Algeria's violence has always been attributed to religious and political factors. While this is partly true, the explanation, in fact, lies in the field of economics. More precisely, Algeria has a problem because of its emphasis on the 'oil-only' strategy. The absence of a leading manufacturing sector meant that the expansion of the economy was inevitably limited, which has had serious implications for private consumption, employment, and technological development.

Private Consumption

Given the absence of a strong manufacturing sector in Algeria, output per head could be increased only by substantial increases in investment; efficiency growth played a minor role. During the 1970s, Algeria sustained reasonably high economic growth rates by accumulating capital which was made available by oil proceeds. The investment rate, which was equal roughly to 25 percent in 1972, had increased to about 45 percent in 1979. However, these investment rates could not be increased forever. As they became higher and higher, less and less output was left for consumption. Thus, from an average growth rate of about 6 percent in 1983-85, real private consumption declined by about 3 percent in 1987, and by more than 8 percent in 1988.

Achieving growth through higher investment rates (as opposed to higher rates of technological progress) became politically impossible as the world oil price collapsed in 1986. The Growth rate of capital per worker declined from 17 percent in 1978 to -18 percent in 1986. As a result, productivity growth, measured by the growth rate of output per worker, declined from 8 percent in 1978 to -2.5 percent in 1986.

Since wages depend on productivity growth, the implication for Algeria's workers was very serious. Real wages growth rate, nominal adjusted for inflation, declined from 19 percent in 1986 to -5 percent in 1987 and to -6 percent in 1991. In a society where the majority of workers are paid the subsistence level, there is no doubt that this decline in real wages is very painful.

This situation was made worse by the fact that private consumption was further suppressed by other factors. The main importance of these is that the oil price collapse in 1986 was coupled with increasing debt servicing, implying less resources for consumption. Thus, in 1986, the debt-to-export ratio amounted to more than 220 percent.

This situation has led to a sharp decline in the country's foreign exchange. This meant that the direct control of the consumer market and the inflation growth by the government was no longer within reach. For one thing, reduction in subsidies and higher inflation rates meant less consumption. For the other, the scarcity of foreign exchange affected consumption through the direct restriction on consumer products imports. Furthermore, because of the government restriction on imported inputs, consumption declined as a consequence of less ability to produce goods domestically.

Technical Progress

The pitfalls of Algeria's dependency on oil proceeds do not seem to have always been appreciated. In industrialised countries, technological progress plays an important role in the determination of economic growth rates. In principle, the pace of this depends on the firm's incentives to innovate and to implement new innovations. These incentives were for the most part absent or even perverse in Algeria. Firms, which could always obtain the inputs they needed to achieve the output goals set in the plan, had little incentives to develop more efficient methods of production. Indeed, firms had incentives not to adopt new methods or introduce new products.

Note: The impact of technological progress has been estimated by first producing an index that combines all measurable inputs (namely capital and labour) and then measuring the rate of growth of national income relative to that index--to estimate what is known as 'total factor productivity' growth, or rates of technological progress.

Despite these disincentives, Algeria was able to achieve reasonably high growth rates of technological progress in the 1970s. But this is hardly surprising since most of it came in from the implementation of techniques developed elsewhere. More precisely, technology transfer involved the building of factories by foreign companies within the framework of what was known as the 'key-in-hand' technology policy. Although the high level of education, and thus of human capital in the country, implied that firms had the competence to adopt and implement the new techniques if ordered to do so, this has never been the case.

The consequences were disastrous. The system Algeria adopted since its independence from France in 1962 would no longer work in the 1980s and 1990s. On the one hand, the nature of required technological progress changed. The increasing complexity of economic organisation and the nature of innovations made central planning a poorer and poorer substitute for the market. On the other, technology transfer through the key-in-hand strategy was no longer affordable in the aftermath of the world oil price collapse.

With the slowdown in output growth, and the 1988 political riots, Algerian policy makers found themselves under increasing pressure to try economic reform. By 1989, the government concluded that wider-ranging reforms were needed and tried to implement a slow transition to a market economy. However, by 1991 it was too late. The shift to the market was going to be much faster than everybody had anticipated. One major problem was the severe loss in employment.

Employment

Transition to a market economy has decreased employment through various channels. Before 1989, most employment was in the state sector--the sector composed of the large firms producing under the central plan. The expectation was that the initial effects of the transition would be to reduce the demand for labour in the state sector but to substantially increase it in the private sector. Unfortunately, the net effect was the opposite: a sharp decrease in employment.

The reasons are not hard to find. First, many firms experienced sharp decreases in demand. With price liberalisation, many of the goods they produced were no longer in demand. Second, contrary to what the IMF and the government expected, demand did not shift to goods produced by the new private sector. Hence there has not been an increase in private employment sufficient to offset the decrease in state employment. This is because the private sector could not grow fast enough. One reason is that production of new goods requires capital and expertise, and both were absent at the beginning of the transition. Another is that the banking system lacked the expertise to make loans, so potential new entrepreneurs could not obtain credit to buy new capital.

More importantly, because entrepreneurial skills were not taught to be very useful under central planning, most would-be entrepreneurs lacked the knowledge and the skills needed to create and run new firms. As a result, the increase in employment in the private sector was insufficient to offset the decrease in employment in the state sector.

This conclusion raises what looks like a paradox in macro-economics: why have real wage decreases not maintained a high level of employment? The answer is simple: the significant reduction in investment due to the world oil price collapse meant that the economy would still have very high unemployment rates even at zero wages!

There are economic costs attached to unemployment. These can be measured by estimating the economy's potential GDP, or what GDP would be if there was no world oil price collapse. The gap between actual GDP and potential GDP is then the Algerian Dinar (AD) value of final goods and services not produced because there was unemployment.

These estimates for Algeria appear in Figure 3. The most important observation to be made from this figure is that the GDP gap for the years in which the economy operated below its potential (i.e. 1986-91) was very significant.

Given the above situation, there is, indeed, no great mystery as to why elections were lost in the early 1990s. In other words, the greatest mystery lies in the fact that Algerians are still obsessed with their oil-only strategy. The reason could be that they are not the only ones.