Heba Handoussa, Mieko Nishimizu, and John Pro ductivity...

World Bank Reprint Series: Number 394 R P 9

Heba Handoussa, Mieko Nishimizu, and John M. Page, Jr.

Pro ductivity Change mnEgyptian Public SedtorIndustries after 'The Op ninwg',1973-1979

Reprinted with permission from the Journal of Development Economics, ol. 20 (1986), pp. 53-73,published by Elsevier Science B.V., (North-Holland), Amsterdarn.

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Journal of Development Economics 20 (1986) 53-73. North-Holland

PRODUCTIVITY CHANGE IN EGYPTIAN PUBLIC SECTORINDUSTRIES AFTER 'THE OPENING', 1973-1979*

Heba HANDOUSSAAmerican University in Cairo, Cairo, Egypt

Mieko NISHIMIZU and John M. PAGE, Jr.The World Bank, Washington, DC 20433, USA

Received January 1984, final version received July 1984

Policy reforms to accelerate growth and improve production efficiency have been undertaken inEgypt since 1973. This paper evaluates the impact of these reforms on Egypt's public sectorfirms in terms of their productivity performance. We find an important asymmetry in theconsequences of the reforms between the rapidly expanding import substitution sector with highproductivity growth and the stagnant traditional export sector. Our results also indicate thatmuch of the observed productivity growth of the import substitution sector may be ascribed toimprovements in capacity utilization, and suggests that Egypt's industrial policies be reassessedsince such a path may not be sustainable.

1. Introduction

Productivity change and the technical efficiency of industry are one of themajor issues confronting the Egyptian economy. Mabro and Radwan (1976)estimated a range of total factor productivity (TFP) growth rates underalternative data and methodologies for Egyptian manufacturing in thefollowing four periods:

1939-45 4.44- 6.70% per year1954-54 1.36- 3.35% per year1954-62 2.66- 2.88% per year1963/4-69/70 -1.90 - -2.20% per year

*This paper describes some results from a World Bank research project: Productivity Changein Infant Industries, and was also prepared as an input into a joint study between the ArabRepublic of Egypt, Ministry of Industry and Mineral Wealth, and the World Bank on 'TradeStrategy and Comparative Advantage in Egyptian Industry'. We thank Kemal Dervis,Mahmoud Hillal, and participants of seminars at the Research Program in Development Studiesat Princeton University and at the University of Sussex for helpful comments on earlier drafts ofthis paper. We thank Deborah Bateman for her excellent research assistance. The views andinterpretations in this paper are those of the authors and should not be attributed to the WorldBank, to its affiliated organizations, or to any individual acting on their behalf.

0304-3878/86/$3.50 © 1986, Elsevier Science Publishers B.V. (North-Holland)

54 H. Handoussa et al., Productivity change in Egyptian public sector industries

These estimates show a substantial productivity slowdown in Egyptian

manufacturing since the interwar period. The three postwar periods distin-

guished by Mabro and Radwan correspond to three policy regimes that

significantly altered the production environment of Egyptian industry.The period 1945-54 can best be characterized as an import substitution

regime. The government pursued an 'Egyptianization policy' directed at

creating a market economy with predominantly private Egyptian ownership

(although the Egyptianization policy was reversed after the 1952 Revolution

in a brief effort to encourage foreign investment). In 1952, the public sector's

share in GDP was about 13 percent, and in gross fixed capital formation

(mostly in infrastructure) about 28 percent. The period 1954-62 was a transi-

tion period from a market to a centrally planned economy. Government

intervention in productive activities steadily increased, and nationalization

of foreign interests and major Egyptian financial concerns took place. By

1960, the public sector's share in gross fixed capital formation had risen to

about 74 percent. In both of these periods, TFP changes remained positive

and were comparable to the average productivity performance of other

countries.The transition was completed by the 1961 'Socialist Revolution', when a

wholesale nationalization of industrial and financial enterprises took place.

The period 1962-70 corresponds roughly to the central planning regime

under 'Arab socialism'. Industrial activities in the private sector were heavily

curtailed, and annual investment allocation plans and price controls became

major instruments for the state control of the Egyptian economy. Mabro and

Radwan's estimates show negative TFP change during this period, repre-

senting a sharp break from the preceding twenty years.Shortly after the October 1973 war, initiatives were taken to redirect

economic policies in Egypt. Partly in response to indications of declining

industrial performance, the policy reforms collectively known as 'El-Infitah',

-r 'The Opening', were undertaken beginning in 1973. The basic economic

objective of The Opening was to accelerate economic growth and improve

production efficiency. Broadly interpreted, The Opening is founded on three

sets of policy reforms. First, a series of new trade and exchange control

regulations were brought about to gradually liberalize trade and access to

foreign exchange. Second, a policy of gradual decentralization in the control

of public sector firms was introduced to give greater autonomy to public

sector managers. Third, a set of new investment laws were formulated to

encourage foreign and domestic (both public and private) producers to

introduce new products and technologies through joint-ventures, and to

stimulate export activities.' These policies, taken together, were intended

'The Opening has been conventionally associated only with this third policy reform. We take

in this paper a broader interpretation of reformns under The Opening.

H. Handoussa et al., Productivity change in Egyptian public sector industries 55

gradually to shift the economy from a centrally planned system to a mixedmarket economy.

Those reforms were not the only aspect of the post-1973 transformation ofthe Egyptian economy. The years 1973-79 were also a period of rapidgrowth. Real GDP grew at about 8 to 9 percent per year, due mostly tosubstantial increases in the external resources available to the economythrough oil revenues, Suez Canal earnings, Egyptian workers remittances,tourism, direct foreign investment, and foreign aid. In particular, imple-mentation of policy reforms on trade and exchange control liberalizationwas made easier by the increasing availability of external resources. Theliberalized trade regime removed supply-side constraints on imported inputsthat plagued many firms under the preceding regime.

The years 1973-79 can therefore be characterized as the period duringwhich both supply-side and demand-side constraints were significantly re-laxed for public sector firms. The objective of this paper is to assess theimpact of this confluence of policy reforms and rapid growth on theproductivity performance of Egypt's public sector firms. In particular, weshall investigate an important asymmetry in the way aspects of The Openingaffected two different groups of Egypt's public sector firms: firms engaged inimport substitution activities, and firms who have exported traditionally.

This paper applies a methodology recently developed by Nishimizu andPage (1982), which permits the decomposition on TFP change into 'bestpractice' TFP change and technical efficiency change. The methodology issummarized in section 2, where we also discuss specification and estima-tion of the frontier production function on which the productivity estimatesare based.2 Section 3 discusses the empirical results, and conclusions arepresented in section 4.

2. The framework of analysis

As conventionally defined the production function describes a productionprocess that is technically efficient, in that it is impossible to do any better atthe given level of technological knowledge. Technological change pushes theproduction function outward, and improves the productivity of factor inputs.If, on the other hand, one is technically inefficient and producing within thetechnically feasible limits, changes in technical efficiency also alter theproductivity of factor inputs. Technological change always implies produc-tivity change. Productivity change, however, does not necessarily imply tech-nological change.

The empirical estimate of the production function which corresponds mostclosely with this definition is the frontier or best practice production

2 For further details, see Nishirnizu and Page (1982).


function, which defines over any set of observations the maximum output

obtained from a vector of measured inputs. It, thus, provides an efficiency

standard which is based on the best practice actually observed in a given

economic environment. This empirical concept of the production frontier

may differ in application from the production function in theory. The

estimated frontier will lie below the 'true' production function, if, for

example, the observed best practice firms defining it are not entirely free of

some form of technical inefficiency. For this reason, we refer to the rate of

shifts of the frontier as best practice TFP change rather than technological

change.We can represent the production relationship as

x(s, t) =g[z(s, t); s, t](1)

<g[z(s, t); s, t] = x(s, t),

where x(s,t) and z(s,t) are, respectively, the index of aggregate output and

the vector of inputs of firm s at time t. ., t, and x denote the potential or best

practice productivity and output levels. For any observed combination of

output and inputs of a firm, the inequality in (1) holds when the observed

firm is not employing its inputs with the productivity level of best practice at

the observed input mix. We assume that the usual conditions for regularity

of production are satisfied by g.We define the actual level of TFP relative to the best practice level for any

firm as an output level comparison between observed output and potential

output at the observed input mix,

e(s, t) = x(s, t)/x(s, t). (2)

Thus, e(s, t) is an index of TFP level arising from technical inefficiency in

production.3

From (1) and (2), the rate of change of actual TFP observed for the firm

can be expressed as

g(z, s, t) = x(s, t) -g(s, t)z(s, t)(3)

=g(z, 3, t) + e(s, t) + [g,(9, t) -g,(s, t)]z(s, t),

where g,(s, t) is the vector of output elasticities of each component of z, and

the dot over variables denotes logarithmic time derivatives.3 For a fuller derivation of this index, see Nishimizu and Page (1982). The definition is due to

Malmqvist (1953). See Caves, Christensen and Diewert (1980,1981) for discussion of Malmqvist

index in productivity comparisons. It is also analogous to Farrell's (1957) definition of technical

inefficiency for the case of a linear homogeneous production function. [See Kopp (1981).]


Eq. (3) represents a decomposition of actual TFP change into threecomponents: best practice TFP change, technical efficiency change, andoutput elasticity differences between the frontier and the interior. The rate ofshift of the frontier, g(z, s, t), represents the rate of best practice TFP change.Its movement over time, however, must not be confused with changes inefficiency relative to best practice. These effects are captured by e(s, t), whichrepresents the rate at which any observed firm is moving toward (e>O) oraway (e <0) from the best practice frontier. We refer to e as the rate oftechnical efficiency change. Finally, at any given level of inputs, an interiorfirm's effort to reach its potential output may entail changes in outputelasticities. The last component of observed TFP change represents this.

Thus, our analytical framework permits us to conceptualize and quantifychanges in actual TFP, best practice TFP, and technical efficiency, and sortout the analytical relationship among them. Empirical implementation of theframework requires us to characterize and estimate the production frontier,based on a set of panel production data.

We estimate the production frontier separately for fifteen industries in theEgyptian public sector over the time period 1973-79. The panel data consistsof firm level observations for 96 firms which cover most of the population ofpublic sector firms. Output is gross output and factor inputs are capital,labor and materials. The gross output and material input series are inconstant 1972 producer prices. The capital input is net capital stocks atreplacement cost in constant 1972 prices, and the labor input is number ofworkers employed. A description of the data and their sources are given inthe appendix.

In selecting a frontier production model the principal issues which ariseare the specification of the frontier's functional form, that is its ability toapproximate the underlying true functional relationship between inputs andoutput, the nature of the error term, which determines the characteristics ofthe measures of technical efficiency generated by the estimates, and thetechnique of estimation of the production function parameters.

Flexible functional forms such as the translog production function imposerelatively few a priori restrictions on the structure of production. We specifythe translog production function corresponding to (1) as

In x(s, t) = ao(s, t) + E ocjs, t) In zm(S, t) + 2 E EBmn In zm(S, t) In zy(s, t), (4)m m n

where

x0 (s, t) = a0(s) + 0(,(s)t +1 2,B(s)t2,

am(s, t) = am.(s) + lm,(s)t.

There are three approaches in estimating the frontier production function:


deterministic, probablistic, and stochastic. We choose in this paper to takethe deterministic approach, which permits us to utilize the entire sample of

observations, and specify a one-sided error structure to restrict all observedpoints in output space to lie on or below the frontier. We therefore use alinear programming estimation procedure, and minimize the sum of devia-tions from the frontier subject to the on-or-below the frontier constraint. 4

We minimize the objective function which is linear in the unknown

parameters,

T S

min E E [o + at + ± ,S,t2] + m + Imtt) In Zm(S, t)E sl ( m t)

+ 2 flE , In Zm(S, t) In zJ(s, t) - In x(s, t) (5)m n

subject to the constraints of the model,

[cta + a,~t + 2f,2 ] + E (am + 3m,t) In Zm(S, t)m

+'Y 2 E .mn zm(s, t) In z,(s, t) > In x(s, t), s =1, ... , S, t =1, . .. ,T7m n (6)

We also impose on the frontier the following set of restrictions for constant

returns to scale:

XGOm= , Ypm.=O and Zfim t =O. (7)m m m

Finally, we impose concavity and monotonicity restrictions, since the trans-

log form is neither monotonic nor concave for any arbitrary set of argu-

ments. For concavity, we restrict #3mm to be non-positive. For monotonicity,

4 The deterministic technique is the closest representation of the theoretical concept of the

frontier as an outer boundary of the production set. It, however, is more sensitive to errors inobservations compared with the other two techniques which attempt to reduce the sensitivity to'truly' random errors distinguished from efficiency distribution. If one has sufficient informationto specify the random distribution and efficiency distribution explicitly in the error structure,then procedures have been suggested for the maximum likelihood estimation of the frontier. Theliterature has yet to provide guidance on the appropriate specification of the error structure,however, and the statistical properties of the maximum likelihood frontier estimators are notalways straightforward. The deterministic technique, on the other hand, does have the drawbackof presuming that all errors are due to the efficiency distribution. For a recent comprehensivesurvey of the literature and other important contributions on the formulation and estimation of

frontier functions, see Aigner and Schmidt (1980).


we restrict am and a, to be non-negative, and

am + f3mtt + Efl,mn In z,(S, t) _ 0,

(8)(Xt + |ttt + Y. Bmt In zm(s, t) 0.

m

We estimate the frontier using the geometric mean of the sample as the pointof expansion for the translog approximation. The estimated translog frontierparameters for each industry are presented in table A.1 of the appendix.

3. The empirical results

Estimates of average annual rates of actual TFP change, best practice TFPchange, and technical efficiency change are presented for the 'average' firm(with mean level of output and inputs) in each industry in table L.' There arethree important aspects to the results.. First, many industries show highaverage rates of best practice TFP change. Ten industries have best practiceTFP growth of more than 2 percent per year, and only one industry (Cottonproducts) has a stationary frontier. Second, the average gap between actualand best practice TFP performance is widening over time in most of theindustries. All but three industries show negative rates of technical efficiencychange. Third, despite this widening gap, actual TFP growth is stillrespectable for many of the industries. Negative technical efficiency changesare smaller in their absolute magnitudes than corresponding best practiceTFP changes in all but five industries. Average firms in these industries areexperiencing productivity improvements, although at slower rates than theirpotential as defined by best practice.6 Table 1 shows seven of the fifteenindustries with actual TFP growth of more than 2 percent per year.

5Thus, our estimates of actual TFP change are not adjusted for the effect due to differencebetween observed interior output elasticities and estimated frontier elasticities. We evaluate bestpractice TFP change by combining input levels with the estimated frontier parameters in eachyear, and taking simple averages of consecutive time periods. Technical efficiency levels ofaverage firms as defined in (2) can be obtained as the antilog of the slack variables in our linearprogramming constraints (6). The rates of technical efficiency change can be obtained by takingthe log differences of this ratio in successive time periods. Actual TFP change can be computedas the sum of the best practice TFP change and technical efficiency change.6A portion of the discussion of the results which follow focuses on differences between bestpractice and interior firms. As noted in footnote 4, the deterministic estimation techniqueascribes all deviations from best practice to technical inefficiency. There is therefore a dangerwith this technique that purely random components may give rise to spurious identification ofbest practice firms and bias the interpretation of the results. In the Egyptian case this risk ispresent but not large. The fifteen individual sectors on which the aggregate results are basedshow very similar patterns of productivity differentials between best practice and interior firms.Moreover, extensive investigations at the firm level, using direct interviews, confirmed that in thegreat majority of cases underlying technical and behavioral evidence could be found to supportthe stratification of the sample into best practice and average practice firms using the estimatedproduction frontiers. These two arguments, taken together, lend substantial weight to the use ofthe deterministic production function to establish best practice in the Egyptian context andsupport the utility of our analysis of the sources of productivity differentials between best andaverage practice firms.

Table 1

Actual TFP change, best practice TFP change, and technical efficiency change (in percent per year).'

Egypt (1973-79) Actual TFP change

Best-practice TechnicalTFP efficiency Actual TFP Japan USA US and Japanese

Egyptian industries change change change (1955-73) (1947-73) industries

FoodEdible oils 9.45 -1.84 7.61 221 0.01 FoodBeverages and tobacco 2.21 3.74 5.95 0.28 TobaccoOther food 2.50 0.97 3.48

TextilesCotton products 0.00 -2.00 -2.00 1.70 1.54 Textiles mill products

Other textiles 2.96 -1.56 1.40 1.94 0.67 Apparel

ChemicalsPaper 7.71 -5.36 2.34 1.62 0.01 PaperBasic chemicals 0.91 -3.74 -2.83 2.50 2.33 ChemicalsFertilizer 1.66 11.51 13.17Rubber and plastic 1.92 -3.49 -1.57 -1.22 0.99 Rubber and plastic a

Light consumer goods 4.43 -5.75 -1.32

Metal products and engineeringIron and steel 3.16 -2.51 0.65 0.96 -0.49 Iron and steel

Transportation equipment 8.18 -3.66 4.52 2.53 0.74 Transportation equipment

Fabricated metals and 0.84 0.19 Fabricated metals

machinery 5.68 -5.22 0.46 3.14 0.55 MachineryElectrical machinery 9.03 -5.22 3.81 4.42 1.48 Electrical machinery

China and glass 0.31 -0.46 -0.15 1.73 0.23 Stone, clay and glass

'Source: The estimates for Japan are from Nishimizu and Robinson (1983). The estimates for USA are from Gollop and Jorgenson (1980).

I I


TFP growth in mature industrialized economies over a sufficiently longperiod of time is conventionally believed to approximate rates of techno-logical change. The stylized facts accumulated in the productivity literatureshow that one can expect these long-run rates to cluster closely around 1 to2 percent per year, and this is observed in the productivity growth estimatesfor roughly comparable industries in Japan and the USA given in table 1.TFP growth for developing countries, on the other hand, is often influencedsignificantly by factors other than technological change especially whenimportant changes occur in demand conditions, production constraints, andtrade and industrial policies.7 TFP estimates for developing countries tend tobe distributed more widely around 1 to 2 percent as we observe in Egypt. Itis reasonable to consider, therefore, particularly in light of the high rates ofestimated best practice TFP change, that not only actual but also bestpractice TFP change in Egypt reflect short-run adjustment by firms to thenew production environment. 8 Best practice firms may be those which weremost successful in adjusting rapidly.

The period 1973-79 in Egypt cannot in general be characterized as an eraduring which new industrial activities, new plants, or new firms came onstream to add to the productive capacity of the public sector. Rather, mostof the industrial production capacity was in place before 1973. This industrialcapacity, however, was reportedly severely underutilized before 1973. The lowrate of capacity utilization was in part due to stagnant domestic demand, butwas mostly caused by acute shortages of imported material inputs. Firmsengaged in import substituting activities were particularly hard hit, sincetheir import requirements were high and demand was slow growing. Importrequirements of traditional export activities in Egypt were low, and they hadthe secure bilateral trade markets with the USSR and other Eastern Bloccountries. 9

By 1973 centralized control of industry and the combination of supply-sideconstraints on imported inputs with slow growth in aggregate demand hadresulted in low productivity levels in most branches of industry and in littledispersion among individual firms in relative levels of TFP. It is notsurprising, therefore, that the single most important policy change thataffected public sector firms was the liberalization of trade and foreignexchange control. The liberalization, however, was asymmetric in that it

'See Nishimizu and Robinson (1983), for example.8 This is precisely the reason why we chose not to refer to the shift of the frontier production

function as technological change, since part of the estimated shift may not represent reduction inlong-run average cost.

9 The most important traditional export activity is Cotton products. In addition, there arefirms from each of the following industries: Other textiles, Food products, and Light consumergoods. All other activities can be considered import substituting activities. Estimates of effectiverates of protection at the sectoral level are contained in Handoussa (1980) and Hansen andNashashibi (1975).

I.D.E. C

62 H. Handoussa et al.. Productivity change in Egyptian public sector industries

permitted easier access to imported inputs but continued to protect domesticmarkets for the output of public sector firms from import competition. Themajor constraint on capacity utilization of import substituting firms was thusremoved, aided greatly by rapidly increasing domestic demand. Short-runadjustment to changing supply- and demand-side constraints created anenvironment in which import substituting firms could and did react withvarying speed to the new economic opportunities. These varying rates ofadjustment resulted in a widening gap between best practice and averageTFP levels within import substituting industries and in some increase in thevariance of TFP levels across firms. Since the comparative advantage ofEgypt's traditional export firms was natural resource based, liberalization onthe input side had minimal impact on them. The impact of the new traderegime, however, did not remain neutral for many of the traditional exportfirms, since with The Opening bilateral trade markets closed and firms wereforced to look for new markets in convertible currency areas.

The policy reforms of The Opening and the rapid increase in aggregatedemand following 1973 thus benefitted import substituting firms but not thetraditional export firms. Trend output and TFP (actual) growth rates forimport substituting firms and for traditional export firms are presented intable 2. The differences in output growth between the two groups arestriking. The overall trend growth rate in output for the entire sample ofpublic sector firms is 8.9 percent. For import substituting firms the trendoutput growth rate is 11 percent, while for traditional export firms the trend

Table 2

Trend growth rates of output and total factor productivity, Egypt's industrial sector,1973-79.'

Output growth TFP growth

Best BestAll Interior practice All Interior practicefirms firms firms firms firms firms

Import substitutingfirms I1.00b 11.96 10.08 2.40' 2.64 2.16

Traditional exportfirms 0.00b 0.00 0.00 - 1.91 -3. 4 6 d 0 .0 0 d

All firms 8.94 9.06 9.19 1.17 0.00 2.02

'All non-zero trend growth rates are significant at the 0.01 level. TFP growth rates arethe actual TFP rates.

bImport substituting and traditional export firms differ at the 0.10 level in the timetrend regression with a dummy variable for the latter.

'lmport substituting and traditional export firms differ at the 0.01 level in the timetrend regression with a dummy variable for the latter.

dinterior and best practice firms differ at the 0.01 level in the time trend regression witha dummy variable for the latter.


growth rate is not significantly different from zero. The difference in growthrates between import substituting firms and traditional export firms issignificant (at the 0.10 level). In each group, the output growth rates for firmsdefining best practice do not differ significantly from those of interior firms.Thus, the rapid increase in industrial output was almost wholly confined toimport substituting firms. Among traditional export firms increases indomestic demand were offset by reductions in deliveries to foreign buyers,and there was no overall trend in output growth.

Trend TFP growth rates presented in table 2 further reinforce theperception of dramatic differences between the two groups. The trend growthrate of TFP for the public sector as a whole is about 1.2 percent. In importsubstituting firms the trend growth rate is 2.4 percent, while for traditionalexport firms it is - 1.9 percent. The growth rates differ significantly betweenthe two groups (at the 0.01 level). Among import substituting firms there isno statistically significant difference between the trend rates of TFP growthof best practice and of interior firms. Among traditional export firms,however, the trend rate of TFP growth of interior firms is about -3.5percent and significantly lower than that of best practice firms (at the 0.01level).

Taken together, these results suggest that there may exist a strongassociation between output growth and productivity performance in theEgyptian public sector. Fast growing, import substituting firms experiencedrates of productivity change which greatly exceeded those exhibited bytraditional exporters.

The important question to ask is what underlies the observed asymmetryin the productivity performance between the import substituting firms andtraditional export firms. The discussion so far suggests capacity utilization asthe key differentiating factor. Rapid improvement in capacity utilization fromlow pre-1973 levels towards optimum levels may underlie the high rates ofmeasured TFP change in import substituting firms (both best practice andinterior firms). Traditional export firms on the other hand, probably failed toachieve significant changes in capacity utilization. Output growth was low ornegative, and most firms encountered difficulty in shifting export markets asthe opportunities for trade with non-convertible currency areas diminished.'0

The capacity utilization adjustment problems arise because there are quasi-fixed inputs in the short run which can only be changed at increasingmarginal cost of adjustment. Such quasi-fixedness is usually associated with

'°Ikram (1980, p. 240) reaches a similar conclusion. Unfortunately, reliable and independentestimates of capacity utilization rates do not exist for the period. Nevertheless, we are reasonablyconfident of our interpretation which is largely based on plant visits and interviews with manyof the sample firms.


capital stocks." Strictly speaking, our analytical framework presumes long-

run production equilibrium at the frontier. If this is true, the estimated shift

of the frontier is equivalent to the shift in long-run average cost. If not, part

of the estimated shift is the movement along short-run average cost schedule

as the capacity utilization changes over time.'2

If firms are operating at optimum capacity utilization, variations in output

growth should mostly be accounted for by variations in input growth; and

there should be little systematic correlation between measured (actual) TFP

growth and input growth or output growth. If, on the other hand, firms are

increasing capacity utilization towards optimal rates, variations in output

growth among firms and variations in their input growth should have

weaker correlation. Although there should be no systematic correlation

between TFP growth and input growth, there should be a substantial

correlation between TFP growth and output growth.

This argument can be explained in terms of the following three

relationships:

(A) output growth = a1 + b, input growth,"3

(B) TFP growth = a2 + b2 input growth,

(C) TFP growth = a3 + b3 output growth.

There should be high correlation in (A), and since output growth is always

the sum of TFP growth and input growth, a1 should equal the average rate

of TFP growth and b, should equal unity. There should be low correlation

in (B) or (C), and b2 and b3 should be zero.' 4

Since our measure of TFP change for each firm is derived by applying

output elasticities of each factor input evaluated at the estimated frontier

production function, b1 in (A) should be unity for the best practice firms who

define the frontier regardless of the capacity utilization factor in their TFP

change. For interior firms, however, this need not be the case. If a quasi-fixed

factor is more underutilized in interior firms relative to best practice firms, its

"In the case of Egypt's public sector firms, however, it is probably appropriate to consider

labor as quasi-fixed as well. This is the consequence of employment policies which not only

make it difficult, if not impossible, to lay off workers, but also require compulsory addition of

workers to public sector firms in labor categories whose tasks cannot be easily changed. See

Berndt and Fuss (1981).'2 See Berndt and Fuss (1981)."3 By input growth, we mean total factor input growth which is the weighted average (by

output elasticities) of capital, labor, and material input growth rates.1 4 Given that output growth is the sum of TFP growth and input growth, a2 = a, and b2 = b, -1.

A similar approach was adopted by Bruton (1967) in analyzing capacity utilization and TFP

change in Latin American countries.


marginal product should be less than that implied at the frontier. Bydefinition, quasi-fixed factor must be growing relatively slowly comparedwith other inputs. It is likely, that we may have overvalued the contributionof inputs which are growing relatively slowly, and consequently undervaluedthe contribution of those inputs which are growing relatively more rapidlyfor interior firms. Thus, in relationship (A), b1 should be significantly greaterthan unity for the interior firms, and a, should be significantly less than theaverage rate of measured TFP change."5 If capacity utilization is animportant component of measured TFP change, we should expect b3 to besignificantly positive for both best practice and interior firms. The greater theforce of capacity utilization in measured TFP change, the greater should bethe value of b,. Since a3 can be interpreted as the average rate of TFPchange net of the capacity utilization component, the greater the force ofcapacity utilization, the lower should be the value of a3.

We have estimated these simple relationships (A), (B) and (C) usingordinary least squares, on the average annual growth rates of output, input,and actual TFP for 96 firms, separated into two groups: (1) 67 firms engagedin import substituting activities, and (2) 29 firms engaged in traditionalexport activities. In each relationship for each group, we enter intercept andslope dummy variables for best practice firms.' 6 The regression results arepresented in table 3.

The most striking aspect of the regression results is the contrast betweenthe import substituting firms and traditional export firms in the relationship(C). For the import substituting firms, 75 percent of the variance in TFPgrowth can be attributed to output growth. For the traditional export firms,the multiple correlation coefficient is much lower at 24 percent. Theestimated 'elasticities' of TFP growth with respect to output growth (b3) aresignificantly positive (at the 0.01 level) for both best practice and interiorfirms in the import substituting group. For the exporting group, however,they are not significantly different from zero (at the 0.05 level). The elasticityis significantly higher for import substituting interior firms compared to bestpractice firms: TFP growth improves by 0.64 percent for a one percentincrease in output growth for the interior firms, and by 0.42 percent for thebest practice firms. The estimated intercepts show that TFP growth forimport substituting firms is significantly negative when output growth is zero:as much as - 3.6 percent for the interior firms, and - 1.4 percent for the bestpractice firms.

"5 See Berndt and Fuss (1981). They argue that the correct adjustment for capacity utilizationis in terms of marginal products of quasi-fixed inputs, and not in terms of the quantity of theseinputs which has been the traditional method.

'6Applying covariance analyses to our panel data indicates that there are statisticallysignificant differences in the estimated regressions between the import substituting firms andtraditional export firms. We therefore report separate regressions for each group. Although thebest practice firms are not always different from the interior firms (particularly in exportinggroup), we report the regressions with dummy variables for symmetry.

ol

Table 3TFP change and capacity utilization in Egypt's public sector firms (1973-79).' -

Import substituting firms (67 firms) R2 Traditional export firms (29 firms) R22

(A) output growth= -0.018+0.034F+(1.700-0.542F) inpul growh 0.63 output growth -0.003+0.015F+ (0.667+0.359F) input growth 08(0.020) (0.026) (0.210) (0.277) (0.012) (0.021) (0.150) (0.319)

(B) TFP growth= 0.018 +0.034F+(0.700-0542 F) input growth 0.16 TFP growth= -0.003+0.015F+(-0.332+0.359F) input growth 0.25 >(0.020) (0.026) (0.210) (0.277) (0.012)(0.021) (0.150) (0.319) '

TFP growth= -0.029+0.034F+ (0.309-0 148F) output growth (.'4 z(C) TFP growth --0.036+0.022F+(0.644-0.221F) output growth 0.75 (0.010) (0.022) (0.154) (( 299) >

(0009) (0.013) (0.052) (0.087)

'Standard error is presented in parentheses under each estimated coefficient. F is the dummy variable equal to unity for best practice firms and zerootherwise.

'5'5.

I~~~~~~~~~~ I


These results are consistent with our interpretation that improvements incapacity utilization may underlie measured TFP growth in import substi-tuting firms while this was not the case for exporting firms. Furthermore, thecapacity utilization factor in measured TFP growth seems to be significantlymore important for interior firms as opposed to best practice firms amongthe import substituting firms. This is also consistent with our interpretationthat the best practice firms are those who were most successful in adjustingrapidly to the new production environment after The Opening.

The estimated coefficients of relationship (A) for the import substitutingfirms are also consistent with this interpretation. The coefficient for inputgrowth (b,) is significantly greater than unity (at the 0.01 level) for interiorfirms, indicating that we have underestimated the input contribution tooutput growth for these firms by applying the frontier output elasticities.' 7 Itimplies, in turn, that measured TFP change adjusted for capacity utilizationshould be lower. The estimated intercept for both interior and best practicefirms is not significantly different from zero, implying that, on average, all ofthe measured TFP change could be attributed to improvements in capacityutilization.

The estimated coefficients for relationship (A) invite a different interpret-ation for traditional export firms. The coefficient for input growth (b,) issignificantly less than unity for interior firms, indicating that we haveoverestimated the input contribution by using frontier elasticities, andtherefore underestimated TFP change. (The estimated intercept is notdifferent from zero for both interior firms and best practice firms.) This resultis probably due to a phenomenon unique to the cotton textile industry,which forms the bulk of our sample of traditional export firms. After TheOpening, many firms in the industry were forced to shift away from bilateralexport markets in the Eastern Bloc to convertible currency markets and tothe domestic market. The loss of the bilateral markets meant a shift from thehigher negotiated prices in the Eastern Bloc to lower prices in the convertiblecurrency areas. In the domestic market, many firms were subject to increasesin the proportion of products assigned by the government to be sold at lowcontrolled prices. In both cases, unit values for output declined without anaccompanying decline in the quality of the product. The best practice firmsare those who were least subjected to these changes and/or those whoadjusted product mix and cost structure quickly to new prices. The interiorfirms are those who were substantially affected by the changes and haddifficulty in adjusting particularly in the face of the dual price and quantitycontrols imposed by the government. The constraint in the adjustmentprocess was the difficulty in 'scaling down' quasi-fixed inputs. By using the

"7 The estimated b, for the best practice firms is not different from unity as expected. This isalso the case for the traditional export firms.


frontier elasticities, therefore, we have assigned lower weights to quasi-fixed

inputs and consequently higher weights to other more rapidly growing

inputs. The overall bias on estimated input growth is upward, which is

consistent with the result that the coefficient b1 is significantly less than

unity. As we have stated earlier, this implies in turn that our measured TFP

change for interior traditional export firms is probably biased downward.These results are necessary but not sufficient confirmation of the hypo-

thesis that capacity utilization determined productivity change in Egypt,

since we can always question the causality relationship of the estimated

regression equations. In particular, one can always interpret the relationship

(C) to mean that rapid TFP growth is correlated with high growth in output

since the former reduces unit cost of production. Falling unit costs may

engender rapid price reductions leading to greater demand.

4. Conclusions

The main objective of this paper was to assess the impact of The Opening

on the performance of Egypt's public sector industry in the period of rapid

growth following 1973. In particular, we noted and investigated an important

asymmetry in the way policy reforms of The Opening favored firms engaged

in import substituting activities, perhaps at the expense of firms engaged in

traditional export activities.Given this objective, we have focused on one measure of industrial

performance, total factor productivity. Our results indicated that Egypt'spublic sector industries experienced impressive rates of TFP growth by

international standards. Our decomposition of TFP change into best practice

TFP change and change in technical efficiency revealed that in most

industries the rates of best practice TFP growth were very high relative to

what is usually expected as the long term rates of technological change.

These high rates of best practice TFP growth were offset somewhat by

deteriorating technical efficiency. In most industries in Egypt the average

firm was experiencing a widening gap between its level of TFP and the level

of best practice. This pattern of TFP change is consistent with the view that

public sector firms adjusted to the liberalization of the trade regime, increasesin effective demand, and increased autonomy at different rates. Best practicefirms were those which were most able to adapt quickly to the changing

production environment while other firms adjusted more slowly.We view the rapid overall rates of productivity change as indicative of the

sucess of the liberalization efforts undertaken following 1973. The deterior-

ation of the average level of technical efficiency and the increased dispersionof relative levels of efficiency which occurred in most industries is probablyan inevitable consequence of the movement from highly centralized direction

of public sector firms to a more decentralized environment for production.

I I


It is important to remember, however, that we are viewing a relativelyshort run process of adjustment. Here, we noted the asymmetry in theliberalization efforts of The Opening, and the great difference in theproduction and productivity performance between import substituting firmsand traditional export firms. High rates of measured TFP change in Egypt'spublic sector basically occurred in the import substituting firms whoseoutput expansion was very rapid, while traditional export firms showed noimprovement or deterioration in TFP and stagnant output growth. Theanalysis of this difference led us to propose that much of the measured TFPchange in Egypt's public sector may be due to improvements in capacityutilization among import substituting firms. Although far from being con-clusive, our simple empirical analysis supports such a view.

If we are correct in our assessment that the improvement in capacityutilization was the prime mover of TFP change, it may have implications forindustrial policy in Egypt since such a path is not sustainable. In the longerrun, efforts to adopt or generate technical innovations will be necessary ifindustries in Egypt's public sector are to continue to improve their produc-tive efficiency, and if Egypt is to regain the sustained rate of productivitychange characteristic of the period 1945-62.

Appendix

Data and assumptions

Data on gross output, material inputs, capital stock and investment, andemployment by enterprise are provided by the annual standardized accountsof Egyptian public sector enterprises reporting to the Ministry of Industryand Mineral Wealth.

Producer price indices for output were constructed on a firm specific basisby rebasing the value of output at previous years' prices reported by eachfirm to constant 1972 prices. Material input prices were constructed bycombining commodity specific price indices for major inputs (with costshares greater than 5 percent), the wholesale price index for all otherdomestic inputs, and an import price index for all other imported inputs.Commodity specific international prices for major imported inputs wereobtained from the World Bank's Commodity Trade and Price Trends and TheBank of Japan Price Indexes Annual, and adjusted for transportation marginsand exchange rate changes. Commodity specific domestic prices for majorinputs produced in Egypt were provided by the Ministry of Industry. Thewholesale price index is published by Central Authority for Public Mobiliz-ation and Statistics, and the import price index was constructed by combin-ing the OECD export price index with an exchange rate adjustment factor.


Capital stocks in constant prices were constructed by deflating the annualvalue of net investment provided in the standardized accounts by a capitalinvestment deflator reflecting price changes in construction costs, machineryand equipment, and other assets and adding these constant price investmentvalues to a base year (1972) capital stock estimates. Weights for the capitalinvestment deflator were derived from data on the composition of gross fixedinvestment provided in World Bank (1980). The standardized accountsprovide base year capital stock at historic cost in 1972 prices. We generatereplacement cost base year capital stock estimates by adjusting the historiccosts stocks with a perpetual inventory estimate of the relationship betweenhistoric cost and replacement cost valuations, given a rate of depreciation of0.085, inflation in capital goods prices of 8 percent, and an estimated annualrate of growth of the capital stock of 5 percent per annum between 1963 and1973.

Table A.lFrontier translog production function parameters, Egypt 1973-79.'

Food Textiles

Edible Beverages Other Cotton Otheroils and tobacco food products textiles

a0 9.58418 10.72291 9.35827 9.80521 9.73027a, 0.09465 0.02220 0.02518 - 0.02954/3, 0.01209 -0.00051 - 0.00281 - - 0.00933aK 0.22930 - 0.26700 0.32342 0.13573arL 0.12716 0.02916 0.29492 0.35695 -

aM 0.64355 0.97084 0.43808 0.31963 0.86427IJKK - -0.13360 -0.23713 -0.18838fALL -0.44330 - -0.32126 -0.08080 -I;MM -0.11253 - - -0.45248 -0.18838/3RL 0.16539 0.22743 -0.06728 -/KM -0.16539 - -0.09383 0.30441 0.18838/LM 0.27791 - 0.09383 0.14807 -PK, 0.07720 - -0.00437 - 0.00330/3LI -0.02215 0.00972 -0.04476 -PMl -0.05506 -0.00972 0.04913 - -0.00330


Table A.1 (continued)

Metal products and engineering

FabricatedIron and Transportation metals and Electrical China andsteel equipment machinery machinery glass

CXO 9.42521 9.17384 8.31111 8.77156 8.11484C!, 0.03206 0.08246 0.05591 0.09115 0.00317fit, 0.00363 0.00287 -0.00963 0.01918 -0.00017a,K 0.17065 0.09290 0.25567 0.04185 0.26415at, 0.23175 0.29103 0.23923 0.22330 -am 0.59759 0.61607 0.50509 0.73485 0.73585&KK -0.02528 -0.07615 -0.03165 - -fiLL -0.19470 -0.30936 - -fiMM - -0.25229 -0.03165 -PKL 0.10999 0.06661 - -#KM -0.08471 0.00954 0.03165 -fiLM 0.08471 0.24275 - - -PK, 0.02575 -0.00070 0.00751 -0.01395 0.00479fLI -0.00405 -0.06961 -0.07974 0.02809 -fMl -0.02170 0.07031 0.07224 -0.01414 --0.00479

Chemicals

LightBasic Rubber and consumer

Paper chemicals Fertilizer plastic goods

ao 9.05293 8.63793 8.77953 8.95663 7.91731a, 0.07320 0.00909 0.01667 0.01896 0.03999f,,, -0.01755 0.00303 0.00109 0.00145 0.00718OCK 0.24242 - 0.50197 0.05920 0.21334GCL 0.31865 0.29981 - 0.00255 0.40987aM 0.43893 0.70019 0.49803 0.93825 0.37679fKk -0.21857 - -0.16975 - -0.08655fiLL -0.25610 -0.02466 - - -0.54068fMM -0.28271 -0.02466 -0.16975 -

fiKL 0.09598 - - - 0.31362&KM 0.12259 - 0.16975 _ --0.22707fiLM 0.16013 0.02466 - - 0.22707fKi -0.01054 - 0.01902 -0.01973 -0.01176fLI -0.02232 - -0.00085 --0.02014flK 0.03285 -0.01902 0.02058 0.03189

at= time, K = capital, L = labor, M =material.


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