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Ishac Diwan and Jamal Ibrahim Haidar, respectively Chaire d'Excellence Monde Arabe at Paris Sciences et Lettres and postdoctoral research fellow at Harvard University


February 2017
Creating Jobs Through Pro-Market Rather Than Pro-Business Policies

As part of a series highlighting key challenges facing Lebanon, the Lebanese Center for Policy Studies has sought input from leading experts on what the new government’s priorities should be. Creating a sufficient number of jobs to employ Lebanon’s labor force has been a key challenge for the country, even though Lebanon has adopted a pro-business policy environment. This policy brief argues that policies supporting particular businesses are not constructive. Instead, Lebanese policy makers need to embrace a broader pro-market approach, which includes institutional reforms to reduce business-government transaction costs and enhance competition.
 
Lebanon can claim a comparative advantage on account of its skilled labor force, giving the country the possibility of becoming a leading services and high-tech hub in the Middle East. Such a development would lead to the creation of high-paying jobs for the country’s educated youth in sectors such as education, health, banking, media, tourism, and high-tech and agri-businesses. But the Lebanese private sector is instead struggling, and many young graduates end up emigrating to parts of the world that offer them better opportunities, thus robbing Lebanon of their potential contribution to its prosperity.
 
The main contention of this policy brief is that the aforementioned situation has come about largely due to economic policies which are termed pro-business but are in fact not pro-market. A pro-market business environment would make it possible for all businesses to compete fairly for market shares, as well as encourage new talents to create firms and support existing small and medium firms that are well-managed to grow and succeed. However, the current pro-business environment is merely supporting some large firms, most often to the detriment of their smaller and less well-connected competitors.
 
In the current environment, small and medium entrepreneurs struggle with bureaucracy from the day they establish a business. This includes navigating a complex maze of regulations and paying a number of bribes as weak public institutions compound the effects of complex and unevenly enforced rules. For example, to start a business, a local entrepreneur needs starting capital of at least $3,219, an amount equivalent to 40.6% of income per capita, as opposed to only 1.3% of income per capita being needed in the US.[1] Abolishing the minimum capital requirement, as well as other costly requirements—such as the obligation to open a bank account and designate a lawyer—as well as increasing the efficiency of the Commercial Registry office, could all help reduce the steps, cost, and time required to start a business.
 
Similarly, existing businesses would do much better without the red tape that hinders their efforts to create value. Eliminating red tape and simplifying regulations—including the process for property registration, paying taxes, going to court, or trading across borders—would reduce costs and allow businesses to focus on creativity and efficiency. Consider that it takes 244 days to obtain the necessary licenses to build a warehouse. Lebanon can learn from more than fifty countries that reformed their construction licensing regulations in the last five years. For example, Lebanon can enforce existing silence-is-consent rules at the municipal level, streamline design approvals from the Order of Engineers to reduce associated procedures and delays, and make police notification an internal process by requiring municipalities to notify law enforcement that a construction permit has been issued.
 
Many such reforms that improve the business climate are “quick-win” reforms because they are primarily administrative in nature and can be accomplished within one year or less through ministerial action. The reason they are not already implemented is that the attention of policy makers is much more attuned to the needs of a few large firms, as opposed to the needs of small businesses.
 
Indeed, evidence from a recent study suggests that one important characteristic of regulation in Lebanon is that it is managed in ways to benefit a few large firms that hold privileged positions due to their political connections.
 
In addition to disincentivizing the government to attend to the needs of smaller firms, the granting of favors to large and politically connected firms has profoundly negative consequences on the operation of a market economy. The dominance of these firms weakens the process of job creation by reducing competitive pressures in the sectors in which they operate. To the extent that these sectors are important inputs to the export sector, they also weaken the export potential of Lebanon by reducing its competitiveness.
 
Our recent work shows that many sectors important to economic growth have high levels of market concentration in Lebanon, and that this is in many cases due to the political privileges that a few select firms enjoy. The type of privileges which allow connected firms to develop large-cost advantages over their competitors that are not connected involve preferential treatment by regulators, which can entail, among other advantages, better access to government procurement, lenient application of regulations, or better access to land. In such a setting, it is not surprising that 61% of Lebanese firms surveyed by the World Bank reported that corruption is a major constraint to their operations.[2] In the same survey, 30.2% of firms reported expecting to pay bribes to secure government contracts and 41.8% of firms expected to pay bribes to obtain a construction permit.
 
Sectors dominated by politically connected firms in Lebanon include the banking, media, education, energy, health (hospitals as well as drug import and distribution), real-estate construction, road paving, water extraction and sale, mining (including quarries), telecommunications, soft drinks, and pharmaceutical production sectors. These are all sectors where the state has influence, such as on licenses, the application of zoning laws, the regulation of quality of service in schools and hospitals, or control over government procurement. Thus, these are also sectors where political connections place pressure on government officials to be more lenient toward politically connected firms, allowing them to gain unfair market advantages.
  
Politically connected firms play an important role in the economy. They constitute 43% of all large firms in Lebanon (of over one hundred workers), employ nearly 16% of the (formal) labor force, and tend to dominate the sectors in which they operate. As a group, politically connected firms control on average 70% of the market in the sectors in which they operate. Importantly, politically connected firms in Lebanon also have lower labor productivity than non-connected firms in their own sector of activity. This suggests that their strength resides in the cost advantage bestowed by their privileges rather than in more effective organization methods, being led by more talented managers, or using more effective technologies.
 
Moreover, the presence of a politically connected firm makes the whole sector in which it operates less dynamic, and in particular, exhibit a slower rate of birth of new firms and jobs. The main problem is not just that politically connected firms outgrow their competitors, but rather, that they deter the growth of their competitors, thus hurting potential economic growth. Indeed, our work shows that while politically connected firms contribute directly to employment growth, their dominance in a sector of operation has had a negative impact on job creation by their competitors, and ends up having a negative influence on their sector as a whole in terms of the number of jobs being created. These sectors end up with a missing middle in terms of firm growth distribution, meaning they tend to become dualistic, divided between large but inefficient quasi-monopolies, and small and inefficient firms that do not have the ability to innovate and grow.
 
These results imply that a precondition for improved corporate performance in Lebanon is to re-establish fair and dynamic competition as a central principle behind the country’s growth strategy. Public policies that encourage new firms to enter the market are beneficial as well as initiatives that give them access to preferential credit, or to space in industrial zones. However, unless the conditions exist for these firms to continue to grow and increase their market shares, any national effort to encourage the creation of new small and medium-sized enterprises will be wasted. 
 
Improving competition does not require the creation of new institutions. Instead, it is necessary to ensure that existing institutions work fairly, and not for the benefit of the politically-connected few. This applies to all institutions that have leverage over private sector growth, from tax authorities, to enforcers of consumers rights and the quality of products (for example in the health and education sectors), to agencies that license land or provide construction or business permits. This government could begin actively supporting such steps by issuing decrees on matters such as creating a one-stop shop for business registration; cutting business registration procedures; reducing the number of requisite procedures to obtain a construction permit; reducing the time to issue a construction permit; lowering the cost, combining and eliminating some procedures, and reducing the time needed for registering property; increasing financial disclosure requirements; allowing electronic submission and processing of tax forms; improving transparency in trade regulations and public procurement processes; using risk-based inspections; and introducing performance measures for judges. In all these cases, discretion by bureaucrats ends up fostering lobbying efforts by the connected few. Reducing discretion with simple rules and more transparency is the best way to level the playing field.
 
Those needed changes amount to a change in mentality. A zero tolerance strategy is best to shift out of the current trap, where the magnitude of corruption is so large as to hide the faults of any one individual regulator, thus encouraging the non-corrupt to behave like their corrupt competitors. Such a strategy could be central to establishing a new status quo where firms know that corruption is rare, and that any attempt therefore will be visible and easily punishable. An early focus on a few prominent cases of blatant corruption will go a long way in demonstrating that a new period of zero tolerance has been ushered in, and that the rule of law stands above short-sighted political motives.
 
Shifting from a pro-business to a pro-market economic regime is both necessary and timely in Lebanon. The above recommendations highlight changes that could be implemented immediately. There are a number of countries that have successfully managed programs of regulatory reform, and they stand as benchmarks for measuring the effectiveness of their respective policy makers. In the same way, implementing the reforms outlined above would deliver tangible results, building confidence at the national level in the Ministry of Finance and Ministry of Economy and Trade, as well as at the municipal level. This would be especially valuable in these challenging times. Moreover, they could build up state capacity and set the stage for implementing smart industrial policies that could over time unleash even greater growth opportunities in new and emerging sectors.
 
 

[1] World Bank Doing Business 2017 database
[2] World Bank Enterprise Surveys 2013 database, latest results on Lebanon.








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