economy since the 1990s has become a national variety of globalized neoliberalism (Panitch and Gindin, 2012, 4).

The rise of neoliberalism, with its call for deregulation, privatization, and liberalization as the means to ending stagflation, coincided almost perfectly with the reintegration of the second and third worlds into the capitalist world order. The end of the Cold War reaffirmed the trend that began in the 1970s and underscored the ideological primacy of neoliberalism to a degree that even gave rise to illusions about the end of history (Fukuyama, 1989). This book, however, holds that capitalist transformation is a much broader process than neoliberalization.

At the country level, domestic institutions, and the sociopolitical coalitions that uphold them, matter (Weiss, 2003). Even in an increasingly integrated world and American-led globalization-cum-neoliberalization, there was room for a variety of national and regional capitalisms (Panitch and Gindin, 2012, 202–203). For example, China’s capitalist transformation initiated by Deng Xiao Ping’s reforms of the late 1970s proceeded on Chinese terms with almost no presence of IMF or World Bank conditionality. In contrast, Chinese trade liberalization was guided by a mercantilist approach aimed at generating a large trade surplus and the accumulation of massive foreign reserves. This included a large role for the state in relation to the market, as well as networks permeating the public and private sectors. On the central and subnational regional levels, the government continued to run public sector enterprises alongside semipublic and semiprivate firms. In the end, China was undoubtedly integrated into the global division of labor; however, this unfolded largely along particular Chinese lines and resulted in the production of a variety (or many varieties) of national, and possibly even regional, capitalism(s) (McNally, 2006; Peck and Theodore, 2007, 57; Peck and Zhang, 2013).

Even with countries that had less international leverage than a large, powerful country like China, domestic institutions and coalitions were crucial in shaping the terms of transformation. This makes it very difficult to tackle neoliberalism as a uniform power active on the global scale. Rather, it was more of an ingredient that is channeled through market, hierarchical, and ideational linkages in order to shape domestic capitalist transformations. The result was the rise of a great variety of institutions and outcomes across and within nations in the Global South. In Egypt, they have mediated and shaped the influences of neoliberal globalization, defining to different extents the pace, scope, and scale of the transformation. Domestic forces have also defined the institutional basis for the capitalist transformation on the national level.

A Record of Poor Market Development

Nevertheless, Egypt’s resultant market-based development performance has been rather humble, a fact that is seldom contested. In fact, myriad indicators reveal that little improvement has occurred in terms of the standard of living for a large majority of Egyptians. Economic growth has hardly kept pace with population growth. Whereas the average per capita GDP growth rate was 2.6 percent between 1990 and 2012, average population growth for the same period was 1.7 percent. In the 1990s, GDP per capita growth averaged 3.7 percent versus a population growth rate of 2.2 percent (World Bank, 2017b).

In addition, growth generation and distribution have been concentrated in a handful of capital- and energy-intensive sectors that are dominated by big business—private domestic, multinational, and within the public sector.² For instance, most high-growth enterprises prior to the 2011 revolution were in capital-intensive sectors such as cement, iron and steel, aluminum, glass, fertilizers, financial services, and telecommunications, in addition to extractive industries (natural gas and oil). These high-growth sectors were based on Egypt’s traditional competitive edge in providing cheap energy through generously subsidized fuels, which ultimately proved unsustainable: Egypt became a net oil importer in 2006 and net energy importer (including natural gas) by 2012.

With these humble growth rates and the confinement of growth generation to a handful of capital-intensive sectors, the capacity of the Egyptian economy to generate productive and well-paying jobs was quite limited. In response, the majority of job seekers found employment in microenterprises or became self-employed in the menial and marginal service sectors. In other words, the majority of the Egyptian labor force was caught between unemployment and underemployment, further exacerbating the problems of income generation and distribution. The jobs created were either insufficient in number or unsatisfactory in quality due to their low productivity, low wages, and job insecurity (UNDP, 2011; Barsoum, Ramadan, and Mostafa, 2014; Sahnoun et al., 2014). According to the World Bank vulnerable employment indicator, the average percentage of vulnerable employment in Egypt between 1997 and 2007, as a percentage of total employment, was as high as 24.09 percent (World Bank, 2017c).

Notes

1. According to the Heritage Foundation, the index measures economic freedom based on ten quantitative and qualitative factors grouped into four broad categories, or pillars, of economic freedom: rule of law (property rights, freedom from corruption), limited government (fiscal freedom, government spending), regulatory efficiency (business freedom, labor freedom, monetary freedom), and open markets (trade freedom, investment freedom, financial freedom). Each of the ten economic freedoms within these categories is graded on a scale of 0 to 100. Averaging these freedoms, with equal weight being given to each, derives a country’s overall score.

2. Distribution refers to the shares of different factors of production in the value created out of the production process—for example, wages for workers, profits, dividends and interest for capital holders, and rents for landowners. Redistribution is a political process through which the value created is reallocated among different groups, usually through taxation and public expenditure.