This paper was presented by Mohsin Khan at the Fifth Advantage Forum Global Perspectives Competitiveness & Growth held in Milan on May 13, 2013.
by Mohsin Khan, Rafik Hariri Center for the Middle East, Atlantic Council
The Arab Spring that swept the Middle East starting in early 2011 dramatically altered the political landscape of the region for the better with the overthrow of autocratic regimes in Egypt, Libya, Tunisia, and Yemen. It signaled an end to dictatorships and the beginning of a long overdue democratic transition process in the Arab world.
The monarchies of Jordan and Morocco also experienced profound political changes, even though the rulers maintained their power. There were two main reasons for this. First, unlike the authoritarian rulers in the other four Arab transition countries, King Abdallah II of Jordan and King Mohammed VI of Morocco have considerable legitimacy in the eyes of their citizens because of their long lineages. Second, the Jordanian and Moroccan rulers saw the signs of change very early and embarked on a process of political reforms to pacify the protesters who took to the streets in 2011. Whether the two monarchies will be fully successful is still an open question, but they have managed to contain the political upheavals for the time being.
While the promise of political change in the Arab transition countries was very welcome, the Arab Spring also created considerable uncertainty over the future of economic policies and economic reforms. The desire of the populations is summarized in the call by the protesters in Tahrir Square for “Bread, Freedom, and Social Justice”. The explosive combination of popular unrest against undemocratic governments, corruption, high unemployment, and widening income inequalities all created the conditions for the uprisings. The new governments thus have to simultaneously address the political and economic demands of the public.
Will the political transition triggered by the Arab Spring lead to a continuation of the market-oriented economic reforms that most Arab countries had embarked on over the past two decades, or will more populist regimes emerge that will undo these reforms and adopt policies catering primarily to the immediate demands of the restive and empowered public?
Unlike the Central and Eastern European transition countries, the Arab countries do not have the European Union economic model to which they can aspire. As such, they are seeking their own economic model. Two years after the beginning of the Arab Spring, it is now becoming clear that this model will contain elements of both populism and reforms, with the weights assigned to each differing across countries.
What have been the economic consequences so far of the Arab Spring? The Middle East and North Africa (MENA) region saw only a slight fall in the average growth rate along with a rise in average inflation in 2011-12. However, this outcome largely reflects the strong performances of the oil exporters in the region, particularly the larger Gulf countries, who benefited from higher world oil prices and could thus afford large-scale fiscal stimulus policies. The effects of high oil prices also showed up in the large current account surpluses in MENA in 2011-12, as well as in fiscal surpluses despite the sharp boost in government expenditures by many countries in the region.
The Arab transition countries, excluding Libya for which reliable date is as yet unavailable since the uprising began, represent about 16 percent of total MENA GDP of $2.7 trillion. These 5 countries were hit hard by both domestic and external shocks. Not only did they face dramatic political changes and widespread social unrest at home, they were simultaneously confronted with high oil prices, the European crisis, and spillover effects from their neighbors.
As a result, all the Arab Spring countries grew less than the average growth rate of the MENA region of 4.2 percent during 2011-12. Only Morocco—generally the best performer of the group grew at a rate just below that of the region as a whole. Two of the countries—Tunisia and Yemen—in fact experienced negative growth rates in 2011. Accordingly, unemployment rose in each of the countries despite the fact that reducing it was a top priority of the governments, as it was one of the main factors that led to the uprising in the first place.
The only saving grace of the recessions in these countries was that inflation was largely contained, except in Egypt and Yemen. Nevertheless, with inflation in the Arab transition countries running at an average annual rate of 8 percent, and with growth averaging less than 2 percent per year, it is imperative that the countries adopt policies to try and change these numbers. While it is possible to generate a spurt in the growth rate through expansionary macroeconomic policies, this effect cannot be sustained as inflation rises, and eventually growth will fall. In the long run the evidence is that the relationship between inflation and growth is negative. Empirical estimates specifically for MENA countries show that once inflation reaches about 6-8 percent, its effect on growth becomes negative. Clearly, Egypt and Yemen are in that danger zone and have to be concerned about the negative effects that their relatively high rates of inflation will have on longer term growth.
Because of political instability and deteriorating security, a well as the slowdown in Europe, both tourism receipts and workers’ remittances fell off sharply, leading to a widening of the external current account deficits. Foreign direct investment into the countries came to a virtual standstill and capital flew out. It is therefore not surprising that all the Arab transition countries experienced a significant loss of international reserves in 2011-12, with the largest decline occurring in Egypt, where international reserves fell from $36 billion in December 2010 to $15.5 billion at the end of 2012.
Fiscal deficits in the Arab transition countries increased as governments engaged in expansionary fiscal policies to meet the demands of the public to create jobs and improve living conditions. Wages were increased and subsidies for food and energy continued to expand. Subsidies are a big ticket item in the MENA region, to the extent that according to IMF estimates almost half of the world subsidies for energy—amounting to $1.9 trillion—originate in MENA. In the Arab transition countries, subsidies for petroleum, electricity, and natural gas range from a low of 20 percent of government revenues in Morocco to a high of over 50 percent in Egypt. Total subsidies in Egypt account for 10 percent of GDP and 27 percent of government expenditures; fuel subsidies alone amount to 50 percent of the total subsidies bill. In Morocco subsidies amount to over 6 percent of GDP, with energy subsidies representing 90 percent of total subsidies. During the first two years of the transition process there has only been a limited effort in rationalizing the subsidy systems in Jordan and Morocco, while in the other countries there are as yet only plans to change the system.
Some modest improvements in the principal macroeconomic indicators are projected for 2013. Growth is expected to pick up slightly in all the Arab transition countries, expect Egypt where the political situation remains unsettled and no coherent economic strategy has been formulated, let alone implemented. Inflation is projected to rise in all the countries and governments will accordingly need to keep a watchful eye on it so that it does not rise to a level where it starts to have an adverse impact on the growth rate. Current account deficits, with the exception of Yemen, are expected to fall and consequently the loss of international reserves will be contained and reserves should stabilize at their 2012 level. In the case of Egypt, which has received substantial financial assistance from Qatar and Libya in 2013, reserves will rise to nearly $19 billion. As it is unlikely that these countries will be able to reform their subsidy systems, fiscal deficits will continue to rise or at best remain relatively constant.
The other major item that will keep fiscal deficits large in the Arab transition countries is increases in public employment. Creating jobs is the first priority of these governments. But jobs cannot be created out of thin air. Improving the education system to eliminate the skills mismatch between the types of graduates produced by schools and universities and the demands of the private sector is a long run proposition that will take time to show results. Promoting the expansion of private businesses through infrastructure development and the reduction and streamlining of regulations so that they will hire more workers is similarly something that cannot be done overnight. The only way to reduce unemployment in the short run is through expanding government employment. The increase in government employment has already started in Egypt, with some 400,000 public sector jobs being created in 2011-12, and in Tunisia where the budget for 2013 includes an increase of 23,000 jobs in government.
Maintaining subsidies on food and energy, expanding government employment, and increasing wages across the board are obvious populist measures that the Arab Spring countries have already started to adopt in some degree. Other populist measures could include raising import tariffs on “luxury” goods, imposing capital and exchange controls, increasing corporate and personal income taxes for high-income earners, putting caps on banking lending rates, and stopping the privatization of state-owned enterprises. If governments give into populist pressures and adopt these types of measures, the countries will look quite different from what they were like in 2010. This would be very unfortunate, as the economic reforms they have undertaken so far were hard to achieve and their abandonment or reversal would have adverse long-term consequences for their economic development.
So what can the international community do to prevent such an outcome? While the dangers of populist economic policies are clearly there, the good news is that the countries all signaled their intention to sign on to IMF programs. By doing so, the countries stand to gain on two counts. First, they will have access to external finance, both directly from the IMF and from other bilateral and multilateral donors who have made their financing conditional on the countries having an IMF program. Second, an IMF program provides the international community and investors the confidence that the governments are putting their economic houses in order and will not let populist policies derail the economic reform process.
Jordan and Morocco were the early movers in this connection and adopted IMF programs in August 2012. Jordan has a 3-year Stand-By Arrangement (SBA) amounting to $2 billion, while Morocco signed on to a 2-year Precautionary and Liquidity Line for $6.21 billion. Yemen too obtained short-term emergency financing of $100 million from the IMF in 2012, with the intension of having a full-pledged SBA in 2013. Also, in April 2013 Tunisia made a formal request to the IMF for a 22-month SBA for $1.78 billion.
Egypt’s negotiations with the IMF have been more tortuous. As early as June 2011, an agreement was reached between the government and IMF staff for a $3 billion SBA but it did not proceed as the military government backed off finalizing the deal. Then again a larger SBA for $4.8 billion was agreed in 2012 and its formal approval was to be discussed by the IMF Executive Board on December 19, 2012. However, on December 11, the Egyptian minister of finance requested a postponement of the IMF Board meeting “to give more time for social dialogue”. Finally, in 2013 there were strong signals from the Egyptian economic team that an agreement would be finalized at the IMF Spring meetings in April. Unfortunately, there was no agreement and currently all interested parties are in a waiting mode for a program with another IMF team expected to return to Cairo in May.
The challenge for the Arab Spring countries will obviously be to balance short-term populist measures that the governments feel they have to take while keeping on a clear long-term economic reform path they need to take. It is in the interests of the countries, as well as the international community, that the Arab Spring countries succeed in their efforts to become market-oriented economies closely integrated with the rest of the world. With the involvement of the IMF in most of these countries, the signs are positive but without high sustained economic growth that leads to significant job creation, the political goals of the uprisings will be threatened. In other words, economic failure could lead to new round of political instability in the Arab Spring countries, and possibly even in the wider MENA region.