Report No 19975-MOR

Kingdom of MoroccoPrivate Sector Assessment UpdateFulfilling the Promise of Private Sector-Led Growth

December 15, 1999

Provate and Financial Sector Development DepartmentMiddle East and North Africa Region

Document of the Worfd Bank

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CURRENCY AND EXCHANGE RATE

(as of June 30, 1999)

Currency Unit = Dirham (DH)US$1.00 = DH 9.98

FISCAL YEAR

July 1 - June 30

ABBREVIATIONS AND ACRONYMS

ANRT Agence Nationale de Reglementation du Secteur des T6lecommunicationsAMC Associations de Micro CreditAMITH Association Marocaine des Industries Textiles et de I 'HabillementBAJ Barnamaj al Aoulaouiyat al Ijtimaiya (social priority program)BAM Bank Al-Maghrib (Central Bank)BCP Ban que Commerciale PopulaireBMCE Banque Marocaine du Commerce ExterieurBNDE Banque Nationale pour le Developpement EconomiqueCDG Caisse de Depot et de GestionCDM Charbonnage du MarocCDVM Comite Deontologique des Valeurs MobilieresCEN Caisse d 'Epargne NationaleCGEM ConfiM&ration Generale Economique MarocaineCIH Credit Immobilier et H6telierCIOR Cimenterie de l'OrientalCNCA Caisse Nationale de Credit AgricoleCPI Consumer Price IndexCRAPP Comite de Reflection, d 'Accelration du Processus de PrivatisationCSDP Contractual Savings Development ProgramCTM-LN Compagnie de Transports au Maroc-Lignes NationalesDEPP Direction des Etablissements Publics et des ParticipationsDH Moroccan DirhamEPICS Etablissements Publics a Caractere Industriel et CommercialEU European UnionESNITH Ecole Superieure Nationale de TextilesFDI Foreign Direct InvestmentFTA Free Trade AgreementGDP Gross Domestic ProductGATT General Agreement on Tariffs and TradeGIAC Groupements Interprofessionnels d 'Aide au ConseilGPBM Groupement Professionel des Banques MarocainesIAM Itissalat al-MaghrebIBRD International Bank for Reconstruction and DevelopmentIMF International Monetary Fund

INEJ Institute for Judicial StudiesIPO Initial Public OfferingMENA Middle East and North AfricaMSTQ Metrology, Standards, Testing, and Quality ManagementNGO Non-governmental OrganizationOCP Office Cherifien des PhosphatesODI Office de Developpement IndustrielODEP Office d 'Exploitation des PortsOECD Organization for Economic Cooperation and DevelopmentOFPPT Office de la Formation Professionelle et de la Promotion du TravailONCF Office National des Chemins de FerONDA Office National des AeroportsONE Office National de l 'Electricit6ONEP Office National de l 'Eau PotableONPT Office National des Postes et T6l6communicationsONT Office National du TransportPE Public EnterprisePEP Plancher des Effets PublicsPERG Programme d'Electrification Rural GroupePAGER Programme d 'Approvisionnement Groupe en Eau Potable des Populations

RuralesPHRD Policy and Human Resources DevelopmentPSA Private Sector AssessmentPSD Private Sector DevelopmentPSDAL First Private Sector Development Adjustment LoanRAM Royal Air MarocREER Real Effective Exchange RateRME Ressortissants Marocains a 1 'EtrangerSAL Structural Adjustment LoanSAMIR Societe Anonyme Marocaine de I 'Industrie du RaffinageSBVC Societe de la Bourse de Valeurs de CasablancaSEFERIF Societe d' Exploitation des Mines du RifSONASID Societe Nationale de SiderurgieTA Temporary AdmissionTFP Total Factor ProductivityUJNCTAD United Nations Conference on Trade and DevelopmentUSAID United States Agency for International DevelopmentWTO World Trade Organization

Vice President: Kemal DervisCountry Director: Christian DelvoieSector Director: Wafik GraisTask Team Leaders: Michel Kerf,

Clemencia Torres

KINGDOM OF MOROCCO

PRIVATE SECTOR ASSESSMENT UPDATE:

FULFILLING THE PROMISE OF PRIVATE SECTOR-LED GROWTH

TABLE OF CONTENTS

EXECUTIVE SUMMARY_ i

CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT i

1. INTRODUCTION 1

2. RECENTECONOMICPERFORMANCE 1

3. ECONOMIC POLICIES IN THE 1990s 5

3.1. Foundation for private sector development 5

3.2. Institutional and Sector-specific Reforms 8

4. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT 15

4.1. Results of the 1998 Enterprise Surveys 15

4.2. Comparison with 1994 PSA results 18

S. ANAGENDA FOR PRIVATE SECTOR DEVELOPMENT 20

5.1. Strengthening the Foundation for Private Sector Development 20

5.2. Addressing First-tier Issues: Administration, Labor, and Finance Constraints 23

5.3. Addressing Second-tier Issues: Industrial Land and Infrastructure, Technology Support,and Market Information Constraints 27

ANNEX 1: PERFORMANCE AND STRUCTURE OF THE ECONOMY

ANNEX 2: FOUNDATIONS FOR PRiVATE SECTOR DEVELOPMENT

ANNEX 3: LEGAL AND ADMINISTRATiVE FRAMEWORK

ANNEX 4: ACCESS TO HUMAN RESOURcES

ANNEX 5: ACCESS TO FINANCE

ANNEX 6: ACCESS TO TECHNOLOGY SUPPORT AND MARKET INFORMATION

ANNEX 7: ACCESS TO INFRASTRUCTURE AND LAND

Principal contributors to this paper include: Hamid Alavi, Saad Belghazi, Ferid Belhaj, JudithBrandsma, Olivier Fremond, Luis Guillermo Hakim, Eric Haythorne, Michel Kerf (Co-Task TeamLeader), Axel Peuker, Valerie Reppelin, Andrew Stone, Clemencia Torres (Co-Task Team Leader),and Luc de Wulf. Extensive comments were received from the report's peer reviewers: HassaneBenabderrazik, Andrew Ewing, Ahmed Galal, and Charles Humphreys. Support and comments werealso received from Denis Chaput, Joumana Cobein, Fran,ois Corfmnat, Christian Delvoie, Karim El-Aynaoui, Mourad Ezzine, Youssef Fehry Fassy, Stephanie Gober, Pierre Guislain, John Page,Mauricio Saavedra, Manuel Schiffler, Nemat Shafik, Elisabeth Sherwood, Vera Songwe, Rene Vaurs,and Paolo Zacchia. Deborah Davis edited the paper and Nicole Wautiez De Blaye translated thedocument into French. Ebru Engin, Richard T. Carter, Maude Jean-Baptiste, Ernest Forkpah andLiliane Vert helped with production of the document.

EXECUTIVE SUMMARY

This report is an update of the private sector assessment (PSA) for Morocco undertaken by the World Bank in1994. During the last four years, the country has clearly demonstrated its choice in favor of economicliberalization and opening to the global economy, as evidenced, for example, by the signing of importantinternational trade agreements. In the resulting environment, firms will need to become more efficient in orderto enhance their competitiveness, and the Government has a crucial role to play in facilitating that transition.The recommendations laid out below are intended to contribute to the development of Government policies thatwill support a more competitive, private sector-led economy. This report draws on extensive consultations withthe Moroccan Government and on the views of private entrepreneurs, as captured by two field surveys of 370enterprises carried out in seven cities in March and April 1998.

MOROCCO'S PRIVATE SECTOR TODAY: ACHIEVEMENTS AND LIMITATIONS

The Government has done much to promote private sector development (PSD), and these reforms havepaid off. A decade of successful macroeconomic stabilization, progressive economic liberalization andderegulation, and the launching of the privatization program have created a solid foundation for PSD. Sector-specific reforms - such as the development of a new legal and regulatory framework in the financial sector, thelaunching of on-the-job training programs, and the promotion of private participation in infrastructure (PPf) -have also improved the conditions for PSD. As a result, the private sector's contribution to GDP went from 64in 1985 to 73 percent in 1997, and its share in total exports went from 60 to 75 percent between 1985 and 1995.Foreign direct investment (FDI) has also increased significantly over the same period.

However, the performance of the private sector has fallen short of the high expectations generated bythe achievements of the 1980s. The private sector's share in investment has remained below 60 percentover the past decade and private savings have not risen. In addition, recent estimates show that total factorproductivity (TFP) growth has slowed considerably during the 1990s. Low private savings, investment, andproductivity, along with droughts and shortcomings in the performance of the public sector, have negativelyaffected the economy in general and the private sector in particular in recent years: non-agricultural realGDP grew at an average annual rate of 2.7 percent over 1991-97, in contrast with an average 3.9 percentgrowth per year over 1986-90.

CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT

The modest performance of the private sector suggests that the macroeconomic, trade, and privatizationpolicy reforms designed to establish a solid basis for PSD have not gone far enough. Key policiesfavorable to PSD have been maintained in the 1990s, but public savings are low and the fiscal deficit has beenfinanced through extensive borrowing from the rest of the economy. Two financing mechanisms, in particular,have been used by the public sector and have reduced the pool of resources available for private investment:government bonds, and accumulation of public arrears and late payments. In addition, fiscal prudence has beenachieved mainly through reductions in public investment that would have been complementary to PSD. Onanother policy front, the appreciation of the real effective exchange rate (REER) in the 1990s has hinderedMorocco's competitiveness. At the same time, while the Government has taken significant steps to open theeconomy, trade liberalization has not been rapid or uniform, and domestic competition has been limited byinappropriate regulations. Finally, the achievements of the privatization program have been relatively modest,leaving Morocco with a public sector larger than that of other countries at a similar stage of development.

This modest private sector performance is also due to institutional and sector-specific constraints thataffect the business environment. The findings of the two firm-level surveys indicate that in addition to sloweconomic growth, which has had a dampening effect on demand, and to other factors discussed above,entrepreneurs consider the following to be the most binding constraints to PSD: costly administrativeprocedures, scarcity of qualified and flexible human resources, and lack of access to and high cost of credit.

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The administrative procedures about which entrepreneurs complain, in their answers to the surveys, concernboth impediments to the creation of new enterprises and difficulties encountered by existing firms. Whileprocedures for the establishment of new enterprises are less time consuming than they were in the 1980s,they are still cumbersome by international standards and do not promote FDI for small and mediumenterprises. Concerning existing enterprises, difficulties relate mostly to tax administration and the judicialsystem. Procedures in these areas are considered inefficient, time consuming, and costly. Until recently,entrepreneurs also complained about customs procedures, but interviews in 1998 indicate that they arebeginning to notice positive changes due to computerization, streamlining of procedures (e.g., reliance onsample controls, which reduce clearance time), and a progressive change of the culture of customs, withauthorities taking the needs of users better into account.

The lack of appropriate skills is also at the forefront of entrepreneurs' worries. An unemployment rate of 25percent among young university graduates suggests that the main problem is a mismatch between the skillsof graduates and the needs of firms. The Government, through l'Office de la formation professionelle et dela promotion du travail (OFPPT), has launched a series of actions to make vocational training moreresponsive to firms' requirements, but further efforts are needed in that direction, and a long-term solutionwill require going beyond vocational training to correct the shortcomings of the formal education system.The slowdown of Moroccan exports demonstrates that having lower wages than the OECD countries is not asufficient condition to maintain competitiveness. High illiteracy rates and poor preparation of unskilledworkers are becoming serious burdens for firms attempting to survive in a more competitive environment.

Financial constraints appear to be less binding than in earlier years, reflecting the progress toward formalliberalization of the financial markets. These constraints do persist, however, and affect firms differentlyaccording to their size. For smaller firms, including microenterprises, the problem is, as it was in 1994, thelack of access to credit: these firms are frozen out of the formal financial system, and financial NGOs cancater only to the needs of a limited number of businesses (an issue that is being addressed, in part, throughthe recently approved law on micro-credit). For larger firms that have established formal relations withbanks, the main problem is the paucity of medium and long-term financial instruments, and to a lesser extentthe cost of credit. Banks still prefer to acquire widely available low-risk government bonds rather than tolend to the private sector; and even though capital markets are developing, they are not yet a real alternativeto the banking system in supplying private sector financing.

Finally, there is another set of constraints, less severe than the ones already discussed but likely to becomemore important as the economy grows and economic globalization progresses. These constraints include:the lack of well-equipped industrial land; the high price and poor quality of infrastructure services ingeneral, as well as the lack of such services in rural areas; and the lack of technology and marketinformation support services. The specific nature of these constraints and possible measures to alleviatethem are not further discussed in this Executive Summary but are elaborated in the main text.

AN AGENDA FOR PRIVATE SECTOR DEVELOPMENT

To enable the private sector to become the main engine of growth in the Moroccan economy, there is need forfurther reforms on several fronts. Many of those have already been outlined in the Government's "Economicand Social Reform Program," which accompanied the World Bank's 1999 Policy Reform Support Loan (seeReport No. 7287-MOR, May 5, 1999).

FURTHER FISCAL, TRADE, AND PRIVATIZATION REFORMS ARE ESSENTIAL

Implementing sound macroeconomic policies and removing barriers to competition and to private participationin economic activities currently in the public domain are essential to create the foundation for vigorous privatesector development. This involves several measures:

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Increase public savings and use public resources more efficiently to facilitate private investment. Alower deficit will reduce the public sector's need for credit from the rest of the economy and will free upresources for PSD. Contrary to past practice, however, the deficit reduction should not come at the expense ofinvestment expenditure (see section 2); instead, it should be achieved through an improvement of public sectorefficiency and a reduction of current expenditure, as the civil service wage bill now absorbs almost 45percent of fiscal revenues, and the debt service absorbs 23 percent. (see section 3.1). In this context, thecommitment of the current Government to achieve additional budgetary savings of 2.5 to 3 percentage pointsof GDP over the next 4-5 years is a cornerstone of a sound macroeconomic policy. In addition, improvingpublic investment expenditure within a multi-year plan to complement rather than substitute private investmentis also an important requirement.

Improve the competitiveness and productivity of firms by accelerating and broadening trade liberalization,by preventing further appreciation of the dirham in the short term and moving toward a more flexibleexchange regime in the medium term, and by strengthening laws and regulations to promote domesticcompetition. A more flexible management of the exchange rate would make Moroccan products morecompetitive and provide some degree of uniform protection to local producers during the phasing out oftariff protection under the Free Trade Agreement (FTA) with the EU. Advancing the FTA schedule of dutyreductions, applying such rules to all trading partners, and extending the agreement's scope to includeagriculture and services would yield further benefits. Finally, to promote domestic competition, the draftCompetition Law should be enacted and price controls reduced. To be effective, however, the CompetitionLaw will need to be complemented with other measures, such as creating a credible enforcement authority,reforming the judicial system, and restructuring monopolistic sectors.

Accelerate the implementation of the privatization program to improve efficient use of productiveresources and create a leaner, more efficient State. Parliament has approved new legislation that modifiesand complements the current Privatization Law (No. 39-89), including a provision to replace the principle ofa global "positive" list with an annual identification of firms to be privatized within a given fiscal year. TheGovernment has also established ambitious targets for privatization and liquidations to be achieved duringits tenure. It is now critical to accelerate the preparation of the privatization dossiers and advance theimplementation of the program.

INSTITUTIONAL AND SECTOR-SPECIFIC REFORMS ARE ALSO NEEDED

A series of measures needs to be taken to remove the most binding institutional and sector-specificconstraints affecting the business environment.

Reduce the administrative burden on enterprises by streamlining tax administration, making the judicialsystem more efficient, minimizing late payments by the public sector, and simplifying procedures for startingnew businesses. Tax administration procedures are still cumbersome. The simplification of the system,along with the publication of clear procedures, would go a long way toward reducing the scope for arbitrarydecisions.

Two sets of measures are needed to speed up judicial processes. First, the modernization of the overall legalframework needs to be completed by enacting the various draft laws: the Competition Law (currently beforeParliament), the Labor Code, the Customs Code, the Mining Code, and the Insurance Code. Second, the courtsystem needs to be strengthened and the quality of judicial decisions in commercial areas needs to beimproved through proper staffing of the new commercial courts, updating of the commercial law curriculumin universities, timely publication of judicial decisions, and extension to judicial support staff of the incentivesand skill-upgrading opportunities already available to judges.

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To minimize the occurrence of late payments by the public sector, corporatization could be used to increase thefinancial accountability of public entities that perform commercial functions. As for the administation itself, there isno substitute for appropriate budgeting and for designing incentives to promote good financial perfornance.

Finally, further streamlining of the relevant procedures and consolidation of investment promotion agencieswith overlapping responsibilities are essential to facilitate the creation of new domestic enterprises andattract foreign direct investment, especially into small and medium enterprises.

Promote the development of a well-qualified and flexible labor force by providing better education andtraining to a larger portion of the population, and enhance labor mobility by removing legal and regulatoryrigidities. The Government should give priority to literacy programs and to improving basic education, withspecial attention to rural areas. In addition, the content of higher education and vocational training programsshould be revised to better tailor the qualifications of skilled workers to the real needs of the economy.Private participation in these areas could yield substantial benefits but would require a revision of currentlegislation. Finally, to facilitate the transition toward a more competitive and dynamic environment, theGovernment and associations of private entrepreneurs could assist smaller firms in improving theirmanagerial skills through training programs. At the same time, firms need to be well informed about theimplications of current labor rules and regulations, and about any subsequent changes in these rules.

Several legislative measures could also encourage firms to invest in a stable labor force. Adopting a modernLabor Code - with emphasis on facilitating flexible arrangements - would be a first step. In addition,strengthening the capacity and efficiency of courts and promoting effective out-of-court settlementswould expedite the resolution of conflicts. The current system of severance pay should also be revisedto improve labor mobility while providing a safety net during job search. One possible alternativewould be to replace the firm's obligation to pay the worker at the time of dismissal with an obligationto make regular contributions to a fund owned by the worker, who could carry this fund across jobsand access the money at the time of his or her dismissal or retirement.

Facilitate the access of small enterprises to financial resources, help larger firms obtain longer-term loansunder more favorable conditions, and strengthen capital markets as an alternative source of long-termfinancing. Key measures to help small firms include: (i) increasing the lending capacity of financial NGOs,(ii) developing awareness and expertise among banks on how to make microfinance a profitable undertaking,and (iii) exempt from the current guidelines on taux d'usure and other prudential regulations those financialinstitutions that are seriously committed to micro and small firm finance. To increase the availability oflonger-term credit from banks, it will be important to: (i) enhance competition among banks by completingthe liberalization of interest rates, (ii) design better creditor protection, and (iii) promote the provision byfirms, and the use by banks, of transparent financial information. Equally important will be to promote thedevelopment of capital markets, which could provide an alternative to bank credit. To this end, furtherdeepening of the insurance sector and the development of sound pension funds, which under prudentregulations could invest in these markets, are two important initiatives that could broaden the range ofinstitutional investors in the capital markets.

This is a complex reform agenda. Morocco has shown its commitment to support private sectordevelopment and has already implemented a series of difficult reforms to improve the macroeconomic,fiscal, and trade foundations for private economic activities. It has also implemented other institutional andsector-specific reforms to improve the business environment. The challenge now is to build on thesesubstantial achievements so the Government can provide the best possible support to the efforts of theprivate sector to become the engine of growth in an open and dynamic economy.

1. INTRODUCTION

The private sector assessment published in 1994 (the 1994 PSA) provided a wide-ranging assessment of theprivate sector in Morocco and suggested actions to remove identified constraints to private sectordevelopment (PSD). Much has changed since that time. New policies have been adopted and the externaleconomic environment has been rapidly evolving. Nevertheless, the performance of the economy ingeneral, and of the private sector in particular, have not lived up to the expectations that developed over theprevious decade. This report attempts to take stock of the economic changes, identify the key constraints toPSD, and propose a reform agenda to eliminate those constraints and enable the private sector to contributemore fully to the welfare of the Moroccan people.

This report draws on inputs from numerous colleagues both within and outside the Bank and onconsultations with Moroccan Government officials, private sector investors and operators, and academics. Italso builds on two 1998 surveys of 370 private firms. The main volume presents a synthesis of thediagnostic and recommendations, which are further elaborated in a series of annexes.

Following this introduction, section 2 concisely describes the economic performance of the economy duringthe 1990s. Section 3 describes the main achievements and shortcomings of the economic policies over thelast decade and their impact on PSD. Section 4 complements this analysis by highlighting the keyconstraints to private sector activities as perceived by the entrepreneurs themselves. Finally, section 5proposes key components of a short and medium-term reform agenda to facilitate private sectordevelopment.

2. RECENT ECONOMIC PERFORMANCE

This section summarizes the performance of the economy in general and the private sector in particularduring the 1990s. Key performance indicators show that, while the economy grew at a high rate in the1980s owing to the development of exports, there has been an overall slowdown in the 1990s. These resultssuggest that, although the private sector is an important actor in Morocco, it has yet to become the country'sengine of growth.

GDP growth has been slower than expected and also more volatile.

Over 1991-1997, real GDP growth averaged 2.2 percent, compared to an average growth of 4.5 percentduring 1986-1990. Average annual per capita income growth was 2.3 percent during the earlier period butonly 0.2 percent during the more recent one. Weak growth partly reflected the effects of the droughts onagricultural output, but non-agricultural production also slowed, from an average annual growth of 3.9percent during 1986-90 to 2.7 percent during 1991-1997. With 49 percent of the population living in ruralareas, bad agricultural years have a particularly damaging effect on the economy, not only because of thedirect impact on GDP, but also indirectly because of the general reduction of demand due to lowerdisposable income in the countryside.

Unemployment continues to be high in this slowly growing economy.

After having reached 23 percent in 1995, urban unemployment has been declining, largely because ruralmigrants who came to the cities during the drought are now returning to the countryside. However, urbanunemployment is still high at 18 percent, and current trends are disturbing, with the urban labor forcegrowing consistently at about 5 percent. In contrast, employment in urban areas is growing at only 4percent. While the data on unemployment may overstate the problem because many Moroccans work inthe informal sector and in rural areas, the fact is that these jobs often are a form of underemployment dueto their low productivity. Sustained economic growth of 7 to 8 percent would be required to bring urbanunemployment below 10 percent by 2010 (World Bank, 1998a).

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Slow growth reflects low investment and low savings.

Morocco's current investment rate of about 20 percent of GDP is too low to fuel rapid economic growth (anestimated 27 percent or more is needed for a 3 percent increase in the rate of growth of GDP). Thedominance of the public sector in productive activities has had a detrimental effect on investment, not onlybecause public investment tends to be less productive than private investment, but also because of thedrastic reduction of investment expenditures that came with the fiscal austerity program (see section 3.1).Investment growth is also hindered by the paucity of financing resources, with the low level of domesticsavings (15 percent of GDP) due to low growth in recent years, the limited penetration of the bankingsector, and the Government's large borrowing requirements. In addition, the high level of external debt(around 50 percent of GDP) severely constrains the country's capacity to borrow on international markets.

Morocco has become more attractive to foreign investors.

Foreign investors' perceptions of Morocco have certainly improved, and foreign direct investment (FDI) asa percentage of GDP has recovered from a temporary low in 1995, reaching 1.5 percent in 1997 (excludingprivatization receipts; see Table 1). In addition, credit rating agencies have been upgrading theirassessments of Morocco slowly, but constantly, since 1987. And although the ranking of Morocco by theInstitutional Investor relative to other countries temporarily declined in the period 1993 to 1997, it hasrecovered to its previous level.

Table 1: FDI in Morocco and Other Countries (percent of GDP)

FDI as % of GDP 1992 1993 1994 1995 1996 1997Czech Republic 3.59 1.82 2.16 5.03 2.53 2.50Greece 1.16 1.06 0.99 0.92 0.86 1.25Hungary 3.95 6.06 2.76 9.97 4.39 4.56Israel 0.82 0.88 0.84 2.28 2.57 3.47Jordan 0.80 -0.62 0.05 0.20 0.24 1.00Morocco 1.49 1.84 1.82 0.88 0.85 1.49Pakistan 0.69 0.67 0.80 1.17 1.19 1.30Philippines 0.43 2.28 2.48 1.97 1.83 1.53Portugal 1.98 1.83 1.44 0.65 0.65 1.69Spain 2.30 1.70 1.94 1.11 1.11 1.05Tunisia 3.38 3.15 2.76 1.47 1.29 1.90Turkey 0.53 0.35 0.47 0.52 0.40 0.32Sources: UNCTAD, FDI/TN database (1997 United Nations Investment Report),GDF and WDI Indicators, World Bank 1998.

Productivity growth has been slow and falling.

Weak GDP growth in recent years has been accompanied by lower productivity in the use of resources.Recent estimates of the change in total factor productivity (TFP), which indicates the percentage ofgrowth that is not due to an increase in the use of capital or in workers hired, show that increasedproductivity accounted for 38 percent of overall growth in 1984-90, when significant progress was madetoward structural adjustment, but has accounted for practically zero during the 1990s (Belghazi andBouhia, 1997).

External factors have also contributed to the economic slowdown.

Periodic droughts and the economic slowdown in Morocco's main trading partners explain to some extentthe poor performance of the private sector. In addition, while economic liberalization offers great potentialbenefits from the access to larger markets, it also has increasingly exposed the economy to outside eventsand is forcing Moroccan firms to confront a larger array of competitors. For example, as a result of the

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GATT Uruguay Round, Morocco's preferential access benefits will be reduced. Furthermore, quotas underthe Multifiber Agreement are to be phased out and Morocco will face increased competition in itstraditional European Union textile markets.

It is therefore not surprising that economic results in Morocco are being increasingly affected by theeconomic policies and outcomes of its principal trade partners. In particular, after 1991, the EU, a majormarket for Moroccan exports, experienced an economic slowdown that reduced its capacity to import andaltered its expenditure patterns.' At the same time, the opening of Eastern Europe provided the Westwith new opportunities to invest in countries with cheap labor closer to the EU markets. Cheaper Asiantextiles also began to compete with Moroccan exports. Finally, EU trade policies created a series ofquotas for products that favored traditional competitors of Morocco, such as Spain and the CanaryIslands. All these factors contributed to the slower growth of Moroccan exports.

Private sector activity lacks diversification away from agriculture, despite strong potential in otherareas such as tourism.

The flexibility to channel economic resources toward more productive activities has been a characteristicof rapidly growing economies. Morocco's economic structure, however, has remained largely unchangedfor 25 years, with not much increase in the non-agricultural sectors of the economy (see Table 2). Thechronic susceptibility of agriculture to periodic droughts makes this lack of diversification even more of aburden as the country attempts to achieve sustainable long-term growth. Production pattems also havenot changed in other sectors, such as manufacturing, since 1985.

Table 2: Morocco - Composition of GDP (percent of GDP)

1980 1985 1990 1995 1996 1997GDP at market prices 100.0 100.0 100.0 100.0 100.0 100.0Agriculture 18.4 16.6 17.7 14.6 19.3 15.4Industry 30.9 33.4 32.4 33.0 31.0 33.0Manufacturing 16.8 18.6 18.4 18.4 17.1 17.7

Mining & quarrying 4.6 4.3 2.5 1.8 1.8 2.2Construction 6.3 5.7 5.3 4.4 4.2 4.6Gas, elect. & water 3.2 4.8 6.1 8.4 8.0 8.4Services 50.7 50.1 49.9 52.4 49.7 51.6

of which Administrations 11.9 11.5 11.9 13.2 12.8 13.6Source: Office des Changes, 1998.

The lack of diversification is also apparent inthe country's failure to develop activities Figure 1 Tourism Receiptsactivities ~~~(Percentage of GDP)that have strong economic potential. 6.0%

Tourism is one case in point. The country 5.0%

has exceptional tourism potential, stilllargely unexploited, with a wealth of 4.0% -

attractions (cultural and wild nature sites, 3.0 - /

resorts, golf courses, convention centers) 2.0% -

appealing to various types of tourists. In 1.0% _addition, its year-round tourist season setsMorocco apart from its closest competitors, Source: Office des Changes.

Nevertheless, the fact remains that the reduction in Moroccan exports was larger than the reduction in the rate of growth of the EUeconomy, indicating that the loss of export revenues also reflected a loss in market share to more competitive exporters (Riordan,1996).

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Tunisia and Turkey, which have more seasonal variations. But even with these advantages, Morocco hasfailed to exploit its tourism potential. With receipts that represented 4.7 percent of GDP in 1998, tourism isthe second most important source of foreign exchange, after transfers from Moroccans working abroad (seeFigure 1). Yet this contribution to GDP is well below that of Greece at 15 percent, Turkey at 10.6, and 10percent of GDP worldwide. Morocco also attracts far fewer intemational tourists than other similarcountries: 1.7 million in 1997, compared to 4 million in Turkey and 3.7 million in Egypt. In addition,Morocco's share of the world tourism market has declined steadily, from 0.53 percent in 1985 to 0.36percent in 1994. A recent study (Tomatis, 1998) identifies the following causes of this poor performance:the absence of a clear strategy to develop the sector, the inefficiency and multiplicity of institutions incharge of the sector, the lack of maintenance of tourism infrastructure (hotels built during the 1970s anduntil recently operated by the Government), and higher transportation costs to Morocco than to alternativedestinations.

Export growth, while slower than in the 1980s, continues to play a leading role in growth andemployment.

The export industry is key to generating growth and employment in Morocco: comprising only 25percent of industrial enterprises, it employs 60 percent of manpower and produces more than 50 percentof industrial output. Overall, exports have contributed 27 percent to GDP during 1990-97. However,with an annual average increase of 5.3 percent in 1992-1996, which was below the world level of 6.8percent over the same period, the overall growth of exports has not matched the expectations created bythe increasing globalization of the Moroccan economy.

However, efforts have not gone far enough to realize the full potential of export-led development. Asignificant share of exports remains concentrated in a few markets and products, although there havebeen some efforts toward greater diversification.

Clearly, Moroccan firms are trying to adapt to the new international environment (Belghazi, 1998d).First, more than half of Moroccan exports belong to markets where Moroccans have been gaining marketshare, even though Moroccan firms have also lost shares in various markets to more efficient competitors(e.g., exports of shirts, where China has displaced Morocco in the French market). Second, not allexports have lost dynamism in the 1990s. Exports produced under the regime of "temporary admissionwithout payments" (TA), where raw materials are temporarily imported and processed and final outputsre-exported, grew at an annual average of 21 percent between 1992 and 1996 (see Figure 2). Finally,while patterns of production in the economy as a whole have remained essentially unchanged, thecomposition of exports itself has experienced a significant evolution away from primary products towardmanufactured items during the last two decades: in 1996, manufactures accounted for 38 percent of totalexports, up from 16 percent in 1980.

Nevertheless, much work remains to be done ifMoroccan exports are to become again, as in the late FigLre: 2 Structure of Expot (DH million)

1980s, the key source of growth. The TA exports that sooo-are driving export growth today demonstrate the ability 40000-

35,000- of Moroccan entrepreneurs to respond strongly to 30000-

favorable incentives. However, they tend to have low 25,0000 -

domestic value-added, and, as tariff exemptions benefit 1:000W -Lonly the final output, generate only limited backward 50O T-links to other domestic industries. Moreover, it remains i9s 1ssa 1994 o19 .99s 1997 199

true that the process of export diversification needs to be Exports of Goods (FOB), excl. TAdeepened. Exports remain concentrated in a few items Exportabons under temporary admissions (TA)

and a few markets. For instance, in 1996 there were only OdesC

5

four main manufacturing exports: fertilizers, knit fabrics, clothing, and electronic products. For two of theseproducts, a single country, France, accounted for the large majority of demand: 61 percent for clothing and71 percent for electronics.

3. ECONOMIC POLICIES IN THE 1990S

By the early 1990s, after a decade of successful macroeconomic stabilization, progressive economnicliberalization, and deregulation of the economy, a solid foundation for PSD had begun to be established.Since then, the Moroccan authorities have broadly maintained macroeconomic stability; they have launcheda privatization program and implemented other microeconomic and institutional changes favorable to PSD.They have also pursued the integration of the country into the global economy by signing variousinternational agreements. Nevertheless, the disappointing performance of the Moroccan private sector inrecent years, even accounting for the influence of exogenous events, suggests that policy reforms have notgone far enough. An effective incentive framework has yet to be built to induce Moroccan firms to becomemore efficient and enable them to successfully perform in larger, more competitive markets.

3.1. Foundation for private sector development

The 1980s witnessed successful macroeconomic stabilization and progressive liberalization andderegulation of the economy, which translated into strong growth.

Morocco's impressive stabilization effort in the 1980s, supported by large debt relief and structuraladjustment lending, led to a reduction of the fiscal deficit from an average of 11.6 percent of GDP in 1980-1985 to 5.3 percent in 1986-1991. In addition, a 40 percent real depreciation in the early 1980s increasedthe attractiveness of Moroccan products. The gradual shift from an inward-looking, public sector-ledeconomy toward a more outward-looking one, with an increasing role for private entrepreneurs, was alsoreflected in progressive liberalization and deregulation of the economy. By 1993, trade barriers had beenreduced: quota coverage went from 66 to 15 percent of imports, the range of import levies was substantiallydecreased, and most export taxes were eliminated. Foreign exchange controls were relaxed, achieving fullconvertibility of the current account in early 1993. Price and margin controls were lifted for many goods,and, after a slow start, the privatization program took off in 1993. GDP grew at an annual average rate of4.5 percent over the 1986-90 period (compared to 2.1 percent for the world and 0.3 percent for the MiddleEast and North Africa region). Exports grew at an impressive 9.3 percent during the same period. Foreigndirect investment also grew exponentially, from about US$1 million in 1986 to US$317 million in 1991.

Key policies favorable to PSD have been maintained in the 1990s, but low public savings havereduced the pool of financial resources available for private investment. In addition, efforts at fiscalprudence have come at a cost to PSD, as there has been a drastic reduction in public investment toachieve budget equilibrium.

The fiscal burden has been progressively lightened, from 27 percent of non-agricultural GDP in 1993 to about24 percent in 1997. A particularly impressive achievement has been the reduction of the effective corporate taxrate for domestic finms, from 50.3 percent (manufacturing) and 44.2 percent (services) in 1986 to 24.2 percentand 19.9 percent, respectively, in 1995 (Sewell et al, 1996). Fiscal prudence has been preserved with arelatively limited fiscal deficit, averaging about 3.7 percent of GDP in 1992-1997 (see Table 3).

6

Table 3: Morocco - Selected Economic Indicators (percent of GDP)

1991 1992 1993 1994 1995 1996 1997 1998Gross Domestic Investment 22.6% 23.2% 22.5% 21.3% 20.7% 19.6% 20.70%. 22.6%Gross National Savings 21.6% 22.1% 20.9% 19.0% 17.3% 19.7% 20.4% 22.3%Budget deficit (1) -3.1% -2.2% -3.3% -3.9% -5.6% -4.4% -3.7% -4.7%(1) Excludes privatization receipts. Fiscal data are in calendar year and includes VAT transfer to local municipalities.Source: Statistics Office; Ministry of Finance.

Reducing Morocco's fiscal deficit has been sound policy, but its positive impact on economic activity hasbeen reduced by the way cut in spending were achieved. Rather than reducing current expenditures,Morocco has relied on drastic cuts in public investment, which was supporting the development of theeconomy and complemented private sector investment. Accordingly, this reduction contributedsignificantly to the slowdown in total investment (see section 2). Furthermore, the civil service wage billnow absorbs almost 45 percent of fiscal revenues, and the debt service absorbs 23 percent. The currentstructure of public expenditure (mostly wages and debt service) makes it difficult to absorb exogenousshocks, because reducing the debt service would require restructuring the stock of debt, and reducing thewage bill would require difficult negotiations among groups with conflicting interests.

The current level of the budget deficit is still significant, however, and has a negative impact on theresources available to the private sector. The abundant supply of low-risk government bonds financing thedeficit has meant that banks and other financial institutions feel less pressure to expand their base of privateclients or to develop new financial products. Most importantly, the considerable public arrears and latepayments of the public sector to both private and public enterprises amount, in fact, to a form of credit grantedinvoluntarily by these firns, which takes away resources that could be put to more productive use. Theimportance of the problem is confirmed by the PSA surveys, in which entrepreneurs said that public andprivate payment delays are among their main binding constraints.

The appreciation of the real effective exchange rate (REER) over the 1990s has hindered firms'competitiveness.

The decrease in inflation, from 6 percent in 1992 to an estimated 1 percent in 1999, has been accompanied by a18 percent real appreciation of the dirham in the 1990s (see Figure 3). This problem has been exacerbated bythe fact that the real exchange rates 6f a number of Morocco's competitors have depreciated faster over the lastfew years. The appreciation of the REER reflects a combination of factors linked to the evolution of thenominal exchange rate and the slow growth in productivity of Moroccan producers. This deterioration inrelative prices clearly contributed to the slower growth of Moroccan exports during the 1990s (see section 2).Sales to African countries that had been opening to Moroccan products in the 1980s have been particularlyaffected because these countries exhibit a greater sensitivity than the OECD markets to price changes. Finally,the appreciation of the dirham has also favored imports of capital equipment, increasing the capital-labor ratioto the detriment of labor.

Figure 3. REAL EFFECTIVE EXCHANGE RATE AND EXPORTS

1 3 0 .0 -- ---------------------

120.0:

1100=

70.0

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1998 1997

+ REER index -export volume indexSourxe: lMFflxtrx,na,ioxxt Finaxx/el Sta Ostixx end 04 o,cxxx authoflhixs.

7

Economic liberalization has continued in the 1990s, albeit at a slower pace. But competitivepressures remain insufficient, since trade liberalization has not been uniform.

The Govemment has taken several measures during the 1990s to foster economic liberalization. To startwith, the import-weighted tariffs declined from a peak of 20 percent in 19934 to 16 percent in 1996. Inaddition, Morocco adhered in 1993 to the GATT evaluation code, and signed the Free Trade Agreementwith the EU in 1996. The Govemment further liberalized the foreign exchange regime by allowing fullconvertibility of non-resident investors' capital accounts for portfolio investments, profit remittance, andrepatriation of capital.

Nominal tariff protection is still relatively high, however, compared to some of Morocco's key competitors.More than 50 percent of agricultural goods are subject to a tariff of 25 percent or higher, and almost 30percent of non-agricultural imports are subject to a tariff of 32.75 percent or higher. Such levels ofprotection are detrimental to the efficiency of domestic producers and to the development of a strongexport-oriented economy. Morocco has also tended to offer the highest degree of protection to some ofthe weakest segments of its economy, thereby promoting an inefficient allocation of resources. Inaddition, the commitments to further decrease tariffs under international agreements will only take place overtime. The FTA, for example, is to be implemented over a period of 12 years following the agreement'seffectiveness. Further drawbacks include the fact that tariff reductions for items manufactured in Morocco willbe phased out last, while tariffs on raw materials and capital equipment will be eliminated within the first yearof the FTA's effectiveness, so that the effective level of protection for goods manufactured in Morocco willactually be higher for up to five years following effectiveness. Although the FTA with the EU iscomplemented by free trade agreements with members of the Arab League and with other countries, and otherfree trade agreements are envisaged, a number of important trade partners will, in all likelihood, not benefitfrom import liberalization. The FTA thus could entail trade diversion and might give rise to additional controlsto verify declarations of origin. Moreover, the FTA does not cover services, and the schedule of tariff reductionon agricultural products will not be negotiated until 2000. Finally, while a new unified Investment Code wasadopted in December 1995 with the aim of attracting foreign investment, and despite the growing confidenceof intemational investors, the requirements to establish businesses in Morocco remain cumbersome.

Competitive pressures in domestic markets are still limited.

In view of the high level of concentration in the economy (see annexes I and 2, and Table 4 below) and theanecdotal evidence on collusive behaviors (see section 3.2), promoting competition beyond tradeliberalization remains a key objective of policies in favor of private sector development. Since 1994,significant steps have already been taken. Price controls, which covered about 172 product categories in1993, now apply to only 29 goods and services. A draft Price and Competition Law to supersede the 1971legislation is currently awaiting approval by Parliament. The Government has issued new regulations toenhance transparency in procurement, but contracts are outdated and lack safeguards to ensure transparentand competitive procedures. It is now important to deepen these reforms.

Table 4: Structure of Industry in 1997, by Firm Size (no. of employees)

Enterprises Production Exports Investment

Firmsize No. % M. DH % M. DH % M. DH %Small <50 4737 74.0% 25249 17.0% 4414 12.1% 1668 18.2%Mediurn >=50, <200 1195 18.7% 44004 29.6% 7849 21.5% 2543 27.7%Large >=200 467 7.3% 79456 53.4% 24242 66.4% 4969 54.1%Total 6399 100% 148709 100.0% 36505 100.0% 9180 100.0%Note:. Includes private and public enterprises.Source.- Ministere du Commerce, de lI'ndustrie et de l'Artisanat.

8

After a slow start, the privatization program began implementation in 1993. However, 577enterprises are still in the public portfolio, including minority participations in commercialenterprises. A vigorous effort to further pursue the program is needed.

The Privatization Law, adopted in 1989, laid the foundation for the privatization program with a list of 113firms to be privatized by the end of 1998. After a slow start, the program began to be implemented in 1993,tallying DH 15.3 billion (of which DH 13.1 billion accrued to the government budget), with 52 EPICS(etablissements publics a caractere industriel et commercial) and 125 of their subsidiaries privatized by 1998.A number of large enterprises have thus been privatized, resulting in significant fiscal revenues. In addition,the Government is currently implementing the liquidation of Charbonnage du Maroc (CDM) and the Societed'exploitation des mines du rif (SEFERIF). This is an important and courageous decision on the part of theGovernment, which has taken into account both the economic needs of the country and the social impact of theliquidation on the region.

Divestitures of the remaining 61 firms from the first list, however, are still pending. Many of the candidates arein financial difficulty and need to be liquidated. The human and financial resources needed for liquidation arerelatively modest and postponing liquidation only increases the waste of productive resources. These firnsalso have a negative impact on the financial performance of other private firms. Other important transactionscurrently in the pipeline are also waiting be completed, which requires that Parliament authorize the transfer(e.g., the Banque commercialepopulaire, BCP) or that the Government deregulate the sector (e.g., sugar mills).

In spite of advances in the pnvatization program, the relative importance of the public sector in overall valueadded and investment has, in fact, changed little between 1990 and 1997 (see Table 5). As of end-1998, therewere still 573 enterprises under direct or indirect public ownership (56 EPICs and 517 subsidiaries, all ofwhich are incorporated in soci&es anonymes). The persistent direct participation of the public sector in theeconomy hinders growth for various reasons. While some public enterprises have improved their performancein recent years (see section 3.2 below), intemational experience suggests that public entities are often lessefficient than private firms, and that their presence decreases the overall performance of the economy. Equallyimportant in the case of Morocco, the dominant position of the public sector in the economy has magnified thenegative impact of the drastic cuts in public investment on the rest of the economy (see above).

Table 5: Share of Public Enterprises in the Moroccan Economy1990 1997

Value added (% of GDP) 13.4 13.0Salaries (% of GDP) 4.5 4.6Investment (% of total investment) 24.3 22.2

Sources: Ministere des finances et des investissements ext&rieurs, Direction des etablissementspublics et de participation, avril 1998.

3.2. Institutional and Sector-specific Reforms

The legal framework for commercial activities has been partially modernized, but the administrationof business regulations is still perceived as slow and cumbersome, increasing transaction costs forfirms.

A new Investment Code (1995) has replaced the old sector codes. It covers all commercial activities withthe exception of agriculture, and generalizes key incentives, which, under the sector codes, were availableonly to selected enterprises and regions. The new Law on Joint Stock Companies (1996) provides, interalia, for minority stakeholder protection and for more rigorous corporate govemance on the part ofmanagers. The Code des societes (1997) provides businesses with a variety of instruments to choose fromwhen constituting themselves as corporations. The Commercial Code (1997) makes it possible, for the firsttime, to address bankruptcies, liquidations, and reorganizations at an early stage. The Law Creating theCommercial Courts (1998) gives authority to the newly created courts in all matters related to businessactivities. Finally, the Competition Law has advanced to Parliament, and the Cabinet has approved a

9

revised Customs Code. However, other important texts - notably the Labor Code, the Mining Code, and theInsurance Code - have been in preparation for years, but are stalled pending legislative or executive action.

In addition to these advances in the legal framework, tax rules have been modified to reduce the fiscalburden on business (see section 2). Finally, the Government authorities have initiated a comprehenisivereform to modernize customs administration in recent months, resulting in a reduction of clearance time forimports from several days to some 8 hours in average. This demonstrates the potential for efficiency gainsunder strong leadership with clear objectives.

The new laws and the other reforms described above constitute real progress. Now attention needs to shift tothe application and enforcement of the laws and the streamlining of administrative procedures. Theadministration of business regulations remains characterized by a lack of transparency, overemphasis oncontrolling business activity, and excessive scope for discretion. The issues that pose the most seriousproblems, as shown in the surveys discussed in the next section, relate principally to tax administrationand the judicial system. Procedures in these two areas are considered inefficient, time consuming, andcostly.

Despite Government's efforts to modernize and rationalize the system, tax administration remains one of themain areas of complaint. The national tax administration has introduced a unique fiscal identificationsystem and reduced the number of tax forms. There remain, however, more than 30 different tax-relatedforms at the national level. Entrepreneurs complain about the complexity of the system, the scope forarbitrary decisions, and the frequency of errors by the tax authorities (about 40 percent of those surveyedthought they had been charged too much on one or more occasions).

The length and lack of transparency of judicial processes have emerged as the most important issue for theMoroccan legal system. It is expected that the ongoing reform of the judiciary system, including theestablishment of commercial courts, will help to address this issue. For the time being, however, judicialprocesses remain slow and unpredictable, in part because judiciary staff do not have sufficient expertise inspecific areas (labor law, for instance). In addition, laws are often complex and ill suited to the localcontext, new laws are sometimes not well publicized, and essential application decrees take years to beissued, all of which contributes to the lack of transparency.

Finally, although establishing a new business in Morocco takes less time now than in the 1980s,procedures are still cumbersome by international standards and do not promote FDI for small andmedium enterprises. Late payments by the public sector and corruption (which is the target of aconcerted effort by the new Government) are additional burdens.

The Government has continued to invest in public education and has developed vocational trainingprograms. These are important steps, but they have not been sufficient to raise the quality andmobility of human resources to the standards required in a more competitive environment.

Since independence, the Government has made a systematic effort to improve the absorptive capacity of theformal education system, and vocational training has been offered since 1974 by the Office de la formationprofessionnelle et de la promotion du travail (OFPPT). Nevertheless, industrial surveys by the Observatoire in1994 and the 1994 PSA both identified the shortage of skilled workers as one of the main constraints forbusiness in Morocco.

To solve this problem, the Government has taken various steps in recent years to strengthen the publiceducation system and make training programs more responsive to the demands of firms. The SocialPriorities Program (BAJ)2 adopted by the Government includes the expansion of basic education as a

2 Barnamaj al-Aoualaouiyat al-ljtimaya in Arabic.

10

main objective. On the vocational training front, OFPPT has started to develop programs to upgradeworkers' skills within firms, and to retrain the unemployed. The Government has also supported, as partof an overall strategy to facilitate the mise a niveau of the firms, the creation of non-governmental inter-professional organizations, Groupements interprofessionnels d'aide au conseil (GIACs), to assistenterprises in defining their needs and to carry out training programs. This program is still at an initialstage, but GLACs could be an important interlocutor in the private-public dialogue to improve laborefficiency and the living standards of workers. Finally, the private sector has also started to be moreinvolved in the design and implementation of programs to upgrade workers' skills. A case in point is thecreation of ESNITH (Ecole superieure nationale de textiles) by AMITH (Association marocaine desindustries textiles et de 1 'habillement) with the collaboration of OFPPT and the financial support of the EU.

These measures are an important step to improve the quality and mobility of the labor force in Morocco.Nevertheless, they appear to be insufficient in view of the slow growth in labor productivity, the overallmodest economic results, and the evidence revealed by the interviews with private entrepreneurs (seesection 4). However, illiteracy remains high, and the mismatch between the profile of higher-educationgraduates and the needs of firms persists.

This challenge arises, in part, from the development strategy adopted by the country, which creates morejobs but also imposes new demands on the labor force: economic globalization sets higher qualitystandards for products and requires better preparation even for unskilled jobs. The latter becomesparticularly relevant since illiteracy rates in Morocco, especially in rural areas, are among the highest inthe region, and rural emigrants constitute an important source of job-seekers in the cities during badharvest years.

Problems also arise, however, from the limitations of the Government's current strategy for formal educationand vocational training. The Government has allocated considerable resources to education, but resources havenot been used efficiently in either area and there has been a bias in favor of secondary education. Similarly,vocational training has always been considered an important tool to upgrade workers' skills, but the programsstill reflect the priorities of absorbing unemployed youth rather than giving workers the skills needed byenterpnses, and focus more on the insertion of first-time job seekers than on the reinsertion of displacedworkers. Finally, in spite of the shortcomings of the public-led strategy, the rules and regulations providelukewarm support to the development of private alternatives, even though the existing private institutes enjoyconsiderable demand for their services.

There is also a lack of efficient channels for firms to voice their specific needs despite the creation ofGIACs. These institutions are still at the take-off stage, have very limited capacities, and seem to haveadopted a wait-and-see attitude toward the Government. Finally, in spite of the tripartite composition ofthe board of directors, OFPPT as an institution has few incentives to become more responsive to itsclients, since its survival does not depend on demand for its services, but on the earmarked proceeds ofthe vocational training tax (73 percent of its 1994 budget).

In addition, although they are often overlooked, outdated labor laws, and lengthy judiciary processesincrease the cost of managing human resources and discourage firms from hiring a stable work forceand investing in human capitaL

Labor transactions are ruled by 1921 legislation that puts strong emphasis on job security by making it verycostly to fire pernanent workers. The legislation has, in fact, acted as a deterrent for employers to hirepermanent employees. Relying on temporary workers has given considerable flexibility to the Moroccan labormarket, but at the cost of stable jobs and investment in human capital. High social charges in the organizedprivate sector (from 21.7 to 35 percent of gross salary) also increase the cost of hiring permanent workers anddiscourage firms in the informal sector from integrating into the mainstream economy. Finally, the absence ofquick conflict resolution mechanisms and the judiciary's lack of expertise in labor issues increase the cost ofmanaging human resources within legal boundaries.

11

Distorted incentives in the public sector, mostly delinked from economic considerations, alsocontribute to luring workers away from the private sector.

Employment conditions, i.e., job security for all workers and inflated wages for unskilled workers, arestill more attractive in the public sector, although the number of new jobs offered has been declining inline with the program of fiscal austerity and transfer of public enterprises to private ownership. This hasresulted in a rising rate of unemployment among qualified workers, who are willing to endure longerwaiting periods, and in a dichotomy between a protected minority of unskilled public servants, on the onehand, and a majority of marginalized workers with low wages and scant social protection in the informalsector, the rural areas, and the traditional export sectors, on the other.

The legal framework for financial intermediation also has improved considerably, but the access tofinancial resources, and to a lesser degree the cost of these resources, remain important constraintsthat reduce the pool of financial resources available for PSD.

Two new pieces of legislation (the Banking Law and the Securities Law) have contributed to updating andstrengthening the legal framework for financial intermediation. The plancher des effets publics (PEP),under which banks had to hold a certain percentage of sight deposits in below market rate Treasury bonds,was eliminated in June 1998. Absolute maximum lending rates also have been abolished and replaced by arelative ceiling or taux d 'usure,3 while preferred time deposit rates have been removed, with the exceptionof passbook deposits, which still have to be remunerated at 6 percent minimum. Finally, while stateownership in the financial sector remains high, it has steadily decreased and is now about 30 percent of totalassets and 24 percent of banking capital.

Moroccan authorities have also recently begun to address the urgent need for restructuring of the main publicbanks, which are in serious difficulty. The Cabinet has approved legislation that transforms the rural creditinstitution, Caisse nationale de credit agricole (CNCA), into a joint stock company. The Cabinet has alsoapproved a change to the statutes of BCP, to allow divestiture of state-owned shares to its regional network ofbanks (banques populaires). Finally, the authorities are fully aware of the need to conduct an intemal reviewof the Credit immobilier et h6telier (CIH), which has been severely affected by the lackluster perfonnance ofthe tourism industry, before a restructuring plan can be designed and implemented.

In addition, the authorities are formalizing the status of financial NGOs, or Associations de micro credit(AMCs). These associations play a key role in providing financial resources to the tiniest microenterprises(self-employed entrepreneurs), although their institutional capacity is insufficient to satisfy the existing demandof these firms.

The takeoff of the Casablanca Exchange Stock Market (Societe de la bourse de valeurs de Casablanca,SBVC) is another welcome development that should help increase the availability of long-term funds. As ofDecember 1997, 49 firms were quoted on the SBVC and market capitalization had increased substantially,from 5 percent of GDP in 1993 (DH 1.3 billion) to 37 percent of GDP in 1997 (DH 117.9 billion, orUS$12.3 billion).

Despite the liberalization of banking regulations, the development of the SBVC, and the increased activityof financial NGOs, the access to and cost of financial resources are still constraints that limit private sectoractivities in Morocco, albeit not as much as reported in the 1994 PSA. The nature of the problems varysignificantly, however, by the size of the firm. For smaller and microenterprise -firms, the main problemremains the mere access to financial resources, especially from the formal banking system, which does not

3 The taux d'usure limits to 1.7 times the weighted average of lending rates the maximum annual effective rate that can be charged byany financial institution licensed under the Banking Law.

12

see these firms as profitable lending opportunities. For larger firms with formal banking relationships, theirmain financial constraints are the paucity of medium and long-term financial instruments and the high costof credit.

The high cost of credit is due in part to insufficient competition in the financial sector. Until very recently,banks appeared to adhere to GPBM (Groupement professionel des banques marocaines) guidelines to setlending rates, and the evolution of rates as well as anecdotal evidence suggest that some collusion did keeprates at a certain level, although the general trend since 1997 has definitely been downward. In addition,competition is hampered by the fact that despite liberalization, various deposit rates remain regulated (sightdeposits cannot be remunerated, while interest paid on carnets de dep6t cannot be lower than 6 percent). InApril 1998, banks for the first time published their base lending rates individually rather than adhering toGPBM guidelines. This is certainly a positive development, but it is too early to say whether it marks thebeginning of a more competitive era.

Another reason bankers perceive lending to private investors as unprofitable is their lack of experiencemanaging investment credits. Evaluating the net worth and risks of business projects requires specific skillsthat are different from dealing with investment in Treasury bonds. In addition, cumbersome judiciaryprocesses (see Annex 5) increase the risk of lending to private entrepreneurs and explain why banks base theirdecisions more on tangible collateral than on a cash flow analysis of a project. Banks also lack the financialintermediation skills to make use of innovative techniques such as cash flow-based lending and informationtechnology to reduce transaction costs.

The insufficient availability of medium and long-term banking resources for the private sector is alsoexplained by the fact that some medium-sized firms have great difficulty adhering to the transparencyrequirements of the new accounting plan introduced in 1994. This reinforces bankers' tendency to basetheir lending decisions on fixed asset collateral and to discard financial accounts and cash flow projections.

These factors may help explaining why bank investments in Government bonds remain high despite thereduction in the reserve requirement and the elimination of the PEP in June 1998. Banks, in fact, decreasedtheir holdings of T-bills only marginally, from 28 percent of assets in 1994 to 27 percent in 1997.4 It is notclear whether their preferences came from the crowding-out effect of a large supply of low-risk T-bills,which gives these institutions little incentive to compete aggressively for private sector clients, or from thescarcity of private investment projects worth lending to. Further research is needed to understand the rootsof this problem.

Capital markets in Morocco have yet to become a real alternative to the banking system, although they havebeen very active in recent years. Market capitalization on the SBVC has increased, but this has beenaccompanied by lower liquidity ratios (from 21.7 percent of market capitalization in 1993 to about 15 percentin 1997). One problem is the lack of transparency of the rules governing the stock market, combined with thelack of capacity of the supervisory body, the Comite d&ntologique des valeurs mobiliaires (CDVM), toenforce those rules. High transaction costs imposed by the SBVC on securities trading also deter investorsfrom participating in the market and companies from seeking a listing. Bonds and commercial paper are also inshort supply because, among other reasons, corporations lack an efficient benchmark against which to pricetheir bonds in the absence of a market-determined yield curve.

The provision of infrastructure services has increased considerably in the main urban centers.However, important problems still need to be solved: elimination of shortages of industrial land,resolution of cross-sectoral issues, and expansion to rural areas.

Current funds deposited under the PEP have been transformed into I 0-year deposits, and will therefore be gradually released into theeconomy. Funds deposited after June 30, 1998 are not subject to the PEP rule.

13

An issue related to the provision of infrastructure is the shortage of well-equipped industrial land andassociated services (trade facilitation, marketing, and technical and business services) to support PSD. Thisconstitutes a critical constraint to private investment in Moroccan industry.5 Administrative bottleneckshave contributed to the shortage of well-equipped industrial land. For example, the conversion ofagricultural and non-titled land into industrial land has proven very difficult. Also, various factors generatedisincentives for the private development of industrial land. First, there is the risk of unfair competition bypublic agencies, which have traditionally received land free of charge or at nominal prices. Second, theright of the private sector to occupy and use land belonging to the state is precarious: only leaseholds for amaximum of twenty years are allowed, and such interests can be canceled by the state with a mere threemonths notice and without possibility of recourse. Third, when the Government first turned to privateinvestors to develop and manage four industrial zones (Tangier, Nador, Nouaceur, and Jorf Lasfar), it couldnot attract foreign investors despite international bidding. This suggested that investment conditions werenot sufficiently clear or favorable to attract private investors. Private Moroccan investors have, since then,indicated an interest in some of these projects, in particular Tangier and Jorf Lasfar.

Water, electricity, and telecommunications services have clearly improved: a greater mobilization of waterresources has increased the country's hydroelectricity capacity, electricity shortages have all butdisappeared, and the quality of telecommunications services has greatly improved. The financial situationof some public service providers has improved as well, including stronger performance by Royal Air Maroc(RAM) and the Office national des chemins de fer (ONCF). Private operators have been involved ininfrastructure activities since 1984 in the area of bus transportation, with the concession of urban bus routes.In 1993 the inter-city bus company, CTM-LN, was privatized, and the trend has since spread to othersubsectors, notably electricity generation (in Jorf Lasfar) and water and electricity distribution (inCasablanca and Rabat). A modem and procompetitive legal and regulatory framework has been in placesince 1998 in the telecommunications sector, and an active liberalization strategy is actively being pursuedin that sector. Some liberalization measures have also been adopted in the road and air transport sectors.

The country's most important infrastructure problems have to do with a series of issues common acrossseveral sectors (with the exception, for the most part, of telecommunications): lack of overall sectorstrategy; inadequate regulatory framework combined with complex and often unclear allocation ofresponsibilities, with the same officials generally in charge of both regulatory and operational tasks;insufficient competition; uneconomic tariffs; and lack of coordination and expertise to design andimplement coherent infrastructure policies. These shortcomings have not prevented significantimprovements in many infrastructure services in recent years, but they do cause infrastructure performanceto remain below what it could be, even in sectors where progress has been most rapid, such astelecommunications. They also make it more difficult to expand services toward peri-urban and rural areas.6

The Government has also made special efforts to increase access to electricity and water in rural areasthrough the public PERG (Programme d'electrification rural groupe') and PAGER (Programmed 'approvisionnement groupe en eau potable des populations rurales) programs. Nevertheless, progress isstill concentrated mainly in urban areas. Tariff perequation across regions - cross-subsidization that impliesthat tariffs in subsidized regions do not reflect the costs of providing service - combined with low prices for

5 Some numbers illustrate the problems very well: the price of industrial land in Casablanca is more than double that of Tunis, and inTangier it is more than double that of Marseilles and Valencia (Price Waterhouse, 1994). In the metropolitan area of Casablanca, thesupply of industrial land must increase by 1,300 hectares by the year 2000 to sustain the 235,000 jobs in the industrial sector. For anadditional 80,000 new jobs to be created by that year, an extra 800 hectares would have to be developed.

6In some sectors, these problems have seriously constrained the activities of entrepreneurs. A case in point is their complaints, recordedin the surveys, about the poor quality of port services. Long delays to process goods through ports is the most common complaint,followed by the lack of accountability of ODEP (Office d'exploitation des ports) and the lack of security in the areas outside ODEP'swarehouses. Entrepreneurs also express dissatisfaction with the price of electricity and with the delays and costs of obtainingconnections to the water and electricity networks (about 25 percent of the firms surveyed reported connection-related problems duringthe last three years).

14

residential users have prevented the introduction of competition and have made it very expensive to extendinfrastructure networks in rural areas. As of 1998, only 35 percent of rural households had access toelectricity and 37 percent to a water distribution network, and there was only about one telephone line forevery 185 rural inhabitants. With about half the population (13 million) living in rural areas, this situationhas severe economic and social consequences. Limited availability of basic water and electricityinfrastructure in rural and peri-urban areas constitutes a significant obstacle to providing basic health andeducation services. This is true for two reasons: first, because provision of such services is more difficult inthe absence of basic infrastructure; and second, and more important, because the opportunity cost forfamilies to send their children to school rather than having them help with domestic chores is very high inareas lacking modem water and electricity infrastructure.

Various initiatives have been implemented to enhance the dialogue between Government and theprivate sector and to foster private-public partnerships in strengthening the productivity of firms.However, these initiatives are insufficient, given the large potential of the private sector to be anactive partner in the efforts to increase Morocco's competitiveness.

A tripartite consultative committee, Comite de suivi du projet de developpement du secteur prive,comprising an equal number of representatives from the public and private sectors, was established in1994 to advise on the content and implementation of a reform program aimed at developing andenhancing the competitiveness of the private sector. In addition, an Observatoire de la competitiviteinternationale de 1'economie marocaine was set up to provide information to the consultative Comite desuivi on the impact of the reforms. Both the Comite de suivi and the Observatoire, however, focusalmost exclusively on the formal sector.

The Government is well aware of the challenges imposed on Moroccan firms by the transition from highlyprotected markets to a much more competitive environment. This adjustment can be expected to beespecially difficult for the smaller firms, which comprise a large majority of the total enterprises in Morocco(see Table 4 above). To assist industry with the challenges of trade liberalization, the Government inNovember 1997 launched an industrial competitiveness (mise a niveau) program aimed at preparingindustry for the challenges of trade liberalization. One component of the program aims at supplementing theefforts of individual firms with diagnostic studies by outside consultants, restructuring plans, and subsidizedcredit for implementation of those plans. The mise a niveau program is an important effort to helpenterprises prepare for the fierce competition that will result from trade integration. However, to achievesustainable results in the medium run, it is important to maintain the demand-driven character of theinitiative, and to minimize the reliance on guarantees and subsidized loans that might erode the firms'financial discipline.

The private sector has also been active in this public-private dialogue. The CGEM (Confederation generaleeconomique marocaine) has evolved to become more representative of the private sector in its dialogue withthe Government: it is now open to smaller firms and to federations of companies outside the manufacturingsector, and regional offices have been created to expand the scope of the association.

4. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT

This section presents the results of two field surveys of 370 enterprises, carried out in seven cities andcovering multiple sectors, in March and April 1998. The nature and ranking of the constraints on businessactivities that emerged from the interviews with entrepreneurs underlie much of the analysis developed inthe previous sections, and confirm the need for further reforms to improve the business environment inMorocco and to facilitate firms' efforts to improve their efficiency and become more competitive.

The survey samples cover firms of different sizes: Large (more than 100 workers), medium (50 to 100workers), small (6 to 49 workers), and micro (5 workers or fewer). A key finding of the surveys is that

15

different constraints have different impacts depending on the size of the firm. These differences are mostimportant between the group of firms with more than five employees (small, medium, and large firms in theformal sector) and the microenterprises (most firmns in the informal sector). But these differences are alsosignificant among firms of varying sizes within the formal sector itself. Section 4.1 first presents the resultsfor enterprises with more than five employees, followed by those for microenterprises. Section 4.2discusses how these constraints have evolved since the 1994 PSA, which drew on various firm surveys toelaborate a ranking of the problems affecting the private sector at that time.

4.1. Results of the 1998 Enterprise Surveys

Overall, entrepreneurs employing more than five employees find the following problems to be mostconstraining: administrative behavior, lack of qualified workers and good managers, late payments,and insufficient demand, as well as lack of access to and the high cost of finance.

Entrepreneurs were asked to identify the three most severe problems they face in their daily activities.Figure 4 ranks their responses according to the number of times a given problem was reported.

The behavior of the administration appears to be the most severe constraint now faced by entrepreneurs.This behavior includes tax administration, judicial processes, late payments by public entities, andcorruption, which is especially problematic for small firms. Customs procedures are a severe problem forlarge and medium firms, while small firms complain more about problems related to companyincorporation.

The next most severe constraint is related to human resources. The lack of qualified workers is one of theproblems most often mentioned, especially by large entrepreneurs, who rank it in first position. Small finnscomplain more about the high turnover of unskilled workers. The scarcity is not limited to the technical fields;there also appears to be a scarcity of managerial skills, with fnmns complaining about insufficient internalcapacity to adapt to the changing external environment. To a large extent, poor managerial skills are rooted inan organizational structure with little staff mobility or versatility, which characterizes family-run enterprises aswell as corporate establishments in Morocco. Many firms do not make plans to periodically assess their needfor workers, capital, or other resources and do not invest in researching appropriate technology and marketinformation (see below). Finally, although the legal environment is often overlooked, outdated labor laws -combined with lengthy judicial processes - have been shown in various studies to increase the cost ofmanaging human resources in Morocco.

Figure 4: Most Often Mentioned Problems for Firms with More than Five Employees(percentage of entrepreneurs who mentioned them)

Behavior of the administration _

H um an resources , ______________-_...__:-.:-_______'___________________'_

Late payments by private clients

Insufficient demand/Strongcorn petition

Access to/Cost of finance

High level of taxes

Infrastructure weaknesses

0 1 0 20 30 40 50 60

Source: E.quite sur les A touts et les Obstacles au Developpem ent du Secteur Privi au Maroc (1998).

Late payments by both private clients and public agencies are also an important problem that can beattributed in part to the recent slowdown of economic activity. Many entrepreneurs have seen their clientbase stagnate or decrease, which has taken its toll on their ability to pay debts on time. In addition, despite

16

the progress achieved, many firms do not have easy access to financial resources: the survey confirms thatmany small businesses do not have a relationship with a bank, and often do not accept checks as a means ofpayment. As a result, during bad times, these firms, as well as many of their customers,7 do not have accessto bank credit or to overdraft facilities. Smaller firms thus have difficulty maintaining sufficient liquidity topay their own creditors promptly. The problem is less acute for larger firms, which have easier access tobanking facilities.

The high cost of finance and limited access to medium and longer-term resources are also mentioned byentrepreneurs as relatively important constraints. The recent decrease in lending rates suggests thatcompetition among banks might be increasing and that entrepreneurs' complaints reflect past more than presentexperience. However, it is too early to determine whether the downward trend will last or whether collusivebanldng practices will persist.

High taxes are a less critical constraint than those mentioned above. Nonetheless, they are still a heavyburden for smaller firms, which tend to rank that constraint relatively higher than larger firms.

Finally, infrastructure weaknesses (mainly access to land, but also the price of electricity, quality of portservices, and delays in obtaining connections to infrastructure networks) are also perceived asconstraints. The improvement of services in the main urban areas is evident, but entrepreneurs in otherareas still complain about electricity shortages (mostly in Oujada and Tangier), sewerage problems (inFRs), and road quality (in industrial zones and some tourist areas). Scant competitive pressures amongproducers largely accounts for the lack of motivation to decrease prices or improve quality and attentionto users. The review of sector policies in the previous section indicates that these problems, which arecommon to various sectors, could be best resolved by adopting a comprehensive cross-sectoral strategyrather than through isolated policy measures.

The situation of microenterprises differs substantially from that of other firms. In order ofimportance, the main constraints for microenterprises have been the impact of a weak economy ondemand and payments, high worker turnover, and lack of access to financial resources.

As Figure 5 indicates, the problems of microentrepreneurs are very different from those of larger operators,with insufficient demand appearing to be a much more severe problem for microenterprises. This isconsistent with the fact that large enterprises have had a less difficult time in recent years: only about 20percent reported in the surveys that they had lost market shares, while 55 percent reported gaining marketshares, as opposed to 50 and 40 percent for the smallest enterprises. Microfirms have less ability to diversifytheir markets and therefore strongly feel the impact of an econonic slowdown, both because there is lessdemand for their products and because supply increases as unemployed workers from the formal sectorenlarge the number of microfirms fighting for the same market. In addition, because they have a harder timeupgrading their technical and market skills (see below), the smallest firms are less able to compete to retaintheir customers.

Late payments by clients rank second for firms overall, and this problem is much more acute formicroenterprises than for larger firms. This is not surprising, since microenterprise customers often includethe less well off and because these firms have less access to financial resources.

7 According to Lejournal (November 17-23, 1997), 84 percent of Moroccans over 20 years of age do not have a bank account.

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Figure 5: Most Often Mentioned Problems for Microentrepreneurs( percentage of entrepreneurs who mentioned them)

Insufficient demand, strong competition I

Payment delays by private clients

Human resources

HiQh taxes

Access to finance

Product quality±

Infrastructure weaknesses

Administrative behavior

o to 20 30 40 50 60 70

Source:Enqute osur. les Atous et les Obstaclesau Djveloppemt d. Secteur Ptita M-aroc (1998).

The lack of access to financial resources from the banking sector is an even more important problem formicroenterprises than it is for small firms. Although the tiniest microfirms are generally better served byNGOs, worldwide experience suggests that for the larger micro firms, the formal financial sector isnormally the most efficient supplier of finance. However, despite their collective economic importance,'micro businesses, like small businesses, have almost no access to commercial banks.9 Banks in Morocco -as in many other countries - do not see the provision of financial services to micro and small enterprises asprofitable ventures: such firms are seen as risky customers that lack collateral, entail high transaction costs,and are unable to pay the high interest rates needed to cover those costs. (Banks are, in any case, preventedfrom charging very high rates in Morocco under the usury rule.) In addition, the absence of strongcompetitive pressures gives these institutions little incentive to be innovative or look for new groups ofcustomers. The banks' lack of familiarity with microfinance lending techniques also plays a role, as doesthe inability of small finns to maintain proper accounts and provide the information required to obtain aloan.

The inability to access technology to ensure product quality or to obtain market information is also mentionedmuch more often as a constraint by microentrepreneurs than by other operators. The relative cost of acquiringtechnological or informational tools is higher for very small firms that have few contacts with sophisticatedsuppliers or clients.

Administrative constraints, on the other hand, are ranked last by microentrepreneurs, reflecting the ability ofvery small businesses to avoid some laws and regulations.

4.2. Comparison with 1994 PSA results

Table 6 below compares the most important constraints identified in the 1994 PSA with the constraintsidentified in the 1998 surveys."0 While the 1994 PSA acknowledged the "Government's gradual but markedshift to encourage the private sector," it also pointed out some important remaining constraints to PSD. Thelargest firms (more than 100 employees) complained mainly about the high cost of finance, lack of skilledlabor, high taxes, high cost of commercial land, and infrastructure weaknesses. Smaller businesses (20 to

8There are about 700,000 very small and micro businesses in Morocco. The finance market for those businesses is conservativelyestimated at between US$200 and US$400 million.

9Fewer than 15 percent of micro firms have a checking account, and fewer than 4 percent have ever obtained an overdraft or credit.

0 To facilitate comparison with the 1994 diagnostic, the results of the 1998 survey are disaggregated among firms employing between20 and 100 persons and those employing more than 100 persons. This accounts for the minor differences between these results andthose reported in Figure 4, which are aggregated for all firms employing more than 5 persons.

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100) complained less about the lack of skilled labor but said administrative constraints were among theirmost severe problems.

The administration's behavior, already cited as an important problem in 1994, has clearly become a majorbinding constraint in 1998. The same is true for human resources. Also, not surprisingly, constraintsreflecting the disappointing economic performance over the last five years - i.e., late payments andinsufficient demand - are much more important in 1998. New constraints among the top eight include thelack of access to technology and market informnation. Indeed, concerns about these issues are likely toincrease as the country becomes more involved in economic globalization.

On the other hand, while access to and cost of finance remains a significant constraint today, its relativeimportance appears to have diminished since 1994. The same is true for infrastructure weaknesses. Exceptfor the issue of access to industrial land, which remains as much a problem today as it was in 1994,shortages of infrastructure services in urban areas have been alleviated since 1994. Most of the problemsthat remain concern price and quality of service, as well as connection delays.

High taxes also seem to be a less binding constraint now than in 1994. At 24 percent of GDP (down from 27percent in 1994), the current tax revenue-to-GDP ratio is comparable to that of other lower middle-incomecountries. It is important to remember, however, that current levels of taxation imply a relatively high taxburden on the urban formal sector because income from agriculture and the urban informal sector is largelyuntaxed.

Table 6: Ranking Constraints to PSD in 1994 and 1998, by Size of Firms

1994 1998 1994 1998

Cost of finance Behavior of the ft Cost of finance Behavior of theadmrinistration administration

Behavior of the admninistration Insufficient demand 'a Lack of skilled labor Human resources (incl. lack of skilled labor)

High level of taxes Late payments by Q High level of taxes hisufficient demand t

private clients

Access to/poor quality of key Human resources High cost/lack of access to raw Late payments byproduction factors (land, (incl. lack of skilled 1 materials private clientsequipment, infrastructure) labor)

ti5d g g W Cost/lack of access to raw Access to and cost . Access to/poor quality of key Access to andmaterials of finance production factors (land, cost of finance

equipment, infrastructure)Competition from Infrastructure Labor regulations Lack of technol. and Qinformal/illegal firms weaknesses , mkt. information

7 Inflation Lack of technol. and Inflation *Ifrtructure weaknessmkt. information *High taxes

Insufficient demand High taxes Behavior of the administration

Arrows indicate whether the constraint has become more (e) or less (LI) important, or remained equally (<r) important in the overall rankingfrom 1994 to 1998.* Equal rank.Sources: World Bank (1994) and Belghazi (1998a).

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5. AN AGENDA FOR PRIVATE SECTOR DEVELOPMENT

The relatively slow development of the private sector in recent years suggests a need for action. The mainfeatures of a strategy to address some of the most important constraints to PSD are outlined below.

5.1. Strengthening the Foundation for Private Sector Development

Implementing sound macroeconomic policies and removing barriers to competition and toprivate participation in economic activities currently in the public domain are prerequisites forvigorous private sector development. This involves several measures to correct the problemsidentified.

Increasing public savings and using public resources more efficiently would facilitate privateinvestment.

A low fiscal deficit favors PSD because it helps maintain low inflation and reduces public crowding out inthe domestic financial markets. In this context, the commitment of the Government to significantly decreasethe budget deficit from its 1998 budgeted level of 3.6 percent of GDP is an important element of a soundmacroeconomic strategy.

Given the current pattern of public revenues and expenditure, a lower deficit will require that theGovernment reduce the civil service wage bill and enhance cost recovery in the public provision of services.To be sure, these propositions are difficult to implement despite their longer-term benefits, but they can bemade less painful if complemented with other measures, such as promoting public-private partnerships ineducation and training, health, and infrastructure services for marginal areas. Moreover, the liquidation ofloss-making public enterprises would cut the loss of public resources, while allowing a redirection of assetstoward more productive activities.

While other options exist in theory, reducing public wage expenditures and promoting private participationin many areas appear to be the only feasible ways to achieve budgetary equilibrium, given the structure ofthe Government budget in Morocco.' On the expenditure side, public investment is already too low, arestructuring of public debt is unlikely to happen in the short term, and operating expenses in social areasneed to be at least maintained (albeit with more efficient utilization). On the revenue side, increasing the taxbase but not tax rates would support the country's achievement of having reduced the overall fiscal burden(see section 2.1).

Strengthening public investment expenditure within the context of a multi-year development plan couldalso contribute to PSD if public investment is meant to complement rather than substitute privateinvestment.

The exchange rate regime needs to be managed to maintain the competitiveness of the economy.

In the short run, the authorities should ensure that no further appreciation of the REER takes place. Inaddition, the trading margins at which banks buy and sell foreign exchange should be broadened. In themedium term, the Government should move toward a more flexible exchange rate regime responding, inparticular, to changing trends in international trade. This evolution would enhance competitiveness of

In the case of Morocco, simulations results show that civil service wages costs could be cut from 11 per cent of GDP to 9.5per cent over a four-year period by undertaking a << minimum program»> of a one per cent annual reduction in the overallnumber of civil servants-to be achieved by not replacing retirees and filling priority staff needs through redeployment-andsimultaneously limiting annual wage increases to increase in the cost of living. Such a reduction, however could usefully beconsidered in the context of a much wider program for restructuring the civil service, aimed at creating a leaner and moreefficient public administration. (World Bank, 1998 (b)).

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exports and provide some degree of uniform protection to local producers facing tariff reductions in thecontext of the FTA.

Accelerating and broadening trade liberalization would provide more efficient production incentives.

Morocco would benefit from advancing the FTA schedule of duty reductions for manufactured goods andagricultural products, as well as from applying such FTA rules to all trading partners.'2 Extending thescope of the agreement to include agriculture and services would yield further benefits, although thiswould be far from an easy task.

Exposing enterprises to more competitive pressures would unleash untapped growth potential.

Adopting the draft Competition Law, currently before Parliament, would be a step forward. This law,however, will be insufficient by itself to subject enterprises to greater competition, for two main reasons.First, the effectiveness of the law's competition provisions depends on the capacities of the judicial system.Second, even with a thorough trade liberalization, which would increase the potential for competition fromabroad, competition in some sectors would still be hampered by the existence of public monopolies and byremaining price controls on certain products and services.

To successfully tackle these issues, additional measures are required, such as: ensuring a strong and crediblecompetition council to implement the Competition Law; deepening the ongoing judicial reform efforts;further restructuring monopolistic sectors to promote private participation and competition; and acceleratingthe removal of the remaining price controls, replacing them, where needed, with targeted interventionsaimed at helping the poorest segments of the population.

Pursuing the privatization program can foster PSD and strengthen a leaner, more efficient state. Itwfll also bring one-shot fiscal revenues from divestiture.

Concluding the first round of privatization and setting transparent procedures and a reasonable timeframefor implementation are key steps to ensure the success of the second round. Of the 113 firms included inthe first privatization list, 61 are still in Government's hands, including key institutions such as the BCP,the privatization of which is essential to develop a competitive financial sector. Following the liquidationof CDM and SEFERIF, which is currently underway (see section 2.1), it will be necessary to pursue theliquidation of the remaining non-viable enterprises.

Parliament has approved new legislation that modifies and complements the current Privatization Law(No. 39-89), including a provision to replace the principle of a global "positive" list with an annualidentification of firms to be privatized within a given fiscal year. The Government has also establishedambitious targets for privatization and liquidations to be achieved during its tenure. It is now critical toaccelerate the preparation of the privatization dossiers and advance the implementation of the program.

In the past, the Ministry of Privatization relied on donor funds to implement its privatization program, butthis is no longer the case, since implementation costs are now included in the Ministry's regular annualbudget. This is a positive step toward ensuring smooth implementation of the privatization program. In themedium term, another step would be to adopt a multi-year budget to ensure successful completion of thetasks over longer periods. This recommendation holds for all Government ministries.

12 This extension of benefits to all trade partners would increase Morocco's GDP by an estimated 1.9 percent - in addition to theestimated gains from the FTA of 2.3 percent of GDP. See Rutherford, Rutstr6m, and Tarr (1993).

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5.2. Addressing First-tier Issues: Administration, Labor, and Finance Constraints

5.2.1. Easing the Administrative Burden on Enterprises

While the legal framework for business activity has been partly modernized, the administration of businessregulations would benefit from substantial simplification to reduce the time and resources spent byentrepreneurs in complying with these procedures. Six areas are in particular need of reform.

The tax administration needs to be further streamlined.

There is a need to further reduce the number of forms and to consolidate them across fiscal and quasi-fiscaladministrations. Such simplification, along with the publication of written rules on procedures to befollowed, would go a long way toward reducing the scope for arbitrary decisions.

More efficient and more equitable judicial processes would greatly facilitate private sectordevelopment.

Two sets of measures are needed to achieve more efficient and equitable judicial processes. First, the courtsystem needs to be strengthened and a coherent legal framework created by speeding up enactment of thevarious laws that are now stalled (see section 2.2). Second, the quality of judicial decisions in commercialareas needs to be improved through: (i) the proper staffing of the new commercial courts, not only withexisting judges but through lateral recruitment complemented by appropriate training programs;'3 (ii)updating of commercial legal education in universities through a much-needed revision of the curriculum bya committee of experienced practitioners; (iii) the timely publication of judicial decisions to increasetransparency; and (iv) extending the incentives recently granted to judges to judicial support staff, includinga clearer career development path and better remuneration.

The current training program on commercial matters at the Institute for Judicial Studies (INEJ), in charge oftraining magistrates, should be broadened to include judicial support staff and lawyers. INEJ could alsooffer continuing education courses as well as initial training programs. Finally, the private sector shouldcontinue to be called upon to make contributions in the field of legal training (a series of banking lawseminars has already been financed by the banking sector in partnership with 1iNEJ).

Efforts to accelerate and modernize customs procedures, already well advanced, should be sustained.

It is essential to sustain the efforts to better balance the objectives of control and revenue collection withthose of trade facilitation and client orientation. Feedback mechanisms such as independent surveys or amixed public-private sector advisory board would help to further strengthen service performance.

Adoption of the proposed Customs Code would represent an important step toward modernizing customsadministration. Adoption of this text will need to be followed, shortly, by the publication of the textsrequired to enable its implementation. In addition, specific measures are recommended to simplifyprocedures: sample controls should be further reduced; compound imports should be valued as a whole ratherthan by components; the process of updating the electronic data interchange system needs to be completed; andfinally, coordination between customs and the Casablanca airport and regional ports and airports must beimproved. In addition, it is necessary to simplify the rules pertaining to temporary admission if this system is toplay its full role in promoting Moroccan exports.

3 For example, the capacity to enforce judgments could be strengthened through the creation of a judgeship for the enforcement ofjudicial decisions in business-related activities.

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This streamlining and updating of customs procedures, as well as the integration of electronic systems are alsonecessary to promote better use of customs facilities outside of the most congested ports, in line with theGovernment's policy of decentralizing economic activities.

The difficult issue of late payments by public entities needs to be addressed.

The surveys revealed that late payments by public entities are a major problem. They directly affect firnsthat sell goods or services to public entities, and also have indirect spillover effects on these firms' privateclients. In the short term, corporatization could be used to help increase the financial accountability ofpublic entities that perform commercial functions. As far as the administration itself is concemed, there isno substitute for appropriate budgeting and for designing incentives to promote good financial performance.

Simplifying procedures to establish businesses in Morocco would encourage domestic privateinvestment by SMEs and promote FDI.

Further simplification of the procedures, along with the consolidation of agencies that have overlappingresponsibilities for attracting investment, would help to promote FDI, especially for small and mediumenterprises.

5.2.2. Promoting the Emergence of Well-qualified and Flexible Human Resources

The 1998 PSA survey confirms the findings of the 1997 industrial survey conducted by the Observatoire dela competitivite internationale de l&'eonomie marocaine, which shows no significant improvement in mostindicators of availability and quality of the labor force. In fact, human resource problems are more complexin 1998 than in 1994 and appear to affect firms of all sizes, albeit in different ways. To a large extent, theseproblems reflect the additional demands that modernization and globalization of the economy imposes onthe labor force. Urgent actions are needed to meet these demands.

Improving the productivity of unskilled workers is key to restoring Morocco's internationalcompetitiveness and ensuring that economic globalization delivers long-term benefits for the country.

Economic globalization offers larger markets and new job opportunities, but it also sets higher qualitystandards and requires better-trained workers, even among the unskilled labor force. While the larger firmsmentioned the need for better trained workers most often during the surveys, the difficulties that smallerfirms experience in competing and attracting clients also have a lot to do with low labor productivity. Theslowdown of Moroccan exports demonstrates that having lower wages than the OECD countries is not asufficient condition to maintain competitiveness. High illiteracy rates and poor preparation of unskilledworkers are becoming serious burdens for firms attempting to survive in a more competitiveenvironment. A three-pronged approach should be adopted to address these problems. First, priority mustbe given to literacy programs and to improving basic education. Resources derived from a leaner secondaryeducation system (see Annex 4) could provide additional funds for these programs. Special attention shouldbe given to rural areas, where problems are more severe and which, in bad times, provide a large pool ofjobseekers who migrate to urban areas. Second, access to basic infrastructure services in the peri-urban andrural areas has to be improved to increase school attendance, especially by girls. Regardless of how manyresources are poured into education programs, the opportunity costs of sending children to school is too highwhen basic services are lacking. Third, there is a need for in-service training programs focused on basicskills, and for retraining programs to help unskilled workers find more productive occupations in anincreasingly competitive environment.

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It is urgent that the quality of education at all levels be improved and more efficient vocationaltraining programs be developed to better tailor the qualifications of skilled workers to the needs offirms.

At the same time that firms complain about the lack of qualified workers, unemployment among younguniversity graduates has reached 25 percent. The Government, through OFPPT, has launched a series ofactions to make vocational training more responsive to the requirements of firms, including special trainingcontracts and the draft law on vocational training. Additional steps are needed, such as the allocation of thevocational training tax on the basis of actual provision of training in order to promote private provision.Similar efforts should be undertaken in higher education, where private provision should play an importantrole as well. Fostering the more efficient use of public resources devoted to secondary education would alsogo a long way toward creating a better-qualified labor force.

Assisting smaller firms in improving their managerial skills would facilitate their successfultransition toward a unified and more modern economy. Programs channeled through the GIACsshould be strengthened.

It is also important to improve management performance, especially in micro, small, and mediumenterprises operating in the informal sector and in traditional industries. While relatively large, modemfirms can be expected to make the transition to a more competitive environment mostly on their own,smaller firms in Morocco (and everywhere else) have limited staff, are often overwhelmed by day-to-dayproblems, and cannot easily plan ahead. That is why these smaller enterprises can benefit substantially fromassistance programs (channeled through GIACs, for instance) to improve their internal management. Amore flexible and proactive attitude on the part of managers is needed in a competitive environment tomaintain existing customers and attract new ones. Equally important, firms need to plan their demand forfinancial and labor resources to meet production goals and survive economic setbacks. Securing theseresources, in turn, requires management time and skills to select training programs, hire new workers, anddevelop relations with financial institutions.

Removing legal and institutional rigidities in the labor market would reduce the cost of hiringpermanent workers, expedite conflict resolution, and encourage firms to invest in creating a stablelabor force.

Adopting a modem Labor Code - with emphasis on facilitating flexible arrangements - would be a first steptoward increasing transparency, facilitating enforceability, and reducing transaction costs in the labormarket. To this end, it is important to revise the current draft code (World Bank, 1997b).

The current system of severance pay should also be revised to improve labor mobility while providing a safetynet during job search. A possible altemative involves reducing severance payments while developing anunemployment insurance scheme. Another possibility, adopted by various Latin American countries, is toreplace the fim's obligation to pay the worker at the time of dismissal with an obligation to make regularcontributions to a fund owned by the worker, who can access that fund at the time of dismissal or retirement. 14

Non-wage costs should also be reviewed to identify opportunities to lower those costs while maintainingeffective social protection for workers.

While the objective is to design texts that limit the opportunity for conflict, effective dispute resolutionmechanisms will always be necessary to ensure effective implementation of the law. Strengthening thecapacity and efficiency of labor courts is important. In that regard, consideration could be given toreestablishing some type of elected industrial tribunal made up of a magistrate and employee and employerrepresentatives. Promoting effective out-of-court settlements could be pursued in parallel by, for example,strengthening the arbitration process conducted by inspecteurs du travail.

14 See World Bank (1997b).

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The public sector needs to review its labor demand policies.

Incentive regimes in the public sector, now mostly delinked from economic considerations, continue to lureworkers away from the private sector. The solution would involve aligning public pay and benefits withthose prevailing in the private sector, on the basis of economic criteria.

5.2.3. Facilitating the Access of Entrepreneurs to Appropriate Sources of Finance

It is crucial to increase the access of micro and small enterprises to financial resources.

In order to build up the institutional capacity of the AMCs to enable them to satisfy the current demandfor loans, it is important to continue to deepen micro-credit programs and assistance to the AMCs, incoordination with international donors (donors so far have been USAID and the EU).'s

The larger micro firms and small enterprises are better served by the formal banking system. In this regard, themost urgent measure would be to disseminate among Moroccan bankers the accumulated international expe-nence, which suggests that providing a range of financial services to micro and small firms (not only credit, butalso savings and deposit services, retirement planning, insurance, cash management, tax planning, etc.) can bevery profitable. One bank and one societt definancementt6 that show interest in providing services to microand small businesses could also be invited to take part in a pilot program to help develop their capacity toprovide such services profitably. It is also important to adapt banking regulations to the characteristics of microand small business finance. A significant step in that direction would be to exempt financial institutions thatare seriously committed to micro and small finance from the current guidelines on the taux d'usure and otherprudential regulations. Finally, providing training programs and advisory services to small businesses in theareas of accounting and financial planning would enhance their capacity to gain access to formal credit.

Enhanced competition among banks, better creditor protection, and greater reliance on transparentfinancial information would help larger firms get better loan conditions.

Establishing and enforcing anti-trust rules and deregulating rates on deposits would help promotecompetition in the sector and push banks to expand their loan portfolios. Developing a computerizedRegister of Interests in Movable Property, as well as rules allowing commercial banks to bypass normallegal procedures to recover the assets of defaulters, including perishable assets, would facilitate lendingagainst a broader range of security interests. As suggested above for smaller firms, capacity building is alsoneeded, both for the banks (to capitalize on opportunities created by deregulation and to evaluate loanrequests on the basis of cash flow analysis) and for the enterprises (to improve financial management andadherence to accounting rules).

Greater transparency, market-determined yield curves, and additional institutional investors wouldmake the capital markets more attractive to the largest enterprises.

Active capital markets generally allow smaller investors to participate in the economy, create newchannels to attract foreign capital, and generate competition for the banks. To foster transparency in theCasablanca capital market, CDVM's ability to issue regulations and to sanction market operators who fail tocomply with them should be strengthened. In addition, CDVM should upgrade disclosure standards and requirethat accounting practices by companies listed on the Casablanca exchange converge toward international

5 The programs usually start with small short-term working capital loans, which increase with good repayment behavior. This hasproven to be a major incentive for repayment.

16 Societes definancement are being established in Morocco to provide consumer loans. They use some of the same techniques as inmicro finance: they charge high interest rates, track loans very closely, and use a number of methods to ensure payment in case ofdefault (e.g., post-dated checks or direct access to wages).

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standards. SBVC's charges need to be reduced"7 and a wider range of market participants should be invited tobecome shareholders in SBVC to ensure that its policies consider the needs of issuers and investors. Toencourage new listings, listing requirements could be made less stringent for medium and smaller firms.

A series of structural reforms is needed to facilitate the issuing of corporate bonds. On the supply side, themain measures include modifying the adjudication mechanisms of Treasury bills to make them morecompetitive, the consolidation of Treasury bills currently in circulation, and the development of a secondarymarket for these bonds to provide a reference for pricing commercial paper issued by corporations and otherprivate institutions. On the demand side, there is a need to develop regulations for the operation ofinstitutional investors and professional fund managers, to further deepen the insurance sector, and todevelop pension funds that, under prudent regulations, could become an additional source of investmentfinance.

5.3. Addressing Second-tier Issues: Industrial Land and Infrastructure, Technology Support, andMarket Information Constraints

While the second-tier problems are less severe than those analyzed in the previous sections, they are likelyto become more important as globalization progresses, since they will make it more difficult for Moroccanfirms to remain competitive in the international arena.

Removing administrative and legal obstacles to identifying industrial land to be developed, andencouraging private participation in such development, would reduce the current shortage of land.

Administrative procedures need to be streamlined, and private participation in industrial landdevelopment should be encouraged. The latter, in particular, would greatly benefit from: (i) clear rulesregarding the financing of infrastructure; (ii) protection against unfair competition by public agencies;(iii) clear identification of expansion and diversification opportunities available to private developers;(iv) classification of land in the proximity of ports and airports within the private rather than the publicdomain; (v) a revision of the rules pertaining to the management of land within the public domain.

Appropriate strategies and sector reforms favoring competition, including through private provisionof services, are needed to address the remaining challenges in infrastructure.

Various steps should be taken to address these cross-sectoral issues, which, along with the improvementof services beyond the main urban centers, constitute the main challenges in infrastructure. First, insectors such as water, sewerage, electricity, and ports, it is important to go beyond the current deal-by-deal approach to private participation and devise coherent sector strategies. Much heavier reliance oncompetition in the market, wherever feasible, is also crucial. Second, for telecommunications, theobjective must now be to make sure that the potential of the 1997 law, in particular with respect to theintroduction of undistorted competition and privatization, is realized. Third, rebalancing tariffs, targetingsubsidies more precisely to those who need them most, and implementing competitive privateparticipation schemes compatible with the social objectives of the Government (such as competitivelyawarding concessions to operators requiring the lowest subsidies), would greatly facilitate the extensionof services to rural areas.

17 SBVC charges have recently been reduced but remain high by international standards.

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An adequate legal and institutional framework for metrology, standards, testing, and qualitymanagement (MSTQ) needs to be finalized and implemented.

Access to appropriate technology and to information on market opportunities is often problematic in Morocco,where mnany firms are small and resource poor. Setting an institutional and regulatory framework for MSTQ isthus a first step toward ensuring that Moroccan products meet the specifications of increasingly demanding clients.

A 1995 study"8 identified the major gaps and measures needed to strengthen the current system. Thus, thestandards and the system of testing and certification must be improved to ensure intemational acceptance ofMoroccan exports. The prionty is to accelerate the promulgation of standards by borrowing much morefrom intemational standards, especially those applicable in Morocco's export markets.1 9 A testing andcertification system must also be implemented to ensure the systematic application of these standards.Intemationally recognized certification procedures need to be issued for key manufactured exports, and aNational Accreditation Council, administered by the standards body, professional associations, and testinglaboratories should be set up to evaluate testing performance. Most of these recommendations have beenintegrated into new draft legislation, yet to be adopted.

A combination of competitive pressures, private provision of technology and information services,and adequate forms of public support are key for effective technology dissemination and access tomarket information.

Once in place, the MSTQ system would need to be assimilated by enterprises. Increasing competitivepressures on Moroccan firms is the single most important means of promoting both the assimilation oftechnology and an active search for market opportunities. Despite the FTA with the EU and theaccession to the World Trade Organization (WTO), many firms are not yet faced with seriouscompetition, and demand for improved manufacturing technology in Morocco therefore remains weak.

Private sector initiatives - supported by public policies or assistance in some cases - are key for thedissemination of technology and information. The Government should support these initiatives by abstainingfrom giving distortionary incentives to public laboratories. An adequate intellectual property regime isessential, for its part, to foster research and development and the sale of new technologies.20 Finally,international experience shows that subsidizing the services of technology support institutions might bejustified, initially, to inform the firms - especially the smaller ones - about the benefits that such institutionscan provide. To be effective, however, those institutions must begin to cover their costs after a relatively shortperiod of time.

18 DGS Intemational (1995).

19 The surveys revealed that the smallest enterprises identify the lack of standards as the main cause of their problems with respect toproduct quality. The larger enterprises, for their part, point to the lack of a skilled workforce.

20 The 1998 surveys reported a number of complaints about the lack of respect for intellectual property in Morocco.

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