Growing faster, finding jobs : choices for Morocco

n ~ ~ ~ C - l o~~ ~~~ E ZO - PA . r~~ Cm 68 ~m   WORLD BANK MIDDLE EAST AND NORTH AFRICA ECONOMIC STUDIES Growing Faster, FindingJobs Choices for Morocco The World Bank Washington, D. C.  Copyright C) 1996 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing August 1996 The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. 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The complete backlist of publications from the World Bank is shown in the annual Index of Publications, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'1ena, 75116 Paris, France. Library of Congress Cataloging-in-Publication Data Growing faster, finding jobs: choices for Morocco. p. cm. - (World Bank Middle East and North Africa economic studies) "This report was prepared by a team led by Roumeen Islam and is based on background papers prepared by Jean-Paul Azam ... [et al.]" -P. Includes bibliographical references. ISBN 0-8213-3717-3 1. Morocco-Economic conditions. 2. Privatization-Morocco. 3. Monetary policy-Morocco. 4. Labor market-Morocco. I. Islam, Roumeen. II. Azam, Jean-Paul. III. Series. HC81O.G76 1996 338.964-dc2O 96-32184 CIP  Contents Foreword v Acknowledgments vi Acronyms and abbreviations vii Currency and exchange rate viii Summary ix Introduction I Background 2 Chapter 1: The macroeconomic framework S The current situation 5 Where Morocco would like to be 5 Employment effects 6 Fiscal policy 6 Public sector management 8 Investment and savings 8 The rural-urban factor 9 Monetary policy 10 Balance of payments 10 The real exchange rate 10 Chapter 2: International trade 11 Impact of the Uruguay Round 11 Multifiber Arrangement 11 Agriculture 12 Protectionist trade regime 12 Lowering trade protection 13 A free trade accord with Europe 13 Next steps 13 Fiscal considerations 13 Allow employment and relative price flexibility 14 .m  Chapter 3: Factor markets I5 The labor market 15 The labor force 15 The regulatory framework 16 Efficiency of the educational and training systems 19 Gender issues 19 Public versus private 19 The financial sector 19 Structure of the financial system 20 Size of the financial system 20 Interest rate liberalization 21 Regulatory reform of securities and bonds markets 21 Increase the use of indirect instruments for monetary policy 22 Reduce the government's preferential access to credit 22 Reform of the contractual savings system 23 Opening the financial system 23 Bank supervision 24 The water constraint 24 The land market 24 Chapter 4: Privatization and promoting the private sector 26 The PE sector 26 First phase of privatization 27 Next steps 27 Infrastructure 28 The labor issue 29 Public enterprise reform 29 Notes 30 Bibliography 35 iv GROWING FAsmR. FINDING JOBS- CHOICES FOR MOROCCO  Foreword This report-the &rst of a series of Middle East and North global economy on which more rapid growth will depend. Africa Economic Studies to be published by the World But the Agreement is no panacea. Realizing the opportuni- Bank-outlines a strategy for promoting rapid medium ties it presents will need to rely as much on implementing term economic growth in the Kingdom of Morocco. Its a wide-ranging domestic strategy of efficiency-enhancing proposals reflect the achievements of the past ten years, in economic reform as on actions by extemal partners. This which Morocco has already taken major steps to build an report, written on the eve of the signature of the outward looking, private sector oriented economy. Agreement, describes the key elements of such a strategy. Macroeconomic stabilization and adjustment in the latter These include: giving top priority to restoring and main- 1980s and early 1990s substantially reduced budget taining macroeconomic balances; making renewed efforts deficits, while liberalization of the economy helped to to liberalize the trade regime; undertaking substantial labor improve domestic competitiveness, attract foreign invest- market reform and productivity-enhancing human capital ment, and support the emergence of non-traditional development; pressing forward with financial sector devel- exports. Meanwhile, national income has expanded, the opment; and speeding up privatization and public enter- population growth rate has declined, and Moroccans have prise reform. All this should lead to a more integrated soci- experienced modest but real increases in living standards. ety and a reduction of the income and educational gaps But as the report notes, Morocco in the mid-1990s faces that remain too large for balanced and rapid growth. major challenges. The economy is still heavily dependent This is a large agenda. But Morocco today stands at a on agriculture and susceptible to exogenous shocks, as last turning point, which will determine whether it can deliver year's drought-induced fall in Gross Domestic Product rapid economic growth and rising living standards to its (GDP) illustrates. Broadly based private sector develop- people during the remaining years of this century and ment needs to be accelerated by removal of market con- beyond. Based on successive governments' generally strong straints, by legal and regulatory reform, and by cutting the past record of good economic management and of deter- still substantial role of the public sector. Unemployment is minedly undertaking sometimes difficult reforms when high and rising; bringing it down and absorbing rapid pro- they are needed, I believe that the prospects are good. The jected labor force expansion will mean doubling historic World Bank has strongly supported Morocco's develop- rates of GDP growth over the medium term. Poverty, ment strategy in the past: we stand ready to to continue to though greatly reduced, remains a problem, especially in do so with operational lending and policy and analytical rural areas. On the environmental front, the prospect of advice designed to help make the reform agenda a suc- serious water scarcity early in the next century poses a cess-and its benefits in terms of better incomes and potential threat to sustainable growth. And finally, macro- opportunities for all Moroccans a reality. economic balances have deteriorated since the early 1990s. The signature earlier this year of an Association Keemal Dervis Agreement with the European Union (EU) demonstrates Vice President, Middle East and North Africa Region Morocco's commitment to the deeper integration with the The World Bank v  Acknowledgments This report was prepared by a team led by Roumeen Islam Executive Summary, while Mark Bock of American Writing and is based on background papers prepared by Jean-Paul Corporation worked on the text layout. Carine Bolou- Azam, Jacques Coudol, Luc De Wuif, Khadija Khoudari, Mansilla and Alexandra Bernardin provided production Benoit Millot, John Nellis, Sethaput Suthiwart-Narueput, support. Anita Schwarz, and Kouassi Soman. Ishac Diwan, Ross The report could not have been written without the Levine and Klaus Schznidt-Hebbel made valuable sugges- active collaboration of the Government of Morocco. It tions. Additional advice and support was provided by incorporates the results of previous studies and data pre- Christian Delvoie, Miria Pigato, John Underwood, and pared by Government agencies and World Bank staff, as Rene Vaurs. Bruce Ross-Larson served as the editor for the well as the views of many senior Government officials. vi  Acronyms and abbreviations BAM Banque Al- Maghrib CDG Caisse de Depot et de Gestion CEN Caisse Nationale de l'Epargne CDVM Comite Deontologiue des Valeurs Mobilieres CIOR Ciment de l'Oriental CNSS Caisse Nationale de Securite Sociale DH Dirham EU European Union FDM Foreign Direct Investment FTA Free Trade Accord GDP Gross Domestic Product GPBM Groupement Professionelle des Banques Marocaines ICOR Incremental Capital Output Ratio MFA Multi-Fiber Arrangement MODULEC A private company OCP Office Cherifien des Phosphates ONE Office Nationale de l'Electricite ORMVA Office Regional de Mise en Valeur Agricole PE Public Enterprise PEP Plancher des Effets Publique RAM Royal Air Maroc SAMIR An oil refinery SCP An oil refinery SMIG Salaire Minimum Industrielle Guarantie SMAG Salaire Minimum Agriculturelle Guarantie SNI A public enterprise UR Uruguay Round vii  Currency and exchange rate Currency and exchange rate Currency unit = Dirham (DH) 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 DH perUS$, 9.55 9.62 8.71 7.80 8.2i 8.12 8.04 8.15 9.05 9.65 8.96 end of penod DH per US$ 8.81 10.06 9.10 8.36 8.21 8.49 8.24 8.71 8.54 9.30 9.20 penod average Fiscal year January 1-December 31 viii  Summary Morocco has made real progress in the past ten years. Fiscal New policies for renewed growth and current account deficits have been sharply reduced and have averaged 3% and under 2% respectively during The government's challenge is to promote greater and 1990-94. External debt as a share of GDP and debt service more efficient investment as well as a large increase in have declined in 1994 to 68 and 33% respectively. Inflation domestic savings. The main policy actions to accomplish has stabilized at around 4-6%. Thanks to structural this are: reforms, progressive liberalization of the economy, and sus- * Continued fiscal adjustment. tained macroeconomic adjustment, the kingdom has grown * A trade policy that provides larger markets for exports at an average annual rate of about 4% over the last decade. and increases internal competition from imports. Yet Morocco is losing ground and has a long way to go to * Further development of the financial sector. prepare for the next century. New jobs have not been creat- * Reform of the labor market aimed at faster human cap- ed fast enough to absorb a growing labor force; at the current ital development, labor market flexibility, and social sector growth rate, urban unemployment could soon rise to over progress. 20%. The economy remains dependent on agriculture and * Changes in regulations and policies to ensure rational vulnerable to weather conditions; three years of drought in use of natural resources. the early 1990s have threatened the economic gains of a large * Further and faster privatization and better management part of the population. Two divided Moroccos, one rural and of the public sector-including the legal and judicial frame- one urban, remain with huge disparities in income, in access works. to education and medical attention, and in opportunities for The government has started the process of reforms, and individuals and families to improve their standard of living. a long term economic strategy is being developed. Below To meet the challenge of rising unemployment and a are the specific steps needed in each of six main areas. weakening economy, Morocco needs to deepen macroeco- The macroeconomic framework. Central government nomic stabilization and to put in place other policies that expenditures, about 27% of GDP, will need to be reduced. will help it achieve a high rate of sustainable growth with Wage expenditures are particularly high. Implementing a benefits more equitably distributed to the rural population. freeze of the wage bill would be a first step toward more By 1991 the number of people in the country below the comprehensive civil service reform. The government is pro- poverty line had fallen from 21% in the mid-1980s to 13%. viding, usually at a loss, many goods and services that could However, about 8% of the population still hovers just be supplied by the private sector. Significant improvements above the poverty line. While overall social indicators have are possible in the internal efficiency of public expenditures also improved, Morocco lags behind the average lower- through greater cost recovery and divestiture of public middle-income country. Moreover, there are wide varia- enterprises. A reallocation of public expenditures towards tions in income and quality of life, especially between basic education to raise literacy is desirable; public health urban and rural areas. A two-pronged approach, consisting expenditures need to be better targeted to the poor; and, in of higher economic growth coupled with targeted govern- the longer run, the social security system will have to be ment expenditures in the social sectors, will have a positive reformed. On the revenue side, reliance on trade taxes will payoff. Sharing the benefits of growth should raise labor need to be reduced while other tax revenues are raised. productivity. Some of the tax advantages granted to agriculture, housing, ix  and land ought to be reconsidered. The government may the very least maintained constant, while the minimum need to adjust the normal value-added tax (VAT) rate tem- wage in agriculture should be raised only in line with porarily in order to maintain revenues during the transition increases in agricultural productivity. These moves would period. induce a decline in urban unemployment and perhaps a International trade. Morocco faces increased competition slowdown in rural-urban migration (currently stimulated by for its main exports (textiles, clothing, and agricultural a 36% differential in the two minimum wages). At the same products) to its main customer, the European Union (EU). time, human capital development needs more attention. However, an export-based growth strategy will in the medi- Government expenditures on education are reasonably um term, benefit from the more liberal, international trade high for a country at Morocco's stage of development. environment that is evolving as a result of the Uruguay However, greater focus on basic education and on efforts Round. A Free Trade Accord with the EU will open the to improve educational opportunities for women, particu- Moroccan market to competition from European goods larly in rural areas, will have a payoff in terms of growth. and, in time, lead to improved Moroccan production. The government could also take steps to shift vocational (Moroccan tnanufactured goods already have free access to training from the public to the private sector with such the EU.) The trade accord needs to be supplemented with changes as a revision of the mandatory payroll tax now nondiscriminatory reduction of trade protection to maxi- used to finance these public sector programs. mize Morocco's gains. Given the current reliance on trade- Sustainable use of natural resources. The country's water related taxes, however, liberalization has to be synchronized supply per capita is dropping rapidly while the quality of with fiscal reform and, to maximize employment gains, water is being degraded. At the present rate of decline labor market reform. Labor market reform will help the pri- Morocco will be a chronically water-stressed economy by vate sector balance the supply of labor between firms that 2020. Without a national strategy that ensures that potable grow through export promotion and those that contract water is available to the rural and urban populations, eco- because of increased import competition. nomic growth will not be sustained. Beyond water, a Financial sector development. To support growth, finan- national environmental action plan needs to address soil cial policy should aim at providing essential services and erosion (which is being aggravated by overgrazing and tools for the private sector. These include interest rates deforestation), air pollution in certain urban areas, and and equity share prices that provide information on pro- waste management. ductivity and investment risk; risk-hedging instruments Privatization and private sector development. Faster such as well-developed stock, bond, and forward foreign growth will require greater change in the government's role exchange markets; means to mobilize the resources of from being directly involved in productive activities to pro- small and large savers in order to finance long-term invest- moting the private sector. Morocco has a strong private ment; lower financial transaction costs; and provision of sector. It accounts for more than 80% of value added, but credit based on the creditworthiness of the borrower and it has been hobbled and has not grown to its potential. the feasibility of the financed project. For Morocco this Private business people encounter legal, judicial, and regu- means liberalization of interest rates, promotion of capital latory constraints from start to finish. Establishing a new markets, elimination of the government's preferential business requires a long and cumbersome trek through access to credit, strengthened bank supervision, and even- bureaucracy. Foreclosing on failing entities is even more tual capital account convertibility. difficult because of the underdeveloped judicial system and Labor market reform. A high minimum wage in the non- rigidities in the labor code. agricultural sector, high social charges, and rigid restric- In addition to reform of the regulatory system and bet- tions on worker dismissals all contribute to unemployment ter public sector management, privatization needs to be and slow growth in the formal sector. International experi- pursued aggressively (public enterprises still account for ence indicates that workers are better protected by market- around 20% of GDP)-by accelerating the process for 112 determined wage rates, rising employment opportunities, companies already on the privatization list and, then, by and a flexible labor market. Thus the nonagricultural mini- accelerating the divestiture of those that remain in indus- mum wage should be allowed to fall in real terms, and at trial and commercial activities. Beyond that, the govern- x GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  ment will need further to encourage private participation in rowing for the Government, ease labor reallocation, and energy and water distribution and other infrastructure enhance the benefits of trade liberalization. At the same activities, such as telecommunications, mining, port, and time, an improved financial market will contribute to the transport activities, as well as in the industrial branches of success of public enterprise reform and privatization. the phosphate industry. * Fourth, reform of the labor market, specifically more effi- cient investments in human capital and a reduction of rigidi- The payoffs to concerted reform ties in the labor market, will promote growth and the cre- ation of jobs by raising labor productivity and facilitating the Since all these policy instruments are interdependent, the reallocation of labor to more productive activities. Targeted objectives of each will be better and more rapidly achieved investments in the social sectors, by spreading the benefits if they are implemented together. Among the many strong of growth equitably, will ensure the necessary public support linkages: for reform. Overall labor market reform will reduce costs * First, deepened macroeconomic adjustment will reduce the for businesses, raise employment and investment, and substantial crowding-out of private investment by the pub- increase Morocco's international competitiveness. lic sector. Higher public savings will raise the overall * Fifth, regulatory and institutional reforms aimed at the domestic savings rate needed to finance investment. rational use of natural resources, particularly water, phos- Conservative fiscal management will also raise the coun- phates, and land, are necessary if growth is to be sustained. try's creditworthiness in international markets. At the same - Sixth, improved conditions for private enterprise through time, current fiscal policies constrain the development of faster, bolder privatization and aggressive legal, regulatory, the financial sector. Improved management of public and judicial reforms will increase the amount of efficient finances will benefit private enterprise and could reduce private investment. Additionally, receipts from privatiza- the cost of public debt. Better management of public tion could be used to reduce the government's debt, help- finances will also be needed to support trade reform. ing it lower the public sector deficit and finance infra- * Second, a more liberal trade policy will promote export structure improvements needed to support economic growth, overcome the anti-export, anti-labor bias of the growth. current regime, and help offset the negative effects of the In sum, establishing the conditions for sustainable and Uruguay Round on Morocco's traditional exports of tex- equitable growth is a big task for Morocco-but no greater tiles and clothing. However, trade liberalization will have than that faced by other developing countries at a similar its greatest impact if it is accompanied by reform of the stage of development. Most important, the kingdom is well labor market and of the financial sector and prudent placed to advance a reform agenda. It has a good track macroeconomic policy. record. The private sector is dynamic. It is well located geo- * Third, further development of the financial sector wil graphically and will benefit from increasing its outward ori- increase the total amount of investment and domestic sav- entation as well as from its open policies for private invest- ings as well as help allocate them to their most productive ment. The key will be quick and strong decision-making by use. Over time, this will lower the cost of domestic bor- the authorities to realize Morocco's potential. SUMMARY I   Introduction The purpose of this report is to identify key elements of a need ror a more prudent macroeconomic framework to medium-term strategy to promote higher growth in raise domestic savings and to encourage private invest- Morocco. Higher growth is essential to improve the living ment; (2) increasing growth in international trade and the standards of the Moroccan people: it will create much- importance of an outward orientation in gaining access to needed employment opportunities and make Morocco's larger markets and in raising product and factor market social objectives easier to fulfill. Improvements in social efficiency; (3) factor markets-ensuring that labor, capital conditions will, in turn, ensure that growth is sustainable and natural resources are allocated efficiently so that pro- over the longer run. Lack of concerted action at this time ductive domestic investment rises and provides increasing and continuation of past policies could lead to a worsen- employment opportunities; (4) accelerating privatization of ing and eventually unsustainable macroeconomic situa- the large public enterprise sector and promoting the private tion as well as to higher unemployment rates over the sector through regulatory reform to raise efficiency in pro- medium term. duction, to ensure that investments crucial for the acceler- To address the goal of achieving higher growth this ation of growth are funded, and to achieve a better alloca- report focuses on four critical cross-sectoral issues: (1) the tion of scarce government resources in essential areas. l  Background To raise growth rates in the medium term in Morocco to an agricultural output and the relatively large share of agricul- average of 7-8 percent a year from its historical average of ture in GDP2 The public sector continues to play an impor- 3-4 percent a year is not trivial. It will require time, con- tant role in many sectors. Export growth in the manufac- certed action on a variety of fronts and interim adjustment turing sector has come from low value-added activities and costs. However, the impact on employment generation over in areas for which, in the new international environment of the medium term would be significant. Given the existing the Uruguay Round (UR), future growth seems unlikely. In high urban unemployment rate (16 percent), the pressing addition, the overall levels of domestic savings and invest- need to improve social conditions, and its natural resource ment remain low at 16 and 21 percent, respectively, in 1994. constraints, Morocco must strive to move toward this goal. These facts suggest that the first policy priority, as Failure to do so will exacerbate current problems and make Morocco moves towards higher sustained growth, will need changes harder to implement down the road. to be a substantial deepening of past stabilization efforts. The public sector deficit will need to be reduced and the The challenge Government's role in the economy will need to be changed further: along with better public sector management there The past decade in Morocco has witnessed a great deal of will need to be a greater focus on the social sectors, such as progress in the area of macroeconomic stabilization with education and health. This will need to be complemented budget and current account deficits falling from 12 and 9 by further structural reform in key areas. percent of GDP in the early 1980s to about 3 and 2 percent of GDP in the early 1990s, respectively. Morocco increased The determinants of higher growth its outward orientation and manufacturing exports grew in importance relative to traditional exports (mainly phosphate- Higher growth in Morocco will depend on faster total factor based). Manufacturing exports in real terms have grown at accumulation, such as higher rates of investment and human an average of 4 percent a year during the early 1990s; real capital formation, as well as on increases in total factor pro- growth is much lower if 1990 is excluded, due to the reces- ductivity3 Empirical evidence demonstrates that some key sion in the EU.' The increase in employment related to ris- elements can affect factor accumulation, factor productivity, ing exports, growth in GDP per capita, as well as government and growth. First, cross-country work has demonstrated the efforts to reduce poverty has resulted in better living stan- overriding importance of prudent macroeconomic manage- dards for its population so that the percentage of people with ment to growth. Macroeconomic stability and in particular average consumption below the poverty line has fallen from sustained small budget deficits (or preferably surpluses) play 21 percent in 1984/85 to 13 percent in 1990/91. a significant role in raising domestic savings and in signaling However, the stabilization and adjustment achieved the government's commitment to reform. (Chile and remain fragile, as demonstrated by the deterioration of Thailand for example, both fast growers, have preserved per- macroeconomic indicators in the first half of the 1990s with sistent budget surpluses in the after-reform period). While budget and current account deficits rising, and as demon- Morocco has undertaken sigrificant macroeconomic adjust- strated by continuing high debt to GDP and debt service ment and as a result has attracted significant foreign invest- ratios at around 68% and 33% respectively in 1994. There ment, recent economic developments indicate that progress has been little diversification of the production structure of in this area remains fragile and needs to be deepened. the economy. GDP growth remains extremely vulnerable to Most countries that have grown in the post-reform period weather conditions because of the extreme variations in have undertaken structural reforms in various areas along 2 GROWING FAsTER, FINDING JOBS: CHOICES FOR MOROCCO  with macroeconomic stabilization. One such area is the mobility and market-based pricing for labor. Income growth financial sector. Cross-country work has also demonstrated has first been followed predominantly by employment that there are strong correlations between growth and finan- growth and then by wage growth (which of course has also cial sector development. In fact, financial sector develop- been tied to the rising skills of the labor force). Greater labor ment has been found to be a robust predictor of long-run market flexibility can raise investment rates by reducing the growth.4 Financial sector development entails both deepen- entry and exit costs of investment; it can also mitigate the ing and liberalization of financial markets and the imple- adjustment costs related to privatization and public enter- mentation of a suitable regulatory and supervisory frame- prise (PE) reform. work. While Morocco has begun financial sector reforms, a Trade reform, of the non-discriminatory kind, has also great deal remains to be done to ensure a financial system been undertaken by many countries that have successfully capable of supporting and promoting high growth. The stabilized and raised their growth rates. In fact, empirical financial sector plays an important role in improving the allo- studies have shown that low distortions in international cation and magnitude of investment and savings, and in trade are positively correlated with growth and, in fact, high influencing the success of nonfinancial policy reforms (trade levels of international trade are positively correlated with and price liberalization, fiscal and public enterprise reform; investment. Chile and Thailand are examples of countries pension reform can also reduce labor market distortions). It where trade reform has led to a spectacular rise in trade vol- has also been associated with falling costs of capital and umes; Argentina and Poland are examples of countries increased access to private international capital.5 where more recent trade reform is having strong results on The East Asian experience, as well as general country trade volumes. Increasing outward orientation not only experience, has demonstrated the importance of human cap- raises efficiency in production but will also provide a large ital in promoting growth. In fact, some studies cite the initial market for Moroccan exports. Though Morocco has liber- conditions related to higher literacy and education levels alized progressively over the past few years, it is recognized (which also raised equity) as the single most important fac- that far deeper policy reform is needed to encourage new tor contributing to higher growth. This underlines the neces- sources of growth and to compete effectively in the new sity of preparing the labor force as well as the labor market international environment of the Uruguay Round. for growth in Morocco by investing directly in human capi- Increasing reliance on the private sector for the provision tal and by facilitating labor mobility and employment growth. of goods and services, accompanied by large reductions in Country experience has also shown that growth that is public spending, privatization, and the establishment of a shared, for example, through efficient investments in health, legal and regulatory framework conducive to the growth of education, and social services, tends to be sustainable, while private business (including streamlining of business regula- rising inequalities in the standard of living will be an obsta- tions)6 has also characterized successful reformers. An cle to growth (often due to low labor productivity and thus increase in the magnitude of private investment, both in low labormoblity and rising social tensions). Morocco needs absolute terms, and relative to public investment, has been to make a greater effort in the development of human capi- associated with improvements in the efficiency of investment tal and in the social sectors in general. One way to achieve both during and after reform. Moreover, privatization can greater efficiency in human capital formation would be provide a significant boost to capital market development, as through the reorientation of government expenditures and a Morocco's initial experience and that of other countries better public-private mix in the provision of training and (such as Chile and Argentina for example) has shown. Many education. It is important to ensure, at the very least, that the countries have successfully used the proceeds of privatiza- income distributional consequences of the policy framework tion to enhance long-term fiscal adjustment by reducing pub- (of which government expenditure is an element) are not lic sector debt. Argentina is a good example of this. Such a regressive in the long run. policy increases fiscal flexibility, essential in Morocco, where Efficient allocation of labor, and, therefore, more pro- increased attention to social priorities is needed. ductive use of the labor force, requires labor market flexi- Privatization and private sector development in general bility. Most countries that have sustained high income and would provide the means to finance essential investments in employment growth have done so by promoting labor infrastructure to support higher growth in Morocco.7 BACKGROUND 3  Each of these main areas of reform is an essential input cial sector development, which in turn will promote privati- to an entire policy package. Accelerated growth will require zation and private sector development. Labor market the simultaneous deepening of reform in these areas since reform will also reduce the costs of unemployment related many of the policies suggested are either complementary or to privatization, and will lower the entry and exit costs of pri- interdependent. For example, trade reform will not be sus- vate firms. tained in Morocco without fiscal reform. The success of Changes in the policy framework are often accompanied trade reform in reallocating factors will depend on develop- by adjustment costs in terms of temporarily falling output or ment of the financial system and the labor market. Labor increasing unemployment. Morocco's past adjustment market development through faster human capital forma- experience did not, on average, result in either (partly due tion will make Morocco better able to compete in the inter- to the large financial inflows provided by the international national arena. Financial sector reform, which will aid labor community). The implementation of a comprehensive reallocation, will to some extent depend on fiscal reform. reform package would help in reducing the duration as well The efficient conduct of monetary policy depends on finan- as the magnitude of possible adjustment costs in Morocco. 4 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  Chapter 1 The macroeconomic framework Conclusion. The essential elements of higher sustained social sectors with better targeting toward the poor within growth will be more efficient and increased investment the sectors. Improving social indicators can help sustain and productivity increases, which will raise output, partic- growth by raising the productivity of labor (by improving lit- ularly exports. To finance this, higher domestic savings will eracy, health, and nutrition indicators) and by helping to be necessary. To raise savings and private investment the maintain social consensus for reform. (c) Reconsider pre- most important prerequisite will be a prudent macroeco- sent tax exemptions and improve tax collection partly by nomic framework. Past stabilization efforts need to be promoting greater formalization of the economy. (d) deepened so that the public sector deficit reaches a surplus Improve management of public finances by adopting a over the medium term in order to raise domestic savings medium-term framework in allocating expenditures and and reduce crowding out of private investment. Such a sce- implementing decentralization of government. nario will require cuts in the overall government expendi- ture to GDP ratio, and an increase in the efficiency of The current situation recurrent and capital expenditures within the reduced envelope. Rationalization of expenditures will increase the As table 1 shows, Morocco has reduced its budget and cur- government's ability to safeguard essential investments in rent account deficits since the early 1980s. During this the face of deficit-reducing expenditure cuts. In this process of stabilization, growth rates were on average pos- regard, expenditure allocations should ideally be deter- itive and around 4 percent a year. Inflation has also fallen mined within a multi-year framework and in accordance since the 1980s. However, both budget and current with government priorities over the medium term rather account deficits have increased during 1993-95. In addi- than in annual allocations. The maintenance of revenues tion, Morocco remains a highly indebted country: the debt as a proportion of GDP through better tax collection, the to GDP ratio was just under 70 percent in 1994 and debt adoption of a regulatory framework that will encourage the service over 30 percent. Investment as a proportion of formalization of production (and raise the tax base), and GDP remains low, as does domestic savings. GDP growth the reduction of tax exemptions will also be required. As has been very volatile in the 1990s due to changing weather recognized by the authorities, to ensure consistent imple- conditions and has contributed to the deteriorating bud- mentation of a forward-looking macroeconomic strategy, getary situation. The average growth rate during 1990-94 the current management of public finances needs to be has been around 3 percent (2 percent if 1995, a bad strengthened and decentralized. The consolidation of drought year, is included). The average growth rate of mer- expenditures and revenues for all levels of government chandise exports has been over 4 percent, unless 1990 is would help in determining total financing needs. The excluded (growth was high in 1990 and made up for the maintenance of the current strategy toward public sector sharp decline in 1989) when it falls to under 2 percent a finances could eventually lead to an unsustainable public year partly due to a recession in the EU. (In fact the growth fiscal balance and/or lower growth. rate of manufactured goods exports during 1991-94 was Key objectives. (a) Reduce expenditures as a proportion -0.9 percent). of GDP: the overall level of expenditures seems high relative to other middle-income countries including the fast grow- Where Morocco would like to be ers. (b) Increase the efficiency of public expenditures within a reduced envelope by improving sectoral management. Table 2 shows two possible paths that Morocco could fol- This will involve the redirection of expenditures toward the low in the future, depending on the policy framework 5  TABLE I Historical macroeconomic indicators (Percent) Averages Actual 1980-83 1984-87 1988-92 1992 1993 1994 Rates of change Gross domestic product 3.6 4.7 3.9 -4.4 -1.1 11.5 Agicufture -0.7 10.3 1.8 -36.0 -6.2 63.0 Industry 1.6 2.6 3.4 1.9 -2.0 2.3 (without manufacturing) 3.8 3.9 4.4 1.8 - 1.5 2.0 Services 6.3 4.1 4.7 5.1 0.7 4.3 Exports of GNFS' 4.4 4.6 4.0 0.9 4.8 5.1 Inmports of GNFS -1.8 4.8 7.3 7.7 0.4 4.8 Ratios to GDP Gross investment 25.6 24.1 23.1 22.7 21.2 21.0 Domestic savings 13.5 16.5 18.3 16.2 15.7 15.9 National savings 16.1 20.3 22.0 21.1 19.1 18.7 Current account balance -9.6 -3.7 -1.1 -1.6 -2.0 -2.3 Govemment revenue 21.6 20.3 23.7 26.4 27.6 24.1 Govemment expendiure 33.8 29.2 27.6 28.6 30.0 27.2 Fiscal deficit, commitrnent ba.sis -12.2 -8.8 -3.9 -2.2 -3.3 -3.8 ICOR(Syears) 5.2 6.1 4.7 5.8 14.7 6.5 External debt burden Debt outstanding (DOD/GDP)b 74.6 113.0 85.7 74.6 80.5 68.3 Debt service (TDStXGS)' 37.7 31.3 25.7 23.3 30.4 32.6 Inflation (GDP deflator) 8.0 8.1 5.1 4.5 3.8 2.7 Real effective exchange rated (1990= 100) - 114.4 102.6 104.1 105.1 107.9 Real GDP per capita (in 1980 $US) 958 1021 1120 1097 1063 1162 a. GNFS denotes goods and nonfactor services. b. Extemal debt includes medium- and long-term. IMF, and short-term. c. XGS denotes export of goods and services; includes workers' remittances. d. This is the IMF's definiion and is obtained from Intemational Finonciol Statistics. Source Government of Morocco and World Bank staff estimates. adopted. The high-case scenario is based not only on Employment effects improved management of public sector finances (a bud- getary surplus, improving debt indicators, and better bud- Estimates show that only under a high-growth scenario of getary procedures) but also on the implementation of var- the type envisaged here, can Morocco achieve substantial ious structural reforms discussed elsewhere in the report. reductions in unemployment. If Morocco continues on its These include the structural reforms suggested for the historical growth path of 3-4 percent on average a year, the financial sector, the labor market, international trade, the rate of unemployment can be expected to worsen consider- PE sector, and the establishment of a regulatory, legal, and ably The current rate of unemployment at 16 percent in institutional framework conducive to private sector devel- urban areas would probably rise to over 20 percent by the opment. These reforms will be essential to raise investment end of the decade even without rising labor force participa- and savings to the levels necessary for higher growth. The tion rates. However, it could decline several points under low-case scenario is based on the continuation of the exist- the high-growth scenario even with labor force participation ing policy framework. The numbers in the low-case sce- rates rising twice as fast over the medium term.8 nario indicate that, if present policies continue, there would be continued crowding out of the private sector. Estimates Fiscal policy indicate that this could eventually lead to an unsustainable situation, as growth would not be sufficient to absorb the To provide a boost to private investment, and to raise pub- growing labor force. lic savings, the consolidated public sector deficit would need 6 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  TABLE 2 Key macroeconomic indicators: medium-term outlook and resource allocation (Percent) High-case scenario Low-case scenario 1995 1996-2000 2000-03 2004-05 1996-2000 2000-3 2004-05 Rates of change Gross domestic product -5.1 5.2 6.1 7.5 4.2 3.8 3.8 Agriculture -36.5A 9.1 4.0 4.0 8.9 3.5 3.5 Industry 3.8 6.3 8.6 9.0 4.1 4.2 4.2 (without manufacturing) 4.0 7.4 9.5 10.0 4.0 4.0 4.0 Services 1.8 3.6 5.4 7.6 3.0 3.6 3.7 Exports of GNFSb 4.8 7.9 8.8 8.9 4.8 5.0 S. I lmports of GNFS 8.6 5.6 7.0 6.7 3.7 4.0 4.2 Ratios to GDP Gross investment 21.6 24.5 28.3 31.8 21.8 22.5 22.1 Domestbc savings 15.0 18.1 23.2 28.0 15.8 17.5 18.1 Nationalsavings 18.3 22.4 27.3 31.0 18.4 19.4 19.3 Current account balance -3.4 -2.2 - 1. 1 -0.8 -3.5 -3.1 --2.8 Govemrnent revenue 24.4 23.6 24.2 24.1 22.9 22.9 22.9 Govemrnment expenditure 28.6 25.8 24.3 23.6 27.5 27.4 27.2 Fiscal defica, commit. basis -4.2 -2.2 -0.I 0.5 -4.7 -4.5 -4.3 ICOR(I year) -4.0 4.7 4.3 4.0 5.6 6.2 6.2 External debt burden Debt outstanding (DOD/GDP)' 69.8 58.7 46.6 37.2 54.4 44.0 36.3 Debt service (TDS/XGS)d 26.5 22.7 21.2 18.2 25.5 28.7 29.6 Inflatione 5.6 2.6 2.0 2.0 5.7 6.2 7.0 Real GDP per caprta (1980 US$) 1082 1224 1388 1621 1194 1275 1362 a. The numbers for 1 995 reflect policy ad1ustments that should be made under the high-case scenario. The figures for the fiscal deficit do not include privatization receipts. b. GNFS denotes goods and nonfactor services. c. External debt includes medium- and long-term. IMF and short-term. d. XGS denotes export of goods and services: includes workers' remittances. e. The inflation figure is derrved from the GDP deflator Source Data for 1 995 are from the Government of Morocco. Data for other years are World Bank staff projections. to be falling over the medium term and the central govern- On the expenditure side, several measures could be ment deficit would need to move toward a surplus. A lower implemented in each sector to raise efficiency within the public sector deficit will be associated with reduced crowd- given envelope of expenditures. Moreover, central govem- ing out of the private sector and, as recognized by the gov- ment expenditures at 27 percent of GDP are high in ernment, will also signal the continued commitment of the Morocco relative to comparable countries including the fast government to reform. The experience of other countries growers and need to be reduced. Under a high-growth sce- suggests that the magnitude of the budget deficit is impor- nario, overall expenditures are assumed to decline to about tant for investment. (Both Chile and Thailand, for example, 24 percent of GDP over the medium term. Greater reduc- had budget surpluses during and after reform and have high tions in expenditures will be needed, however, if revenues fall private investment rates). A budgetary surplus will allow more than assumed (see below). A key measure includes debt indicators to improve: this will also encourage private reduction of the high wage bill of the government (which investment. Moreover, the current fiscal policy of the gov- amounts to about 10 percent of GDP). Non-wage recurrent ernment could, over the longer run, lead to an unsustainable spending is low by international standards. In the past decade public sector deficit, currently estimated at 4-5 percent of the drop in overall expenditures has been borne mostly by GDP (a lower bound), particularly if revenues are not main- reductions in non-wage recurrent spending and capital tained as a proportion of GDP due to declining trade taxes; expenditures. Other import measures include implementing expenditures do not fall; and the financial conditions of cost recovery for publicly provided goods and services, and PEs, of the local governments, and of the public social secu- reducing the size of the public enterprise sector by encour- rity system worsen.9 aging the private provision of many goods and services cur- THE MACROECONOMIC FRAMEWORK 7  rently produced solely or primarily by the public sector. tor development, while temporarily increasing the costs of Increased efficiency of expenditures within sectors will also borrowing for the government, wiDl, in the long run, allow be needed. For example, public expenditures on education more flexibility in the financing of fiscal deficits, and lower the and health would need to be better targeted to the poor."' In cost of borrowing for the Treasury, as evidenced by the expe- addition, to pursue a high-growth scenario, government rience of many Latin American countries that have under- expenditures will need to be directed relatively more toward taken financial sector reform. Improvements in the overall investment expenditures (to provide investments comple- management of public finances will, in turn, be needed to mentary to private investment) and away from current expen- complement financial sector reform. ditures within the reduced envelope. Rationalization of the public investment program will thus be necessary to improve Public sector management the efficiency of government expenditures. Revenues at around 24 percent of GDP (they have fallen As widely recognized by the authorities, the current system somewhat due to recent changes in the tax regime) are high of public finance management hinders the efficient alloca- in Morocco compared to other fast growers (for example tion of expenditures in Morocco. First, management within Thailand at 19 percent and South Korea at 17 percent). the central government is overcentralized. Expenditure However, under a scenario of increased trade liberalization, decisions for each ministry are decided a priori and individ- Morocco could face substantial trade-related revenue ual expenditures must be approved. Second, local govern- losses." Tax reform in the last decade has included the ments do not have control over expenditures due to lack of introduction of a value-added tax (VAT) and the lowering effective decentralization. Third, a definition of medium- of income taxes. Though tax collection has improved and term priorities is lacking (and thus hinders continuity in fis- tax reform was implemented without revenue losses, this cal policy) in the allocation of expenditures; financing for was partly aided by supplementary taxes imposed on exter- longer-run sectoral objectives is determined on an annual nal trade. Given recent developments in international basis and is too dependent on year-by-year ad hoc deficit trade, the heavy reliance on trade-related taxes will be nei- containment attempts. Fourth, the current management of ther a feasible nor a desirable alternative. Continuing PEs does not ensure efficient resource use. To promote improvements in tax collection will be needed, as will a re- greater efficiency in the allocation of government resources evaluation of the tax system. Simplification of the various and to ensure continuity in the financing of activities in investment codes and eliminations of some tax exemptions accordance with government priorities, it is recommended may need to be considered to boost revenues. For example, that the budgetary process be made more flexible. One sug- the implicit subsidy for agriculture (which is tax exempt) gestion would be to prepare 3-4 year rolling investment pro- may not be justified either on economic grounds or for grams. The same strategy would be required for recurrent poverty alleviation reasons. 12 The case is similar for taxes in expenditures. Efficiency in decision making would be the housing and land markets. In addition, as a temporary increased if the government were effectively decentralized. measure, an upward adjustment in the normal VAT rate This can be implemented only gradually and will require the may be an option to consider to replace trade revenues.13 strengthening of the administrative capacity of local gov- Unification of the various investment codes and simplifica- ernments and the implementation of an efficient resource tion of business procedures, labor market reform, and transfer system to local governments from the central gov- greater private sector development can play an important emient. The regulatory system governing PEs will also role by broading the tax base through greater formalization need to be overhauled to reduce the drain on government (for tax purposes) of production and employment. resources. (See chapter 4 on PE management issues.) The privatization of a large part of the PE sector should have a beneficial effect on public finance on two fronts: future Investment and savings loss-making investments will be avoided by the government and revenues will be generated for the Treasury. Receipts from Gross investment at around 21 percent of GDP, and pri- privatization, if used to reduce the debt stock, will enable the vate investment in particular at just over 12 percent, are government to further improve debt indicators. Financial sec- low compared to fast growing countries, even though 8 GROWING FASTER, - NDING JOBS: CHOICES FOR MOROCCO  Morocco's reform program began several years ago. In and eventual balance in the Treasury budget (and the corre- addition to an increase in overall investment, a shift in sponding increase in public savings) should have a significant investment from the public to the private sector will be positive effect on domestic savings. Private savings will also needed.'4 One of the key ingredients necessary to boost be boosted by income growth and lower unemployment. In private investment is a much tighter budgetary policy addition, financial sector reform, by changing the incentive aimed at near balance to reduce crowding out and to sig- structure for financial intermediaries and by increasing con- nal government commitment to continued reform, as men- fidence in the financial system, should increase domestic tioned above. Other elements that will encourage increases financial savings. Direct action to reach savers, particularly in the magnitude and efficiency of private investment small savers, can also help (such as the development of the include: (a) leveling the playing field between the public postal savings system). As the performance of savings and private sectors in all sectors of the economy, and accel- improves with income growth and as active policies are erating privatization, (b) reforming the legal, judicial and undertaken to attract savings in financial institutions, domes- regulatory systems, and generally reducing the cost of tic savings are expected to increase as a proportion of GDP doing business (including excessive administrative require- At around 31 percent of GDP, national savings would be ments); these reforms will also encourage formalization of comparable to that in many fast growing countries (all the the economy and have been detailed in the Private Sector East Asian countries for example). (See table 2.) Assessment; (c) reducing entry and exit costs of private Under an accelerated program of privatization, improve- businesses (for example, by increasing labor market flexi- ments in the fiscal position of the overall public sector, finan- bility and privatization); (d) providing a competitive envi- cial sector, labor market, and trade reform, FDI is expected ronment and access to larger markets (for example, by to increase to reach about 3 percent of GDP over the longer trade liberalization); (e) allowing better allocation of run (comparable to the level in Thailand, though much resources and better risk management through financial below that for Malaysia). However, even if FDI remains sector development; (f) improving human capital forma- below this level under the high-growth scenario, Morocco tion through more efficient public sector provision and could borrow more externally to finance its expenditures encouragement of private provision of education and train- and still maintain debt indicators at an acceptable level. ing;l1 and (g) developing domestic infrastructure through higher private sector provision (privatization and foreign The rural-urban factor direct investment) and a redirection of central government expenditures toward capital expenditures to complement Development and growth have historically entailed redistri- private investment. These reforms should raise foreign bution of factors from lower to higher productivity activi- direct investment (FDI) as well, which in turn could raise ties, generally a move away from agriculture to industry, and productivity by contributing to inflows of foreign technol- increasing urbanization. In Morocco, similarly, the agricul- ogy. The implementation of the entire package of reforms ture sector as a percentage of GDP can be expected to fall. will be important to raise private investment to 20-22 per- Efficiency increases and technological improvements may cent of GDP over the longer run. Together they would raise lead to faster and more intensive growth in agriculture (such the returns to investment. This ratio would be comparable as through the development of drought-resistant varieties of to that in many countries that have sustained high growth crops) than in the past, but slower growth relative to indus- rates (some examples are Chile and Malaysia). Increases in try and services, which can be expected to rise as a propor. private investment in this scenario can be expected to be tion of GD? These changes need to be accompanied by sup- associated with productivity gains and a falling ICOR. portive government policies in rural areas especially to (Many countries have shown significant improvements in strengthen social infrastructure and to rationalize the incen- productivity during and after reform leading to low ICORs, tive framework in agriculture. Any increases in agricultural for example Chile at 3 and China at 3.7.) value added must come under market conditions, keeping Domestic savings are very low in Morocco at around 16 in mind Morocco's very serious water constraint, if it is to percent of GDP, and particularly so compared to fast grow- be part of a sustainable growth strategy. The future of irri- ing countries. The reduction in the total public sector deficit, gated crops and the net additional benefit from investments THE MACROECONOMIC FRAMEWORX 9  in irrigation need to be reconsidered. Under the current dis- manufacturing exports and services is expected to average torted incentive structure (including trade policy in agricul- 8-9 percent a year in the longer term as trade reform ture),16 sustained, efficient growth and alleviation of poverty reduces the antiexport bias and macroeconomic stability in the rural sector will not be possible. promotes investment. Increasing integration with the inter- national community should also promote the tourism sec- Monetary policy tor. Trade liberalization and rising investment needs will be associated with rising imports, particularly of investment Monetary growth in Morocco has been conservative, lead- goods, and the trade balance can be expected to deteriorate ing to low inflation at around 4-5 percent in the early 1990s; somewhat in the short run. the continuation of similar policies will be important for the growth of investment and savings. Financial sector devel- The real exchange rate opment will facilitate the conduct of monetary policy by pro- viding the authorities with indirect instruments and lessen- The Moroccan dirham is pegged to a basket of currencies. ing their reliance on direct controls on the financial sector. Since 1990 the real effective exchange rate in Morocco has appreciated by about 8 percent by end 1994 (and is appre- Balance of payments ciating further in 1995 as a result of the higher rate of infla- tion in Morocco with respect to partner countries). Such an Increasing outward orientation should have positive effects appreciation undermines external competitiveness and its on exports and on the composition of exports. Growth in reversal will help raise exports. 10 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  Chapter 2 International trade Conclusion. To realize its growth objective, given the small signing of the FTA. (b) Synchronize trade liberalization with size of its domestic market, Morocco will have to turn more fiscal reform to ensure the sustainability of both trade and aggressively to its export sector, especially to new sources of public sector reform (see chapter 1). (c) Allow employment export growth. The direct and short run effects of the and relative price adjustments: a decline in real labor costs Uruguay Round (UR) will be negative for Morocco's tradi- and higher labor market mobility will boost exports and tional exports and will erode the benefits that Morocco cur- maximize the gains from factor reallocation. rently reaps from preferential access to the European Union (EU) market. However, over the longer run, there will be Impact of the Uruguay Round gains from increased access to other rnarkets and technology, and trade volumes should rise. Morocco is engaged in nego- Morocco will benefit relatively less in the short run from the tiations concerning the formation of a Free Trade Accord worldwide reductions in developed country tariffs on indus- (FTA) with the EU. Such an association will increase com- trial products under the UR since it already enjoys essentially petition for domestic producers in Morocco; there will also duty-free access to the EU markets for its industrial exports be gains from the harmonization of standards. The net trade- under a 1976 agreement." However, there will probably be related welfare effects of such an agreement depend on the benefits associated with increasing exports to other geo- relative magnitudes of trade creation with the EU, trade graphical areas and overall increases in trade volumes over diversion, and the drop in tariff revenues.'7 Currently, there the longer run. Under existing trade patterns, the primary are no other agreements directly tied to the successful con- and direct implications for Morocco of the UR stem from the clusion of the FTA. There may be nontrade gains from form- dismantling of the Multifiber Arrangement (MFA) and the ing an FTA; for example, the magnitude of total grants from liberalization of trade in agriculture. These developments the EU to Morocco may increase; an FTA may result in could effect Moroccan textile, clothing, and agricultural greater investor confidence as it would signal the commit- exports (especially fruits and vegetables) to the EU nega- ment of the government to reform, and could raise FDI. It tively. Textiles and clothing accounted for over 25 percent may also result in quality improvements for Moroccan goods. and agricultural products for 11 percent of total exports in Many of these gains would also be obtained with nondis- 1993. criminatory liberalization. Other benefits to Morocco could include lower trading costs if the EU finances improvements Multifiber Arrangement in infrastructure to facilitate trade. The current trade regime continues to be significantly protective, which engenders a Morocco was not party to the MFA but benefits from pref- bias against exports and also favors capital-intensive pro- erential access to the markets of the EU.'9 Under the UR, duction. Thus, further trade liberalization measures are export quotas on MFA-restricted goods will be freed and desirable. To maximize welfare gains for Morocco, nondis- import tariffs reduced over a ten-year period. Outstanding criminatory liberalization would need to accompany the FTA import quota restrictions (QRs) will also be expanded. with the EU. This will cause prices of textiles and clothing to fall in cur- Key objectives. (a) Lower trade protection in a nondiscrimi- rently MFA-restricted markets and to rise in other markets. natory fashion: both the average level of protection and the Since Morocco sells 86 percent of its total textiles and dispersion of tariffs should be lowered to reduce the anti- clothing exports to the EU, a MFA quota-constrained mar- export and anti-labor bias and to encourage outward-ori- ket, while facing no quota constraint itself, it will unam- ented growth. This reduction in tariffs could accompany the biguously lose from the dismantling of the MFA through a 1]  significant loss of quota rents on its textile and clothing below 92 percent of the entry price. (In many cases, it exports to the EU. While much of the quota phaseout appears that these minimum import prices have been set so occurs in the tenth year, Moroccan competitors party to high above the internal EU price that Morocco would be the MFA will benefit from significantly expanded quota excluded fromn the market.) Moroccan estimates show that growth rates to the EU in the interim under the UR agree- under the original terms of the EU offer to the GATT, it ment. Moroccan exports may be particularly vulnerable would lose approximately 90 percent of tomato and since its cost competitiveness relative to the countries with clementine exports and 40 percent of orange exports. expanded quotas is not favorable. For example, its unit Morocco reached a temporary agreement with the EU for labor costs in the sector are estimated to be 58, 100, and its tomato and zucchini exports for the 1994/95 season. 262 percent above those for Malaysia, Thailand, and While the impact of the final agreement for agricultural Indonesia respectively.20 products will depend upon its specific terms, the prospects for further growth of agricultural exports to the EU appear Agriculture very limited. The UR provides for the tariffication of agricultural imports Protectionist trade regime and a reduction in these tariffs over time. While there is likely to be a limited impact on Moroccan imports, the terms The trade regime still exhibits a significant degree of pro- of the EU offer at the UR would erode Morocco's prefer- tectionism. In the nonagricultural sector, Morocco has no ential access to the EU market, consisting of duty-free quo- QRs in place and has eight tariff rates ranging from 0 to 35 tas for fruits and vegetables (notably tomatoes, clementines, percent with an unweighted average of 23 percent in 1993. and oranges). Moroccan exports to the EU in 1993 repre- To these must be added the Prelevement Fiscal a sented 76 percent of total exports for these products. ]'Importation (PFI), an import surcharge ranging from 12.5 Morocco was also subject to various minimum selling prices percent to the normal rate of 15 percent.22 (The PFI, (przx de reference) during the year, which excluded it from intended as revenue collection rather than a protection the market during certain periods. device, hardly varies across sectors.) Nominal statutory pro- The EU offer to the GATT consists of (a) the replace- tection rates therefore run up to 50 percent. The sectors ment of reference prices by higher and more binding min- benefitting from higher nominal protection are clothing and imum entry prices (prix d'entree); (b) the imposition of cus- textiles, food and drink, and metal-working. The actual tar- toms duties;21 and (c) the application of the maximum tariff iff collection rate is around 12.8 percent; with an average equivalent (Squivalent tarifaire) if the selling price drops PFI around 14-15 percent, the actual (average) nominal trade protection rate is around 27 percent.23 Table 3 pre- TABLE 3 sents tariff and PFI rates. Note that if the 19 percent VAT Total protection rates at IS percent PFI were applied on the tariff-exclusive rather than the tariff- TarifP PFlb Tot inclusive price of imports, the nominal protection afforded 0.00 15.00 15.00 to domestic production would be lower.24 Additional pro- 2.50 15.00 17.50 tection is provided by reference prices. The reference price 7.50 l5.00 22.50 12.50 15.00 27.50 system establishes minimum import values for a range of 17.50 15.00 32.50 industrial goods, mostly textiles, clothing, and some house- 25.00 15.00 40.00 hold durables (such as washing machines and refrigera- 30.00 15.00 45.00 35.00 15.00 so.oo tors).25 This system provides additional protection for Note: Tariff rates on some consumer goods which are not produced domestically were industrial goods whose tariffs are already at the maximum lowered in November 1994, but these new rates are not reflected in this table. a. Excludes some rates cred in circular, but not found in other data sources. Tariff rates 35 percent rate. In principle, they cover no more than 10 on some consumer goods not produced domestically were reduced in 1 995; these percent of industrial production. changes are not reflected in this table. In addition tariff rates on some agricultural com- modities remain at 40 or 45%. Agriculture remains by far the most highly protected sec- b. Free agricultural access to the EU is available only under full membership. tor. QRs in place are to be removed in 1995 and replaced Source: Administration des Douanes et Impots Indirects: Circulaire No. 4320 du 17/3/1994. with tariffs in accordance with the UR. However, unless 12 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  Morocco sets its actual tariffs significantly below the tariff cluded separately; Morocco is unlikely to get any improved ceilings submitted at the UR, there are likely to be few import access beyond what it already has.29 Moroccan imports from liberalization benefits even after the GATT-required 24 per- the EU, on the other hand, will increase. cent tariff reduction over ten years. This is because the ceil- The welfare impact therefore depends largely on the ings were set very high, e.g. 190 percent for soft wheat, 171 effects within Morocco's domestic market. The net effect percent for barley, and 221 percent for sugar. These levels depends on the sum of trade diversion, trade creation, the exceed current protection levels: the tariff equivalent on soft drop in tariff revenue, and the extent to which domestic wheat in 1994 is estimated at 123 percent.26 prices fall after the creation of the FTA. Foregone customs- Imports under the admission temporaire (imported inputs related revenue would be quite substantial, on the order used in exports) and investment code categories are exempt of 8.5 billion dirhams (DH). Large trade creation effects from tariffs. The overall tariff collection rate,that is, exclud- would offset the above and have a positive net welfare ing exemptions, was 12.8 percent for the first six months of impact.30 Though it is not yet determined what other ben- 1994. Tariff collection rates tend to be significantly higher fits will be directly tied to the conclusion of an FTA, there on final consumption products than on raw materials and are expected to be non-trade benefits such as higher grants semi-finished products. While such a tariff pattern is fre- from the EU. The association with Europe is viewed by the quently observed and used as a means to encourage high Moroccan authorities as more than a closer commercial value-added activities, it tends to create high and dispersed linkage; it is viewed as bringing the two parties closer tech- effective protection rates. nologically, culturally, and sociologically. The most recent study of effective protection which was conducted in 1991 may still be roughly indicative.27 This Next steps study showed that though export incentives significantly reduced the negative effective protection on exports (from The above analysis suggests Morocco could maximize its -23 percent to -5 percent), the anti-export bias-given by welfare gains and promote exports through further non-dis- the difference between local and export incentive rates- criminatory liberalization of the trade regime. The FTA will remained significant at 35 percent. Morocco already grants be phased in gradually over the next several years. Morocco substantial export incentives; another way to reduce this could start a process of non-discriminatory liberalization: anti-export bias is to further lower import protection the first step would be a reduction in the number of tariff levels.28 rates from the current eight rates to perhaps no more than four, and in average tariffs to 20 percent, followed by fur- Lowering trade protection ther reductions to 10-15 percent. To boost exports and growth Morocco should (a) lower tar- Fiscal considerations iff dispersion, which will result in positive welfare and effi- ciency gains, and (b) lower the average level of protection Further trade liberalization should take place in the context (inclusive of tariffs, PFI, and reference prices) in a nondis- of overall fiscal reform. Tariff and PFI revenue accounted criminatory fashion. for 25 percent of total tax revenue in 1993. This is almost as much as total value-added tax revenue (29 percent), a high A free trade accord with Europe proportion of which was from imports (52.7 percent). Broadening the domestic tax base for the application of the The creation of an FTA with the EU is currently under nego- VAT is an issue that is recognized as a priority of the reform tiation. Under the current terms, the free access of EU agenda. goods into Morocco would be phased in over a period which In an attempt to curb smuggling, the authorities have remains to be determined. Since Morocco already has duty- lowered tariffs to 5 percent on about 500 goods which are free access to the EU for its industrial exports, these exports not produced locally. However, since the remaining taxes will not be affected. Trade in agricultural products will not (15 percent PFI and 19 percent VAT) on these products be part of the FTA. The agriculture agreement will be con- will not be lowered, this is unlikely to divert trade sub- INTERNAnONAL TRADE 13  stantially to formal channels, while leading to an immedi- Allow employment and relative price ate loss of about 203 million DH in tariff revenue. The flexibility elimination of the PFI on equipment imports under the Code d'Investissement is estimated to result in a 500 mil- Many of the benefits of trade liberalization are predicated lion DH revenue loss.3" This is in addition to the 8.5 bil- upon freely-functioning factor markets which permit ready lion DH revenue loss from the proposed FTA, which rep- resource reallocation. The high levels of urban unemploy- resents 68 percent and 17 percent of total 1993 customs ment and underemployment in Morocco, however, indicate and tax revenue respectively. The best strategy may be for that significant labor market rigidities exist)2 Further Morocco to first lower dispersion in trade taxes in the con- import liberalization in such a context could increase unem- text of revenue-neutral reform and, as a next step, lower pioyment rather than exports and would therefore raise average tariffs further. adjustment costs.33 34 14 GROWING FASTER, FINDING JOBS: ChIOICES FOR MOROCCO  Chapter 3 Factor markets The labor market encourage the formalization of employment. (b) Make the current system of social security more efficient by separat- Conclusion. Significant rigidities exist in the way the labor ing the distributional component of the high social charges market functions primarily because of the enforcement of on labor from the savings component. Non-wage costs of stringent labor regulations, which can hinder growth in out- labor are high. Lower total labor costs will reduce disin- put, exacerbate urban unemployment, weaken Morocco's centive effects in the labor market and encourage formal- ability to compete in international markets, and increase the ization of the economy. (c) Relax the regulations govern- informalization of employment (which has regressive effects ing dismissals to allow firms to change the skill mix of labor on income distribution). While improvements in the educa- employed, as well as the total number employed. (d) tion and training system are absolutely necessary to develop Develop an unemployment compensation system over the human capital efficiently and to raise employment, they longer run and ensure more rational implementation of the need to be accompanied by changes in the regulatory frame- current severance payment scheme. (e) Increase the effi- work for labor to maximize gains in employment. Trade lib- ciency of the educational and training systems to produce eralization and the changing international marketplace will the "right" skill mix for growth and raise the overall pro- have stronger positive effects on employment creation, ductivity of the labor force. In particular, take active mea- wages, and export growth if labor market rigidities are sures to remove the gender bias fhom the education removed. Greater labor market flexibility can also reduce sphere. the adjustment costs associated with privatization and pub- lic enterprise reform. By reducing entry and exit costs for The labor force enterprises in the formal sector in Morocco, labor market reform can promote investment. High entry and exit costs Of the total population of just over 26 million, 48.6 percent provide strong incentives for the informalization of produc- live in rural areas and 51.4 percent in urban areas. Overall tion and put large formal sector firms at a disadvantage in a population growth continues to be high at just over 2 per- competitive environment.35 Labor market reform, by cent; urban areas have had average annual growth rates of encouraging the formalization of production and employ- about 3.7 percent, and rural areas of 0.79 percent during ment, will also raise the tax base. This will be an important 1987-92, putting enormous pressure on the urban labor element of the high growth scenario: it will help to maintain market. The gross labor force participation rate is 39 per- budget revenues as a proportion of GDP as trade liberal- cent, with 44 percent in rural areas and 33 percent in urban ization proceeds. Formalization of the labor market will also areas, the difference stemming from variations in the labor encourage firm-level (or on-the-job) provision of training force participation of women (33 percent in the rural sector and a better allocation of financial capital. and 17 percent in the urban sector). Key objectives. (a) Increase the differential between the The rate of unemployment is very high at 16 percent in non-agricultural minimum wage (SMIG) and the average urban areas; those in the age group 15-24 years and with no urban wage, and reduce the differential between the education have the highest rates of unemployment (see SMIG and the agricultural minimum wage (SMAG) by, for tables 4 and 5). Though rural unemployment is low at example, allowing the SMIG to remain constant. This will around 5 percent the evidence indicates the existence of encourage employment creation in the formal sector, pos- substantial underemployment. In urban areas, 62 percent of sibly reduce the rate of rural-urban migration, raise the labor force is classified as wage earners, while only 17 Morocco's competitiveness in international markets, and percent of the rural labor force work for a wage (only 5.2 15  TABLE 4 The unemployed by educational achievement and age Age Educational achievement 15-24 25-34 35-44 45-59 60 and over Total Percentages No education 109,868 92,318 32,242 18,650 2.467 255,545 37.5 Certifycate of primary education 78.220 43,701 9.093 1,988 - 133,002 19.5 Certificate of secondary education or equivalent 35.303 54.539 3.089 601 - 93,532 13.7 Baccalaureates or equivalent diplomas 8.998 25.373 1 197 172 - 35.740 5.2 Degrees of higher education except medicine 6,679 32,095 2,382 41.156 6.0 Degrees of higher education-medicine only 633 1.830 370 - - 2,833 4.0 Technical diplomas 9,799 29.685 1,713 538 - 4 1,735 6.1 Other professional diplomas 31.622 41.760 3,600 276 - 77,258 11.3 Total 281,122 321.301 53.686 22.225 2,467 680.801 Percentages 41.3 47 8 3.3 0.4 Sou,ce Urban LarOr Force Survey 1993. percent of rural women work for a wage, versus 25.4 per- on raising literacy by concentrating its resources on pro- cent of men). The figures for rural areas probably underes- moting basic education.36 timate the fraction of the labor force working for a wage since many earn a large part of their income from more than The regulatory framework one occupation and are classified only according to their main activity. Hence, labor market conditions in rural sec- Morocco has fairly well enforced labor regulations. The tors affect a substantial proportion of the population. administrative framework is strong with a very active As is widely recognized within Morocco, the quality of enforcement department, and labor unions play an impor- the Moroccan labor force needs substantial improvement: tant role. The three main aspects of the regulatory system the adult literacy rate at 49 percent (38 percent for women) that have contributed to the rigidity of the labor market are is very low compared with other middle-income countries the minimum wage policy, mandated non-wage labor costs, and particularly the fast growers. Moreover, employers face and regulations governing hiring and dismissals. shortages of certain skills, particularly management and technical skills. However, public expenditures on education Minimum wage policy at over 5 percent of GDP are relatively high. In addition, the The SMIG, which has been rising in real terms, has a strong government is intensively involved in vocational training. impact on the formal urban private sector and appears to be TIhis indicates that significant inefficiencies exist in the man- one of the reasons for the high rate of unemployment in ner in which public expenditures are currently utilized for urban areas. By raising total labor costs in formal sector the development of human capital. One striking example is firms, it also encourages the informalization of production, the fact that the government currently allocates a very high and the use of relatively more capital-intensive techniques, proportion of its expenditures on education in the provision and lowers Morocco's competitiveness in international mar- of higher education; it would probably have a greater impact kets. It may also play a role in accelerating rural-urban migration and thus in affecting urban unemployment. This TABLE 5 policy is also regressive in its effects. International compar- Labor force participation and unemployment rates isons show that Morocco's unit labor costs in its main man- (Percent) ufactured exports (textiles and clothing) are much higher Age Participation rate Unemployment rate than in competitor countries; over the last decade, thev have 1 5-24 years 32.2 30.0 declined much less than in these countries. This can be seen 25-34 years 63.1 20.3 in table 6 below. 35-44 years 63.6 5.S 45-59 years 50.0 3.4 A large share of the labor employed in the urban sector 60+ years 20.6 1.9 is paid at or just above the SMIG, as can be seen in figure Source Urban Labor Force Survey, 1993. 1. The wage distribution is unimodal around the SMIG, 16 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  FIGURE I ferential is not warranted for cost-of-living reasons.42 Urban private sector wage distribution, 1992 Further ad hoc real wage increases could have negative (Number of hours) effects on employment in the rural sectors. By making future 7,000 increases in the SMAG conditional on improvements in 6,000 Aotal labor productivity, further aggravation of unemployment in 4,000 / \ rural areas would be avoided. In conjunction with the above 3,000 SMIG policy, this should have the desirable effect of com- 2,000 Women pressing the gap between the two. 1,00 - Woe~--- -- - -- - 0 I 2SmIG 3 4 5 6 7 8 9 10 No-gest 1,000 2,000 3,000 4,000 5,000 Non-wage costs Note: In the horizontal axis label, the top line refers to wage classes and the bottom to The social charges levied by the main (mandatory) social Source Caisse Nationale de Securrt6 Sociale, Government of Morocco. security organization for the urban private sector, the Caisse Nationale de Securite Sociale (CNSS) amount to suggesting that the latter is well enforced. Empirical evi- 18.6 percent of the take-home pay. Firms must also pay a dence shows that SMIG revisions have followed the aver- 1.6 percent levy for vocational training. In addition, firms age wage more than proportionately; in fact, revisions have pay for various types of insurance (such as accident insur- overcompensated for changes in the average wage.37 This ance), which are not compulsory. These charges drive a has led to a shrinking margin between the two and a com- wedge between the cost of labor and the net take-home pression of the lower tail of the wage distribution, as well pay that varies between 20.2 percent and 35 percent. This, as the upper tail.35 This shrinking margin has contributed particularly in conjunction with the minimum wage policy, to the high urban unemployment rate and further changes has negative effects on formal sector employment that in the SMIG should not occur until unemployment is could be significant. For example, with a 60 percent elas- restored to an acceptable level. The wages of the lowest ticity of the demand for labor with respect to the cost of paid workers and their employment opportunities are labor, it is estimated that the wedge results in a level of adversely affected by a high SMIG. 9 As table 3 shows, the employment (for the lower tail of the wage distribution, i.e. unemployment rate is highest for those with no or little edu- for those for whom the minimum wage is binding) that cation, precisely the category for which the minimum wage could be lower by 18 percent. Many countries with high would be binding.A0 social charges have non-binding minimum wages, keeping The SMAG is about 36 percent lower than the SMIG, the total costs of labor low.43"44 and is well enforced; labor unions seem to be active in rural International comparisons show that the ratio of non- areas as well. The large differential between the agricultural wage costs to per capita income is very high in Morocco and non-agricultural minimum wages has probably acceler- though the ratio of non-wage to wage costs is not.45 While ated the rural-urban migration that would normally occur it may not be possible to find less distortionary tax with increasing industrialization, raised urban unemploy- revenues to achieve necessary social objectives, the oper- ment, and put pressure on urban services." Such a large dif- ations of the CNSS could be made more efficient to TABLE 6 Cost competitiveness in textile, clothing, and footwear, 1991 Real wages Value added Unit labor cost Share of EU imports in ECU- per worker, in ECU' 1985 1991 Morocco 58 89 88 0.9 1.6 Tunisia 62 105 76 1.0 1.6 Turkey 92 145 82 2.6 4.2 Malaysia 55 142 S0 0.3 0.7 Indonesia 5 1 154 43 0.2 1.6 China 53 126 55 2.3 4.9 a. As percent of 1985 values. Source Kingdom of Morocco, Republic of Tunisia-Export Growth. Determinants and Prospects. World Bank. 1994. Annex I11. FACTOR MARKETS 17  reduce the disincentive effects in the labor market. The encourages informalization of production. The segmenta- current social security system does not link contributions tion of the economy generally penalizes the poorest in urban directly to benefits and may be an important cause behind areas. In a country like Morocco, with a rapidly increasing the informalization of much of the economy. Given the and young population, greater flexibility would mean gains necessity of raising the tax base for more efficient forms of in both economic and social terms. Moreover experience taxation, the underprovision of training by the private sec- worldwide seems to indicate that labor is best protected by tor (and the potential fall in labor productivity) and nega- market flexibility that allows economic growth, and growth tive consequences for growth, greater formalization is in employment (which is either followed or accompanied by desirable. growth in real wages), rather than the by premature creation of a welfare state. Hiring and firing Another probable consequence of this system is the par- The Moroccan system penalizes worker dismissal and this ticularly archaic matching between job seekers and employ- reduces labor mobility and employment; more flexible laws ers in Morocco. The data show that job seekers rely on per- governing dismissals and layoffs would raise mobility and sonal contacts with potential employers, friends, and labor market efficiency Individual firing for economic or relatives for finding jobs, rather than on marketing their technological reasons is forbidden by law.46 Collective lay- qualifications successfully. In a system where a worker can- offs are permitted for economic reasons with prior approval not be dismissed for economic reasons, and employment by the regional authorities.47 In addition, rather than pro- agencies are not well-developed, employers need more viding for appropriately designed unemployment compen- information than they otherwise would before making hir- sation the labor code emphasizes severance pay and judicial ing decisions. recourse.48 These two elements together ensure that sever- To mitigate the possible increase in unemployment ance payments are very large, or their magnitude is uncer- associated with the stringent regulations, the authorities tain, or both. (Trade unions seem to be very active in ensur- have allowed the use of "temporary" workers (those who ing that these regulations are enforced.) These rigidities have worked less than a year) and "apprentices" (young have negative incentive effects, lower productivity, and, by people with secondary school degrees who can be hired for raising exit costs, make it harder for firms in need of restruc- eighteen months) who can be dismissed at the end of their turing or filing for bankruptcy, to adjust. The new draft labor contract period.50 There has been a dramatic increase in code proposes changing the laws relating to collective dis- the use of temporary workers recently, especially in the missals by making the process of prior approval somewhat export-oriented sectors and among the unskilled. While more flexible.49 these provisions may reduce the costs associated with the Labor market intermediation was forbidden by the old rigidities in the labor law, particularly for the unskilled, it labor code: the new code is supposed to remove this con- is only a partial solution. The recourse to temporary labor straint on hiring. Though this restriction was not binding in to avoid labor market rigidities can encourage underin- the sense that firms relied on "consulting" firms for infor- vestment in training, lower long-run productivity, and mation, legalizing employment agencies will probably enhance disincentive effects on labor. In addition, these increase the free flow of information that is important for solutions penalize outsiders (who are generally poorer) hiring decisions. and favor incumbents, who know that adjustments in the As a consequence of the rigidity of the labor market, work-force will come from the temporary work-force. employers need to be more cautious than they would oth- These solutions therefore not only have negative incentive erwise be before hiring. The irreversibility of hiring deci- effects but are also regressive. sions, combined with uncertainty regarding the future, As a result of the high cost of labor caused by the con- probably causes firms to delay hiring and to hire less than junction of the minimum wage, high social charges, high and they would in the absence of these restrictions, thus encour- uncertain severance payments, and recourse to the judicial aging the use of capital-intensive techniques. This could system, the incidence of long-term unemployment in reduce the rate of job creation. The system also protects Morocco is very high in the urban sector. More than 50 per- those who are employed at the expense of new entrants and cent of the unemployed stay so for more than a year."1 18 GROWING FASTER, FINDING JOBS: CHOICES FOR MOROCCO  Efficiency of the educational and training systems FIGURE 2 State wage distribution, 1993 The literacy rate in Morocco is 49 percent, very low com- (Number of persons) pared to other middle-income countries and particularly the 80,000 fast growers. Both supply and demand factors are important 60,000 in affecting literacy Raising the literacy rate is important soooo State since this is positively related to labor productivity. Key ele- 40,000 ments necessary to raise literacy will be improving the allo- 30,000 cation of public resources spent on education (to favor basic 20.000 education) and encouraging extensive private sector provi- 0 sion of training and higher education. In particular, the 1.6 1 2 SMIG 3 4 5 6 7 8 9 10 Wage classes percent payroll tax on employers which is used to finance Source Data from the governent of Morocco. publicy provided training needs to be revised. Payroll tax credits could be introduced against enterprises' training- * The average wage is higher in all sectors where the state related expenditures and eventually the tax could be elimi- is the dominant employer (gas, electricity). nated, as enterprises should ideally be allowed to choose not * The probability of being unemployed is much lower in only the type of training provided to their employees but also the sectors where the state is predominant. the magnitude of overall expenditures devoted to training.52 * Seniority and education have stronger effects on earnings In addition, public and private training institutes could be and employment in the public sector. The reason for the put on an equal footing in terms of fiscal incentives, recog- higher pay and the higher premium on education in the pub- nition, and standardization of certification procedures. lic enterprise sector does not seem to be justified on eco- nomic grounds. Gender issues The financial sector Education. While literacy rates in urban areas are similar for males and females, there is a large disparity in rural areas: Conclusion. Accelerated financial sector development is only 10 percent of rural girls are literate as compared with essential to raise both the magnitude and the efficiency of 38 percent of boys. A concerted effort to educate women in investment. It will do this by mobilizing resources, lowering rural areas will raise the productivity of this generation's and the cost of transactions (for example by bringing small the next's labor force through higher overall literacy and savers and investors together), and providing information improvements in family health, and finally, it will help reduce on alternative investments for savers. With a diversity of poverty.3 investment instruments and competitive pricing, businesses Laborforceparticipation. Biases in the employment of women and investors will be better able to manage the risks associ- persist. Though women in the labor force have a greater ten- ated with doing business (for example, riskier projects can dency to acquire higher education, women find it much be rewarded with relatively higher returns). A developed harder to access first employrnent, and in fact the probabil- financial sector can also improve corporate governance in ity of being unemployed is much higher for women."4 Morocco through the provision of both information (to investors and savers) and credit. In the longer run, better Public versus private financial intermediation will lower the cost of credit to the government. Though past reforms have led to a relaxation Certain differences in labor market characteristics stand out: of controls on the pricing and allocation of credit, the estab- * Thegovernment'swagedistributionisverydifferentfrom lishment of a solid regulatory framework for the banking that of the private sector, which is unimodal around the min- sector, and the development of a stock market invigorated imum wage: there are proportionately more people with by recent privatizations, much remains to be done. The much higher wages in the central government so that the gov- financial sector in Morocco does not provide the necessary emnment's wage distribution is bimodal as shown in figure 2. services to the extent required for higher sustained growth. FACTOR MARKETS 19  This is partly reflected in the low domestic savings and ticipation.56 There are five state-owned specialized financial investment rates. Empirical evidence indicates that there is institutions," including the Caisse de Depot et de Gestion no unique structure of the financial system that is necessary (CDG), which is used as a conduit to channel a large part for the efficient provision of the above services; thus, finan- of the economy's savings to the public sector, the national cial policy in Morocco should be directed toward facilitat- savings bank (CEN), some pension funds, and the ing the provision of these services by creating the enabling Casablanca stock exchange. Recent reforms in the banking environment and developing the existing structures.55 sector have led to the establishment of a relatively solid pru- Financial sector development is also closely tied to the suc- dential and supervisory framework. Institutional savers still cessful reform of public enterprises including privatization play a modest role in the Moroccan financial system. In (as Morocco is demonstrating), newly privatized firms must 1993, total assets managed by institutional investors go to financial markets and institutions to raise capital. It amounted to about 20 percent of GDP compared with, for enhances the resource re-allocation effects of trade reform; instance, about 150 percent in the US, 50 percent in as capital moves to where it is most needed, other resources Malaysia, and 30 percent in Chile. The insurance industry is will also be attracted to these activities. growing rapidly but remains financially weak and underde- Key objectives. (a) Liberalize interest rates to allow interest veloped. rates to allocate and mobilize financial (and therefore other) resources for their best economic use and to permit risk- Size of the financial system reward management. (b) Accelerate the use of indirect instruments for the efficient conduct of monetary policy, to The size of a financial system is a good indicator of its rela- allow better allocation of resources and to encourage capi- tive importance in economic activities and of the diversity tal market development. (c) Eliminate the government's of services that it provides. Table 7 presents some indicators preferential access to credit. This will help mobilize for Morocco. Some interesting features of the financial sys- resources for more productive purposes. (d) Accelerate reg- tem are evident: a large share of bank credit still goes to the ulatory reform of the securities market and strengthen insti- public rather than private sector, and stock market capital- tutions: capital market development facilitates the manage- ization is increasing rapidly. As a percentage of GDP, it has ment of risk, provides market information, allows doubled since 1992 largely because of the privatizations that ownership changes without disruption of productive activi- ties, and helps mobilize resources. (e) Take measures to TABLE7 The financial system in Morocco: some indicators, ncrease domestic savigs by reform of the contractual say- 1993 ings system. (f) Open the financial system to the interna- tional market by establishing a foreign exchange market; Millions of Percent this will allow better risk management and allocation of dirhams of GDP resources. (g) Strengthen bank supervision and prudential Deposit-taking banks Deposits 112,720 45.5 regulations to maintain the soundness of the banking sys- Domestic credit II 1,005 44.8 tem in a more open and competitive economy without govemment 44.657 18.0 Private sector 65,840 26.6 without mediumAong-term 15,771 6.4 Structure of the financial system Specialized financial institutions Deposits 53,938 21.8 Morocco's financial sector includes thirteen commercial Credit without government 7,980 3.2 banks (including the central bank, BAM) and three foreign without prvate sector 35,542 14.3 off-shore commercial banks in Tangiers' off-shore commer- without mediumAong-temm 30,265 12.2 cial banking sector, a financial holding company which was Stock market capitalization 25,623 14.0' recently privatized (SNI), six leasing companies, twenty-two 1980-93 1993 insurance companies, and a few recently created brokerage M2/GDP 49.4 62.3 houses operating on the stock exchange. All except one of ahi fi f 1994 the thirteen have significant but minority foreign bank par- Source. Bank AJ-Maghrib, Govemment of Morocco. 20 GROWING FAsTER, FINDING JOBS: CHOICES FOR MOROCCO  have taken place. M2/GDP compares favorably with other Within the context of a continuing stable and sustainable middle-income countries.58 macroeconomic framework, and given the progress made in the area of bank regulation and supervision, the authorities Interest rate liberalization recognize that interest rates should be liberalized and plan to implement liberalization in the near future. Real interest rates in Morocco, though positive, are not mar- ket-determined. Figure 3 Fhows the evolution of interest Regulatory reform of securities and bonds markets rates in Morocco. The BAM sets the maximum lending rates for loans of varying maturity based on an estimate of the cost At present there is no market for private bonds in Morocco, of resources to the banks. These calculations lack trans- the capitalization of the stock market has risen rapidly but parency and the differences between rates for long and short remains low at 14 percent of GDP, on-floor trading remains term loans were set arbitrarily The ceiling rate was to be low with off-floor transactions being three times greater, and adjusted periodically, but this has not been done on a regu- there is no active money market. Reform of the securities, lar basis; nearly all bank lending takes place close to the bond, and money markets will help achieve an important maximum rate. Deposit rates are set within the guidelines objective. These markets are essential for efficient risk man- provided by the Groupement Professionel des Banques agement through portfolio diversification and better liquidity Marocaines (GPBM). Legal restrictions exist to prevent management.59 Stock market development is closely tied to remuneration of most sight deposits. Interest rates on sav- the privatization process. Those firms which have been sold ings accounts are set at 7 percent for commercial banks and on the stock market have been several times oversubscribed: 9 percent for the Caisse d'Epargne Nationale (CEN), the not only has stock market activity increased as a result of the national savings bank. The CNSS and CEN deposit their privatization process, but the privatization process can bene- resources at the CDG, for which the CDG must compen- fit substantially from capital market development. Moreover, sate them at 9 percent. This restriction sets the cost of securities markets also reveal information about firms and resources to a major player in the financial market at 9 per- thereby facilitate the monitoring of managers and invest- cent thus establishing a lower bound for its lending rates. ments. In addition, securities market development encour- Since interest rates have not reflected the true cost of ages the establishment of capital market intermediaries such resources in the economy, they have not been able to play their as rating agencies, investment banks, and auditing firms, role in resource allocation effectively As a result, small- and which enhance the flow of information about firms and thus medium-sized enterprises, relatively more risky ventures, and improve resource allocation. Capital market development those on which information may be hard to obtain have had will aid in the mobilization of resources for the private financ- difficulty in accessing credit. In addition, banks' incentives to ing of infrastructure. It also lowers transactions costs in be aggressive mobilizers of savings have been dampened. another important manner: stock markets allow the exchange of ownership to take place without disrupting productive FIGURE 3 Morocco-interest rates, 1990-94 activity, increasing firm productivity and encouraging invest- (Percent) ment.60 The development of the money market is important 16 for the conduct of monetary policy in a context of liberalized ------- -----~~~~~~ _-''--~~ -------- Cedhng rates interest rates and free credit flows. 12 /\ /\ < ^ , _ ' The securities, debt, and money markets could play a 0 Rrence res much larger role in the economy than they currently do. 8 Though the legal framework is in place for their develop- 6 ment, some implementing decrees remain to be put in place. 4 Specific actions to promote development of these markets 2 include the following: a a Making the Comite Deontoligue des Valeurs Mobili&res O 9t lan May Sept 92an May Sept lim ySept994 (CDVM-the equivalent of the Securities and Exchange Source Bank AJ-Maghrib. Cotnmission of the United States) operational, FACTOR MARKETS 21  * Eliminating government guarantees for bonds issued by regime, the Treasury has preferential access to financial public enterprises, as these distort the market. This action resources through a variety of mechanisms: will level the playing field for private sector borrowers. * Banks are required to hold 20 percent of their sight e Implementing measures to enable effective open market deposits in public paper that pays 4.25 percent (Plancher operations to be carried out as swiftly as possible. These des Effets Publics, or PEP). The implicit tax on the finan- include the development of the institutional environment cial sector from these below market interest rates would and training of BAM staff. have amounted to 0.35 percent of GDP. Note that because * Strengthening the regulatory and institutional frame- of the other distortions in the economy (few alternative work of the securities market on the basis of the recom- investments, controlled interest rates), banks currently hold mendations of the G-30, in particular the implementation an additional 18 percent of their deposits in Treasury paper, of a central depository system and a trade settlement and though at higher interest rates. delivery system. - The Treasury has interest-free access to funds from the * Modifying the regulatory framework so as to permit BAM up to a limit on the stock of around DH 5.5 billion banks and other financial institutions to issue mortgage- plus the equivalent of 10 percent of the previous year's tax backed bonds. revenue. Interest payments on these funds could cost the government an additional 0.4 percent of GDP, assuming Increase the use of indirect instruments for monetary interest rates of 10.5 percent. policy - All the reserves of the postal savings bank and the main social security organization (CNSS) are required to be The monetary policy instruments available to the BAM con- deposited, at a fixed interest rate of 9 percent, with the sist of non-remunerated reserve requirements with the banks, Caisse de Dep6t et de Gestion (CDG). rediscounting of conmmercial paper, auction, and repurchase - Insurance companies are required to invest 40 percent of agreements (established in 1995), in addition to the controls their reserves in Treasury paper.6' on interest rates mentioned above. The secondary market in The above mechanisms direct credit to the public sector short-term debt needs to be developed so that the govern- (much of it at preferential rates), tax the financial sector, and nient can efficiently affect liquidity (and thereby interest impede the efficient mobilization and allocation of financial rates). Monetary policy reform will allow more efficient resources. Financial managers have little incentive to financing of government budget deficits at lower costs and acquire and market information and, in some cases, are pre- improve the allocation of financial resources by removing pos- vented from playing any role in capital markets. Private sec- sible distortionary and implicit taxes on the financial system tor firms lose twice: first, from the reduction in the avail- and the private sector. The government will be able to move ability of long-term funds and from the implicit tax on the away from direct controls on credit and prices to the use of financial sector,62 and second, from the other benefits that indirect instruments to influence these variables. Some pol- come from capital market development. As is widely recog- icy measures that would need to be implemented are: nized, the above restrictions on the use of the funds of finan- * Allowing remuneration of reserve requirements, cur- rently required to be maintained at 10 percent of sight FIGURE 4 deposits. Morocco-credit to government, 1980-93 * Strengthening the technical capacity of the BAM staff to (Fraction of total) implement open market policy and providing the necessary o.s infrastructure (computers, for example). 0.4 0.3 Reduce the government's preferential access tot credit 01 Figure 4 shovvs domestic credit to government as a propor-