28 March 2013

Towards a New Economic Model for Tunisia

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The African Development Bank has officially released the report entitled "Towards a New Economic Model for Tunisia: Identifying Tunisia's Binding Constraints to Broad-Based Growth". The new AfDB report, prepared in close collaboration with the United States Government and the Government of Tunisia, aims at identifying the most binding constraints to growth in Tunisia in order to identify areas where policy reforms are most needed.

The study attempts to identify these constraints, both as they were manifested in the years leading up to the revolution and today. The methodology starts from the widely accepted proposition that private sector investment and entrepreneurship are ultimately the keys to sustained economic growth and follows the Growth Diagnostics approach proposed by Ricardo Hausmann, Dani Rodrik and Andrès Velasco.

The application of the methodological framework has revealed two broad categories of binding constraints to economic growth in Tunisia:

First, a lack of effective institutions to ensure public sector accountability, the rule of law, and checks and balances on power in Tunisia results in weak protection of property rights and barriers to entry. Property rights and investment freedoms are fundamental to the development of entrepreneurship and to investment, innovation and risk-taking, and therefore to achieving growth in productivity and the higher wages and living standards that accompany it. Establishing a sound framework of economic governance including institutions that provide investors with a clear and transparent set of rules and assurance that they will be able to reap the fruits of their investments will require a sustained effort.

Second, although social security programs and labour protections are intended to enhance the pay, benefits and economic security of workers, many measures currently in place in Tunisia have been counterproductive in achieving these aims for all but the most fortunate Tunisian workers. Rather than enhancing the provision of acceptable jobs, they result in reduced investment, greater informality, lower worker pay, higher unemployment, and increased economic insecurity. Firms remain small and use a variety of means to circumvent the formal requirements of employing workers, including informality or under-declaration of employees.

Their inability to adjust employment according to market conditions discourages them from growing to attain economies of scale and from investing in worker training. These responses in turn reduce innovation and productivity growth and make Tunisian firms less competitive internationally. Tunisia's slow growth in labour productivity relative to other middle-income countries reinforces the pressure to reduce private sector wages. Alternatives for designing social security systems and labour market protections should be considered with the aim of protecting people rather than specific jobs.

These binding constraints operate on a national level and therefore have negative consequences both in faster growing and lagging regions. While a lack of investment in infrastructure and poor school quality are widely believed to reduce investment and employment opportunities in lagging regions, the lack of demand for the products and workers emanating from those regions is primarily driven by national and international markets. Indeed, the constraints identified in this diagnostic may be even more binding on the growth of lagging regions.

The identified constraints affect exporting firms and foreign-owned firms to a somewhat lesser extent than firms primarily serving domestic markets. Exporters enjoy exoneration of social charges and other taxes for several years and, given their larger scale and higher productivity, are better able to adhere to formal labour requirements.

They also appear to have been less subject to infringement of property rights under the prior regime. However, the identified constraints are still likely to dampen investment and employment creation by exporting firms as well. Meanwhile, the constraints present a tremendous barrier for Tunisian firms serving the domestic market - some of which would otherwise supply exporting firms or export directly but under current circumstances cannot expand or innovate to the degree needed to compete internationally.

Although Tunisia has relied upon an industrial policy and various tax breaks to promote innovation and competitiveness, without removing these fundamental obstacles further government efforts to directly subsidize or promote innovation are not likely to succeed in transforming the economy.

In addition to the two binding constraints identified above, risks have emerged since the revolution that could become binding constraints if not effectively addressed. First is the risk that social unrest becomes persistent and pervasive, in which case it would deter investment in the coming years. Related to this is the risk of macroeconomic instability that could emerge if internal social and economic pressures override the government's commitment to fiscal sustainability.

In addition to this risk, the analysis highlights the problematic nature of the financial sector; the low quality of primary and secondary education, particularly in lagging regions; the need for improved water resource management; and the limits of Tunisia's current seaport capacity and management. Although not currently binding constraints, these problems could become more important constraints in the future.

Based on the outcomes of this analysis, the African Development Bank and its partners will support Tunisia in overcoming these constraints to achieve a stronger and sustainable broad-based growth.

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