III. Constraints to Growth in Lebanon1
Lebanon’s growth over the last decade has lagged the MENA region and other emerging markets. A diagnostic approach following Hausman and others identifies a large infrastructure deficit, high public debt, political risks, and a weak governance and business environment as the most binding constraints to growth. Removing these constraints will be key to increasing growth and making it sustainable.
1. Lebanon’s growth performance over the last decade has been mixed. Though the economy expanded on average by 4.9 percent during 2000–10 (Figure 1), this does not compare favorably with the average growth of comparator groups (Table 1). High volatility has been the main feature of growth, with downturns—primarily caused by security incidents or regional conflicts—followed by catch-up growth.
Figure 1.Real GDP Growth
Source: Economic Accounts of Lebanon or 1997-2007, 2008, and 2009 published by Presidency of the Council of Ministers; and IMF staff estimates for 2010 and 2011.
|Emerging Market Top Performers||6.4||2.8|
2. Lebanon faces the challenge of finding new sources of growth. The recent expansion came to an end in 2011 and potential output is estimated at around 4 percent in the medium term. Increasing potential output will require addressing the structural weaknesses that constrain growth.
3. This note identifies the most binding constraints to growth in Lebanon. We address this question by applying the growth diagnostic method following Hausman and others.2 The approach begins from the proximate causes of growth, establishes the greatest constraints to growth, and identifies the specific distortions behind them. While this approach is not new, it offers a systematic way to document constraints and whittle them down to the most binding.
4. What are the constraints to growth in Lebanon? Hausman and others postulate that economic activity is constrained by either low returns to investment or high cost of finance. The first step is to diagnose which constraint is binding for Lebanon (Figure 2).
Figure 2.Potential Constraints to Growth
Source: Hausman and others.
A. Is it High Cost of Finance?
5. It is not the high cost of finance. If domestic savings were low, there would be a willingness to remunerate savings through higher interest rates. Though interest rates have been high over the last decade, this has reflected Lebanon’s risk premium from political uncertainty and high debt levels. With the large banking sector (assets of almost 350 percent of GDP) funded by sustained deposit inflows and able to finance both the public and private sectors, crowding out of the private sector is likely to be at the margin only. Poor intermediation is also not likely a problem, as Lebanese banks have increasingly channeled their deposits to the private sector, resulting in high private sector credit growth.3 Private sector lending at 80 percent of GDP in 2010 is substantial, and the economy has a vibrant small-and medium-size enterprise (SME) sector4 (ESCWA 2007).
6. Lebanon’s financial system is inclusive compared with other MENA countries. Financial systems that provide access to finance to younger enterprises allow for faster growth and employment creation. On the basis of various indicators, Lebanon performs well. The World Bank’s Financial Access and Stability Report from 2011 finds a positive correlation plotting private credit against the number of loan accounts per 1,000 adults. While most MENA countries fall below this regression line, reflecting poor bank penetration and limited access to credit, this is not the case for Lebanon. Compared with MENA, Lebanon has one of the lowest loan concentrations and the largest shares of SME loans in total loans. At 16 percent in 2009, loans to SMEs are on par with middle-income countries, and much higher than the MENA average of 7 percent (World Bank, 2011a). Consistent with this story, survey data find that SMEs do not identify access to finance as a constraint to doing business. In fact, 70 percent of firms have access to a line of credit, which compares favorably to the regional average of 20 percent; and 50 percent of firms use banks to finance expenses while the regional average is 24 percent (World Bank, 2011b). Long-term financing (i.e., housing finance) is also well developed (20 percent of total loans) compared to MENA and other regions (Figure 3).
Figure 3:Housing Loans
Sources: Financial Access and Stability, World Bank (2011); and IMF staff estimates.
B. Is it Low Returns to Economic Activity?
7. Low returns to economic activity due to both low social returns and low appropriability appear to be a problem. Low social returns can be due to high production costs, while low appropriability occurs when producers are unable to capture a significant part of the wealth they create due to distortions such as high taxes, corruption, or poorly defined or protected property rights.
Is it low social returns?
8. Lebanon has an infrastructure deficit and high political risks which depress social returns. Poor infrastructure lowers not only social returns, but also private investment returns due to lack of complementary public inputs. Domestic and external political risks create uncertainty about the environment in which projects will be undertaken, inhibiting investment and growth. Low human capital accumulation, however, is not considered a key contributor to low social returns in Lebanon. Despite some evidence that firms identify labor skills as a constraint to business, the Lebanese workforce is highly educated as reflected in high adult literacy and the availability of scientists and engineers, owing to good access to education (as measured by high enrolment rates). Thus, while there may be some skills mismatch, low human capital is not considered a problem.
9. Lebanon’s infrastructure bottlenecks are severe. According to the World Economic Forum’s Global Competitiveness Index (GCI), Lebanon ranks 115 on the quality of roads and 135 on the overall quality of infrastructure among 140 countries.
- Poor road network. Lebanon has around 7,200 km of roads, many of which are in need of maintenance and repair. Despite somewhat better road conditions than in suburban and rural areas, Beirut suffers from traffic congestion due to weak traffic management, further exacerbated by heavy reliance on private transportation.
- Costly and unreliable electricity. The state-owned electricity company is highly inefficient, while tariffs—unchanged since 1996—do not reflect actual production cost. Years of underinvestment led to systemic power shortages, estimated at 700 MW (50 percent of current capacity). Outages are frequent and much of the excess demand is met by costly private generators, adversely affecting the competitiveness of the economy, especially the energy-intensive manufacturing sector.
- Poor water supply. The water and sanitation sector is unable to meet demand leading to intermittent public water supply. Though private water supply now accounts for 75 percent of total household water consumption, it is costly and some areas are underserved (World Bank, 2010).
- Expensive and underdeveloped communication infrastructure. With 31 internet users and 69 mobile subscriptions per 100 inhabitants, Lebanon ranked 10th and 14th, respectively, out of 17 countries in the region, and 100th and 144th out of 233 countries worldwide in 2010.5 In addition to low penetration, Lebanon’s Internet and Communication Technology (ICT) services are among the most expensive and least competitive in the region.6
10. Political risks reflect a fragmented political system and regional tension. Lebanon scores poorly on political risk compared to most other emerging markets (Figures 4 and 5).7 More recently, risks have increased owing to the regional unrest, particularly in Syria. Since 1990, Lebanon has gone through fifteen governments (the average life of each less than two years), political assassinations, and a volatile external environment (military conflicts with Israel in 1996, 2000, and 2006).8
Figure 4:Political Risk Rating in MENA Countries, August 2011
Source: Political Risk Services Group, Inc.
Figure 5:Political Risk Rating, by grouping
Is it low appropriability?
11. Difficulty in appropriating resources reflects largely institutional failures. Market failures are not a relevant constraint for Lebanon because of its capacity for innovation and the private sector’s ability to identify profitable products for investments.9 The main constraints come rather from institutional failures at the micro and macro levels. On the micro side, the likely source of risks is a poor business and governance environment. A good environment in general provides equitable provision of services and access to resources, while a weak environment fosters corruption, political instability or government ineffectiveness, which handicaps entrepreneurship and decreases private investment returns. Taxes are not seen as a major constraint in Lebanon because the country has one of the lowest corporate tax rates in the region and the 10 percent value-added tax is moderate by regional standards. While property rights are not a major constraint, corruption is perceived as one. Transparency International ranked Lebanon 127th out of 180 countries with a Corruption Perception Index of 2.5 in 2010.10 On the macro side, Lebanon has maintained financial and monetary stability, but carries a high debt. A debt level among the highest in the world, substantial rollover needs for the government, and a large exposure of banks to the sovereign present persistent risks to macroeconomic stability and thus growth.
12. The business environment is poor. Lebanon ranks 113th out of 183 countries and 11th out of 18 MENA countries on the World Bank’s Doing Business indicators (DB). The rankings cover the nine steps to set up, operate and close a business. Results are based on rules and regulations as they appear on paper, but practice differs. For example, the World Bank’s Business Environment and Enterprise Performance Surveys (BEEPS) question firms on the business environment and find that it takes close to 80 days to open a business in Lebanon, not 11 days as reported by DB (Figure 6). Responses to BEEPS also provide a way to assess the access of firms to government services. In Lebanon, while DB suggests it should take firms only 15 days or less to get a license, the median firm in the survey received its license in 60 days, while 10 percent of firms received it in 179 days (Figure 7). Such a large variation could be indicative of preferential treatment and a weakness in the business environment.
Figure 6:Days to Start Operation Based on DB, 2011
Sources: World Bank Enterprise Surveys (BEEPS) 2011; and Doing Business 2011.
Figure 7:Days to Get Operating License (Firm Level) in MENA (90th -10th percentile difference; sorted by 90th percentile), 2011
Sources: World Bank Enterprise Surveys (BEEPS) 2011; and Doing Business 2011.
13. Lebanon has the seventh lowest rank on governance among 18 MENA countries (Figure 8). Very broadly, governance includes the capacity of the government to effectively formulate and implement sound policies. Lebanon’s low score comes from lack of political stability, weak control of corruption, and low government effectiveness.
Figure 8:MENA Countries Average Percentile Rank on World Governance Indicators, 2009
Source: IMF staff calculations based on World Bank’s World Development Indicators.
14. Lebanon is saddled with high debt. At 137 percent (end-2010), Lebanon’s government debt-to-GDP ratio is among the highest in the world. Literature finds that high public debt is associated with lower growth rates. Reinhart and Rogoff (2010) show that emerging countries’ growth declines substantially once debt exceeds 90 percent of GDP (Figure 9).11 High interest outlays, averaging 13 percent of GDP in 2000–10, limit fiscal space thus making it difficult for the government to make the investments needed to address the infrastructure deficit (Figures 10 and 11). High debt also threatens macroeconomic stability—critical for confidence and private investment. Risk associated with high debt potentially increases interest rates and the cost of financing for the private sector (though not the availability of financing in Lebanon).
Figure 9:Real Growth Rates (in percent) and Public Debt Levels
Source: Reinhart and Rogoff (2010).
Figure 10:Average Public Investment, 2003-08
Source: IMF staff estimates.
Figure 11:Public Investment in Lebanon, 1990-2009
15. The binding constraints identified in this note are consistent with those reported by the World Economic Forum. Among a group of 142 countries, Lebanon ranks 89th on the GCI, behind emerging markets and the MENA average (Figure 12).12 The low rankings are driven by government instability, inadequate supply of infrastructure, and an inefficient government bureaucracy.
Figure 12:WEF Global Competitiveness Rank, 2010
Source: World Economic Forum’s Global Competitiveness Indicators’ (GCI) Rank (2010).
16. Reforms should remove the most binding constraints to growth. Advancing these reforms will require building consensus and therefore time. In the short term, the authorities could focus on measures they can implement quickly.
- Infrastructure. Recent improvements in the provision of ICT services and the parliament’s approval of investments in the electricity sector are welcome. Scaling-up investment in infrastructure, especially electricity, must go in parallel with structural reforms so as to make gains long-lasting and safeguard fiscal sustainability.
- Business environment and governance. Transparent enforcement of rules and regulations (i.e., what is on paper happens in practice), reduction in red tape, improvements in the judicial system, modernization of legislation, and upgrading of information technology for public services (i.e., electronic applications) could decrease the perception that the bureaucracy is inefficient.
- Debt. The medium-term agenda should target a sizeable reduction in the debt-to-GDP ratio, while creating fiscal space for higher investment and targeted spending to the poor. This could be achieved by making the tax regime more efficient and equitable, while rationalizing expenditure.
Bank Audi (2011) Lebanon Weekly Monitor Issue 29.
BhattacharyaR. and H.Wolde (2010) “Constraints on Growth in the MENA region,”IMF Working Paper.
Economic and Social Development Commission in Western Asia (2007) “The Integrated SME Support Program,”available at: http://css.escwa.org.lb/sdpd/presentations/3-4Nov07/2-4-Lebanon.pdf
HausmanR.RodrikD.VelascoA. (2005) “Growth Diagnostic,”ReproducedHarvard University.
International Finance Corporation (2012) “Doing Business, Economy Profile: Lebanon.”
KyobeA.NakhleN. and A.Sadikov (2012) “Private Sector Credit Growth in Lebanon—Supply or Demand Driven?,”Lebanon—Selected Issues Chapter 1.
ReinhartC. and K.Rogoff (2010) “Growth in a Time of Debt,”American Economic Review Papers and Proceedings.
The World Bank (2011a) “A Road Map for the Middle East and North Africa,”Financial Access and Stability Report.
The World Bank (2011b) Enterprise Survey.
The World Bank (2010) “Republic of Lebanon Water Sector: Public Expenditure Review.”