Economic Reform in Libya: Measures, Performance and Challenges.

 

Ahmed M. Jallala

 

Economic Adviser - Industrial Research Center Tripoli – Libya.

 

 July - 2004

Libyan economy is typically a small economy. It depends mainly on oil exports. During the last 34 years the economy went through several dramatic changes none of which lasted for a long time. The economy shifted from the dominance of private sector in the early 70's to varying degrees of state intervention and controls.  Presently the country witnesses the beginning of economic transformation process that can be labeled as economic reform.

 

However, the meaning of economic reform today is completely different from what it was in many developing countries after their independence.[1] Libya was no exception. In the early seventies economic reform was understood as establishment of large state economic enterprises to make use of economies of scale. Local production was protected from foreign competition by state imposed barriers. Economic policy was designed to substitute imports and achieve goals of self-sufficiency. No plans were made to produce for export markets. These measures seemed appropriate then because the economy was almost static with very low growth rates and slow development process, although the economy was relatively open one and relied on market mechanisms. 

 

Today a different interpretation is given to economic reform. It means transforming the economy to one that relies on market mechanisms. The transformation process goes beyond simple economics. It is a very complicated multidimensional process that involves beside economics political and social dimensions. The transformation process itself requires time and its speed depends, among other things on the level of development or initial conditions, the way reform is understood and social and political relations in a given society. The outcome of economic reform may be disastrous if not done in a way that takes into consideration all relevant factors and with the appropriate speed.

 

Economic reform, in almost all countries undergoing the reform process, faces economic, political and social resistance and challenges. Resistance is usually to the goal of reform and mainly of political and social nature that have an economic dimension. Challenges are to strategies designed to implement reform and mainly economic in nature with political and social dimensions.

 

This paper does not claim to discuss all the issues related to economic reform in Libya, but it attempts to present:

a.   A brief summary of economic measures taken so far and the performance of the Libyan economy recently.

b.   Challenges to the economic reform process.

 

The latter is an important matter at least in the beginning of the reform process. The presentation and discussions are done with some level of generality in the absence of a master plan for economic reform in the country and data limitations.

 

 

The initial conditions for economic reform in Libya are non-comparable to many other countries undergoing the same Process. There are at least four major reasons:

1.    The dominance of public sector was not based on ideological believes. The second part of the Green Book neither question market mechanisms nor call for establishment of public sector. It does, however, calls for collective ownership of economic enterprises. In the absence of capital markets, it is not easy to make such a proposition operational. Several attempts have been made to set a minimum number of owners. Yet no criterion has been developed to decide what the optimal number is.  Capital markets seem to be the ideal solution.

2.    The Libyan economy is relatively small as compared to east European nations or some other developing countries undergoing the reform process such as China, India, Egypt...etc.

3.    The Libyan experience with state control and public sector was relatively short.

4.    Major trade partners of Libya remained all along market oriented countries such as Germany, France, Spain, Italy, S. Korea, and Turkey ……etc.

  

I.      Background:

 

Prior to 1970, the Libyan economy was an open small economy. Major economic activities were under the control of ex-colonizers (Italians). Foreign banks such as bank of Rome and Barclay's bank and others were present. Very few Libyans were major players in the economic front. Income gap was very wide. Although the economy was an open economy to some degree, it was rather static one. Development process was very slow. In order to speed up economic growth and development, economic reform was understood then as intervention of the state in the economic activities.

After 1970 foreign assets were nationalized. The belief was that Italians ownership is a result of confiscation during occupation era and assets has to be returned to its rightful owners. Major economic activities at the time such as foreign banks and industries (e.g. Pepsi bottling company and cement factories) were nationalized. Public sector emerged, but private sector was still present. With the emergence of the public sector a shift in economic policy occurred. Like many third world countries at the time the way of thinking shifted toward import substitution and self-sufficiency. In the absence of private sector big enough to do the job, public sector was seen as the only mean to achieve policy goals in the shortest time possible. All other alternatives were ignored including development of institutions to enhance competitive environment. This resulted in major distortions. The choices of new projects were not according to comparative advantage, public sector monopolies produced goods of lower quality with higher costs under state protection, and the financial burden of maintaining increasing state owned enterprises increased. 

 

AT the later half of the 70's the public sector became the dominant sector. By the end of the 70's and with the exception of agricultural, private sector was nonexistent. Public sector power increased to the extent that it took over distribution.

 

Eight years later the ills of the public sector became clear. These ills appeared in shortages of consumer goods, lower efficiency and high costs of production, and rising state spending. The state became the only source of employment, with the exception of agriculture and very small economic activities. State new investment could not keep pace with growing demand on employment. As a result of over-employment public services efficiency declined and so did productivity in state owned enterprises.

 

Public sector got out of the distribution process and was replaced with new small private traders. New private traders handled imports of some consumer goods. However, the institutions necessary to protect new emerging private sector did not exist. Private traders relied on parallel market for foreign currency. Laws preventing private economic activities remained but not implemented. Small size economic activities reemerged such as small industries. However, Public sector remained the dominant sector.

 

In the early 90's the embargo was imposed. That put things on hold until 1999. Three-exchange rates coexisted, official rate, commercial rate and parallel market rate. The role of public sector enhanced through its use of preferred official exchange rate. The economic policy of the country did not change much.

 

 

 

II. Economic reform measures and performance:

 

The purpose of this section is to review the main recent development in the Libyan economy after some steps of reform has been taken. It should be noted that there is no master plan of reform published. However, it is evident from the steps taken so far that the authorities are implementing a gradual reform. The main steps are:

 

1.   Unification of the exchange rate:

Prior to 1999 three exchange rates prevailed in the market: official rate, commercial or special rate and parallel market rate. In 1999 the Central Bank of Libya (CBL) introduced a special exchange rate close to the parallel market rate (2.15 L.D./1U.S$ as compared to 0.36L.D. /1 U.S.$ official rate). Most state owned enterprises continued to use the official rate and the special rate was used for personal imports, medical treatment abroad and pilgrimage. The spread between the two rates was gradually decreased. By Jan. 2002 the exchange rate was unified. However, a Great Man Made River (GMR) tax was imposed on the transactions of the private sector and public economic enterprises not financed by the state. In June 1^est 2003 the tax was included in the unified exchange rate. This led to depreciation of the Libyan Dinar by 15%. Figure (1) shows the changes in exchange rate in Libya 1999-2003.

 

 

 

 

 

 

2. Deregulation of prices:

Prices of most goods are market determined. Prior to 2003 prices of 12 subsidized food commodities, utilities, domestic petroleum products, cement and products of publicly owned steel factory are all determined by the state. However, 2003 witnessed the liberalization of steel products and cement. In the same year private sector is allowed to import the 12 subsidized commodities previously imported only by National Supply Corporation (NASCO). NASCO and private sector today operate on the same grounds as competitors. In addition, there is a proposal this year to remove subsidies and thus price controls on subsidized food commodities and increase incomes as compensation. The proposal faced strong opposition from the public in the meetings of popular committees. However, the state cannot continue financing such a scheme and authorities have to find a way out. One would expect that allowing private sector to import subsidized and previously state controlled food commodities will automatically lead to dismantling of NASCO, if the private sector succeed in offering better prices.

 

3. External Trade:

In 2002 import licensing was eliminated. Previous restrictions on individual purchase of foreign currency were lifted and as mentioned above the Libyan Dinar appreciated in value as a result of exchange rate policy. These factors combined contributed to increased imports by both public and private sectors. The value of imports increased by almost 110%, from 2660.4 millions L.D. in 2001 to 5585.7 millions L.D. in 2002.

 

Figure (2) shows the recent development in foreign trade.

 

 

 

 

3. Privatization:

Clear distinction between private and public is not an easy matter.[2] A common understanding is that private means non-state ownership of economic activities, while public refers to state owned enterprises. Between these two extremes there are different arrangements if the term is understood to mean in addition to ownership rights management and finance. State owned enterprises can be managed by private sector or private activities can be financed partially by the state.

 

Privatization is not a goal rather it is a mean to create a competitive environment. Creation of competitive environment requires more than changing the ownership rights.[3] The same source suggests that success of privatization depends on several other factors, beside transfer of ownership rights, such as:

a.     Privatization political impact including perceived fairness, distribution of political power, political legitimacy...etc.

b.     Establishment of efficient legal, financial, administrative institutions of private market economy. These institutions should include organizations that provide information for market to functions (credit-rating and consumer protection agencies).

 

These institutions and others such as environmental protection agency are not necessarily new creations. Some of them already exists and should be reformed.

 

In Libya privatization has a specific meaning. It refers to collective ownership of large economic enterprises. The political ideology forbids employing others. In the absence of capital markets, it is very difficult to make such proposition operational, but it is not impossible. In China e.g. “most of the new entrants were not private firms but rural enterprises run by local governments, township and village enterprises.”[4]. In Libya in recent years non-state large economic enterprises were developed such as banks and airline industry. The main concern in a market-oriented economy is the existence of competitive environment not the type of ownership. However, the proposition of collective ownership is not easy to operate when it comes to small and medium size enterprises. The issue has not been resolved yet. A different interpretation of the Green Book propositions concerning employment is needed and laws and regulations has to be changed accordingly.

 

Reforming existing institutions or creation of new ones necessary for privatization to be successful is very slow. Their existence and efficient operation is a precondition, or at least should be considered in tandem with the whole transition process. Lack of such institutions while measures of reform are introduced may result in negative consequences that lead to strong public resistance to reform.

 

Creation of new large private firms in Libya is relatively slow. Risks are still high especially in the industrial field. Banking is still inefficient in providing credit and handling international transactions. Regulations concerning creation of new firms have to be improved. Bureaucracy, corruption and resistance by state owned enterprises constitute major embedment to change.

 

Recently two private airline firms (Alburak and Libyan Air) are working as domestic carriers. Alburak has very recently established few international flights.

 

Today there are four private banks. The first of these is the bank of commerce and development. The bank opened officially for business in 1996.[i] Aman bank for commerce and investment opened officially for business in 2003.[ii] Alejma’a alarabi bank opened for business in 2003.[iii] The most recent is Alwafa bank that opened officially for business in 2004.

Privatization attempts of the public sector enterprises were not very successful so far. A Privatization Agency was established in 2000. The agency has 360 different enterprises to be privatized. The failure of privatization is due to several reasons: (a) most of the enterprises to be privatized use old technology and were not maintained properly in the past. (b) Some of these enterprises were established for self-sufficiency goals and their locations were chosen to develop some areas, hence private sector is not interested. (c) Most, if not all, of these enterprises employ a large number of employees (over employment). In the same time employment laws are still in effect and thus private owners cannot reduce the level of employment near the optimal level. (d) Lack of capital markets.

 

However, an attempt to change the ownership rights to the workers in these enterprises is pursued presently. One would not expect much success in this direction. Most of these enterprises have to be upgraded first.

 

 

 

Several other economic reform steps have been taken recently. Tax system has been reformed. New laws passed granting commercial agents licenses. A new agency to attract foreign capital was established.

 

The time since the introduction of the above measures is not long enough to assess their economic impact. Unlike many other countries the performance of the Libyan Economy in the last 5 years was satisfactory to some degree. In Transition economies Gross Domestic Product tend to decline. These economies usually experience high or hyperinflation.

 

Although economic reform measures were introduced in a very short time, the performance of the Libyan economy during the transition was not bad. It is understood that the country has a long way to go to implement reform.

Figure (3) shows Gross domestic product (GDP) in constant 1997 prices increased from 11367.8 L.D. millions in 1986 to 15736 L.D. millions in 2003. This is a very modest change of annual average of 2.1%.

 

 

 

Table (1) shows that GDP increased from 13655.1 L.D in 1999 to estimated 15736 L.D millions in 2003. This translates to 3% average annual increase. However, the contributions of oil and non-oil sectors remained almost constant around 30% and 70% respectively.

 

Table (1): GDP in constant 1997 prices divided between oil and natural gas and non-oil economic activities.

Million L.D.

Source: Central Bank of Libya, Economic Bulletin, Fourth Quarter 2003, vol. No.43.

 

 

 

Table (2) shows GDP per capita for the period 1997-2002 (constant 1997 prices). It is clear from the table and figure (4) that GDP per capita has declined through the period from 2936.3 L.D. million in 1997 to 2758 L.D. millions in 2002. A similar trend can be observed for GDP per capita (oil and gas) and GDP per capita non-oil economic activities see figure (5).

 

 

 

 

 

 

Table (2): GDP per capita in constant 1997 prices divided between oil and gas and non-oil economic activities.

Million L.D.

Source: Central Bank of Libya, Economic Bulletin, Fourth Quarter 2003, vol. No.43.

 

 

 

The economy experienced deflation instead of inflation. The exchange rate policy since 1999, among other things, has contributed to deflation. During the period 2000-2002 IMF suggests an average annual deflation rate of 7.2%.[5]

 

Table (3) shows a summary of actual revenues and Expenditures 1998-2002. It is clear from the table and figure (6) that the 2002 revenue in Libyan Dinars was boosted due to devaluation of the official exchange rate. Oil revenues are determined by the world prices and the quota set by OPEC. Development expenditure rose from L.D.485 millions in 1998 to L.D.3702 millions in 2002.

 

However, revenues from taxes and customs in 2002 declined despite the increase in imports. This could be due to exemptions granted to public enterprises.

 

 

Table (3): Actual Revenues and Expenditures.

Millions L.D.

Source: Ministry of finance.

 

 

Official records estimate unemployment in 1972 at 3.61%, in 1984 at 3.68% and in 1995 at 10.86. In 2003 unemployment is estimated at around 17%. Unofficial estimates of unemployment presently range between 20% and 25%. However, these estimates are unacceptable. There are a large number of non-Libyan unskilled and skilled workers mostly from nahboring and African countries. There is no reliable official estimate of foreign workers, but one expects their number to be higher than the Libyan unemployed. Accordingly, there are several hypotheses that can be tested. The first is that Libyans look at jobs held by foreigners as inferior jobs. Second, Libyans unemployed do not have appropriate training, or over qualified for jobs available. Third, Libyans prefer working in the public sector because of the guarantees offered by the state. Fourth, laws and regulations are biased toward employing foreigners. These hypotheses deserve studying to determine the causes of unacceptable unemployment figures.

 

III Challenges:

 

Public sector and state controls are still a dominant feature of the Libyan economy. Economic reform process faces several challenges, the most important ones are:

1.     Libyans have to change their way of thinking from old ideas of reform of self-sufficiency and import substitution toward integrating the Libyan economy with that of Europe.

2.     Libyan economy depends almost entirely on production and export of oil. The first challenge is thus to diversify sources of income. The country has very limited agricultural land and water is scarce. Accordingly looking at agriculture as a possible source of income beside oil is not realistic. Services such as tourism and commerce are not very promising. Productivity growth rates in services-led growth have the unfortunate consequence of slowing down and thus the growth rate in the standard of living is doomed to slow.[6] The only sector left to lead is the industrial sector. However, Libya cannot establish an efficient income generating industrial sector all alone. It is a developing country, but can use its natural endowment of oil and its location near Europe to try to integrate its industry with that of Europe. It has to target European market being a very large market for its industrial products. It can do so by producing parts of European industrial products that are energy intensive since price of energy is relatively cheaper in Libya as compared to Europe. Lower transport costs across the Mediterranean Sea gives the country better competitive edge. This is not an easy thing to do. It requires seriousness, good planning and patience.

3.     Rather than concentrating on getting red of state owned enterprises, the priority should be creation of competitive environment and establishment of new firms. This can be done through establishment and reforming existing institutions necessary for efficient functioning of a competitive market.

4.     Reforming education system especially higher education. In addition, training of Libyans in areas demanded most by the market. Unemployment levels estimated may be a result of inefficient training.

5.     Civil services suffer from over-employment and in order to increase efficiency numbers of civil servants have to be decreased. It is necessary to establish institutions that provide the same guarantees offered by public services.

6.     Building the infrastructure necessary for the establishment of knowledge-based economy. Libya was one of the developing countries that missed the industrial revolution. It should not miss the opportunity to catch up with the new revolution of knowledge economy.

 

 

 

 

 

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