This Selected Issues paper and Statistical Appendix deals with the issue of low growth in Algeria. A growth-accounting exercise indicates that negative total factor productivity growth explains Algeria’s low growth rates. This paper highlights the sources of this low growth that mainly consist of incomplete structural reforms and the weaknesses of Algeria’s institutions. It describes policy recommendations, focusing on the institutional reforms required to improve the business environment. The paper also analyzes Algeria’s monetary policy in the context of volatile hydrocarbon revenues.


This Selected Issues paper and Statistical Appendix deals with the issue of low growth in Algeria. A growth-accounting exercise indicates that negative total factor productivity growth explains Algeria’s low growth rates. This paper highlights the sources of this low growth that mainly consist of incomplete structural reforms and the weaknesses of Algeria’s institutions. It describes policy recommendations, focusing on the institutional reforms required to improve the business environment. The paper also analyzes Algeria’s monetary policy in the context of volatile hydrocarbon revenues.

II. The Sources and Institutional Underpinnings of Sustained Growth in Algeria1

Over the past two decades, Algeria has not been able to achieve high growth rates. Similarly, productivity growth has been negative during most of the last three decades. This chapter aims at analyzing the main problems hindering growth in Algeria and providing policy recommendations to reverse these trends, with a special focus on the institutional changes required to improve the business environment.

A. Why Is Growth in Algeria so Low?

6. Despite very high investment rates, the Algerian economy suffers from growth well below its potential and from high unemployment. After an initial phase of rapid growth in the 1960s and 1970s (6.4 percent on average for the period 1966–80), Algeria’s growth performance was at best modest (2.3 percent from l981–01 and even negative growth rates in the early 1990s). However, during most of the 40 years since its independence in 1962, Algeria’s investment rate has been one of the highest in the world; it averaged 32 percent of GDP annually from 1971–00.2 Human capital, proxied by the average number of years of schooling for the population aged over 25, also grew rapidly (Table 1 and Figure 1).3 As the stock of factors of production grew faster than output, total factor productivity (TFP) growth has been negative.

Figure 1.
Figure 1.

Evolution of GDP, Physical Capital, Labor, and Human Capital, 1965–2001

Citation: IMF Staff Country Reports 2003, 069; 10.5089/9781451811421.002.A002

Sources: Algerian authorities and IMF staff estimates.
Table 1.

Algeria Growth Accounting, 1965–2000

(in percent)

article image
Source: Staff estimates based on Bosworth, Collins and Chen (1995), and Barro and Lee (2000).

7. To quantify the extent of Algeria’s negative TFP growth, this paper has used a Cobb Douglas production function with physical and human capital, and labor as the factors of production.4 Rather than producing a single estimate for TFP growth, the paper presents a range based on two scenarios, to assess the robustness of the results. The first scenario (the “low-case scenario”) assumes a one-third share for physical capital and two-thirds for labor and human capital combined, with the human capital proxied as described in the previous paragraph. This scenario yields particularly low TFP growth (-2.1 percent per year on average), which is partly the consequence of the very rapid growth of human capital. The second scenario (the “high-case scenario”) uses a more conservative estimate for the growth of human capital (4.5 percent of average, or the same as physical capital) and assumes an increase in the share of capital to one half. Even under this optimistic scenario, average TFP growth remains negative (at -0.5 percent per year). The results are presented in Table 1 and illustrated on Figure 2.

Figure 2:
Figure 2:

TFP Evolutions 1965–2000 (3-year moving averages)

Citation: IMF Staff Country Reports 2003, 069; 10.5089/9781451811421.002.A002

Sources: Algerian authorities and IMF

8. Time series indicate that the negative growth of total factor productivity began in the mid-1970 and continued to the mid-1990s. The sluggish growth output of the Algerian economy can thus be ascribed to the inefficient use of the factors of production, rather than to insufficient investment in human and physical capital. The modest improvement in TFP growth observed after 1995 corresponds to the period when the Algerian authorities embarked on an ambitious and comprehensive reform program, with the support of the IMF. Today, growth remains insufficient to create enough employment opportunities for the fast growing labor force.

9. The poor growth performance in Algeria is mainly due to delays in completing the transition to a market economy, which was initiated in the late 1980s after about two decades of central planning. During this process significant results were achieved, but other factors prevailed to cause growth to weaken. Macroeconomic stability was restored, setting the foundations for reforms. The share of the private sector in the nonhydrocarbon “productive sector” increased substantially after 1989 (Table 2). Controls on retail prices and margins were lifted for most goods and services under the Fund-supported programs from 1994–98, and the dinar became fully convertible for current transactions in 1997. However, the overall share of the public sector remains great and markets for credit and land have not been developed. The financial sector is overwhelmingly state-owned and the banks’ portfolios have long been burdened by nonperforming loans to public enterprises.5 Ownership of most agricultural land and a large part of industrial real estate is restricted to the public sector. In addition, since 1992, social and political tensions have hampered economic activity.

Table 2.

Public Enterprise Sector, 1989–2000

article image
Source: Algerian authorities.

Excludes public administrations, banking, insurance, and real estate firms.

B. The Environment for Economic Growth in Algeria

Macroeconomic Policies

10. Economic management contributes to growth performance. Economic literature and empirical studies show that macroeconomic policies have an impact on growth.6 They emphasize the role of maintaining a stable macroeconomic environment, including price stability. Macroeconomic instability generates uncertainty about the future, discourages long-term investment and thus hinders growth.

11. Over the last decade, Algeria has been able to restore macroeconomic stability. Following the strong record of policy implementation under the Fund-supported programs (1994–98), inflation fell from a peak of about 32 percent in 1992 to about 4 percent in 2001. Since 1999 the balance of payments and the budget have been in surplus7, international official reserves have increased from less than 1 month of imports in 1990 to around 20 months in 2002, and external debt has decreased from about 80 percent of GDP in 1993 to about 21 percent in 2002.

Trade Openness

12. Trade increases growth. Aside from the benefits of exploiting comparative advantage, studies stress additional gains from trade liberalization arising through economies of scale, exposure to competition, and the diffusion of knowledge.

13 Algeria has achieved significant progress in price and trade liberalization. Under the Fund-supported programs, trade and payments were liberalized and the dinar became fully convertible in 1997. A second wave of measures starting 2000 includes the abolition of the remaining non-tariff barriers to imports, a comprehensive tariff reform, the signing of an association agreement with the European Union, and negotiations toward accession to the World Trade Organization.

Institutional Environment

14. However, sound macro policies and liberalization, while necessary for growth, are not enough. For growth to occur, the private sector has to operate in an environment that rewards innovation and growth rather than rent-seeking activities. For Algeria, deeper institutional reforms are needed to create the environment in which enhanced economic freedom and opportunities rising from liberalization and other structural reforms lead to growth.

15. The new literature highlights the importance of institutions to promote growth.8 This new strand emphasizes that stability and incentives alone would not be sufficient to generate growth in the absence of adequate institutions.9 Recent empirical research also confirms the correlation between good institutions and growth.10 11

16. Sound institutions and laws, together with effective law enforcement improve interactions among economic agents and reduce transaction costs.12 If institutions are not well developed, and in particular if there is a lack of accountability and transparency, the business environment would not be conducive to growth. The focus on rent-seeking activities aimed at building and exploiting market power which, rather than support efficiency is likely to undermine economic growth prospects.13

17. Indicators on investors’ perception of the business environment show that Algeria’s performance with regard to institutional/governance variables remain weak. The political science literature has constructed a variety of cross-country indicators on investors’ perception of the business environment to capture economic notions of institutional quality.14 These indicators distinguish between measures that describe the attributes of institutions and those that evaluate their performance. The analysis of Algeria’s ranking in the set of these indicators demonstrates a high degree of perceived weakness in Algeria’s business environment. Table 3 provides Algeria’s ranking among the countries which have been in the pool of evaluation. Specifically, Algeria was ranked in the bottom 32 percent of the samples for the World Bank indicators on regulatory burden, government effectiveness, rule of the law, corruption,15 and the International Country Risk Guide (ICRG) country risk,16 however, it is ranked close to the median for the Heritage Foundation index for economic freedom17 and for the Economic Intelligence Unit country risk index.18.

Table 3.

Country Ranking of Selected Indicators of Attractiveness for Foreign Direct Investment

(Percent share of countries with lower score)

article image
Sources: Various country reports; for details see footnotes.

Includes Morocco, Tunisia and Algeria.

Includes Czech Republic, Hungary, and Poland.

Aggregate indicators of governance developed in Kaufmann. D. et al., Governance Matters, Policy Research Paper No. 2196, World Bank, 1999; and database available at\wbi\governance\gov_data.htm, and

Index of Economic Freedom published by the Heritage Foundation and The Wall Street Journal, 2002.

Composite risk ratings by International Country Risk Guide, October 2002.

Aggregate scores of business environment in the Economist Intelligence Unit’s Country Forecast, September 2002.

Growth Competitiveness index published in Competitiveness Report by World Economic Forum, 2002.

Based on results of survey used for the World Bank’s World Development Report 1997 as presented by Brunetti, a et al., in Institutional Obstacles for Doing Business, Policy Research Paper No. 1759, World Bank, 1997; and database available at\wbi\governance\wdr97data.htm.

18. According to these indicators, investors often perceive Algeria as a politically unstable country that harbors corruption. They also see it as a country with inadequate regulations and weak regulatory bodies, lacking enforceable property rights and institutions to manage internal conflicts, such as the rule of law, a strong and independent judicial system, and democratic accountability. The relative ineffectiveness of the privatization strategy, which had raised high expectations, has also negatively affected the credibility of the authorities’ economic reform. The cumbersome administrative bureaucracy and lack of confidence in the judiciary system have also been perceived as impediments to investment in Algeria.

19. In Algeria, the development of the formal sector is also hampered by weak institutions. Stringent and unsuitable regulations and lengthy administrative procedures have led to the emergence of a large informal sector. For instance the restrictions on acquiring foreign currency and the regulations on the exchange rate market resulted in the emergence of a black market and reduced the efficiency of resource allocation.

20. The economic literature classifies market supporting institutions into five types: Property rights; regulatory institutions; institutions for macroeconomic stabilization; institutions for social insurance; and institutions for conflict management.19 Understanding where Algeria stands in each of these institutions will help identify the key issues.

Property rights

21. While property rights are generally well-defined in Algeria, the land rights—agricultural, industrial, commercial, and residential land—are subject to numerous administrative and legal constraints preventing transfers. For example, a large share of unused land in industrial zones is owned by former state-owned enterprises that have ceased to operate, and there is a need for more efficient procedures to transfer the assets of failing enterprises. These obstacles undermine the efficient use of land and hinder economic growth.

Regulatory institutions

22. Market failures occur when transaction costs prevent the internalizing of externalities, or when incomplete information results in moral hazard and adverse selection. To avoid such failures, vigilant regulatory institutions that regulate trade in goods, services, labor, asset and financial systems should oversee market economies. An important characteristic of well functioning regulatory institutions is a sufficient degree of administrative certainty.20

23. Algeria’s regulatory institutions need to be strengthened to allow for the operation of a free market. Although regulatory bodies have been established recently in the areas of mining, electricity and telecommunications, and the institutional framework for banking supervision is being strengthened, institutions required for a broader enforcement of competition are not functioning effectively. There is a need to change the focus of regulatory institutions from central planning to promotion of a market economy based on transparency, competition, and creation of a level playing field to ensure open market access. For example, the foreign exchange regulations emphasize the control of exchange transactions, rather than facilitating the functioning of the markets and reducing transaction costs. In the banking sector, political and administrative interventions in the management of state-owned banks are common, while prudential regulations and supervision remain underdeveloped and the banking supervisory body lacks the capacity to evaluate credit risk. Consumer protection mechanisms are often used to shelter local producers from competition.

Institutions for macroeconomic stabilization

24. Institutions for macroeconomic management in Algeria have been strengthened but continue to suffer from lack of coordination. Their performance is somewhat hindered by insufficient coordination between the Bank of Algeria and the treasury. Furthermore, there are no legislative safeguards to guarantee formally the central bank’s independence from political authorities. A strong independent central bank requires more robust fiscal institutions.

Institutions for social insurance

25. In many cases, establishing a market economy results in uprooting economic agents from their traditional support systems. Unless social insurance is provided to agents affected by this transition, the social cost of the transition would be unfairly allocated. Social insurance could include such entities as social security, unemployment compensation, public works, public infrastructure, and health insurance. Social insurance is needed to maintain social stability and social cohesion and to legitimize the market economy.

26. Institutions for social insurance have been undergoing development in Algeria since the start of economic reform. However, the social safety-net of the scale needed to accompany the privatization and restructuring of the remaining large loss-making public enterprises is not yet in place. The absence of such social safety net is likely to erode political support for reforms because of concerns regarding the social cost of transition on the population.

Institutions of conflict management

27. Continuing strife characterizes Algeria since 1992. Discontent with the management of the economy and the political system has been amplified by the weakness of institutions that could provide people with voice and participation, and help resolve internal conflicts in a fair and equitable manner. This dissatisfaction has been reinforced by the perception of widespread corruption and an ineffective judicial system.21

28. Improving the quality of institutions would enhance Algeria’s long-term growth prospects. The World Bank suggests that by improving the quality of institutions to the levels achieved by an average economy in the world, Algeria could add an additional 0.4 percent to its long term growth.22 The per-capita growth bonus that would come with institutions at par with developed country standards would equal 1.5 percentage points. A modest increase in the growth rate, other things being equal, could have significant implications on the growth of the per capita income over a generation.

Structural Policies

29. Well-designed institutions constitute a key underpinning for growth-promoting structural reforms. While Algeria is well-advanced in price, trade and foreign exchange liberalization, two broad areas require special attention: the size and role of government and the financial system.

The size and role of government

30. The size and role of government influences growth. The government contributes to growth by the provision of public goods. It is widely held that at low-to-moderate levels, the productive effects of public expenditure are likely to exceed the social costs of raising funds, and the net contribution of government is positive. However, large government expenditures may reach levels where the negative effects on efficiency, and hence growth, start to dominate.23

31. In Algeria, the size of the public sector in the economy is large and expanding. The size of the government, as measured by total government expenditures over GDP, increased from 25.6 percent in 1990 to 31.3 percent in 2001 (with an estimated 35 percent in 2002). While the government contributes to growth by the provision of public goods, the large share of the public sector in economic activity, together with other institutional and structural constraints, has made it difficult for the private sector to compete. With limited private activity, the public sector is expected to absorb a large share of the increase in the labor force

The financial system

32. The financial sector in Algeria suffers from major weaknesses. The banking sector is dominated by six public banks that account for approximately 90–95 percent of all deposits and assets. These public banks have financed (and continue to a lesser extent to finance) loss-making public enterprises. Periodically since 1992, the budget recapitalized these banks and the treasury issued large amounts of treasury debt to clean up the banks’ loan portfolio. Public banks’ inefficiencies (inadequate management and high level of nonperforming loans) continue to be a drag on private sector development (long delays in examining requests for loans, incapacity to adequately assess borrowers’ creditworthiness, and the like). These drawbacks hinder the mobilization of domestic saving and lead to suboptimal allocation of the financial resources available for intermediation. They have undermined prospects for economic growth.

C. Institutional and Structural Reforms in Algeria

33. The review of Algeria’s position relative to the optimal growth promoting environment described earlier suggests that Algeria has made considerable progress in establishing macroeconomic stability and in achieving significant economic liberalization. However, challenges remain in the institutional and structural areas.

Priority Institutional Reforms

34. To complete the transition to a market economy and encourage private activity, it is necessary to ensure that supportive institutions are in place. While progress has been achieved in this regard over the past decades, urgent reforms are needed in the following areas:

35. Enforcing property rights in the land and real estate market. To promote private activity, property rights in the area of land and real estate ownership need to be clarified. A proper land cadastre and a titling system are necessary first steps.

36. Strengthening the role of state institutions in facilitating business entry, investment and growth. This requires an efficient and fair tax code (with taxes that are as “neutral” as possible and do not discriminate on the basis of the nature of the activity or personality of the economic agents) and a strengthening of the tax administration to create a level-playing field for all economic agents. It also requires a review of the legal business framework, including the bankruptcy mechanisms to facilitate an efficient resource allocation, among other things, through the elimination of enterprises that do not create wealth.

37. Strengthening institutions for competition and encouraging the development of the formal sector. This requires: (a) reassessing all administrative rules and procedures with a view to lessening their burden on doing business in Algeria; (b), lowering the relatively excessive taxes and levies on labor (which give labor-intensive activities a strong incentive to evade these costs by operating in the informal sector); and (c) reducing customs tariffs, which encourage smuggling. By cutting the cost of doing business and improving compliance, incentives for operating in the informal sector will be reduced. These reforms will also increase confidence of economic agents in the system, reduce the cost of enforcement enhance the mutual trust between enterprises and the administration, and contribute to a better overall business environment in Algeria.

38. Strengthening the judicial system to speed up the legal proceedings, ensure that decisions are applied equitably, and increase the consistency, predictability and impartiality of judgments. This reform will involve modernizing the legislation governing the judiciary, training manpower to deal with commercial and economic matters, and promoting alternative, less cumbersome, methods to resolve conflicts (arbitrage mechanisms).

39. Improving transparency, accountability, and governance including at the local and regional level, through in particular, strengthening the independence and effectiveness of institutions in charge with investigating financial abuses and misappropriations.

40. Strengthening the statistical system and disseminating systematically available information to facilitate decision making by private investors by allocating sufficient resources to the agencies in charge of producing the statistics and encouraging their publication. Regular publication of good quality statistical data on the balance of payments, the national accounts, the budget (revenue and expenditures) and the consolidated balance sheet of the banking sector will allow investors and savers to make informed decisions. It is also important to monitor the performance of the State and enhance public accountability and good governance.

Priority Structural Reforms

41. In addition to institutional reforms, structural reforms are urgently needed to improve financial intermediation, and accelerate the reforms and downsizing of the public enterprise sector.

Improving financial intermediation

42. A first priority to accelerate growth is to improve and modernize the banking system, which is by far the most important component of the financial sector in Algeria. Currently, less than 20 percent of the domestic credit is allocated as credit to the private sector, and the state-owned banks do not have incentives to intermediate resources efficiently. The following initial steps should be taken to allow banks to fulfill efficiently their financial intermediary functions:

  • Removing from public banks the burden of being the financier of last resort for large loss-making public enterprises. In practice, this will shift the decision from the banks to the government, which will need to make, in a transparent and accountable manner, a direct budgetary transfer to these enterprises. To minimize such transfers, the government would need to encourage a rigorous restructuring–or if necessary closure – of public enterprises accompanied by an orderly winding down of government support for these enterprises.

  • Privatizing the state-owned banks. This would help prevent political and administrative interference with credit decisions. There is also a need for strengthening the prudential framework (including the enforcement of banks’ reporting to the central bank) and banking supervision by the monetary authority (such as the capacity to follow up the evolution of nonperforming loans). In the absence of such steps, resource allocation will remain distorted by political expediency, with resources being channeled to well-connected rather than to the best managed enterprises.

Downsizing the public enterprises

43. To facilitate the efficient use of resources, the government has recognized that it is important to free-up the resources that are currently retained by underperforming public enterprises. However, the process has been slow and has not yet had a major impact. It is essential to accelerate the pace of privatization, in conjunction with the creation of a healthy institutional environment and a reformed financial sector.

D. Conclusion

44. Algeria has good prospects for sustained economic growth. It has abundant natural resources, a well-educated population, and a capacity to accumulate savings that can be invested in productive sectors. Algeria also enjoys a good access to European markets, especially following an Association Agreement with the European Union. However, to realize its growth potential, the Algerian economy must implement reforms to reverse the trend of negative factor productivity and use its vast resources more efficiently.

45. Among the three foundations of a growth-promoting environment—macroeconomic stability, structural reform providing incentives and opportunities for the creation of wealth, and the institutional underpinnings for an efficient market—macroeconomic stability has to a large extent been achieved along with price and trade liberalization. For now, institutional reforms require the most urgent attention for transition to a market economy. Establishing clear property rights, ensuring the legitimacy of institutions and the credibility of policy programs, promoting transparency and accountability, strengthening the ownership and the consensus necessary for effective implementation constitute a very ambitious undertaking. Success requires careful sequencing, and begins with the building of a broad constituency for the reform agenda.


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Prepared by Philippe Callier (ext. 37143) and Taline Koranchelian (ext. 38592) who are both available to answer questions.


It compares to an average of 24.4 percent in the MENA region and 21.4 percent for the world.


Data are from Barro and Lee (2000).


See Mankiw, Romer and Weil 1992. See also Bosworth, Collins and Chen (1995) for an application of this methodology to a large sample of countries.


To enable banks to meet the prudential ratios, the Treasury repurchases some of these loans from time to time.


See for example Bassani, Scarpeta and Hemmings (2001). For a critical review of the recent relevant literature, see Rodrick, Subramanian and Trebbi (2002).


However, a small budget deficit is expected for 2002.


For a critical survey of the literature, see Aron 2000. See also Rodrik, Subramanian and Trebbi 2002, and Camdessus 1999,


According to North (1994), institutions are defined as “humanly devised constraints that structure human interaction” and comprise formal constraints in the form of rules, laws, and constitutions, and informal constraints in the form of norms of behavior, conventions, and codes of conduct.


The IMF Operational Guidance Note far Staff Fallowing the 2002 Biennial Surveillance Review (SM/02/292 of September 13, 2002, paragraph 18) also recognizes the potential impact of institutional factors on growth prospects.


See Olson 1971 and 1982 for an analysis of these two opposite types of collective action.


The list of indicators is included in Aron 2000.


This index is a composite of indicators on security of contract and property rights. It includes: rule of law, corruption in government, quality of the bureaucracy, repudiation of contracts by government, and expropriation risk of private investment.


This index is a composite of the dimensions of market efficiency. It includes: trade policy; taxation; government intervention, monetary policy, capital flows and foreign investment regulations; wage or price controls; protection of property rights, efficiency of regulations; and extent of parallel market.


This index combines seven different elements: the political situation (political stability and efficacy), the economic policy (monetary, fiscal, exchange rate, trade and regulatory policies), the economic structure (global climate, growth/savings, current account stability, debt structure and financial structure), the liquidity, the currency, the sovereign debt and the banking sector.


This is illustrated in a recent enterprise survey undertaken by the World Bank.


See World Bank (forthcoming).


There are, however, exceptions, for example in some European continental countries and, especially, the Scandinavian countries, where government-to-GDP ratio tend to be high. Such economies are generally characterized by high levels of development and good governance.

Algeria: Selected Issues and Statistical Appendix
Author: International Monetary Fund