NS4054Summer Term 2015

Algeria: Oil Dependency

Overview I

• Since independence, Algeria has spent nearly • 25 years to build a model of socialist development• 25 years to escape from socialist development• Country is at the heart of the debate on success or failure

of development strategies pursued by former colonies• Use of non-renewable natural resources for development

raises questions of sustainability of choices made• Challenges Algeria has to deal with rooted in

• The construction of the economy

• The way the ruling elite is selected and

• How the revenues from non-renewable energy sources are used

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Overview II

• Economy often characterized as• Oil-based “rentier state”

• “Patrimonial state”, and

• “Authoritarian state”• These characterizations underscore the extent of corruption and

patronage that affects the whole political-administrative mechanism

• Keeping the FLN at the head of the country for over 50 years raises questions as to the nature of political power• Country neither a democracy, nor

• Full dictatorship• Economic failure and political stalemate suggest FLN destroyed its

own dreams

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Model of Self-Reliance I

• Following independence in 1962• Algeria introduced an introverted development strategy

based on Soviet socialist model underpinned by• Single political party FLN

• Difficulty in correcting any errors (strong ideology and weak opposition), and lack of appraisal of public policies

• Protectionism, state monopoly over international trade, absence of export support mechanisms – desire for autarchy

• Centralized planning – centrally administered economy

• Priority given to heave industry

• Agricultural reform (collective farming)

• Transfer of agricultural resources to industry

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Model of Self-Reliance II

• Idea that • economic independence would consolidate its political independence

• Country should create a unified production mechanism by developing its own industries financed by its own resources

• Model proved ill conceived• Government’s investment in heavy industries – steel,

petrochemicals too ambitious with respect to size of the domestic market• As in soviet model, agriculture, consumer goods and housing were

sacrificed

• Resources drawn from sale of oil and gas were insufficient to create the conditions for long-term economic growth

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Model of Self-Reliance III• Algeria did not build up a sovereign fund to prepare for the post-oil

era• There was a failures to back up the management of oil sale

revenues with a long term strategic vision• Government tended to develop polices based on stat-allocated

income rather than on the creation of new production driven wealth• Country suffered from the Dutch Disease – blockage of

industrialization process due to increases in prices of raw materials• Shift in labor force towards the expanding sector

• Increased salaries in this sector

• Growth in revenue leading to general inflation

• Rise in exchange rate which handicaps domestic industry subjected to international competition

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Changing Economic Priorities I• Oil drop of 1985/1986 cast doubt on • government’s ability to support employment and

consumption through subsidies, and • An industrialization model financed by revenue from oil and

gas.• Illustrated country’s vulnerability leading to reforms• Felt the need ro revise the role of the public sector in the

economy• First reforms applied to national firms such as Sonatrach• After nationalizing the oil industry forced to backtrack at

beginning of the 1990s to attract foreign investment• Partial privatization introduced and the socialist areas

farming and state-owned industry were given greater autonomy

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Changing Economic Priorities II

• Revised constitution 1989 • Got rid of all references to socialism, and• Acknowledge the complementarity of private

entrepreneurship with the public sector• The country officially began a vast-post-socialist reform

program

• Riots October 1988 and military coup in beginning of 1992 (Islamic group had won the elections) started the civil war 1992-1999 between the military and Islamic movements

• Left almost 100,000 dead• Country could not service debts and in 1994 forced to

accept a IMF free market policy8

Changing Priorities III

• Despite repeated promises to liberalize energy market, status quo of the patronage between Sonatrach and the government continued

• Sontrach’s strategy remained pretty much the same despite globalization of the oil and gas industry

• Government has been determined to keep its grip on the sector

• Reason moves to liberalize industry have continually been abandoned

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Assessment

• Today, Algerian economy is a service-based “rentier economy”

• Over 83% of economy based on trade and small-scale services

• Over 90% of industrial segment is made up of family-based SMEs

• Country owns the third largest oil reserves in Africa and a third of the gas resources, but still does not have the resources needed to build a modern economy outside the oil and gas sector.

• In these conditions, Algerian population cannot take advantage of its potential wealth.

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Algerian Population I

• Since beginning of the 1960s the Algerian population has tripled to over 38 million

• For a while rentier economy neutralized drivers on demographic transition

• With oil price drop 1985/86 – falling incomes and fertility• In last few decades despite a redistribution of part of

revenue from oil• Little sign of rising living stands of population• However Algeria has steadily improved position in terms

of human development despite economic and political turmoil

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Algerian Population II

• In 1990s Algeria confronted with an acute identity crisis in religious, economic, social and cultural terms

• Crisis still reverberates today• The armed conflict and economic crisis led to

• Destruction of key infrastructures

• High unemployment

• Poor working conditions and social services

• Exodus of top and middle managers – resulted in significant demand for foreign skills

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Algerian Population III

• Gap remains wide between educational supply and demand

• In most instances programs available in higher education do not match requirements of business or the economy

• Skills are rare and firms find it extremely difficult to recruit the right workers

• Higher education system managed in bureaucratic manner – ill adapted to needs of business

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Uncertainties I• Before the 2014-15 oil price drop

• Country’s financial situation was healthy

• Very little external debt – paid off early

• Country had around $200 billion in reserves

• Positioned with pipelines to supply gas to Europe• However:

• Production structure distorted in favor of energy and at expense of manufacturing – despite massive government investment in industries

• Country lacked many crucial skills and had obsolete infrastructures in key sectors.

• Led to a mass exodus of academics and top managers

• Number of administrative obstacles and low level of human capital among young generations made it very difficult to start a business 14

Uncertainties II

Major issues for concern•Absence of any real tourist industry – poor infrastructure and closed economy after independence•Little foreign investment – 49/51 regulation forbids foreigners from having majority stockholding•Some years Algeria imports over 40% of cereals placing population in position of food dependency due to

• Choices made after independence

• Amount of land lying fallow

• Persistently poor harvests – little fertilizer

• Uncertainty over government policies•All have prevented a genuine food supply chain from being developed.

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Uncertainties III

• Lack of diversification in country’s exports• Oil and gas revenues financing around 75% state budget• Of 183 countries mentioned in WB Doing Business Algeria ranks

137 position fallen steadily• Also 111 out of 180 in Transparency International Report• In building and civil engineering sector, local companies unable

to take part in major infrastructure construction programs because• Lack of a real human resource policy

• Lack of formalized skills identification

• Outdated recruitment with little or no consideration given to qualifications and

• Sector very traditional – lacks any leading edge technologies

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Voice: Accountability

1996 2000 2003 2005 2007 2009 2011 20135

10

15

20

25

30

35

40

45

Perc

entil

e: V

oice

and

Acc

ount

abili

ty

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

Source: World Bank, Worldwide Governance Indicators, 2014

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Political Stability

1996 2000 2003 2005 2007 2009 2011 20130

10

20

30

40

50

60

Perc

entil

e: P

oliti

cal S

tabi

lity/

Abs

ence

of V

iole

nce

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

Source: World Bank, Worldwide Governance Indicators, 2014

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Government Effectiveness

1996 2000 2003 2005 2007 2009 2011 201310

20

30

40

50

60

70

80Pe

rcen

tile:

Gov

ernm

ent E

ffect

iven

ess

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

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Regulatory Quality

1996 2000 2003 2005 2007 2009 2011 20135

10

15

20

25

30

35

40

45

50

55

60Pe

rcen

tile:

Reg

ulat

ory

Qua

lity

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

Source: World Bank, Worldwide Governance Indicators, 2014

20

Rule of Law

1996 2000 2003 2005 2007 2009 2011 201310

15

20

25

30

35

40

45

50

55

60

65Pe

rcen

tile:

Rul

e of

Law

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

Source: World Bank, Worldwide Governance Indicators, 2014

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Control of Corruption

1996 2000 2003 2005 2007 2009 2011 201310

20

30

40

50

60

70

80Pe

rcen

tile:

Con

trol

of C

orru

ptio

n

Country/GroupALGERIAEGYPT, ARAB REP.MOROCCOTUNISIAAverage

Source: World Bank, Worldwide Governance Indicators, 2014

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Total Governance

1996 2000 2003 2005 2007 2009 2011 201310

15

20

25

30

35

40

45

50

55

60

Perc

entil

e: T

otal

Gov

erna

nce

Country/GroupAlgeriaEgyptMoroccoTunisiaAverage

Source: World Bank, Worldwide Governance Indicators, 2014

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Algeria: Recent Growth

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Algeria: Patterns of Unemployment

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Dual Gaps

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Post Arab Spring I

• Algeria remained on sidelines during Arab Spring years 2010-11 giving it appearance of stability

• Protests diffused with• Wage increases

• Police presence and the traumatic memories of the civil war• Many factors have led to present situation

• Government never managed to free itself from the war of independence

• Power has remained in hands of a military clan which still rules today and whose legitimacy linked to the armed struggle

• Leaders are former freedom fighters

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Post Arab Spring II

• Failure of economic development (initiated in 1962) and the democratic transition (which began in 1980) are directly linked to the incompatibility between• On one hand system that clings to power by advocating inaction,

and

• On the other hand the legitimate changes expressed by civil society

• Army remains real power in country but its status proses a problem• Is it in the service of a legal power? or

• Is it the power which defines what is legal?

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Post Arab Spring III

• In geopolitical terms, Algeria resembles a fortress under siege

• Borders with Morocco have been closed since 1994, and• Those in the south with Mali and in the East with Libya

are under high surveillance• President is 78, in power since 1999 and in poor health• Has urged Algerians to take their destiny into their own

hands insisting that a new generation must take over and that his generation has had their day

• Still ran for reelection in 2014 paralyzing any potential for real change.

• Next election 2019• Country is in a deadlock and condemned to remain

immobile for many years to come 29

Post Arab Spring IV

• Algeria’s long term prospects depend on government’s ability to introduce real diversification into economy outside oil and gas industry

• Make the private sector the new driver of growth• Involves introducing a series of structural reforms that have been

put off for far too long. • Most impotent

• Instruction of incentives in favor of entrepreneurship and the creation of SMEs

• Algeria is attempting to move from a centralized to a post-socialist economy, but reforms engaged to date have been too timid

• Country caught in political stranglehold resulting in the paradox of a rich country with a poor population.

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Future I

• Algeria is a large country run opaquely by a closed elite and a powerful security apparatus.

• While the police state structure may seem like the key to its stability, in fact, it is reason for its fragility.

• Without real avenues for • inclusive governance and

• urgently needed political and economic reforms, • The system will remain closed, potentially leading to civil unrest as

internal pressures grow. • If oil prices stay low or fall further, the regime may be forced into

political and economic change more quickly than it wishes.•  

•  

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Future II• Algeria's ability to reduce spending is limited by its

reliance on buying social peace with • subsidies,

• grants,

• low interest loans and

• a large public sector. • Although Algeria has substantial buffers

• its sovereign wealth fund as well as foreign reserves of more than 200 billion dollars,

• in December 2014 the IMF stated that for first time in 15 years Algeria's current account is expected to be in deficit.

• The fiscal deficit is set to grow in the medium term as oil prices stay low and capital expenditure and public spending commitments remain high .

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Future III

• Budgeted social transfers and off-budget implicit subsidies have spiraled in an effort to avoid popular revolt• Subsidies amounted to $61.8bn in 2013 or 29% of GDP

• Energy subsidies represent nearly two thirds of total implicit subsidies

• Have can only encourage wasteful consumption, and

• Smuggling into Morocco and Tunisia. • Smuggling of oil products is estimated to cost over $1bn• annually.

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Future IV• Between 2003 and 2013, total energy demand grew at an

annual rate of 4.1% • While supply declined by 0.8%. • Exports took the brunt, contracting by 2.6% every year • Led to growing concerns over depletion of oil and gas

reserves. • Yet the revision of the rules of engagement offered to

international oil companies (IOC) in 2013 yielded a meagre response.

• Out of 31 licenses auctioned in September 2014, only five were submitted and four auctioned.

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Future V

• IOCs are not prepared to play the game by the rules set by the Algerian government.

• The bear market further weakens its hand. • In the context of heightened international concerns about

broader security in the region following the unprecedented attack on the gas field of Tingentourine by Islamist terrorists in early 2013, the country offers less attraction than it has for years as a place to explore.

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Future VI

• The development of shale gas has received much attention from the government as a possible means of increasing natural gas production.

• Estimates suggest the s potential for the unconventional resource at 1,000trn cu ft. This figure may be optimistic, and commercial reserves could be much smaller.

• But tapping the gas would require foreign technology and massive quantities of water, two issues that would have to be overcome.

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Future VII

• Issue of shale even more complicated• In early 2015 tens of thousands of demonstrators

mobilized in a succession of protests against plans to exploit shale gas resources in the south of the country

• Protests were also over the stark lack of economic development in the southern region.

• The shale gas protests, coordinated across several towns,

• Became a rallying cry for those protesting what they see as the authorities neglect of socioeconomic development of the regions in favor of a focus on the northern coastal belt.

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Future VIII

• Opponents of the regime sought to characterize the protests as part of a more general failure of the government to look after the interests of its people

• Also try to link this in with the Berber/Arab conflicts in Ghardaïa

• The authorities' failure to address underlying social problems, particularly in the regions, is concerning.

• The sharp decline in the international oil price over the past year a reminder that the government cannot afford to buy off social discontent indefinitely

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Assessment

• The preconditions to recasting Algeria’s economic policy are simple. They include:• Having an informed public debate, casting aside rigid and

traditions mindsets

• Allowing the private sector both domestic and foreign, a much freer rein and

• Offering investors stable long term conditions which encourage rational investment strategies and,

• Fighting corruption. • If the government chooses to let matters drift, in the past

the consequences for Algeria could be dire.

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