# **B. IMPLICATIONS FOR POLICY**

The only way to recover the long-run GDP losses estimated in the previous section is by adopting policies that lift the potential GDP growth rate above the 6 percent prevailing before the crisis. This can be achieved through higher productivity growth rates or by increasing permanently the rate of capital accumulation, either physical or human. Higher permanent rates of capital accumulation require stable funding sources, such as domestic savings. Given the trend and level of domestic savings in Egypt, this does not seem a viable option in the short term. The rate of human capital accumulation can be changed through increasing the labor force participation and through increases on the return to education. All these are elements of a medium-term agenda. The most viable alternative in the short to medium-term is through higher growth rates of productivity.

We identify two factors that are critical to productivity growth in Egypt. The first one is the public spending channel, particularly in infrastructure and transportation sector. Recent international evidence shows that reducing commuting costs by 10 percent can increase labor productivity by 1 or 2 percent (Rice and Venables, 2004). The critical question is how much public spending can actually reduce commuting costs. Winston and Langer (2006) estimate that for each dollar spent in highway construction, commuter costs decrease by 11 cents. Extrapolating these precise figures to the Egyptian setting to estimate the impact of additional infrastructure spending on commuting costs to infer the resulting increase in productivity would be highly speculative.

Another study of the relationship between infrastructure spending and growth in Egypt (Loayza, et.al. 2009) finds that the country has a level of infrastructure similar to other countries of similar income per capita. The study showed that additional spending in infrastructure by 1 percentage point of GDP could increase growth by half a percentage point after one decade, and could reach 1 percentage point of additional growth after three decades. These results coincide with evidence presented in Annex 4 and in Fawzy (2006), of the complementary nature between public investment and private capital formation: a shock to public capital by 1 percent of GDP is associated with a rise in private capital of around 0.5 percent (equivalent to .6 percent of GDP) 5 to 6 years after the shock.

The more long term issue is how to shift from a factor-accumulation based growth strategy to a productivity growth based process. There are both microeconomic and macroeconomic studies of determinants of productivity in Egypt. On the micro side, studies of productivity of Egyptian firms (Escribano and Pena, 2010) show that the main factors affecting productivity are transportation and logistics costs, labor skills, and product quality and innovation. At the macro level, studies of the determinants of productivity growth in Egypt (Kheir El Din and Moursi, 2007; World Bank, 2008) point at the consolidation of fiscal adjustment, the advancement of trade integration, lowering inflation, improving infrastructure, and advancing institutional reform as necessary factors to support productivity growth. The bulk of the institutional reform, as described elsewhere (World Bank, 29