Pouring Oil on Troubled Waters
A Study of International Economics and Rentier Theory:
The Cases of Egypt and Saudi Arabia
Naam: Sanne Reus Student number: 1723952
DECLARATION BY CANDIDATE
I hereby declare that this thesis, “Pouring Oil Over Troubled Waters: A Study of Institutional Economics and Rentier Theory: The Cases of Egypt and Saudi Arabia”, is my own work and my own effort and that it has not been accepted anywhere else for the award of any other degree or diploma. Where sources of information have been used, they have been
acknowledged.
Name
Sanne Johanna Maria Reus
Signature
Date
T
ABLE OF CONTENT
Introduction 5
Chapter 1, Theoretical framework 11
Institutional economics 11
Operationalization 16
Rentier theory 18
Operationalization 22
Chapter 2, Egypt’s Institutions 27
Egypt’s economic performance 27
Economic policy developments 28
Economic performance: key economic indicators 31
Conclusion 37
Institutional economics 38
Political developments 38
The Governance indicators 41
Conclusion 59
Chapter 3, What’s oil got to do with it: the case of Egypt 61
Natural resources 61
Egypt as rentier state 67
Rentier mechanisms 73
Conclusion 85
Chapter 4, Saudi Arabia’s Institutions 88
Saudi Arabia’s economic performance 88
Economic policy developments 89
Economic performance: key economic indicators 94
Conclusion 100
Institutional economics 102
Political developments 102
The Governance indicators 107
Conclusion 124
Chapter 5, What’s oil got to do with it: the case of Saudi Arabia 127
Natural resources 127
Saudi Arabia as rentier state 134
Rentier mechanisms 136
Conclusion 148
Conclusion 151
Saudi Arabia 153
Egypt vs. Saudi Arabia 155
Institutional economics vs. rentier theory 159
In conclusion 161
Epilogue 162
Bibliography 164
Appendix 1: Egypt’s World Governance Indicators 178
I
NTRODUCTION
In 2008 a financial crisis hit the United States. Years of over-accumulation, maintaining a large negative balance of payments, growing sectorial imbalances, increased inflation and savings imbalances caught up with the country and a recession started.1 The at first domestic financial crisis soon spread to other countries due to globalization and trade interdependence.2 More and more countries were confronted with rising inflation, higher unemployment rates and many bankruptcies. However, not all countries suffered from the crisis that erupted. Several countries, especially in the developing world, actually seemed to benefit from a changing global economic geography caused by the crisis.3 Academics Ignacio Munyo and
Ernesto Talvi of the Center for the Study of Economic and Social Affairs (CERES) have studied this phenomenon and concluded that the crisis not only produced losers but also certain winners. They developed the CERES Global Index of Economic Exuberance, which was designed to measure whether a country’s macroeconomic performance was stronger or weaker relative to its performance prior to the financial crisis. The index was based on six macroeconomic variables and predicted whether countries were exuberant economies (positive index) or anaemic economies (negative index). Based on this index the academics showed that many of the anaemic countries included advanced economies while many of the exuberant economies were emerging economies. Developing countries in Asia, South America, sub-Sahara Africa, the Middle East and North Africa were more often labeled as exuberant countries and were appointed as ‘winners’ by these academics.4
Two of those exuberant countries were Egypt and Saudi Arabia. While these Middle Eastern countries have experienced a (small) downfall immediately after the collapse, their economic performance was still reasonable. For example, Egypt experienced gross domestic product (GDP) growth of 4 to 5 percent per year post-crisis5 and while unemployment rose it was comparable to western countries.6 Saudi Arabia’s GDP growth fell sharply in 2009 but
1 L. Grigor'ev and M. Salikhov, "Financial Crisis 2008: Entering Global Recession," Problems of Economic
Transition 51, no. 10 (2009): 36.
2 Grigor'ev and Salikhov, "Financial Crisis 2008: Entering Global Recession," 35.
3 Ignacio Munyo and Ernesto Talvi, "Anaemia, Exuberance, and Vulnerability: A post–financial Crisis New
Global Economic Geography," (2011): 1.
4 Munyo and Talvi, "Anaemia, Exuberance, and Vulnerability: A post–financial Crisis New Global Economic
Geography," 13.
5 "GDP Growth (Annual %)," The World Bank, accessed September 11, 2013,
http://databank.worldbank.org/data/views/reports/tableview.aspx?isshared=true.
6 "Egypt Unemployment Rate," Trading Economics, accessed October 16, 2013,
was again above 7 percent in 2010.7 Furthermore, unemployment has seemed relatively stable in the kingdom.8 These counties were able to continue performing relatively well after the crisis, as they had done before the crisis. Both countries experienced positive growth over the last decade. Egypt’s economy grew from 4 percent GDP growth in 2004 to more than 7 percent just before the crisis.9 Saudi Arabia’s growth with percentages being between 3 and 9 over the last decade was more volatile but always positive.10 It has to be mentioned that while both countries have performed relatively well the first years post-crisis, more recently the economic situation seems to have changed in Egypt. Since 2013 economic growth in Egypt has been declining.11
Throughout the years economists have tried to explain economic growth in countries like Egypt and Saudi Arabia by formulating different theories. One of these theories was developed by Douglas North, who showed that there exists a connection between institutions and economic growth. The economist explained that institutions are the structure of an economy and that they shape the direction of economic change towards growth, stagnation or decline.12 He defined institutions as: ‘the humanly devised constraints that structure political, economic and social interaction, which consist of both informal and formal constraints and are devised to create order and reduce uncertainty in exchange.’13 North stated that efficient political and economic institutions reduce transaction costs and increase productivity which have a positive effect on economic growth.14 Other academics have built on this theory developed by North. For example, Stephen L. Parenté and Edward C. Preston who focused on monopolies and stated that institutions facilitating monopolies are barriers to economic growth,15 or Robert E. Hall and Charles I. Jones who focused on ‘social infrastructure.’ These academics explained that differences in long run economic performance between countries are related to differences in the social infrastructure and institutional quality of countries. By this they meant the differences in institutions and government policies that determine the economic environment.16 These theories, which fall within the framework of institutional economics, have linked economic performance to institutional quality of countries.
7 Country Intelligence: Report: Saudi Arabia (IHS Global, December, 2013), 4-6. 8 Saudi Arabia Country Update: Political Risk Services, 2009, 6-7.
9 "GDP Growth (Annual %)," The World Bank.
10 Saudi Arabia Country Update: Political Risk Services, 2009, 6-7.
11 Country Intelligence: Report: Egypt (IHS Global Inc., December, 2013), 6.
12 Douglass C. North, "Institutions," Journal of Economic Perspectives 5, no. 1 (1991): 97. 13 North, "Institutions," 97.
14 North, "Institutions," 98.
15 Stephen L. Parente and Edward C. Prescott, Barriers to Riches (Cambridge, Mass: MIT Press, 2000), 133-145. 16 Robert E. Hall and Charles I. Jones, "Why do some Countries Produce so Much More Per Worker than
While these theories are well known within the field op International Political Economy, there seems to be a contradiction when comparing these theories to the article mentioned before written by Munyo and Talvi. It is remarkable that the countries that they appointed as winners are in not always countries with the highest scores on institutional quality. For example, Egypt scored 0.29 and Saudi Arabia 0.52 on a scale from 0-1 portraying social infrastructure and output developed by Hall and Jones.17 When researching these case studies more closely by looking at related factors like corruption and political institutions, it becomes clear that practices in these countries might not be in line with theory on institutional economics.
For example, corruption in both countries is fairly high. In 2013 Egypt ranked 114th (of
the 177) with a score of 32 and Saudi Arabia 63th with a score of 46 on the Corruption
Perceptions Index. This index scores countries on a scale from 0 (highly corrupt) to 100 (very clean). As both countries scored below 50, it indicated that corruption was a serious problem within Egypt and Saudi Arabia.18
Furthermore, when looking at the state of political institutions the situation again seems troubling as both countries have had autocratic regimes with institutions that were conservative and sensitive to favoritism and patronage.19 Moreover, these already weak institutions have come under pressure due to political turmoil. Egypt was one of the first countries to be part of the Arab Spring. In 2011 thousands of people flooded Tahrir Square to protest against the autocratic regime of Hosni Mubarak. These people wanted the old regime to be punished for years of fraud, corruption en nepotism and demanded a more democratic regime.20 Even though Egypt was officially a republic, in practice it had been a one party state with very limited freedoms, and the people of Egypt were done with the farcical elections and the repressive regime.21 After being forced to step down the Supreme Council of Armed Forces made up of twenty high-ranking military officers collectively exercised presidential powers until parliamentary elections were held and Mohamed Morse of the Muslim Brotherhood was chosen as the new president. However, under Morsi’s ruling the political situation did not immediately improve, as political institutions were still far from democratic. Thousands of people were unlawfully arrested, detained and sometimes tortured by military
17 Hall and Jones, "Why do some Countries Produce so Much More Per Worker than Others?" 103. 18 Corruption Perceptions Index 2013 (Transparency International, 2013).
19 Clary and Karlin, "Saudi Arabia's Reform Gamble," 16.
20 Steve Hess, "From the Arab Spring to the Chinese Winter: The Institutional Sources of Authoritarian
Vulnerability and Resilience in Egypt, Tunisia, and China," International Political Science Review 34, no. 3 (2013): 255-263.
21 Hess, "From the Arab Spring to the Chinese Winter: The Institutional Sources of Authoritarian Vulnerability
police or security forces22 and Morsi was criticized for forcing through an Islamist-slanted constitution and a drop in living standards.23 Exactly one year after Morsi came to power thousands of protestors again gathered in Tahrir square. These protests resulted in a military coup.24
When comparing the situation in Saudi Arabia to Egypt a different image arises. Even though Saudi Arabia has not experienced a revolution as in Egypt, it did not mean that Saudi Arabia has not experienced some political turmoil of its own. Years of corruption, nepotism and especially the discrimination of the Shi’a minority also led to unrest Saudi Arabia.25 However, the kingdom’s ruler quickly stepped in and ordered thousands of security forces to crush any public dissent, close off spaces for public assembly and offered up a national spending package of over 100 billion dollars.26 The situation in Saudi Arabia stabilized
without the departure of its autocratic ruler or large policy changes. Institutions remained fairly conservative27 and the influence of Islamic teachings and more specifically Sunni Wahhabism28 on institutions is still large.29 These high levels of corruption, recent developments and the limitation of freedoms indicate that the level of institutional quality in Egypt and Saudi Arabia might not be as high as is expected for countries with relative good economic performance.
The countries do not only share having questionable levels of institutional quality, they have more in common. First of all, these countries are both larger and more moderate countries of the region and have a predominately Sunni population.30 Furthermore, for years the (former) leaders Mubarak and Abdullah have been allies and good friends.31 Even after Mubarak stepped down Saudi Arabia kept its eye on Egypt, especially because Saudi Arabia had a difficult relationship with the Muslim Brotherhood. Therefore, it was King Abdullah who was one of the first to congratulate Egypt after the coup in July of 2013. He also pledged to support Egypt financially with 5 billion dollars in aid.32 However, when comparing these countries’ differences it becomes even more interesting. As described above the Arab Spring
22 Eberhard Kienle, "Egypt without Mubarak, Tunisia After Bin Ali: Theory, History and the ‘Arab Spring’,"
Economy & Society 41, no. 4 (2012): 532-540.
23 Patrick Kingsley, "Protestors Across Egypt Call for Mohamed Morsi to Go," The Guardian, June 30, 2013. 24 Kingsley, "Protestors Across Egypt Call for Mohamed Morsi to Go."
25 Kevin Sullivan, "Saudi Arabia's Secret Arab Spring," The Washington Post, October 23, 2012. 26 Toby Craig Jones, "Saudi Arabia Versus the Arab Spring," Raritan 31, no. 2 (2011): 44.
27 Christopher Clary and Mara E. Karlin, "Saudi Arabia's Reform Gamble," Survival 53, no. 5 (2011): 16. 28 A stark and austere reading of Islam derived from the teachings of eighteenth-century theologian Mohammed
ibn Abd al-Wahhad.
29 Mai Yamani, "The Two Faces of Saudi Arabia," Survival 50, no. 1 (2008): 144. 30 Yamani, "The Two Faces of Saudi Arabia," 152.
31 "Don't Humiliate Mubarak," Fox News, February 10, 2011.
had very different results for both countries and while Saudi Arabia’s GDP growth is still strong, Egypt’s has been declining recently.
So, it is of importance to look at alternative theories for two reasons. Firstly, theory on institutional quality might not be sufficient to explain economic performance in Egypt and Saudi Arabia and secondly to explain the before mentioned differences. One factor that cannot be ignored when researching these countries, and especially when researching Saudi Arabia, is the effect being oil producers has on economic performance and policy choices. While Egypt is a small oil country that has only 4.4 billion barrels (bbls) of proven oil reserves,33 Saudi Arabia is one of the largest with 267 billion bbls of proven oil reserves. Having almost one-fifth of the world’s oil reserves has a huge impact on the country’s economy.34 This oil wealth, which depends on generating high rents from oil, creates certain
opportunities. King Abdullah of Saudi Arabia used these revenues to invest in large domestic incentives programs as an insurance against protests, which was an opportunity the Egyptian president did not have.35 The link between bad institutions, patronage and autocratic regimes in oil rich nations has been a subject of extensive research on rentier theory. Rentier states are mineral exporters of which the minerals tend to generate rents. These rents are largely captured via export taxes, corporate taxes and state-owned enterprises. The mineral extraction employs relatively little labor.36 Rentier theory focuses on economic performance and regime formation in oil producing countries and can therefore contribute to this study of economic performance of Egypt and Saudi Arabia.
Overall, the focus of this thesis will be twofold. The first part of the thesis will focus on the theory of institutional economics and how this theory can be used to explain economic performance in Egypt and Saudi Arabia over the last decade. However, as shortly touched upon before, the level of institutional quality in these countries seems below average and economic performance and political developments have resulted in very different outcomes. Therefore, it is of importance that a second theory is included to research these phenomena. The second part of this thesis will focus on rentier theory. The main question reflects these two parts as it is: ‘to what extent can theory on institutional economics and/or rentier theory explain the economic performance of Egypt and Saudi Arabia over the last decade?’ The main question will be answered by researching certain sub questions. The first chapter will contain a theoretical framework in which the theory on institutional economics and rentier theory are
33 Egypt (U.S. Energy Information Administration, 2013), 1. 34 Saudi Arabia (U.S. Energy Information Administration, 2013), 1. 35 Jones, "Saudi Arabia Versus the Arab Spring," 44.
described in detail. The following (second and third) chapters will include a detailed description of economic and political developments in Egypt. These chapters will answer the questions ‘to what extent can theory on institutional economics explain the economic performance of Egypt over the last decade?’ and ‘to what extent can rentier theory explain the economic performance of Egypt over the last decade?’ by analyzing the level of institutional quality and presence of rentier mechanisms in this country. The next two chapters will discuss the same questions, but then for the case of Saudi Arabia. The last part of the thesis contains a conclusion. By analyzing in how far both theories can explain the economic performance of both countries and also touch upon the differences and connections between these countries and the theories, the main question will be answered.
C
HAPTER
1,
T
HEORETICAL FRAMEWORK
This chapter includes a description of the theories that are applied within this thesis. The first part of the chapter discusses the theory of institutional economics. Institutional economics as a theory arose during the 1900s after economists and scholars from other backgrounds started challenging the classical economic theorist traditions and focus on the relation between institutions and economic performance. 37 This part of the chapter starts with a short introduction of the theory. Thereafter, the main developments are discussed and a general description of the theory is given. This section ends with describing how the theory will be operationalized.
The second part of the theoretical framework includes a description of the rentier theory. This theory is designed to explain the existence and stability of authoritarian regimes in oil producing countries. Rentier theory explains this process based on the existence of several mechanisms, which affect institutions and economic performance.38 As being oil producers could have consequences for the institutional quality and economic performance of countries, it is of importance that this variable is included in this thesis. This part of the chapter will give a short description of the main developments within the theory, discuss the theory in general and explain how the theory will be operationalized.
I
NSTITUTIONAL ECONOMICS
Differences in income and development between countries have always intrigued economists. Questions as ‘why do some countries perform better than other countries?’ or ‘what causes the gap in income between developed and underdeveloped countries?’ has motivated extensive research on economic growth. Over the years economists have tried to explain these phenomena and create strategies to promote economic growth. Their research has resulted in the development of different theories on economic growth.
For long, most of these theories fell within the neoclassical framework. Neoclassical theories of growth explained differences in income per capita in terms of different paths of factor accumulation. The theoretical traditions included studies focusing on different variables as saving rates, preferences, factor productivity growth, innovation, economies of scale,
37 Ronald H. Coase, "The New Institutional Economics," Zeitschrift Für Die Gesamte
Staatswissenschaft/Journal of Institutional and Theoretical Economics (1984): 72.
38 Matthias Basedau and Jann Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth
education and capital accumulation. These studies had in common that all provided insights into mechanisms of economic growth.39 Some well-known theorists within this school were Robert Solow, Paul Douglas and Charles Cobb.40
It was this focus on mechanisms that was challenged in the early 1900’s. A group of economists didn’t believe these mechanisms to cause economic growth, but believed it to be proof of economic growth and started looking for other explanations. Within their search for new explanations, they included not only economic ideas but also looked at sociology, anthropology, political science, law and sociobiology for ideas.41 These theorists stood at the beginning of a new school of thought, often referred to as institutional economics.42
The works of Thorstein Veblen, John Commons and Wesley Mitchell became known as the first theorists within this school of thought. Veblen was a social scientist who tried to develop a theory of economic and institutional evolution along Darwinian lines by using evolutionary metaphors from biology.43 He criticized the classical economists for being too generic and also criticized their focus on ‘natural laws.’ Veblen stated that economic interest does not act in isolation and that variables as human action, habit and culture should be included in economic theory.44 Commons also included the human actor in his work. He focused on how individuals participated in different forms of transactions. These transactions led to relations of conflict, dependence and order and he was interested in how to subject these relationships to legal control. Here, the role of institutions was introduced which he defined as collective action in control, liberation and expansion of individual control.45 Mitchell was mainly known for his empiric research for the United States’ National Bureau for Economic Research in the 1920s and 30s. His research showed that macroeconomic phenomena had an ontological and empirical legitimacy, which was different from what the traditional theorists believed, namely that macroeconomics could only be derived from micro stabilities.46 Mitchell’s works on business cycles, in which he stated that economic crises are not abnormal events but a feature of recurring business cycles, became fairly popular.47 The
39 Daron Acemoglu, Simon Johnson and James Robinson, "Institutions as the Fundamental Cause of Long-Run
Growth," National Bureau of Economic Research, Inc., NBER Working Papers: 388.
40 Acemoglu, Johnson, and Robinson, "Institutions as the Fundamental Cause of Long-Run Growth," 388. 41 Ronald H. Coase, "The New Institutional Economics," 72.
42 Coase, "The New Institutional Economics," 72.
43 Geoffrey M. Hodgson, "The Approach of Institutional Economics," Journal of Economic Literature (1998):
166-167.
44 Thorstein Veblen, "Why is Economics Not an Evolutionary Science?" The Quarterly Journal of Economics
12, no. 4 (1898): 393-397.
45 John R. Commons, "Institutional Economics," The American Economic Review (1936): 652 -657. 46 Hodgson, "The Approach of Institutional Economics," 171-172.
47 Wesley C. Mitchell, “Business Cycles,” in Business Cycles and Unemployment ed. a committee of the
focus of these men on human actors, behavior, transactions and the move away from microeconomics, formed the beginning of the theory of institutional economics.
Besides these three theorists, there were of course many other contributors. For example, Armen Alchian and Harold Demsetz, who focused on the structure of property rights in a society, how these structures influenced social interaction and how these property right structures came into being.48 Herbert Simon forms another example. He stated that “nothing is more fundamental in setting our research agenda and informing our research methods than our view of the nature of human beings whose behavior we are studying.” 49 However, all these theorists had one thing in common, and that was that they were often accused of being anti-theoretic. Their theories were repeatedly written off and dismissed for failing to provide a systematic and viable approach to economic theory.50 There was no theory
to bind together the collections of facts many of the older institutionalists had developed.51
Therefore, it were not these theorists but Ronald Coase and especially Douglas North who became the first presidents of new institutional economics (NIE).52 The term new institutional economics was given to the school of thought to differentiate this theory from the older theories.53
Robert Coase introduced new institutional economics by writing the article ‘The Nature of the Firm’ in 1937.54 In this article he made the connection between institutions, transaction costs and neoclassical theory.55 He explained that if it were costless to transact, neoclassical theories would be the solution. When competition is strong and markets efficient, income could be maximized regardless of the institutional arrangements. However, in the real world, markets are not perfect and transaction costs do exist.56
North, as Coase did, believed that institutional economics would be a modification of neoclassical theory. The assumptions of scarcity and competition would still be fundamental, however he challenged the rationality assumption. He saw institutions as the structure of a society and stated that political and economic institutions were the underlying determinants of
48 Armen A. Alchian and Harold Demsetz, "The Property Right Paradigm," The Journal of Economic History 33,
no. 01 (1973): 17.
49 Oliver E. Williamson, "The New Institutional Economics: Taking Stock, Looking Ahead," Journal of
Economic Literature 38, no. 3 (2000): 600.
50 Hodgson, "The Approach of Institutional Economics,"166. 51 Coase, "The New Institutional Economics," 72.
52 Williamson, "The New Institutional Economics: Taking Stock, Looking Ahead," 600.
Hodgson, "The Approach of Institutional Economics,"166.
54 Coase, "The New Institutional Economics," 72.
55 Douglass C. North, "The New Institutional Economics and Development," (1993): 1-8, accessed September
10, 2013, http://www2.econ.iastate.edu/tesfatsi/newinste.north.pdf.
economic performance.57 Institutions create order and reduce uncertainty in exchange and therefore determine transaction and production costs and this way the profitability and feasibility of engaging in economic activity. Institutions provide the incentive structure of an economy and shape the direction of economic change towards growth, stagnation, or decline.58 He defined institutions as “the humanly devised constraints that structure political, economic and social interaction; they consist of both informal constraints (sanctions, taboos, customs, traditions and codes of conduct) and formal rules (constitutions, laws, property rights) and are devised by human beings to create order and reduce uncertainty in exchange.”59 North believed institutions to be necessary because markets are imperfect and individuals act on incomplete information. This means that there exist transaction costs, which he defined as “the costs of specifying what is being exchanged and of enforcing the consequent agreements.” He stated that imperfect markets need rules to play the game and that institutions form these rules.60
After North, many followed in his footsteps and researched institutions as determinant for economic growth. Some of these studies were more general studies on institutions while other studies focused on certain aspects of institutions. Research by Oliver Williamson, Nobel price winner, is an example of a more inclusive and theoretical study. In his articles he described the importance and complexity of institutions and explained that there are multiple levels of social analysis. He summarized the core ideas of NIE as the focus on human actors; the fact that students of NIE eschew hypothetical ideas and deal instead with feasible organizational alternatives; the including of alternative modes of governance (firms, spot markets, bureaus etc.) and the effort to operationalize and theorize the ideas of NIE.61 While he was very positive about de developments within institutional economics, he was also very critical; he believed there was still a vast amount of unfinished business. The theory needed refinements, extensions, new applications, more good ideas and more empirical testing before it would be a fully formal theory.62
While Williamson’s work was theoretical, others engaged in more empirical research as Robert Hall and Charles Jones or Stephan Parenté and Edward Prescott. Hall and Jones wrote the article ‘Why do some countries produce so much more output per worker than
57 Douglass C. North, "Economic Performance through Time," The American Economic Review 84, no. 3 (1994):
359.
58 Douglass C. North, "Institutions," Journal of Economic Perspectives 5, no. 1 (1991): 97-98. 59 North, "Institutions," 97.
60 North, "Economic Performance through Time," 361.
others?’ in 1999. Their hypothesis was that differences in capital accumulation, productivity and therefore output per worker are related to differences in social infrastructure with which they meant institutions and government policies. A social infrastructure favorable to high levels of output per worker provides an environment that supports productive activities and encourages capital accumulation, skill acquisition, invention and technology transfer.63 They also stated that diversions as thievery, corruption, and expropriation have a negative impact on growth and that the social infrastructure should protect output against diversion.64 Hall and Jones measured economic performance by using a Cobb-Douglas approach and used several indexes (government anti-diversion policies index, international country risk guide, openness to trade) to measure social infrastructure. Based on their results they concluded that differences in social infrastructure account for much of the differences in long run economic performance throughout the world.65 Parenté and Preston also engaged in empirical research,
however their focus was mainly on monopoly rights as barrier to economic growth. In their work Barriers to Riches they stated that differences between countries are based on differences in total factor productivity and that many of the apparent constraints exist on account of monopoly rights. When governments protect monopolies, insiders with vested interests can impose restrictions on work practices, which provide strong barriers to the adoption of better technologies, which negatively affects economic performance.66
These examples show that the framework of (new) institutional economics includes many different works, which focus on different aspects of the theory. Some examples of these aspects are: corruption, bureaucratic quality, volatility of government, foreign investment, economic freedom, democracy, property rights, development of privatization, market competitiveness and openness to trade.67 The overall idea of institutional economics is that not mechanisms of growth (as productivity, scale economy etc.) determine economic growth, but that it is the institutional quality of a country. A country’s economic performance depends on the state of its institutions. As North said the quality of institutions shape the direction of economic change towards growth, stagnation, or decline.68 All the aspects mentioned above are factors that affect institutional quality.
63 Robert E. Hall and Charles I. Jones, "Why do some Countries Produce so Much More Per Worker than
Others?" Quarterly Journal of Economics 114, no. 1 (1999): 84.
64 Hall and Jones, "Why do some Countries Produce so Much More Per Worker than Others?" 84. 65 Hall and Jones, "Why do some Countries Produce so Much More Per Worker than Others?" 113-114.
66 Stephen L. Parente and Edward C. Prescott, Barriers to Riches (Cambridge, Mass: MIT Press, 2000), 133-145. 67 Samad Rasoulzadeh Aghdam, Behjat Yazdkhasti, and Mohammad Sadegh Mahdavi, "Comparative Study of
Political Institutions in Developed and Developing Countries Based on Institutional Economy," Mediterranean
Journal of Social Sciences 4, no. 2 (2013): 100-103.
Parenté and Prescott, Barriers to Riches, 133-145.
O
PERATIONALIZATIONIncluding all these aspects does not fall within the limits of this thesis. So, when operationalizing this theory, a choice has to be made with regard to which aspects will be researched when studying the chosen cases. The main focus of this thesis is on the relationship between political institutions and economic growth and how these affect each other. Therefore, economic performance and the quality of political institutions of the cases need to be tested.
Economic performance will be described based on information provided by different sources. Firstly, information on economic performance provided by international organizations as the IMF and World Bank will be used. Both these organizations provide publicly accessible economic information on many different economic indicators as GDP growth, income level, consumer prices, export and foreign exchange. Besides these organizations, information provided by private organizations such as the Economist Intelligence Unit, Datamonitor, Political Risk Services, Trading Economics and IHS Global will be used. These organizations write yearly reports on countries’ economic performance including information on real economic growth, consumer spending, exports, employment, inflation, economic policy and economic forecasts. The combination of these resources will provide the information needed to describe the economic performance of Egypt and Saudi Arabia.
Besides economic performance institutional quality needs to be measured. Measurements of institutional quality will be based on the works of Daniel Kaufmann, Aart Kraay and Massimo Mastruzzi who developed the governance indicators for the World Bank Institute. They developed six dimensions of governance and measured 215 countries from 1996 to 2012.69 The indicators developed by Kaufmann, Kraay and Mastruzzi include most aspects that are part of institutional economics and have been used by other academics, as Samad Rasoulzadeh Aghdam, Behjat Yazdkhasti, and Mohammad Sadegh Mahdavi, to study international economics.70 These are the following indicators:
Voice and accountability: this first indicator measures the extent to which a country’s citizens are able to participate in selecting their government as well as freedom of expression, freedom
69 Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and
Developing Countries Based on Institutional Economy," 103.
70 Application of institutional economics based on the World Bank Governance indicators in the following
of association and freedom of the media.71
Political stability: this indicator shows the extent of vulnerability of political systems against threats and illegal actions as it captures the likelihood that the government will be destabilized or overthrown by unconstitutional or violent means, including religious, cultural and tribal conflicts, political unrest, violent strikes, urban rebellions, political assassinations, kidnaping, coup d’états and politically motivated violence and terrorism.72
Government effectiveness: the third indicator captures the quality of public services, the quality of civil service and the degree of its independence from political pressure and the quality of policy formulation and implementation.73 This includes many aspects as the quality of: tax gathering, budget assignment and the bureaucracy. Furthermore, it includes the government’s ability to maintain national substructures, respond to economic issues and natural disasters, monitor economic and social revolutions and execute announced programs.74
Regulatory quality: this indicator measures the ability of governments to formulate and implement sound policies and regulations that promote private sector development.75 This indicator includes variables as export/import constraints, fair competition, price and wage control, discriminating tariffs, governmental intervention, business rules, foreign investments, banking, donating citizenship to foreigners and the existence of needed rules of the occupations.76
Rule of Law: the fifth indicator measures the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights and the courts as well as the likelihood of crime and violence.77 It includes the legal systems’ independence versus the government, commitment to contracts by governments, speed and neutrality in judgment processes, regulation settlement, public and private sections,
71 Daniel Kaufmann, Aart Kraay, and Massimo Mastruzzi, "The Worldwide Governance Indicators:
Methodology and Analytical Issues," Hague Journal on the Rule of Law 3, no. 02 (2011): 3.
72 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
Issues," 3.
73 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
Issues," 3.
74 Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and
Developing Countries Based on Institutional Economy," 103.
75 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
Issues," 3.
76 Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and
Developing Countries Based on Institutional Economy," 103.
77 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
ownership rights, black markets, money laundering and organized crime.78
Control of corruption: this last indicator captures the extent to which public power is exercised for private gain, including corruption as well as capture of the state by elites and private interests.79 This includes corruption control in government, privilege donation to relatives and supporters of the government, diversion from investment, generalizing extra payment for certificating exports and imports, public facilities, financial credit requests, tax payments and abusing authority in legal orders and law execution.80
The Country Data Reports provided by Kaufmann et al. and other resources provided by organizations as the World Bank, Freedom House, Economist Intelligence Unit, Global Insight, and sources as the Political Risk Services International country Risk Guide, Bertelsmann Transformation Index and the Transparency International Global Corruption Barometer Survey will be used to research these six indicators.
R
ENTIER THEORY
While the focus of this thesis is on institutions and economic growth, there is one variable that cannot be ignored. The two cases that are researched in this thesis are both oil producing countries in the Middle East. Therefore, a theory on the effect of being oil producers on a state’s institutional quality and economic performance needs to be included within this framework.
In 2000 Dick Cheney, former vice-president of the United States of America stated “the problem is that the good lord didn’t see fit to put oil and gas reserves where there are democratic governments.” 81 With this statement Cheney referred to the fact that many of the oil producing countries in the world have autocratic governments. However, whether this was a coincidence, divine intervention or maybe something else was the question. This issue has been repeatedly researched by academics over the years, not only after Cheney’s statement but also long before Cheney presented his view.
The idea that there existed a connection between the abundance of natural resources and economic performance was firstly formed with regard to gas and/or gold winning in
78Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and Developing
Countries Based on Institutional Economy," 103.
79 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
Issues," 3.
80 Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and
Developing Countries Based on Institutional Economy," 103.
81 Michael L. Ross, The Oil Curse: How Petroleum Wealth Shapes the Development of Nations (Princeton and
countries as the Netherlands and United States. In November 1977, the magazine The Economist introduced the term Dutch disease to describe the effect of natural gas exports on the Dutch economy.82 However, the underlying syndrome characterizing the Dutch disease was already noticed in the nineteenth century following the California gold rush of 1849 and the Australian gold rush of 1851. The gold rushes, just as gas production in the Netherlands, were said not to stimulate the entire economy because of an enclave effect.83 The Irish economist John Elliot Cairns, who researched this phenomena even stated that is would harm other sectors.84 The Dutch disease was defined as “the process that causes a boom in a country’s natural resource sector but causes a decline in its manufacturing and agricultural sectors.”85 The disease was caused by two effects: the resource movement effect (as one
sector booms it draws resources from other sectors) and the spending effect (as money from the booming sector enters the economy it raises the real exchange rate, import grows and domestic sectors suffer).86 This theory focused on the economic effects of having large natural resource reserves. While the term Dutch disease became generally accepted, it lacked to include the political effects of having large amounts of natural resources.
Therefore, economists went looking for a broader concept, which led to the development of new theories on resource abundance. The term resource curse was given to theories that explained the political effects of having large amounts of natural resources.87 These theories explained why mineral rich countries often suffer from authoritarian rule, violent conflict and economic disarray. Despite the fact that these countries have large revenues due to oil production, oil is seen as curse as it is the reason that countries experience these political and economic ailments.88 Academics within this framework have focused on different political effects as corruption, authoritarianism, economic decline, civil war and armed conflict and have linked these phenomena to the presence of large oil reserves.89 Michael Ross is one of the largest contributors to the study of the resource curse. In his book The Oil Curse: How Petroleum Wealth Shapes the Development of Nations he concluded that oil does hurt democracy, that it favors violent conflict and that it perpetuates patriarchy.90
82 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 47. 83 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 47. 84 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 47. 85 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 48. 86 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 47-48. 87 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 1-3. 88 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 1-3.
89 Matthias Basedau and Jann Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth
and Oil Dependence on Violent Conflict," 757.
As the resource curse, rentier theory, also focuses on the effect of natural resources on a country’s regime, however in a different way. While the resource curse hypothesis claims that abundance in natural resources encourages civil war and conflict, as the existence of resources provide a motive and opportunity for conflict, rentier theory suggests that regimes use revenues from abundant resources to stabilize authoritarian regimes. Rents on oil production provide ruling elites with vital resources to offset negative effects on the stability of an authoritarian regime.91
Rentier states are countries that receive substantial amounts of external rent on a regular basis. Rent comes in different forms, as oil royalties.92 An important difference between rentier states and other states that receive rent is that the rent revenues in rentier states are not directly connected to the production processes in those states. There is no visible connection between the level of oil production and the existence of an efficient local economy.93 Hazem El Beblawi, an early rentier theory scholar, gave a definition of rentier states which consisted of the following aspects. Rentier states are mineral exporters of which the minerals tend to generate rents. These rents are largely captured via export taxes, corporate taxes and state-owned enterprises. Furthermore, the mineral extraction employs relatively little labor.94
When there is a rentier economy, the possibility of developing a so-called rentier mentality exists. Because a rentier gets an income without having to work for it, it induces different economic choices. The current wealth of natural resources deceives the rentier into the expectation that rents will ever increase.95 Furthermore, the rentier elite becomes satisfied with the current situation and will devote much time and effort to maintaining the status quo. There is a lack of necessity to make improvements, this will negatively affect the drive to innovate.96 Besides, the high volume of rent money also induces the choice of easy solutions, instead of the best ones.97 The existence of a rentier mentality is often visible in countries’ economic behavior and the presence of rentier mechanisms.
91 Matthias Basedau and Jann Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth
and Oil Dependence on Violent Conflict," Journal of Peace Research 46, no. 6 (2009): 757-761.
92 Hussein Mahdavy, "The Patterns and Problems of Economic Development in Rentier States: The Case of
Iran," Life (1970): 428.
93 Mahdavy, "The Patterns and Problems of Economic Development in Rentier States: The Case of Iran," 429. 94 Hazem Beblawy in Michael L. Ross, "Does Oil Hinder Democracy?" World Politics 53, no. 3 (2001): 331. 95 Charlotte M. Levins, "The Rentier State and the Survival of Arab Absolute Monarchies," Rutgers Journal of
Law & Religion 14, (2013): 393.
96 Charlotte M. Levins, "The Rentier State and the Survival of Arab Absolute Monarchies," 393.
97 Hazem El Beblawi, Economic Growth in Egypt: Impediments and Constraints (1974-2004) (International
According to rentier theory rents could have a stabilizing effect on authoritarian regimes through certain mechanisms.98 By allocating resources in a certain way, authorities can secure their position. Authorities could for example use their resources to buy off public demand.99 By increasing social spending, raising salaries and benefits for (state) personnel, providing a good infrastructure, increasing subsidies on food, water and power consumption, governments buy their popularity and limit possible opposition to the regime.100 Besides the use of resources to buy of demands, the resources can also be used to build a huge state security apparatus. By investing extensive revenues in the military and secret services, governments are able to block any opposition that might take up arms.101 The use of rents as described here, form internal factors that secure the governments’ position. However, these governments often also enjoy external support. Because major oil producing states play a vital role in world energy security, outside powers benefit from stability in these countries. So, when the stability of oil producing states is threatened, other governments might be persuaded to step in and support the regimes financially and/or military out of commercial interests.102 Overall, the use of abundant resources to buy off opposition, suppress armed rebellion, attract external support are all examples of how these regimes use resources in a manner contributing to political stability and preventing armed conflict.103
Over the years the rentier theory has been often applied to study processes in the Middle East. While the theory is not per se limited to this region, it is very suitable to study it.104 The Middle East does not only contains 65 percent of the world’s oil reserves,105 it is at the same time characterized by the presence of authoritarian regimes.106 Rentier theory is designed to connect these two aspects. The study of Middle Eastern countries by using rentier theory became especially popular after the 1970s. Before then countries in the Middle East were just as likely to be ruled by dictators and have civil wars as all other countries. However, this changed after a wave of oil industry nationalizations. Governments in countries like Iran,
98 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
Dependence on Violent Conflict," 761.
99Oliver Schlumberger, "Opening Old Bottles in Search of New Wine: On Nondemocratic Legitimacy in the
Middle East," Middle East Critique 19, no. 3 (2010): 234-246.
100 Christopher M. Davidson, “ The Last of Sheiks,” The New York Times, October 18, 2013.
101 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
Dependence on Violent Conflict," 761.
102 George Joffe, "Libya and Europe," The Journal of North African Studies 6, no. 4 (2001): 89.
103 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
Dependence on Violent Conflict," 758.
104 Mahdavy, "The Patterns and Problems of Economic Development in Rentier States: The Case of Iran," 428. 105 Giacomo Luciani, "Oil and Political Economy in the International Relations of the Middle East,"
International Relations of the Middle East (2005): 81.
Iraq, Libya and Saudi Arabia gained control over their national oil production and subsequently transformed their finances. The size of government revenues grew enormously and governments grew larger, richer and more powerful.107 The large amount of rents these countries had to their disposal made including the role of these rents essential.
O
PERATIONALIZATIONIncluding all factors, internal and external, of the rentier theory would again not fall within the limits of this thesis. Because this thesis focuses on political institutions and economic performance it is most interesting to focus on mechanisms that directly affect these. Therefore, this thesis includes rentier mechanisms that directly affect the governance indicators described earlier or economic growth in the chosen countries. The thesis will focus on the following internal mechanisms.
‘No taxation, no representation’: high oil revenues relieve the public of their duty to pay taxes. The public, in turn, will be less likely to demand accountability. This is a reversal of the idea of ‘no representation no taxation.’108 Citizens may feel less motivated to protest against a government that doesn’t levy taxes.109
The cooptation effect: rents provide authoritarian regimes with large revenues, which can be used by authoritarian regimes to invest in healthcare, educational systems, infrastructure and more. The goal of these investments is to buy of public demands. This way, the public is kept satisfied and will not oppose the regime.110
Repression mechanism: a regime can invest extensive revenues in a sufficient state security apparatus. Subsequently, this apparatus could block any opposition that might take up arms. Money earned by inning rents, is used to repress opposition.111
Creating clientelist networks: elites may distribute rents selectively and create clientelist networks. Through this mechanism resource revenues are distributed among a relative small part of the population and to accommodate potential political rivals. This mechanism includes practices as corruption, patronage and clientelism.112
107 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 1-7. 108 Ross, "Does Oil Hinder Democracy?" 332.
109 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
Dependence on Violent Conflict," 761.
110Oliver Schlumberger, “Opening Old Bottles in Search of New Wine: On Nondemocratic Legitimacy in the
Middle East,” Middle East Critique 19 (2010): 234-246.
111 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
Dependence on Violent Conflict," 761.
112 Basedau and Lay, "Resource Curse Or Rentier Peace? The Ambiguous Effects of Oil Wealth and Oil
These four mechanisms affect institutional quality in different ways. As described in the first part of this chapter, institutions are measured by looking at the six governance indicators. It is essential to describe how these indicators are related to the rentier theory mechanisms, to explain why these mechanisms are of importance to include in this thesis.
The ‘no taxation no representation’ effect has been said to weaken institutions. Kiren Aziz Chaudry, the writer of The Price of Wealth: Economies and Institutions in the Middle East, was one of the first academics to describe this process by linking the absence of taxation to underperforming institutions. As described above oil rich nations were able to dismantle tax and regulatory bureaucracies because of large oil revenues. Capital (from rents) flowed directly into the state treasure. The decline of tax bureaucracy had the unintended effect of damaging the long-term development of all parts of the bureaucracy.113 According to Chaudry
extractive institutions are the base of an administration and without them regulation and redistribution is impossible. All processes necessary for taxation (territorial control, acquirement of information, collection and enforcement procedures) are vital for the functioning of the national market. Therefore he claimed that no taxation led to weaker institutions.114 This process directly affects government effectiveness, as the quality of civil service deteriorates. The government’s ability to maintain national substructures, assign budgets, monitor economic and social revolutions, and overall bureaucratic quality is affected.115 Here a direct connection between the ‘no taxation effect’ and Kaufmann’s indicators is visible.
However, this is not the only effect in play according to Chaudry. No taxation has led to no representation in many countries. As the public does not pay taxes, they are less likely to demand accountability.116 According to Chaudry this process works both ways. The lack of representation resulted in a gap between government and the public, meaning the government lacks essential information provision. The absence of basic data about the economy has negative effects on the quality of local investments. The bureaucracy becomes unaccountable, inefficient, uniformed and all-powerful.117 Autocratic regimes can maintain their position without tax or representation and citizens do not have the ability to participate in selecting
113 Kiren Aziz Chaudhry, The Price of Wealth: Economies and Institutions in the Middle East (Ithaca: Cornell
University Press, 1997), 32-34.
114 Kiren Aziz Chaudhry, The Price of Wealth: Economies and Institutions in the Middle East, 32-34. 115 Aghdam, Yazdkhasti and Mahdavi, "Comparative Study of Political Institutions in Developed and
Developing Countries Based on Institutional Economy," 103.
116 Ross, "Does Oil Hinder Democracy?" 332.
their government and experience limited freedom of expression and association.118 This directly affects voice and accountability, which is severely limited within rentier states.119
Besides the effect of ‘no taxation no representation’ on institutions, the cooptation effect also impacts the governance indicators, especially regulatory quality. Rentier states are characterized by their dependence on oil income. This provides these countries with huge resources, but it also poses a risk. Due to their dependence on oil these states have to deal with a lot of volatility in income, as their economies are closely tied to global trends in oil prices. If real prices drop the effect on the national income is huge. Oil production can become an economic curse: the more countries produce, the larger their economic decline.120 Normally, a country would choose to engage in countercyclical policies to smooth out fluctuations and stabilize their economies.121 However, when rulers implement these policies,
they have to displease citizens today in order to make them better off in the future.122 This is
not in line with the cooptation effect. When the regime’s stability depends on paid public support, it is risky to engage in countercyclical policies. Rulers who are uncertain about their position or strength of their regimes are more likely to choose short term solutions, using their resources to pay of public support instead of engage in sound economic policies.123 This process affects the government’s ability to formulate and implement sound policies and regulations that promote private sector development, as government intervention is not motivated by rational economic decisions. The cooptation effect, therefore indirectly affects regulatory quality in rentier states.
The repression mechanism, the third mechanism, has both a negative and positive effect on two of the governance indicators. The repressive mechanism firstly negatively affects voice and accountability. A repressive state apparatus does not only includes a high level of military spending to repress protests, it also includes the banning of political parties and independent media.124 All military and state institutions are designed in a way that is repressive and that limits the ability of the public to participate in government, protest and speak freely.125 Governments repress opposition in every way possible. When citizens are not
118 Ross, "Does Oil Hinder Democracy?" 332.
119 Kaufmann, Kraay and Mastruzzi, "The Worldwide Governance Indicators: Methodology and Analytical
Issues," 3.
120 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 205-210. 121 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 205-208. 122 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 216-219. 123 Ross The Oil Curse: How Petroleum Wealth Shapes the Development of Nations, 216-219.
124 Camilla Sandbakken, "The Limits to Democracy Posed by Oil Rentier States: The Cases of Algeria, Nigeria
and Libya," Democratisation 13, no. 1 (2006): 145.
125 Sandbakken, "The Limits to Democracy Posed by Oil Rentier States: The Cases of Algeria, Nigeria and
