Why Nations Fail: The Origins of Power, Prosperity, and Poverty (60 page)

Using this command of the security forces and total control of the media, Karimov first extended his presidential term for five years, through a referendum, and then won reelection for a new seven-year term in 2000, with 91.2 percent of the vote. His only opponent declared that he had voted for Karimov! In his 2007 reelection, widely regarded as fraudulent, he won 88 percent of the vote. Elections in Uzbekistan are similar to those that Joseph Stalin used to organize in the heyday of the Soviet Union. One in 1937 was famously covered by
New York Times
correspondent Harold Denny, who reproduced a translation from
Pravda
, the newspaper of the Communist Party, which was meant to convey the tension and excitement of Soviet elections:

This mood would have captured the suspense surrounding the reelections of Karimov, who appears an apt pupil of Stalin when it
comes to repression and political control and seems to organize elections that compete with those of Stalin in their surrealism.

Under Karimov, Uzbekistan is a country with very extractive political and economic institutions. And it is poor. Probably one-third of the people live in poverty, and the average annual income is around $1,000. Not all the development indicators are bad. According to World Bank data, school enrollment is 100 percent … well, except possibly during the cotton picking season. Literacy is also very high, though apart from controlling all the media, the regime also bans books and censors the Internet. While most people are paid only a few cents a day to pick cotton, the Karimov family and former communist cadres who reinvented themselves after 1989 as the new economic and political elites of Uzbekistan have become fabulously wealthy.

The family economic interests are run by Karimov’s daughter Gulnora, who is expected to succeed her father as president. In a country so untransparent and secretive, nobody knows exactly what the Karimov family controls or how much money they earn, but the experience of the U.S. company Interspan is indicative of what has happened in the Uzbek economy in the last two decades. Cotton is not the only agricultural crop; parts of the country are ideal for growing tea, and Interspan decided to invest. By 2005 it had taken over 30 percent of the local market, but then it ran into trouble. Gulnora decided that the tea industry looked economically promising. Soon Interspan’s local personnel started to be arrested, beaten up, and tortured. It became impossible to operate, and by August 2006 the company had pulled out. Its assets were taken over by the Karimov families’ rapidly expanding tea interests, at the time representing 67 percent of the market, up from 2 percent a couple of years earlier.

Uzbekistan in many ways looks like a relic from the past, a forgotten age. It is a country languishing under the absolutism of a single family and the cronies surrounding them, with an economy based on forced labor—in fact, the forced labor of children. Except that it isn’t. It’s part of the current mosaic of societies failing under extractive institutions, and unfortunately it has many commonalities with other former Soviet Socialist Republics, ranging from Armenia and Azerbaijan
to Kyrgyzstan, Tajikistan, and Turkmenistan, and reminds us that even in the twenty-first century, extractive economic and political institutions can take an unashamed atrociously extractive form.

The 1990s were a period of reform in Egypt. Since the military coup that removed the monarchy in 1954, Egypt had been run as a quasi-socialist society in which the government played a central role in the economy. Many sectors of the economy were dominated by state-owned enterprises. Over the years, the rhetoric of socialism lapsed, markets opened, and the private sector developed. Yet these were not inclusive markets, but markets controlled by the state and by a handful of businessmen allied with the National Democratic Party (NDP), the political party founded by President Anwar Sadat in 1978. Businessmen became more and more involved with the party, and the party became more and more involved with them under the government of Hosni Mubarak. Mubarak, who became president in 1981 following Anwar Sadat’s assassination, ruled with the NDP until being forced from power by popular protests and the military in February 2011, as we discussed in the Preface (
this page
).

Major businesspeople were appointed to key government posts in areas closely related to their economic interests. Rasheed Mohamed Rasheed, former president of Unilever AMET (Africa, Middle East, and Turkey), became minister of foreign trade and industry; Mohamed Zoheir Wahid Garana, the owner and managing director of Garana Travel Company, one of the largest in Egypt, became minister of tourism; Amin Ahmed Mohamed Osman Abaza, founder of the Nile Cotton Trade Company, the largest cotton-exporting company in Egypt, became minister of agriculture.

In many sectors of the economy, businessmen persuaded the government to restrict entry through state regulation. These sectors included the media, iron and steel, the automotive industry, alcoholic beverages, and cement. Each sector was very concentrated with high entry barriers protecting the politically connected businessmen and
firms. Big businessmen close to the regime, such as Ahmed Ezz (iron and steel), the Sawiris family (multimedia, beverages, and telecommunications), and Mohamed Nosseir (beverages and telecommunications) received not only protection from the state but also government contracts and large bank loans without needing to put up collateral. Ahmed Ezz was both the chairman of Ezz Steel, the largest company in the country’s steel industry, producing 70 percent of Egypt’s steel, and also a high-ranking member of the NDP, the chairman of the People’s Assembly Budget and Planning Committee, and a close associate of Gamal Mubarak, one of President Mubarak’s sons.

The economic reforms of the 1990s promoted by international financial institutions and economists were aimed at freeing up markets and reducing the role of the state in the economy. A key pillar of such reforms everywhere was the privatization of state-owned assets. Mexican privatization (
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–
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), instead of increasing competition, simply turned state-owned monopolies into privately owned monopolies, in the process enriching politically connected businessmen such as Carlos Slim. Exactly the same thing took place in Egypt. The businesspeople connected to the regime were able to heavily influence implementation of Egypt’s privatization program so that it favored the wealthy business elite—or the “whales,” as they are known locally. At the time that privatization began, the economy was dominated by thirty-two of these whales.

One was Ahmed Zayat, at the helm of the Luxor Group. In 1996 the government decided to privatize Al Ahram beverages (ABC), which was the monopoly maker of beer in Egypt. A bid came in from a consortium of the Egyptian Finance Company, led by real estate developer Farid Saad, along with the first venture capital company formed in Egypt in 1995. The consortium included Fouad Sultan, former minister of tourism, Mohamed Nosseir, and Mohamed Ragab, another elite businessman. The group was well connected, but not well connected enough. Its bid of 400 million Egyptian pounds was turned down as too low. Zayat was better connected. He didn’t have the money to purchase ABC, so he came up with a scheme of Carlos Slim–type ingenuity. ABC shares were floated for the first time on the
London Stock Exchange, and the Luxor Group acquired 74.9 percent of those shares at 68.5 Egyptian pounds per share. Three months later the shares were then split in two, and the Luxor Group was able to sell all of them at 52.5 pounds each, netting a 36 percent profit, with which Zayat was able to fund the purchase of ABC for 231 million pounds the next month. At the time, ABC was making an annual profit of around 41.3 million Egyptian pounds and had cash reserves of 93 million Egyptian pounds. It was quite a bargain. In 1999 the newly privatized ABC extended its monopoly from beer into wine by buying the privatized national wine monopoly Gianaclis. Gianaclis was a very profitable company, nestling behind a 3,000 percent tariff imposed on imported wines, and it had a 70 percent profit margin on what it sold. In 2002 the monopoly changed hands again when Zayat sold ABC to Heineken for 1.3 billion Egyptian pounds. A 563 percent profit in five years.

Mohamed Nosseir hadn’t always been on the losing side. In 1993 he purchased the privatized El Nasr Bottling Company, which had the monopoly rights to bottle and sell Coca-Cola in Egypt. Nosseir’s relations with the then-minister of the public business sector, Atef Ebeid, allowed him to make the purchase with little competition. Nosseir then sold the company after two years for more than three times the acquisition price. Another example was the move in the late 1990s to involve the private sector in the state cinema industry. Again political connections implied that only two families were allowed to bid for and operate the cinemas—one of whom was the Sawiris family.

Egypt today is a poor nation—not as poor as most countries to the south, in sub-Saharan Africa, but still one where around 40 percent of the population is very poor and lives on less than two dollars a day. Ironically, as we saw earlier (
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–
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), in the nineteenth century Egypt was the site of an initially successful attempt at institutional change and economic modernization under Muhammad Ali, who did generate a period of extractive economic growth before it was effectively annexed to the British Empire. From the British colonial period a set of extractive institutions emerged, and were continued by the
military after 1954. There was some economic growth and investment in education, but the majority of the population had few economic opportunities, while the new elite could benefit from their connections to the government.

These extractive economic institutions were again supported by extractive political institutions. President Mubarak planned to begin a political dynasty, grooming his son Gamal to replace him. His plan was cut short only by the collapse of his extractive regime in early 2011 in the face of widespread unrest and demonstrations during the so-called Arab Spring. During the period when Nasser was president, there were some inclusive aspects of economic institutions, and the state did open up the education system and provide some opportunities that the previous regime of King Farouk had not. But this was an example of an unstable combination of extractive political institutions with some inclusivity of economic institutions.

The inevitable outcome, which came during Mubarak’s reign, was that economic institutions became more extractive, reflecting the distribution of political power in society. In some sense the Arab Spring was a reaction to this. This was true not just in Egypt but also in Tunisia. Three decades of Tunisian growth under extractive political institutions started to go into reverse as President Ben Ali and his family began to prey more and more on the economy.

Nations fail economically because of extractive institutions. These institutions keep poor countries poor and prevent them from embarking on a path to economic growth. This is true today in Africa, in places such as Zimbabwe and Sierra Leone; in South America, in countries such as Colombia and Argentina; in Asia, in countries such as North Korea and Uzbekistan; and in the Middle East, in nations such as Egypt. There are notable differences among these countries. Some are tropical, some are in temperate latitudes. Some were colonies of Britain; others, of Japan, Spain, and Russia. They have very
different histories, languages, and cultures. What they all share is extractive institutions. In all these cases the basis of these institutions is an elite who design economic institutions in order to enrich themselves and perpetuate their power at the expense of the vast majority of people in society. The different histories and social structures of the countries lead to the differences in the nature of the elites and in the details of the extractive institutions. But the reason why these extractive institutions persist is always related to the vicious circle, and the implications of these institutions in terms of impoverishing their citizens are similar—even if their intensity differs.

In Zimbabwe, for example, the elite comprise Robert Mugabe and the core of ZANU-PF, who spearheaded the anticolonial fight in the 1970s. In North Korea, they are the clique around Kim Jong-Il and the Communist Party. In Uzbekistan it is President Islam Karimov, his family, and his reinvented Soviet Union–era cronies. These groups are obviously very different, and these differences, along with the variegated polities and economies they govern, mean that the specific form the extractive institutions take differs. For instance, because North Korea was created by a communist revolution, it takes as its political model the one-party rule of the Communist Party. Though Mugabe did invite the North Korean military into Zimbabwe in the 1980s to massacre his opponents in Matabeleland, such a model for extractive political institutions is not applicable in Zimbabwe. Instead, because of the way he came to power in the anticolonial struggle, Mugabe had to cloak his rule with elections, even if for a while he managed actually to engineer a constitutionally sanctified one-party state.