The economic roots of Egypt’s crisis

By Brad Plumer, Published: July 3, 2013 at 2:10 pmE-mail the writer

Caroline Freund is a senior fellow at the Peterson Institute for International Economics and former chief economist for the Middle East and North Africa at the World Bank. We spoke by phone Wednesday about the massive protests in Egypt right now — and how the country’s ailing economy is at the heart of political unrest.
Brad Plumer: I keep reading that Egypt’s troubled economy is a big part of the reason why we’ve see constant turmoil there (even if it’s not the whole story). So what’s wrong with Egypt’s economy? What’s gone wrong since former President Hosni Mubarak was ousted in 2011?
Caroline Freund: Let me just take a step back. There are the short-run issues and structural issues. And the reason it’s important is that this is a country that had been growing at reasonable rates of 5 percent, 6 percent a year. But because of its demographics, those weren’t strong enough rates to employ a rapidly growing population.

Opponents of Egypt’s Islamist President Mohammed Morsi shout slogans and wave national flags in Tahrir Square in Cairo on  July 2, 2013. (Amr Nabil/Associated Press)

Even before the revolution in 2011, you had 10 percent unemployment and 25 percent youth unemployment. Already there was a sense of a lack of opportunity and declining social mobility. So Egypt went into its revolution when it was already in difficult economic straits.
But then the revolution itself caused a lot of uncertainty. There was the political uncertainty, the economic uncertainty, there was no policy predictability. Investors lost confidence and decided to wait. Because of the security concerns, tourists stopped coming — that’s around 10 percent of Egypt’s GDP. So the economy has taken a real hit at a time when the population already felt there weren’t appropriate opportunities.
BP: So what are those underlying structural issues? Why can’t Egypt’s economy create enough jobs for everyone?
CF: There are several features of the economy that, mixed together, create a sort of economic poison. One is that the government has long used public-sector jobs to keep the population happy — so that they’d accept authoritarian rule. That worked for a certain amount of time, but demographics ultimately bite. The government hasn’t been able to expand quickly enough to employ everyone, and the population gets upset.
People were literally queuing for good government jobs, while the private sector was not the place people wanted to work. And that fed back into education. Egypt has made great strides in educating its population, but people were still getting the wrong skills for the private sector and for the engines of growth, like manufacturing or technology.
Then there were the fuel subsidies. Egypt’s fuel subsidies were another kind of handout from the government to the population as a sort of trade-off for non-democratic government. Basically the government holds the price of fuel down. That has bad effects by encouraging too much fuel consumption, encouraging smuggling, the subsidies accrue to the wealthiest who have the biggest cars and houses. But it also encouraged investment in energy-intensive sectors, which don’t employ a lot of people. So that added to the problem.
Finally I would say the last bit is that Egypt has a private sector that’s not rules-based and easy to work in. You have crony capitalists who are able to function, but for many people, if you try to start a firm and grow that firm, every step of the way, there’s another bureaucratic hurdle. So this is another thing that discouraged Egypt’s private sector from growing and supplying jobs that one would like to see.
BP: And over the past year, how has Mohamed Morsi’s government handled this?
CF: They’ve worsened things. They made some early mistakes, such as regularizing many of the temporary government employee jobs. They already had too many public employees, and then they regularized the temporary ones, expanded the wage bill. These were the kinds of things that were part of the old mindset, thinking they needed to make the transition easier for the public. But it doesn’t serve their long-run goals.

Still, in the short run, it’s really the political uncertainty that is holding Egypt’s economy back. Until that’s resolved, there won’t be much progress.
BP: Often when a country’s in a situation like this — where they need to make reforms but also need loans — they turn to the International Monetary Fund. Why hasn’t that happened in Egypt?
CF: Early on, the IMF was eager to come in and help the transition. But at that point, the view on the Egyptian street of the IMF was not positive. You can see that from Gallup polls,  the public didn’t want an IMF program. They had a negative view of borrowing from international institutions. So early on, the government didn’t want to do it. And later, when the economic situation really deteriorated, the IMF’s hands were tied, because the IMF needs a program that’s viable to support.
BP: So let’s say someone wanted to reform the Egyptian economy. How would they start?
CF: The biggest concern at the moment is the fuel subsidies, they’re really unsustainable and they’re now taking over 8 percent of GDP. It’s just too costly, and as the pound depreciates, it’s becoming even more costly.
So I think you’d want to see some restructuring there. And it’s not something you can do in one step, but you can do it gradually. And you need to have a strong communications program around it. The government would need to slowly phase it in and be able to offer something as exchange that targets most vulnerable population [to protect them from spikes in the price of gasoline]. But it’s difficult. Other countries, like Nigeria, have tried this and it only led to increased political protests. So the government’s understandably afraid.
The unfortunate part is that this would have been easier to do post-election [in 2012]. The public was excited, we were seeing pictures with ink on their fingers, there was a broad understanding that things were changing. If the government had been able to give rewards to the population in terms of voice and accountability, it would have been easier to push difficult economic reforms.
BP: Is that realistic? To think that painful economic reforms would have been easier if they happened earlier?
CF: That’s what we saw in successful Eastern European transitions, because people were getting something on the political end, they were willing to accept other types of changes.
We’ve looked at over 100 transitions around the world now, when countries go from autocracy to democracy or the reverse. And what we found is that in revolutions and other political transitions, speed seems to be an important factor for success. A big part is for investors to have some confidence about what policies will be there in the future.
BP: So it seems like Egypt is caught in a trap of sorts. The political transition post-Mubarak has been dragging out slowly and uncertainly, which makes it difficult to carry out needed economic reforms. But the economic problems are creating constant political turmoil.
CF: It’s a vicious circle. The virtuous circle would’ve been one where Egypt had an election, the new leader said they’d start moving on things people asked for, like more checks and balances, more transparency and accountability. And then on the other hand they’d say we also need to do more difficult economic reforms because we can’t afford the old system. That would have been a virtuous circle. International financial institutions would have been willing to help out, that would have encouraged private investors. But the window is really closing for things to go that way.
BP: So is there anything the government can do now?
CF: Sure, it just seems unlikely. We’ll need to see what happens with the Egyptian military, but Morsi could say, we need a more inclusive cabinet and replace the prime minister and ministers with people from other parties, and then give in on many of these demands, and try and turn over new leaf. Or he could resign and the military could install a technocratic government. If the population was satisfied with either of those options, there might be a way to get back on track economically. But right now, the political situation comes first.
Transcript has been lightly edited for length and clarity.