Egypt's dead capital

Yesterday I came across this column from Isobel Coleman of the Council on Foreign Relations (HT: DC Exile) which discussed the vast disparity between the economies of the rich and poor in Egypt. Key excerpt:

Liberalization picked up steam after 2004 when Mubarak put in place a so-called "dream team" of economic ministers who relentlessly slashed tariffs and taxes, courted foreign direct investment, pursued trade agreements, and tackled the country's stifling bureaucracy. (A group of Egyptian entrepreneurs recently boasted to me that it now only takes a few days to set up a new business, although it still takes two years to shut one down.)

After averaging about 4 percent in the 1990s, growth shot up to 6, 7, and even 8 percent in the years prior to the financial crises of 2008. During the global downturn, Egyptian growth slowed but did not turn negative, and economists were predicting growth of 5-6 percent for this year. However, ordinary Egyptians felt they were not reaping the benefits of this expansion.

During a visit I made to Egypt last week, the contrast between rich and poor was readily apparent. On the road from Cairo to the new campus of American University in New Cairo, gated communities with names like Beverly Hills, Mayfair, and Le Reve are under construction, with stand-alone villas going for anywhere between $250,000 and well over $1 million (before the unrest).

Meanwhile, in the small town of Darshour we visited forty kilometers south of Cairo, families live in mud houses along potted dirt roads lined with garbage and raw sewage. They have few material possessions, apart from cellphones and television. In other words, while they are poor, they're connected to the outside world in unprecedented ways, reinforcing a sense of relative deprivation.

This then begs the question of why Egypt's economic growth (previously noted in this post) has not filtered down to the bottom rungs of society. Is this an indictment of the shortcomings of free market reforms? Writing in today's Wall Street Journal, economist Hernando de Soto gets at a very plausible explanation -- reform has benefitted the rich not necessarily because they are rich, but because they operate in the formal rather than informal/black market sector of the economy:

Today, when the streets are filled with so many Egyptians calling for change, it is worth noting some of the key facts uncovered by our investigation and reported in 2004:

• Egypt's underground economy was the nation's biggest employer. The legal private sector employed 6.8 million people and the public sector employed 5.9 million, while 9.6 million people worked in the extralegal sector.

• As far as real estate is concerned, 92% of Egyptians hold their property without normal legal title.

• We estimated the value of all these extralegal businesses and property, rural as well as urban, to be $248 billion—30 times greater than the market value of the companies registered on the Cairo Stock Exchange and 55 times greater than the value of foreign direct investment in Egypt since Napoleon invaded—including the financing of the Suez Canal and the Aswan Dam. (Those same extralegal assets would be worth more than $400 billion in today's dollars.)

...The entrepreneurs who operate outside the legal system are held back. They do not have access to the business organizational forms (partnerships, joint stock companies, corporations, etc.) that would enable them to grow the way legal enterprises do. Because such enterprises are not tied to standard contractual and enforcement rules, outsiders cannot trust that their owners can be held to their promises or contracts. This makes it difficult or impossible to employ the best technicians and professional managers—and the owners of these businesses cannot issue bonds or IOUs to obtain credit.

...The key question to be asked is why most Egyptians choose to remain outside the legal economy? The answer is that, as in most developing countries, Egypt's legal institutions fail the majority of the people. Due to burdensome, discriminatory and just plain bad laws, it is impossible for most people to legalize their property and businesses, no matter how well intentioned they might be.

The examples are legion. To open a small bakery, our investigators found, would take more than 500 days. To get legal title to a vacant piece of land would take more than 10 years of dealing with red tape. To do business in Egypt, an aspiring poor entrepreneur would have to deal with 56 government agencies and repetitive government inspections.

All this helps explain who so many ordinary Egyptians have been "smoldering" for decades. Despite hard work and savings, they can do little to improve their lives.

De Soto's book The Mystery of Capital, which explores the topic of informal economies in far greater detail, is one of the most influential books I have read.