A pyramid of privilege: crony capitalism in the Middle East

Posted:
19 September, 2019

The Arab uprisings in 2011 were not just aimed at overthrowing authoritarian regimes but were also targeted at a well-entrenched system of economic privilege where those attached to the ruler’s insider circle had monopolized all economic opportunities.

For every regime that faced a popular backlash in the Middle East, there were some prominent businesses who became the symbol of corruption and injustice. In Egypt it was Ahmed Ezz, the steel magnate. For Ben Ali’s regime it was his wife, Leila Trabelsi, who together with her husband and extended clan controlled 220 firms in some of the most lucrative sectors of the economy. In Syria it was Bashar Assad’s cousin, Rami Makhlouf, the owner of Syria Tel, who symbolized the concentration of economic power at the top.

In the popular Arab imaginary, corruption of regimes and that of businessmen is often treated as the same. The Arab private sector is typically a handmaiden of the state, surviving and thriving in the comforts of the ruling circle. The mutually constitutive relationship between economic and political power has long been recognised by Middle East specialists, but it became a particularly important concern after the initiation of economic reforms in several Arab states in 1990s. Arab countries liberalised their economies without liberalising their polities, and autocrats remained in place across the region. To stay in power in the face of rising social grievances, they reverted to repression—not only of people, but also of markets.

The Arab spring provided a fresh impetus for studying the nexus between business and politics. New accounts became available on how politically connected actors staked their claims in the market. Building on this and, in collaboration Ishac Diwan and Izak Atiyas, we brought together top twenty political economists working on the Middle East. Our objective was to empirically map the nature of political connections among the private sector in key Middle Eastern states, and to probe its impact on prosperity. Capturing variation across countries, firms and sectors, we looked at several dimensions of crony capitalism. The findings are presented in an edited volume on Crony Capitalism in the Middle East published by Oxford University Press in June 2019.

Individual chapters in this volume focus on how political connections shaped business performance in Middle Eastern economies during and after the period of economic liberalization. We used an eclectic mix of qualitative and quantitative methodologies. A key concern was to identify the impact of political connections on outcomes (firm profitability, growth, credit, trade policy, etc.). To probe the impact of cronyism, some researchers used discrete events, such as the revolutionary overthrow of regime, the EU trade agreement with Egypt, and elections in Lebanon. Others provided a contextual description of cronyism and its after-affects, and focused mainly on stylised patterns of such correlation.

What do learn on the nature and extent of cronyism?

The volume provides concrete information on the number, presence and characteristics of politically connected firms (PCFs) in several MENA countries. We show that about 50% of the sectors in Egypt were exposed to PCFs, and PCFs included 8 of the top 20 firms trading on the stock exchange. In Tunisia, this ratio was about 40%, and the Ben Ali firms were over-represented at the top end of the firm-size and output distributions. In Turkey, religious-network affiliated firms constituted about 20% of the total firms. These differences partly reflect the differential reach of the state in these countries, and thus its ability to create regulatory rents.

Cronies tend to conglomerate in sectors that are sheltered from competition and susceptible to policy manipulation through regulatory barriers and selective enforcement. Services sectors oriented towards domestic markets remain a preferred home for political cronies in the post-liberalisation era. Across the region, PCFs tend to cluster in banking, real-estate, tourism, distribution, natural resources, and telecommunications sectors. These sectors were often selectively opened in the wake of liberalisation through discretionary licences, which were typically awarded to political insiders.

Some evidence also points to the intensification of cronyism during the liberalisation era. Since the late 1990s Egyptian manufacturing saw a growing exposure to cronyism. While, in 1996, there was, on average, less than one crony operating in a typical sector this number had doubled by the late 2000s. Morocco witnessed a similarly upward shift. Since 1993, there has been a steady shift away from sectors facing international competition to sectors that are mainly subjected to domestic regulations.

Impact on job creation and growth

Several chapters in the volume examine the relative performance of PCFs and probe the effect of unfair competition on the dynamism of unconnected firms. Connected firms in Egypt tend to be larger in size, more indebted, capital-intensive, and reliant on subsidies. In 2010 such firms derived 60% of net corporate profits but generated only 11% of employment. Sectors where PCFs entered became more skewed in terms of employment distribution and had relatively fewer middle-sized firms. The overall estimated effects are quantitatively large: employment in the formal sector could have been 25% larger in an ideal world of perfect competition.

Evidence on Tunisia is similarly instructive. Firms owned by the Ben Ali clan displayed considerable heterogeneity, including firms at both ends of the size distribution. While together they produced around 5% of all private sector output and derived 15% of all net private sector profits, the very large firms were hugely profitable. For instance, the top ten Ben Ali firms accounted for approximately 4% of economy-wide output and 10% of gross profits in the economy. Strikingly, these firms dominated sectors that were protected by regulatory restrictions.

Lebanon presents an interesting parallel where, at face value, the presence of political connections and job creation do not run in opposite directions. The bulk of job creation in Lebanon takes place through large firms who employ around 16% of the total labour force. When excluding self-employed firms, large firms actually accounted for 55% of net job creation in Lebanon. Importantly, in Lebanon, PCFs created 20.32% more jobs each year on average than unconnected firms operating within the same sector, but their output per employee is 20.38 percent lower.

On a net basis, job creation has indeed been constrained by the dominance of political connections, as in Egypt. For every additional PCF in a sector, 6.8% fewer jobs are created each year, on average, in this sector. There is a suggestion that Morocco has managed to achieve moderate levels of growth despite pervasive cronyism, possibly because connected individuals were under more pressure by the Palace to manage their firms efficiently in the service of the national economy.

Turkey adds crucial source of variation. The gap between the labour productivity of new growth centres in Anatolia, the AKP heartland where the country’s emergent devout bourgeoisie is based, and that in traditional industrial centres (such as Istanbul, Ankara, Izmir, and Kocaeli) was reduced, especially in the 2000s. This productivity catch-up was accompanied with an increase in the share of Anatolian provinces in total exports of the country. Second, they show that the number of firms associated with religious networks among the top manufacturing firms in Turkey increased significantly, again in the 2000s.

While cronyism can be clearly viewed as a barrier to prosperity in some countries, it can be entirely consistent with economic growth in others (e.g., Morocco and Turkey). In Turkey the rise of new economic players, popularly described as Anatolian tigers, supports not just export-oriented growth but also a new brand of popular politics. While there are many instances of insider privileges, including advantages in the bidding of construction contracts, Turkey’s emergent private sector is supporting export-oriented growth with favourable effects for domestic job creation. Iran presents a distinct intertwining of economics and politics where organisational interests, rather than private sector firms, control the commanding heights of the economy.

Mechanisms of privilege

Although there is some variation in the type of mechanisms used to privilege connected firms, there is common reliance on preferential access to finance, energy subsidies, licenses, regulatory capture, non-tariff measures, and privileged access to land. In Egypt, PCFs disproportionately benefited from energy subsidies. In turn, such subsidies incentivise these firms to become more capital-intensive. Anecdotal evidence from Tunisia and Morocco also point to a greater reliance of connected firms on energy subsidies.  

Connected firms also thrive on regulatory capture. Firms owned by the Ben Ali clan had a disproportionately greater presence in sectors that were closed to foreign direct investment and required licences to operate. These firms were more profitable, and the gap in profitability was higher in sectors subjected to greater entry regulations.  Another important mechanism used to privilege insider firms is preferential access to credit. This phenomenon is fairly widespread across the Middle East, where PCFs tend to have a much higher capital intensity than the rest of the economy. 92% of the overall loans extended to the private sector in Egypt in 2010 went to PCFs. This extraordinary concentration of loans in capital – and typically energy intensive firms – contributes to the inefficient deployment of capital, starving the rest of the economy from capital, and forcing firms to remain self-sufficient and to give up growth opportunities.

Finance plays a particularly salient role in the Lebanese political economy where the ruling class directly controls the ownership of local commercial banks in Lebanon. By contrast, the control of banking system is more indirect in Morocco where the regime uses indirect corporate governance instruments such as board membership to appoint men close to the ruling circle. Board members of key bank and non-bank financial institutions are tied to the royal family, and represented in multiple boards. Such inter-locking presence  on multiple company boards ensures that the king holds the reins from behind the scenes.  

Connected actors also captured the privatisation process. Many public companies went into private hands connected with rulers. This was especially the case in Tunisia where Ben Ali’s family was able to acquire many privatized firms. It was mainly these newly acquired firms whose profits witnessed a huge increase after privatisation; the non-Ben Ali privatised firms did not enjoy similar profitability. Evidence suggests that the greater profitability of Ben Ali firms was largely attributable to their privileged and protected status after privatisation.

There are some important differences between the Arab and Iranian experiences with regards to privatization. In Iran, public assets were privatised to organisations rather than families. These Iranian organisations sit at the fluid boundary between the public and private sectors, and enjoy the commanding heights of both economy and polity. As guardians of the Revolution in 1979, they cater to its key social constituencies.

Connected firms also tend to be shielded from global competition through conventional instruments of trade protection, such as tariffs and non-tariff measures (NTMs).Another arena where connected firms are privileged is procurement, especially in relation to construction contracts. This has acquired particular salience in Turkey where more than 50,000 firms are awarded public procurement contracts and such contracts can serve as an important form of rent distribution. Studying 18,000 procurement contracts in Turkey, indicate systemic evidence of favouritism for firms that are connected to the religious business networks associated with AKP.

Conclusion

While the evidence in this volume opens a new window into a relatively understudied subject, we have only begun to scratch the surface of a complex phenomenon. Rather than mapping a straight-line relationship between cronyism and economic outcomes, our work paints cronyism as a differentiated tapestry whose effects are often subtle and highly context-specific.

While all forms of privilege in the market result in exclusion, the Middle East stands out for the sheer scale and political function of such exclusion. Business climate is marked by a vicious logic of partner or perish: as businesses becomes successful they are either forced to partner with one of the regime insiders or face extinction. Arab regimes are extremely reluctant to see independent sources of economic power thrive from below, as they tend to view them as a potential threat to the regime’s power. Differentiating the form and function of cronyism within and across the region remains a fertile area for future research.

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About the author(s)
Adeel Malik
Globe Fellow in the Economies of Muslim Societies and Associate Professor