Abstract: The Kafala (or sponsorship) system is the key instrument behind the economic development of the United Arab Emirates (UAE) and most Middle East economies. The system governs both labor migration and foreign investment by assigning a native-UAE sponsor to each migrant worker and each foreign investor. Sponsors enjoy significant command over these factors and extract sizable economic rents. Firms in free-zones, in contrast, are exempt from the Kafala system. Therefore, they provide an appropriate counterfactual to study the effect of policy regulations on technical efficiency. Using a representative sample of 600 firms of Dubai we estimate stochastic frontier models to identify and compare the degree of technical inefficiency between firms operating under the Kafala system and those in free zones. Our results suggest that on average technical inefficiency resulting from the Kafala amounts to 6.6% of total costs (or 11% of profits). Inefficiency is also greater among firms in Main Dubai in all economic sectors.
Keywords: Labor sponsorship (Kafala), technical inefficiency, economic rents