Analyze effects of globalization on Egyptian market structures
The name of the game for many countries trying to grow their economy is globalization. An open, competitive market that gives the opportunity for increased efficiency, exports and investment has been the goal of many of these countries. But globalization potentially has an additional benefit to these growing nations: the shrinking of the informal sector, as can be seen in the globalization of the Egyptian economy.
The informal market is the part of the economy that is not taxed or monitored by the government, which means that it is very easy to enter, as there are no legal restrictions. But it is also unstable, as it lacks any legal security. According to a published in the International Economics Journal, informality has posed a major barrier to growth in most developing countries, where it accounts for 32 percent of the economy, on average. Although informality can be beneficial in an economy where people lack social support and are unable to enter the formal economy, in most cases, it represents an untaxed and unregulated market with low wages and poor working conditions that harms the formal economy by siphoning its human and capital resources. Globalization has managed to reduce this informality, at least in Egypt, where, according to Mohammad Farzanegan’s paper, “The Impact of Economic Globalization on the Shadow Economy in Egypt,” the shadow economy was shown to have a statistically significant shrinking in the first three years after a set of economic reforms in 2004 which caused a globalization shock. At the time, Egypt had a growing industrial economy of mostly cotton-related manufacturing, following years of the government protection of local industries. As mentioned in the paper, 2004 saw a massive set of reforms, which included the slashing of personal and corporate income taxes, the privatization of government assets, customs reforms and the introduction of a properly functioning foreign exchange market, among other things.
There are two key causes for the shrinking of the informal sector following globalization shocks. First, globalization gives formal firms an advantage over informal ones. Formal firms can freely export and import goods across larger markets thanks to trade agreements. One such agreement in Egypt is the Greater Arab Free Trade Area Agreement, which allows formal Egyptian businesses to specialize and enter foreign markets. With access to these global markets came increased imports, exports and investments. In order to gain easy access to these increased opportunities, firms had to join the formal sector.
Second, globalization reduces the informal economy through the policies used to promote business. In an effort to globalize, Egyptian policymakers shaped policy to improve ease of business by lowering entry standards, abolishing fees and simplifying tax systems, according Farzanegan. These policies made working in the formal economy less burdensome, stimulating the entry of firms from foreign economies, but also from the local informal economy as the costs of formality shrunk and the benefits grew.
In essence, globalization has shrunk the informal market because it created a less burdensome formal market with more potential benefits. If the benefits are significant enough to make the formal economy more profitable than the informal one, workers and firms are pulled out of the informal market and into the formal one and we see a shrinking of the informal sector.
It is important to note that, along with economic reforms, changes in Egyptian legislation were a key factor in making the 2004 transition successful. In many cases, foreign firms invest in developing countries because of their abundance of cheap labor. Without the proper legislation in place, they can use their economic power to promote the informal economy by hiring on an informal basis in order to keep production costs low. In Egypt’s case, this was prevented by the introduction of new labor laws, such as Labor Code No. 12 in 2003, which required foreign firms to hire and invest in local population to work in their facilities. This had the effect of preventing the abuse of local labor while simultaneously creating job security.
Job security is another problem that Egypt needed to face in order to avoid increases in the informal sector. With globalization comes increased competition, and as smaller firms lose their niches, they are unable to compete with large international firms. In order to cut costs, they began replacing formal full-time employees with temporary, informal workers. By forcing foreign companies to hire local workers, Egypt ensured that the newly unemployed workers would be attracted to the formal economy rather than the informal one, thus avoiding the growth of the informal economy and ensuring the improvement of its human capital at the same time.
Although it is important to reduce the shadow economy, the mitigation of corruption and crime does not have a particularly strong correlation to globalization, so it is not considered among the benefits of globalization in shrinking the informal sector. Economic growth, on the other hand, is associated with globalization. Its relation to the shadow economy has been thoroughly studied and shown to be negative. This makes the growth associated with globalization another important aspect of its reduction of the informal sector.
Like in the case of Egypt, globalization has the possibility to be an important factor in reducing the size of the informal economy in the short and medium terms. An important part of that success, however, was its ability to protect the local workforce in the formal economy while easing regulations to allow for increased competition. If a host country does not implement legal protection while globalizing, it may face a growth in its informal sector that could work to counteract the benefits gained by globalization and deprive the economy of the growth it needs. Therefore, in order to globalize successfully, it must take legislative measures to help keep and integrate local workers into the newly globalized formal economy.