Revolution in Egypt… But Can It Unlock the Hidden Economic Potential?
by Carl Delfeld, Investment U’s Emerging Markets Specialist
Monday, February 14, 2011: Issue #1449
It took a while, but Hosni Mubarak finally understood the determination and desire for change among the Egyptian people and resigned as president last Friday.
But even with the Egyptian military having now dissolved parliament – the first step towards implementing a new, democratic regime in the country – the widespread discontent has underscored the complex nature of Egypt’s economy.
On the one hand, for example, the Egyptian stock market is up almost ten-fold since 2003. But despite that, the majority of its people live frustrating lives on the margins of society, mired deep in poverty. The national poverty rate is 40%, while 30% of Egyptians are also illiterate.
So what forces are at work here and what are the lessons for Egypt and other emerging markets?
No Capital = No Growth
There’s no doubt that economic development will underpin the many conversations about how to improve the lives of Egypt’s many impoverished citizens.
One of my favorite books on this very subject is The Mystery of Capital by the Peruvian economist Hernando de Soto.
Mr. de Soto led a team of researchers who looked at the Egyptian economy and found that 92% of Egyptians don’t hold a legal title for their homes. This is key, as it cripples people’s ability to access credit and de Soto believes that a lack of legal property rights prevents many people and small businesses from having access to the capital and legal contracts needed to grow. In turn, this leads to an “underground” economy that operates in the shadows, way below its potential.
Unfortunately, the majority of businesses in Egypt also operate outside the legal system. Because they’re not organized as corporations, they too have trouble accessing the capital needed to grow. As a result, many entrepreneurs are doomed to remain in small family businesses and unable to benefit from the broader “economies of scale.” They’re also easy prey for “loan sharks” charging exorbitant interest rates.
Egypt’s Budding Entrepreneurs Drowning in a Sea of Red Tape
Adding to the resentment felt by ordinary people and small business owners is the fact that business tycoons have ready access to top government officials and state-owned banks. This “crony capitalism” tends to benefit the status quo and fosters monopolies, while killing new ideas and stuffing endless red tape, delays and corruption in the way of entrepreneurs.
Mr. de Soto’s report cites two examples:
- In Egypt, it takes 10 years of red tape to gain the title to a vacant tract of land.
- To incorporate a business, an entrepreneur would have to deal with 56 government agencies.
Mr. de Soto refers to these limited opportunities as “dead capital” and says that Egypt has 55 times more “dead capital” than foreign direct investment and 30 times more untapped capital than the value of its stock market.
But the issue of a stunted economy and the waste of unlocked capital isn’t just an Egyptian one…
The Lesson for Egypt as it Enters Democracy and Tackles Major Reform
In his book, Mr. de Soto gives other examples, based on his research…
- The Philippines has “dead capital” that is 14 times the amount of its foreign direct investment and four times the value of its stock market.
- Russia’s “underground economy” accounts for roughly 50% of its GDP, while this figure is 35%.
The lesson here is that any economic reforms for Egypt should place a very high priority on unlocking the economic potential of its sizeable assets, in order to foster the growth of a middle class – the backbone of any healthy democracy and society.
Good investing,
Carl Delfeld
P.S. My colleague, Steve McDonald, also commented on the factors behind the Egyptian unrest and how this could be a good opportunity to buy for the long term. He mentioned a well-diversified company that could be a good play and you can check out the article here.
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3 Responses to “Revolution in Egypt… But Can It Unlock the Hidden Economic Potential?”
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Development of agricultural production and marketing progresses more rapidly when the producer has title to his land. Generally speaking, the larger landholders have title to their lands, but the smaller-scale farmers do not. This lead me, as an agriculture and rural devleopment officer in USAID to manage a project of land titling that closed “the cadaster” on the entire Nicoya peninsula of Costa Rica in the period from 1971-1974. This is an example of true agrarian reform.
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The problem of owning one’s title is because under Shria Financial Law, the state always owns the property.
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Thank you for sharing your comments on the economic system in Egypt. Compared to the US, it appears that Egyptians have much less means of earning a living. Reading stories like this, provides eye opening experiences that as Americans we don’t understand till we’ve experienced the frustrations of the Egyptians.
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