The foregoing review of the literature and relevant facts on constraints to growth in Egypt suggests a short list of prime suspects that may deserve deeper investigation(Figure 10). Access to financing, notably, does not appear to be the main recent or current obstacle to growth; real interest rates would be much higher and the external current account under greater pressure if indeed businesses were strongly competing for funding of an abundance of profitable investment ideas. At the same time, there is a question of whether the limited available data really tell the full story: business complaints about lack of access to financing may reflect some nonprice rationing of credit, especially through the state banks, and access to finance for small enterprises and farmers may constitute a binding growth constraint for that sector. The latter would reflect the inefficiency of the financial system in allocating savings to domestic investments rather than lack of domestic or foreign savings, but also capacity constraints on borrowers. The ongoing reform of the financial sector (which by late 2006 had shifted more than half of the banking sector to private ownership, along with governance reform at the remaining state banks and more generally a modernization and liberalization of financial institutions) thus tackles a constraint that would probably become binding soon. But ongoing growth and rising investments may also move the economy, in the near future, to a point where low national savings (reflecting high public dissavings) constitute a critical constraint, unless access to foreign savings (notably higher FDI dedicated to greenfield investments rather than one-off privatizations) could be durably expanded.-Egypt--Searching for Binding Constraints on Growth
32. There is considerable evidence, including surveys and comparative rankings, as well as Egypt’s difficulty in moving toward new higher value-added products, pointing to appropriability of returns as a critical constraint. Private returns are reduced through the high cost imposed by complex regulations and inefficient government services, but perhaps also through the high cost of experimenting and exploring new production ideas. Recent bold reforms have focused on this area, particularly in the tax system and trade regulations, and the concomitant pick-up in growth is consistent with the view that these reforms have been addressing critical constraints. By contrast, a dearth of complementary factors does not appear among the prime suspects of having held up growth—though, again, there is little doubt that over the longer run, and as sophistication in the economy increases, Egypt will need to bolster its human capital if it wants to continue growing.
33. The authorities have started to tackle the high fiscal deficit with a view to halving it to around 4 percent of GDP by 2010, and thus bringing public debt onto a declining trajectory. As indicated above, implementing this plan would help forestall potential debt overhang effects, contribute to greater efficiency of financial intermediation, and help raise national savings—all potential, if not actual, constraints on growth.
34. Overall, the Egyptian reforms launched in 2004 appear remarkably apt at focusing on the most critical constraints and thus maximizing the growth effect out of a limited set of reforms. Since removing the most critical constraint is likely to give both the fastest and the biggest “bang for the buck,” the strategy might also have been the politically most feasible approach, maximizing the return on political capital which, for any government, is always limited. Further reforms aimed at easing the cost of regulations will likely continue to have high payoffs. Increasingly, however, reforms with different political economy characteristics, such as revamping education or reigning in the fiscal deficit, will become the critical challenge. Since these steps take more time (for design, political consensus building, implementation, and pay-off) the authorities are well advised to use the tailwinds generated by the recent reforms to start tackling these more distant constraints. This would reduce the risk that the recent growth episode will become another tale of a growth spurt that fizzled out because some deeper constraints were not addressed.
35. As the various reforms unleash entrepreneurial spirit and investment in Egypt, more attention may also have to be paid to potential pitfalls highlighted by the “Theory of Second Best.” For example, with energy highly subsidized, and energy prices in Egypt among the lowest in the world, lifting financing constraints or raising private returns on investment may trigger higher investment in energy-intensive activities that may not optimize social returns. As highlighted at the beginning, there may be no escaping the fact that, while a few simple bold measures can work wonders for a while, sustaining growth will require reforms along many dimensions and paying attention to the complex interaction among them