This Selected Issues paper on the Arab Republic of Egypt examines the dynamic relationship between the nominal exchange rate and prices during Egypt’s exit from a managed exchange rate regime. The exit from the peg went through several phases, including a series of step devaluations between 2000 and 2002, a first attempt at a float in January 2003, and the successful transition to a unified, flexible exchange rate system in late-2004. From 2000 to 2004, the Egyptian pound experienced a cumulative depreciation of 68 percent against the U.S. dollar.

Abstract

This Selected Issues paper on the Arab Republic of Egypt examines the dynamic relationship between the nominal exchange rate and prices during Egypt’s exit from a managed exchange rate regime. The exit from the peg went through several phases, including a series of step devaluations between 2000 and 2002, a first attempt at a float in January 2003, and the successful transition to a unified, flexible exchange rate system in late-2004. From 2000 to 2004, the Egyptian pound experienced a cumulative depreciation of 68 percent against the U.S. dollar.

II. Sources of Growth: 1960-200415

22. This chapter analyzes Egypt’s growth record from 1960 to 2004. In particular, it tries to ascertain empirically: (i) the contributions of factor accumulation and total factor productivity (TFP) to growth in output per worker; and (ii) the relative importance of the permanent and cyclical components of growth. Growth accounting exercises are useful for comparing the relative importance of capital accumulation (physical and human) and TFP in a country’s growth process. Trend–cycle decompositions are useful complements of growth accounting exercises as they help to understand growth spells and slowdowns, and assess short–term growth prospects.

A. Egypt’s Growth Record: An Overview

23. Economic growth in Egypt slowed from an average rate of 6 percent per year during the period 1961–1980, to 4.8 percent per year during the 1980s and 1990s (Table 1). From 2001 to 2004, growth decelerated further to an average annual rate of 3.5 percent.

Table 1.

Egypt: Real GDP Growth

(In percent, annual average)

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Sources: Ministry of Planning; CAPMAS; and WorldDevelopment Indicators (WDI).

24. From a regional perspective, Egypt has experienced relatively high rates of growth in GDP per capita since the 1960s (Table 2). This rapid growth notwithstanding, income per capita in Egypt remains below that of other non–oil producing countries in the Middle East and North Africa (MENA) region, though the differences have narrowed considerably in recent years.16

Table 2.

Real GDP, Growth, and Investment in Non–Oil MENA Countries 1/

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Source: Ministry of Planning; CAPMAS; and WDI.

Egypt, Jordan, Lebanon, Morocco, Pakistan, Syria, Tunisia, and Turkey.

Defined as the ratio of gross fixed capital formation to GDP (current prices).

Population–weighted average for Jordan, Lebanon, Morocco, Pakistan, Syria, Tunisia, and Turkey.

Data for some years was missing for Jordan and Lebanon.

25. Growth in output per worker in Egypt over the last four decades has exhibited a strong cyclical pattern. Except for the 197 0s, the average annual rate of growth in output per worker has alternated between 1.3 percent and 2.3 percent per year (Table 1). The high and uneven growth in employment during this period accounts for the differences between this cyclical pattern and the secular decline in total output growth observed since the 1970s.17

26. The behavior of the investment–to–GDP ratio since 1960 shows some similarities with the pattern of output per worker (Figure 1). Egypt experienced an investment boom from the mid–1970s to the mid–1980s, with investment ratios nearing 30 percent of GDP. Those levels, and fluctuations, in total investment are atypical among non–oil MENA countries (Table 2). The surge in investment in the mid–1970s may have contributed to the significant increase in growth of output per worker during that decade; however, the investment ratio remained relatively high during the 1980s, when output per worker experienced a sharp drop. The analyses in the following two sections will help reconcile these two stylized facts of Egypt’s growth record.

Figure 1.
Figure 1.

Egypt: Investment Ratio, 1960–2004 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 179; 10.5089/9781451811858.002.A002

Sources: Ministry of Planning; CAPMAS; and WDI.1/ Ratio of gross fixed capital formation to GDP (current prices).

B. Growth Decomposition

27. A regression–based procedure was used to estimate the contribution of capital per worker and total factor productivity to the long–term behavior of output per worker.18 The estimated coefficients were utilized in the standard growth accounting equation (where lower case letters denote logarithms): Δyt = Δαt + αΔkt + (1−α)Δht to calculate the annual ontributions of physical (K/L) and human (H) capital per worker, and of total factor productivity (A), to the observed growth in output per worker (Y/L).Table 3 summarizes the results from the exercise.

Table 3

Egypt: Sources of Economic Growth, 1961–2004

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Sources: Ministry of Planning; CAPMAS; WDI; and IMF staff estimates.

Human capital is calculated as the return on education (see Appendix for details).

Defined as the ratio of gross fixed capital formation to GDP (current prices).

Calculated as the ratio between the increase in the real capital stock and the change in real GDP.

28. The exercise shows that both physical capital accumulation and TFP growth were important determinants of growth in output per worker in Egypt from 1960 to 2004, but their relative importance changed over time. During the period of high growth (the 1960s and 1970s), TFP and physical capital accumulation contributed almost equally to growth in output per worker. However, during the 1980s, TFP growth collapsed and physical accumulation (supported by strong growth in human capital) became the main engine of economic growth. The efficiency of investment fell, and growth in output per worker experienced a large decline.

29. The relative contributions of TFP and physical capital per worker changed during the 1990s. TFP growth recovered, but physical capital accumulation slowed down sharply. This trend continued after 2000: the contribution of physical capital to growth in output per worker fell to 0.2 percent per year and the investment to GDP ratio declined to 17.5 percent—far below its long–term average. With TFP growth and human capital accumulation also slowing, output per worker grew on average by only 1.3 percent annually during 2001–04. However, the overall efficiency of investment improved.

30. The results in Table 3 are broadly in line with earlier findings in the growth literature. For example, in a recent study of worldwide growth, Bosworth and Collins (2003) found that both TFP growth and physical capital accumulation were important for explaining growth in output per worker from 1960 to 2000.19 One of their findings for the MENA region was the occurrence of a sharp decline in TFP growth in the mid–1970s. As Figure 2 shows, the growth accounting exercise undertaken here also finds evidence of a slowdown in TFP growth in Egypt, although it appears to be less severe than the one found by Bosworth and Collins (2003) for the whole MENA region, and to have occurred slightly later. The results in Table 3 are also broadly consistent with the evidence for Egypt reported in the growth chapter of the September 2003 World Economic Outlook (IMF, 2003) for the period 1980–2000.

Figure 2.
Figure 2.

Egypt: Sources of Growth, 1960–2004

(Cumulative growth index; 1960=1.0)

Citation: IMF Staff Country Reports 2005, 179; 10.5089/9781451811858.002.A002

Sources: Ministry of Planning; CAPMAS; WDI; and IMF staff estimates.

C. Growth in Output per Worker: Trend Versus Cycle

31. To ascertain whether the slowdown in the growth of output per worker observed since 2000 reflects mostly cyclical or secular forces, a trend–cycle decomposition of the variables used in the growth accounting exercise was performed.20

32. Figure 3 plots the actual growth and the estimated trend growth in output per worker (Y/L) in Egypt from 1960 to 2004. The figure shows that trend growth increased significantly in the 1970s, declined steadily during the 1980s, returned in the early 1990s to the rates prevailing in the 1960s, and experienced a slight decline after 2000.

Figure 3
Figure 3

Egypt: Actual and Trend Growth in Real GDP per Worker, 1961-2004

(Percent change)

Citation: IMF Staff Country Reports 2005, 179; 10.5089/9781451811858.002.A002

Sources: Ministry of Planning; CAPMAS; WDI; and IMF staff estimates.

33. The trend–cycle decomposition shows that fluctuations in the growth of output per worker around its trend from 1960 to the mid–1980s were very large, and fairly long. Importantly, the decomposition shows clearly that the slowdown in the growth of output per worker observed since the 1980s is explained by both secular and cyclical components.

34. An examination of the trend and cyclical components of two of the three growth determinants (physical capital per worker and TFP) suggest that a similar confluence of factors have been at play in recent years. Concretely, the analysis shows that the slowdown in growth of output per worker observed since 2000 is partly due to the decline in trend growth of physical capital per worker that started in the 1980s, and partly due to a negative cyclical deviation in TFP growth.

35. The above finding suggests that arresting and reversing the downward trend in physical capital accumulation would be necessary to increase growth in output per worker in the years ahead. Gains in productivity also would be needed to return TFP growth to its trend. In fact, the parameters from the growth–accounting exercise suggest that, in order to raise growth in output per worker to 1.8 percent per annum (its growth rate during 1981–2000) for the next six years, TFP would need to increase slightly from its current levels, and investment in real terms would have to grow at an average annual rate of 4.5 percent—almost twice the average rate of growth of real investment during the last 24 years.21

D. Conclusions

36. The main results from this chapter can be summarized as follows:

  • Physical capital accumulation and growth in TFP were both important contributors to growth in output per worker in Egypt from 1961–2004, but the relative importance of the two factors changed over time.

  • Trend growth in output per worker has been declining since the early 1980s, and is currently below the rate observed in the 1960s.

  • The boom in output per worker during the 1970s was driven by an increase in trend growth of physical capital per worker and trend TFP growth.

  • The current slowdown in growth of output per worker is due to the confluence of a decline in trend growth of physical capital per worker, and a negative cyclical deviation in TFP growth. To raise the growth of output per worker in the coming years, the current downward trend in physical capital accumulation would need to be reversed, and/or productivity would need to improve significantly.

APPENDIX II.1 Model Estimation and Data Sources

A. Estimation Results

The Vector Error Correction Model (VECM), estimated with annual data for the period 1960-2004, assumes that the short–term dynamics of output and capital per workforce adjusted for human capital quality is governed by contemporaneous stochastic shocks, εyt and εkt, and by the previous period’s deviation from long–run equilibrium. The estimated equations were:22

ΔyHLt = αy(yHLt−1−αkHLt−1−at−a0)+ϵyt

ΔkHLt = αk(yHLt−1−αkHLt−1−at−a0)+ϵkt

where αy and αk are the speed of adjustment coefficients.

The long–run (cointegrating) relationship, i.e., the long run production function, is: yHLt = at + αkHLt, where at, the logarithm of TFP, was assumed to follow: at = a0 + at + ϵt. The results of the VECM estimation are summarized in the table below:

VECM Estimates

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The coefficients in bold were significant at the 95 percent level.

B. Variables and Data Sources

Yt: GDP at constant 1992 prices. Sources: Ministry of Planning and World Development Indicators.

Kt: capital stock at constant 1992 prices. Constructed as the previous period capital stock, adjusted by a 5 percent depreciation rate, plus gross fixed capital formation. The initial (1959) estimate of the capital stock was obtained from Nehru and Dhareshwar (1993). Gross fixed capital formation at current prices was obtained from the Minister of Planning. The investment deflator was assumed to be the same as the GDP deflator.

Ht: human capital per worker. Measured as the return on education; namely, Ht = (1 + r)Nt where r is the return on each year of schooling (assumed, as in Bosworth and Collins (2003), to be equal to 7 percent), and Nt is the average number of years of schooling per person in year t calculated as the average of the years of schooling in the datasets from Barro and Lee (2000), and Cohen and Soto (2001).

Lt: employment. Source: CAPMAS, except for the years 1963–1968, 1976, and 1985–1989, for which the observations were obtained by linear interpolation.

References

  • Barro, R. and J. W., 2000, “International Data on Educational Attainment, Updates and Implications,NBER Working Paper 7911, Cambridge, MA.

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  • Bosworth, B. and S. Collins, 2003, “The Empirics of Growth: An Update,Brookings Papers in Economic Activity, No. 2: 113–206.

  • Cohen, D. and M. Soto, 2001, “Growth and Human Capital: Good Data, Good Results,Technical Papers 179, Organization for Economic Cooperation and Development.

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  • IMF, 2003, “How Can Economic Growth in the Middle East and North Africa Region Be Accelerated?”, World Economic Outlook, September 2003.

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  • Nehru, V. and A. Dhareshwar, 1993, “A New Database on Physical Capital Stock: Sources, Methodology and Results,Revista de Análisis Económico 8(1): 37–59.

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15

Prepared by Anna Ivanova. The author would like to thank staff from the Ministry of Planning and from the Central Agency for Public Mobilization and Statistics (CAPMAS) for their assistance with the data used in this chapter.

16

Data reported in the Penn World Tables and the WDI suggest that, measured in PPP terms, Egypt’s real GDP per capita caught up with the average level of other non–oil producers in the MENA region during the 1990s.

17

The rapid growth in employment and labor force during the 1980s mirrored the demographic boom of the 1960s and 1970s, which continued through the 1980s, with population growing on average at 2.3 percent per annum. More recently, population growth has stabilized at about 2 percent per annum.

18

A Vector Error Correction Model (VECM) was used to estimate a production function of the form yHLt = αt + αkHLt, where yHLt = ln(Yt/HtLt) is the logarithm of output per workforce adjusted for human capital quality; kHLt = ln(Kt/HtLt) is the logarithm of capital per workforce adjusted for human capital quality; and at (the logarithm of TFP) was assumed to follow: αt = α0 + αt + ϵt. The estimated coefficient of α (the capital share) was 0.25, and the estimated coefficient on the time trend (a) was 0.01. See Appendix II.1 for details.

19

The study covered 84 countries, representing 95 percent of the world’s GDP and 85 percent of the world’s population. Egypt was one of the countries in the sample.

20

The results reported are those obtained from applying the Hodrick–Prescott filter. The main results were not affected when a band–pass filter was used or when the trend in output per worker was calculated as the fitted values from the VECM.

21

Similarly, in order for overall output growth to rise to 4.8 percent per year (the average growth from 1981-2000) on a sustained basis, real gross fixed investment would need to increase by 12.4 percent annually.

22

The number of lags included in the VECM was chosen based on two information criteria: Schwartz Bayesian and Hannan and Quinn. One lag was chosen for the underlying VAR in levels, which implied that no lags had to be included in the estimation in first differences.

Arab Republic of Egypt: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Egypt: Investment Ratio, 1960–2004 1/

    (In percent of GDP)

  • View in gallery

    Egypt: Sources of Growth, 1960–2004

    (Cumulative growth index; 1960=1.0)

  • View in gallery

    Egypt: Actual and Trend Growth in Real GDP per Worker, 1961-2004

    (Percent change)