Attachment_J-1_-_Annex_1.pdf

Tunisia Agricultural Study – 95332418Q0101

ATTACHMENT J-1

Annex 1: MCC - Tunisia Constraints Analysis Summary

1. Tunisia’s Binding Constraints to Growth

Market Controls of Goods and Services: Extreme levels of state intervention and bureaucracy in goods and services markets create unreasonable regulatory requirements and compliance costs to firms, which unduly prohibit certain actors from entering and exiting, and reduce firms’ competitiveness.

Excessive bureaucratic requirements drain firms’ management resources, add administrative costs and time, and privilege market access for connected firms. Managers spend over 45% of their time dealing with government requirements, compared to a global average of 13%.

A number of government price controls, subsidies and trade measures contribute further to market distortions in goods and services, especially in agriculture. For example, the cost of cereals in Tunisia is approximately 30% higher than the world price, encouraging cereals production over other, higher-value items such as horticulture.1 Though there are general compensation funds to subsidize the consumption of staple goods, only 22% of food subsidies go to the poor, meaning that poor consumers are partly subsidizing local producers.

Price controls and subsidies also incentivize the unproductive allocation of resources in the economy and diminish prospects for new opportunities. Energy and water consumption are subsidized, which diminishes incentives to invest and contributes to unsustainable usage. The large distinction made made between onshore and offshore firms creates a useful contrast to consider a Tunisian economy with reduced bureaucracy and regulation.

Poorly governed state-owned enterprises (SOEs) exercise significant market control, with the effect of distorting markets and reducing competitiveness of the economy overall. One-hundred nineteen SOEs currently operate in 19 sectors in Tunisia. The high level of SOE involvement, protection and state regulation of the economy creates an uncompetitive environment wherein some companies, many state-owned, enjoy privileged positions, regulations that favor incumbents or monopolies, and privileged access to decision-makers.

In conclusion, market controls for goods and services are binding constraint, which explains patterns of investment and job creation in Tunisia in the years prior to and since the revolution, is consistent with the narrative regarding exclusion and inequities, and explains the low levels of dynamism and structural change in the Tunisian economy. The effects of uncompetitive distortions are so severe that a World Bank 2014 study estimates that a 5% decrease in the price-cost margin of incumbent firms, resulting from increased competitive pressure, would increase labor productivity by 5%, and translate to GDP growth rates of 5.5% annually.

Restrictive Labor Market Regulations: Inflexibility of wage determination, high social charges, and employment protection mechanisms reduce productivity by discouraging formality, the attainment of https://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Brochure%20note%20politique%20agricultu re%20Anglais.pdf https://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Brochure%20note%20politique%20agriculture%20Anglais.pdf https://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Brochure%20note%20politique%20agriculture%20Anglais.pdf efficient firm size, and increasing youth and non-urban unemployment while depressing economic participation of the working age population, particularly women.

Restrictive labor market regulations, a constraint linked with the market controls on goods and services, affects the distribution and allocation of labor resources in the economy.

Tunisia ranks 133 out of 138 on the labor market regulations indicator for the World Economic

Forum’s Global Competitiveness Index for 2016. A review of employment protection legislations (EPL) shows that stricter EPL reduces formal employment, increases the size of the informal sector, reduces value-added, reduces firm size, and reduces output.

Dismissal procedures are cumbersome and inhibit entry, expansion and exit of firms and Tunisia is among the most restrictive countries in the world to dismiss permanent workers, High labor and social charges also discourage hiring and encourage informality. Tunisia has a relatively low minimum wage relative to average labor productivity, social charges and tax contributions are the highest among comparators and the quality of social services received is low, reducing incentives for employers and employees to enter into formal contracts.

Unions are strong in Tunisia with major political and socioeconomic force, and have a major impact on wages and agreements through collective bargaining.2 3 Unionization is more prevalent in the public sector, at 60% of workers compared to 15% in the private sector, creating a preference for public sector employment, especially among women.4

Tunisian law permits hiring workers on fixed contracts for up to 4 years which can be terminated more simply than open-ended contracts, and firms have an average of 4.13 more temporary full-time workers than comparators, showing a circumvention of labor protections.

Labor market restrictions exclude youth and women, and very likely reduce formal employment in interior regions. According to the World Economic Forum women make about 65% of what men make in comparable positions and the IMF has estimated that Tunisia could gain a 30% one-off increase in GDP growth if gender gaps were removed.5

While the legal minimum wage in Tunisia is competitive, there is evidence that it is still depressing employment and growth (in the absence of a minimum wage, the youth unemployment rate could be reduced by 6%, and formal employment could increase by 6%.

In conclusion, collective agreements are bargained centrally, and apply evenly across the country, without adjustment for regional differences in productivity. Minimum wages are not linked or informed by changes in productivity. In areas with poorer business environments, , labor market regulations are likely to be more constraining for firms that follow them, and exacerbate the divide between those that are protected by them and those that are not. Assessing differential impacts of labor market rules on interior regions, and the interplay between labor market mobility and regulations, will be a task for the root causes analysis.

Water Scarcity: Inadequate and variable supply of water inhibits medium and long term private investment in interior regions and reduces the sustainability of those investments, primarily in agriculture, creating a constraint to regional equity and sustainability

2 http://foreignpolicy.com/2016/07/20/tunisias-celebrated-labor-union-is-holding-the-country-back/ 3 There is a high degree of interaction between labor market regulations / union power to SOE inefficiencies. E.g., it was suggested that the cause for the drastic decline in the Logistics Performance Index since 2011 was due tp union workers at the national freight company slowing down processes in order to extract increased benefits.

4 Hanmer, Lucia et al. Gender and Labor Markets in Tunisia’s Lagging Regions. April 2017. World Bank.

5 IMF. 2017. Women, Work, and Economic Growth: Leveling the Playing Field.

http://foreignpolicy.com/2016/07/20/tunisias-celebrated-labor-union-is-holding-the-country-back/

Coupled with inefficiencies in the capture and mobilization of existing water resources in the northern region, the scarcity and unreliable supply of adequate water raises the costs and risks of medium- and long-term investment in interior regions, particularly for agricultural and agro-processing firms, which are the main forms of employment in those regions.

Surface and renewable groundwater resources in Tunisia are almost completely appropriated and future demand for water is expected to increase due to population growth, urbanization, and growth in industry and tourism and is predicted to surpass supply by 2030 without the implementation of more efficient water conservation strategies. 6 7

Agriculture consumes 80% of Tunisia’s total water resources, and is also a significant share of informal, subsistence based employment and income in rural areas, in particular for women.

Additionally, agricultural development projects are a key element of the GOT’s Tunisia 2020 plan and contribute strongly to the “green economy” pillar of the plan. A study on the potential impact of IFC investments estimates that agriculture and food processing investments have the potential to drive the highest direct and indirect economic returns.8

Despite its scarcity, potential exists to realize substantial water use efficiencies to support increase in growth and sustainability of employment in the more water-stressed interior regions. For example, as much as 40% of water may be lost in the current distribution systems, suggesting that basic improvements could improve water distribution and reduce losses.9 10 In addition, the overall reduction in reservoir capacity is estimated at 40% due to sedimentation – the result of poor watershed management.

Water shortages have led to protests and social unrest, and farmers and firms alike are using various means to fight the scarcity—not all sustainable. Water supply cuts are becoming more regular (not just during droughts)11 and interior areas are suffering long water supply cuts, reservoirs are running dry, and farmers are seeing losses, adding to social tensions.

Farmers have been circumventing this constraint by drilling their own deep wells, a practice which is costly and illegal. Between 2010 and 2015, over 10,000 illegal wells were created leading to high illegal exploitation of water from the country’s deep aquifers.12 Farmers also respond to a lack of rain and shutoffs in irrigation by taking fields out of production.

Fruits and vegetables, being largely irrigated, are more insulated from water availability shocks, although even these farms were being water-rationed in recent years. Investors noted that they were reluctant to put land into use due to water availability concerns.

In a survey of 942 manufacturing and services firms in 2015, approximately 18% of firms operating in the interior regions cited access to/cost of water as a moderate or major obstacle to the firm’s current operations. Some firms are coping by building desalination plants.

In conclusion, the MCC Tunisia Team believes water scarcity is a binding constraint to growth and sustainability in the interior regions, where agriculture is the predominant sector. The analysis suggests that water can be used more efficiently in agriculture without over-extraction of the country’s scarce supply, which can increase growth and sustainability of at least agriculture and perhaps other sectors.

6 USAID, 2017. Groundwater governance in Tunisia.

7 UNFCCC, 2013. Republic of Tunisia, Second National Communication of Tunisia to the United Nations

Framework Convention on Climate Change.

9 Pers com with Ministry of Agriculture; EPA generally considers maximum acceptable loss at 10%.

10 Surface water in the north is mobilized by dams and reservoirs and is transferred through a system of pipes to greater Tunis and coastal areas. This system is Tunisia’s ‘water distribution’ and is where the 40% loss comes from.

This ‘captured’ water is used for hydroelectricity, drinking water, industry, and agriculture.

11 The Ministry of Agriculture is the federal entity that has responsibility for managing water in Tunisia, not only water for agriculture.

12 Ministry of Agriculture. 2010 and 2015. Annuire De L’Exploitation Des Nappes Profondes.

2. Other important but non-binding constraints

Access to finance: Access to finance was noted as a particularly important constraint to firms during many of the consultations held by the team and further analysis confirmed that the Tunisian financial sector suffers from serious distortions.

The banking sector is affected by market controls and state intervention. About a third of total assets are held by public owned banks, market competition is low, and overhead costs remain high, partly due to banks’ inability to capture economies of scale through exit of some banks, or merger with others. The sector is also limited by a lack of deposits, interest rate caps, and non-performing loans

(15%), attributed in part to loans made to struggling SOEs and to sectors favored by the government, such as tourism. However, consultations indicated that these challenges were not a constraint for lending to larger more established clients and feedback on whether it was a constraint for lending to SMEs was mixed.

Access to a variety of financial services varies strongly by gender, income, and location. For example, only 5.4% of women in Tunisia have used an account at a financial institution for business purposes, compared to 22.7% of men. The geographical concentration of banking services may be restricting access to credit for firms in interior areas, making it more difficult for residents of those areas to finance their endeavors.

The analysis does not show a connection between credit to the private sector and investment rates.

This is for two primary reasons; first, banks and firms have pointed to instability and uncertainty in the business environment as a deterrent to investment and so there is more finance going to support short term working capital than long term investment; second, banks have increased lending for consumption which is both less risky and more profitable.

In addition, to the lack of investment, the quality of loan applications, particularly for SMEs, was indicated to be a challenge. Some consultations pointed to an additional need for training or other forms of support to enable these applicants to qualify for financing.

In conclusion, this evidence shows that finance is an important issue in the Tunisian economy. but it does not show that it is a binding constraint, which, if relieved, would have a significant impact on investment. However, given the myriad of supply-side problems with issuing credit, it is possible that credit accessibility could become a constraint if the business environment were to improve and increase the supply of investable projects.

Quality of Human Capital: Limited human capital was noted during consultations as a constraint to entrepreneurship and private sector job creation, with a particular focus on quality of education.

Consultations with the private sector indicated a lack of qualified workers and the inability of universities to provide the proper training required to perform the necessary job duties. In addition, individuals with degrees from vocational training educational institutions exhibit higher than average unemployment rates, reflecting the inability of these institutions to provide employable skills and training for the Tunisian labor market. Despite this, employers are able to quickly fill available job openings.13 And while Tunisia has seen the most employment growth in sectors that do not require skilled labor, many of the fastest

13 https://www.brookings.edu/wp-content/uploads/2016/06/01-youth-employment-tunisia-boughzala.pdf https://www.brookings.edu/wp-content/uploads/2016/06/01-youth-employment-tunisia-boughzala.pdf growing sectors – finance, ICT and other professional services – are skill-intensive, suggesting that necessary training is available. In conclusion, while serious deficits do exist in the quality of education in

Tunisia as well as the mismatch between supply and demand for labor, the constraint is not binding to private investment at the national level. Instead, barriers to catalyzing a thriving private sector more broadly as future employers, by reducing the burden of government bureaucracy and market controls, appear paramount. However, quality of education may be a major barrier for certain high-skilled sectors, such as ICT and entrepreneurial ventures and that will be important to consider in Tunisia’s strategies for economic growth.