The uprising that led to the fall of President Hosni Mubarak has created considerable uncertainty over the future of economic policies and reforms in Egypt. Will the political transition lead to a reform-minded government or a populist one that will try to undo the recent economic reforms undertaken by the Mubarak regime? There are certainly many unknowns, including what type of government will emerge after the parliamentary elections in September. Yet change is inevitable after decades of authoritarian rule. The explosive combination of corruption, educated and digitally-savvy youths, and high unemployment, particularly among the young, along with soaring world food and fuel prices, all created the conditions for the uprising. They also create the conditions for a new economic reality.
Egypt has made a slow transition from a relatively closed to an open economy, starting with a neoliberal macroeconomic campaign in 1991 within the context of an International Monetary Fund (IMF) stabilization and structural adjustment program. The latest series of ambitious economic reforms was launched in mid-2004 under the leadership of former Prime Minister Ahmed Nazif, with his internationally known economic team of Minister of Finance Youssef Boutros-Ghali, Minister of Foreign Trade Rachid, and Minister of Investment Mohieldin, all of whom were close associates of Gamal Mubarak, the former president’s son, who had once been widely considered as likely to succeed as president. The underlying goal of the reform program was to remove binding bureaucratic constraints to growth by restructuring the financial sector, streamlining business regulations, and further liberalizing foreign trade. Coupled with a favorable external investment environment, Egypt’s economic growth increased from 4.5 percent in 2004 to 7.2 percent in 2008. Egypt also managed to avoid the impact of the global recession and grew by an average of 5 percent from 2008-2010.
The new structural reforms covered internal and foreign trade, the public and financial sectors, and privatization. Most notably, they enhanced the business and investment climate, earning Egypt the honor of being among the top reformers in the World Bank’s 2010 Doing Business Report. This was made possible by the elimination of restrictions on access to foreign exchange and reduction of import tariffs from more than 30 percent to 6.9 percent in 2007. Several other changes led to Egypt’s further integration into the global economy. These included reductions in personal and corporate income level ratios; removal of regulations to speed up customs clearance; facilitation of registration for new businesses and property and for the sale of assets; and the modernization of banking and insurance regulations, allowing privatization of joint venture banks, as well as the fourth largest state-owned bank.
Greater exchange rate flexibility was used as an effective monetary tool to target and contain core inflation. Fiscal reforms included tax reforms, public sector wage controls, fuel price adjustments, and premium revenue from licensing sales. These new measures coupled with substantial global liquidity attracted large capital inflows from foreign direct investment.
The IMF has attributed most of Egypt’s economic transformation to the shift from energy, construction and telecommunications to labor-intensive sectors, such as agriculture and manufacturing, which generated 2.5 million jobs. In addition, growth was driven by increased exports and imports, workers’ remittances from overseas, tourism revenues, and Suez Canal receipts. However, there was only a modest decline in the official unemployment rate from 10.5 percent in 2004 to less than 9 percent in 2009.
Despite the many structural improvements, Egypt still remains trapped to a considerable extent by an inefficient government bureaucracy, a web of red tape, inadequate infrastructure, corrupt elites, a weak public sector, and a rapidly growing labor force lacking in necessary skills. Employees in the public sector account for almost 25 percent of total employment of 24 million (out of a total population of 85 million). However, the minimum wage has remained at $50 a month for public sector workers since 1984, while the cost of living has soared. Subsidies on food and fuel prices have been used to placate demonstrators and avoid occasional “bread riots”.
Chronically high unemployment remains a structural problem in Egypt, despite the economic reforms. Wide income disparities and crony capitalism have perpetuated corruption. Therefore, despite the promising macroeconomic statistics, Egypt is riddled with inequality, open unemployment and underemployment, and a crippled tax system unable to redistribute wealth.
The recent political turmoil in Egypt set back the prospects of growth and further economic reforms. Mubarak’s rule ended with temporary economic concessions aimed at tamping down public discontent by offering a 15 percent salary increase to public sector employees. The trend of handouts and subsidies is a theme across the region, although in most cases, including in Egypt, it has not been enough to assuage discontent. The direct short-term economic impact of the unrest resulted in a sharp loss of foreign reserves, an outflow of wealth, a high import bill resulting from soaring global commodity prices, a complete loss of tourism receipts ($10 billion in 2010), and tighter credit standards in the international capital markets. The result was a sudden stop in investment and consumption expenditure reflected in the latest projection of 2 percent growth this year, around half the rate projected prior to protests. At this low growth rate there will likely be an even greater shortage of jobs for the expanding labor force.
Recently, the finance ministry announced a $3 billion balance of payments deficit for the first 3 months of 2011, a major change from the previous year’s surplus of $4 billion. In 2011, foreign reserves were estimated at $36 billion, but the government has used as much as $6 billion to offset currency depreciation, pay a $300 monthly pension to families of demonstration victims, and set up a $250 million emergency fund to buy Egyptian stocks to keep the stock market from crashing after being closed for seven weeks.
What will the Egyptian economy look like when the new elected government takes over later this year? Specifically, what are the economic policies the new government will adopt? Of course, this depends on the makeup of parliament and who is elected as president. What is clear is that the Hosni Mubarak regime has been completely discredited politically. The big question is whether the economic policies and reforms undertaken over the past few years to transform Egypt are equally discredited and will be discarded.
The signs are that the new government will be more populist and less market-oriented than the previous one. The Egyptian uprising was as much about economic issues as it was a political movement, so the politicians will likely have to respond to the economic demands of the population. Heading the list of grievances is unemployment and the rising food and fuel prices. How can the new government address these issues in the short run so as to keep the people from coming back into Tahrir Square? Creating jobs is the first priority. But these cannot be generated out of thin air. Improving the education system to eliminate the skills mismatch between the types of college graduates produced by universities and the demands of the private sector is a long run proposition. Promoting private businesses through infrastructure development and further reduction and elimination of regulations that are still ever present in Egypt also cannot be done quickly. The only way to reduce unemployment in the short run would be through expanding government employment, thereby reversing the shrinking of the government of the last few years. It is also very likely that these public employment schemes will result in a permanent increase in the government workforce.
The adverse effects of high food and fuel prices will have to be addressed as well. In the past Egypt had an extensive system of subsidies and price controls on food, and these have progressively been reduced over the past decade. Now political pressures make it very likely that such subsidy schemes will be reinstated, possibly supplemented by cash transfers to the poorer citizens and increases in public sector wages.
The changes in economic strategy should be expected because the population will demand them. In these circumstances, this is completely understandable. But will other economic reforms launched by the Mubarak regime be maintained, advanced or reversed?
While Egypt has done a lot on the reform front there is still a long agenda of reforms needed to make the country truly a market-oriented economy. The economic model demanded by today’s globalized world and the model adopted by the Egyptian reformers remains valid. The areas for further reforms should include:
- Reducing energy subsidies, which still amount to about 4 percent of GDP (down from a high of 7 percent of GDP before the reforms started).
- Advancing the privatization process to further reduce the number of state-owned enterprises and banks.
- Continuing financial sector reforms to enhance the soundness of financial institutions and reduce bank concentration.
- Promoting Public-Private Partnership Programs to attract private resources for infrastructure investments.
There is little doubt that the first two of the above reforms will be looked at with some skepticism by the new government. Indeed, food and energy subsidies will probably be increased. Privatization of state assets, which in the minds of many Egyptians is synonymous with corruption, will stop and there may even be strong pressures to re-nationalize some of the companies that were bought by individuals close to the Mubarak regime. On the other hand, it is possible that the other two (financial sector reforms and Public-Private Partnerships) will go ahead in the absence of any open public opposition to them.
In addition, other economic reforms also face varying degrees of risk of reversal. If Egypt faces serious balance of payments difficulties, import tariffs could be raised and capital and exchange controls could be introduced. In fact, some exchange controls have already been announced as a temporary measure to contain the loss of international reserves during the last few weeks. Fiscal reforms will also likely be suspended, and it is possible that corporate taxes will be increased. The fiscal deficit, which was on a downward path from a high of 10.4 percent of GDP in 2005/2006 to a projected 7.5 percent in 2010/2011, is going to wind up around 9 percent of GDP this year and will be well over 10 percent next year.
In sum, Egypt is in danger of looking quite different from the Egypt of today, and may look more like Egypt of the pre-reform era. This would be unfortunate as the reforms were hard to achieve and their abandonment would have serious long-term development consequences for the country.
What can the international community do to create incentives for the new government to keep on the general reform path, while allowing for some elements of more populist policies catering to the demands of the protesters? Are there ways to commit Egypt to continue its development into a market-oriented economy? There are several possible commitment devices that can be considered:
- Implementation of an IMF program. The caretaker government has started discussions with the IMF on a possible program to provide financing (reportedly $3-4 billion) to ease the adjustment, while providing a macroeconomic framework to reduce inflation and ease balance of payment pressures. Of course, the IMF program will have to take into account the political circumstances of Egypt so that it does not demand a level of fiscal austerity unacceptable to a new government in the near term.
- World Bank projects and programs. The World Bank has a key role to play in developing programs relating to education, infrastructure, and private sector development. The recent announcement of $2.2 billion assistance by the World Bank is an important step towards this end.
- External debt relief. Egypt’s total official external debt amounts to $33.7 billion, of which almost half is held by members of the Paris Club (and some $3.5 billion by the United States). Debt forgiveness of the type granted recently by the Paris Club to Iraq in 2004, would not only save the country debt servicing costs, but would also send an important signal to Egyptians that their country has the support of the international community.
- Trade agreements. The United States could revive the Free Trade Agreement (FTA) possibility that was abandoned in 2005 in the aftermath of the flawed Egyptian elections. Again the potential of having an FTA with the United States could serve as a signal that the United States is ready to assist Egypt through increased trade.
Egypt has been the leader in the Middle East and North Africa region, and what it does is frequently imitated by other countries in the region. Thus, naturally there is interest and concern in the region, and in the world at large, in the economic model that post-Mubarak Egypt will adopt. Will Egypt be a statist, closed and tightly regulated economy that is unfriendly to business, or a liberalized market-oriented economy integrated with the world? Hopefully, it will be the latter.