The Economics of The Arab Spring– the case of Egypt

The whole region now in turmoil – can Tunisia and Egypt show the way?

Agenda1. The present2. The past3. The revolutionary decision?4. Transition5. Economic reforms6. Policy options

How can economists be useful?

• Economic gains in the past modest, future looks worrisome given demographics and education

• Rising discontent related to perceptions of rising corruption, lack of liberties, increased repression, unpopular external postures

• Economic gains not good enough to sustain an autocratic bargain

The revolts may be mainly driven by political factors, but old economic ills remain and will continue to frustrate popular aspirations

There are risks of populism and bad closures if economics do not come to the rescue

Can a more democratic order allow for more pro-active reforms and more successful growth policies?

1. Understanding the present

• High unemployment, especially among the youth (20 to 30%) – the youth bulge

• Rising inequality – the result of economic liberalization

• Bad governance – low voice and accountability

• High levels of corruption

A young population (Egypt)

.

Very high unemployment (Egypt)

Asaad 2007

Especially for women

Asaad 2007

The unemployed tend to have higher education

• .

Deteriorated governance

• .

Corruption and democracy

Large increase in Inequality Egypt 1998-2006

Nadia Belhaj, 2011

Inequality of opportunity

Source: Nadia Belhaj 2011

2. Understanding the past• SLI of the 60-70 – Arab nationalists

revolutions led by armies and appealing to MC -- Oil and rentier states – the autocratic bargain

• By mid-1980s, decline of oil prices and Forced economic liberalization and reforms start, but unlike LAC after debt crisis, political liberalization is aborted

• 1980-2000, performance declined but on average economic growth not inferior to other regions except for East Asia

Modest economic performance

Not the worst, but modest over the LT, worsened in 1980s (esp for oil based), but improved in some cases in the 2000s

Rate of Growth of GDP per Capita in Constant Prices, 1960-2000

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Middle East OECD East Asia LatinAmerica

South Asia Sub-SaharanAfrica

Source: World Development Indicators, 2003; Taiwan Statistical Databook, 2004

percent

Oil explains a lot of the variability

..

Rising incomes translate into improved life chances…

Infant mortality rate, 1960-2002

0

20

40

60

80

100

120

140

160

180

200

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

Algeria

Egypt

Jordan

Kuwait

Morocco

SaudiArabiaSyria

Tunisia

Note: Deaths per 1,000 live births. Source: World Development Indicators, 2004.

Life expectancy, 1960-2002

0

10

20

30

40

50

60

70

80

90

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

Algeria

Bahrain

Djibouti

Egypt

Iraq

Jordan

Kuwait

Lebanon

Libya

Morocco

Oman

Qatar

Saudi Arabia

Syria

Tunisia

UAE

YemenNote: Life expectancy at birth. Source: World Development Indicators, 2004

years

.

Increased educational attainment…

Human capital accumulation, 1960-2000, typically-endowed economies

0

2

4

6

8

10

12

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Years of educationEgypt

Jordan

Morocco

Tunisia

Bangladesh

Brazil

China

India

Pakistan

South Korea

Taiwan

TurkeyNote: Mean years of total education of the population age 15 and over.Source: Bosworth and Collins (2003)

Human capital accumulation, 1960-2000, resourceendowed economies

0

1

2

3

4

5

6

7

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Years of education

Algeria

Iraq

Indonesia

Nigeria

Venezuela

Note: Mean years of total education of the population age 15 and over.Source: Iraq, Nigeria, and Venezuela: Nehru and Dhareshwar (1993); others: Bosworth and Collins (2003)

But low quality: average math scores of eighth grade students 2003

Singapore 605 Italy 484Korea, Republic of589 Armenia 478Hong Kong SAR2,3586 Serbia4 477Chinese Taipei 585 Bulgaria 476Japan 570 Romania 475Belgium-Flemish537 Norway 461Netherlands2 536 Moldova, Republic of460Estonia 531 Cyprus 459Hungary 529 (Macedonia, Republic of)435Malaysia 508 Lebanon 433Latvia 508 Jordan 424Russian Federation508 Iran, Islamic Republic of411Slovak Republic508 Indonesia4 411Australia 505 Tunisia 410(United States)504 Egypt 406Lithuania4 502 Bahrain 401Sweden 499 Palestinian National Authority390Scotland2 498 Chile 387(Israel) 496 (Morocco) 387New Zealand 494 Philippines 378Slovenia 493 Botswana 366

Saudi Arabia 332Ghana 276South Africa 264

-100

-50

0

50

100

150

8th Grade Science and Mathematics Scores Deviation from Mean - 2003

Science

Mathematics

Percentage of University Age Students Studying Engineering and Science in Universities

0.00

0.05

0.10

0.15

0.20

0.25

Algeria Egypt Kuwait Morocco SaudiArabia

Syria Tunisia SouthKorea

malaysia thailand

0

5000

10000

15000

20000

25000

Graduate Students Enrolled in American Universities, 2000

Manufactured Exports

• MENA nations as a group have disappointing growth despite proximity to EU – especially surprising given that major low resource/labor nations are on the Mediterranean and have low transportation costs

• Competition by Eastern Europe after 1990

• Increasingly stringent global conditions - rise of China and India imply increased competitive pressures

Why job growth slow after reforms? • Structural factors

– LF rising fast – at over 3.5% even before accounting for any increase in female LF participation

– Gains in education faster than gains in new skilled jobs– MIC glass ceiling

• Political factors– Economic reforms have not gone far enough – or were not

politically feasible as the old order favored the status quo– Given perceived political risk and corruption, supply

response was weak – Unequal model of growth: Poor left behind, lagging

regions (SidiBouzid, upper Egypt)

Political economy linkages

• Need to control street (esp after 911) led to police state: liberties curtailed, institutions corrupted (justice, market regulation, finance)

• Economic w/o political liberalization:– Exclusion processes at center: initially, to prevent

constitution of autonomous power centers. Over time, led to corruption among insiders, under guise of liberal policies (privatization, preferential access to capital, tax exemptions, state contracts, monopoly rights)

– Inability to regulate grew over time – logical destiny, hubris, moral decay? Regional contagion at work?

1960s – 70s 1980s – 90s 2000s – 2011

* failed peace process * Iranian revolution * Iran-Iraq war * Gulf war * Islamic movement * 9/11

Issues - evolution of the “political settlement” - consequences of economic without political liberalization - corruption in repressive autocracies

State led industrialization

fails

State led industrialization

fails

Infitah – young leaders

Towards political and economic liberalisation

Infitah – young leaders

Towards political and economic liberalisation

Repressive autocracies with corrupt

liberalism

Repressive autocracies with corrupt

liberalism

revolution

Evolution of political systems

A low equilibrium“Old” political settlement a low equilibrium : elite gets a large share of a small pie -- keeps the street

angry but under control, and scares external actors and middle class to support regime.

A weak state

• Slow growth, consumption expenditures (salaries for diploma holders, subsidies to middle class) led to inability to pay decent wages and to spread of petty corruption in bureaucracy.

• Predatory and inefficient bureaucracy delivering poor quality social services

• Muselled civil society reducing the potential for activism and social accountability at all levels

A weak economy

• Restricted state budgets led to less investment in infrastructure, especially away from the centers of power -> lagging regions

• Private activity repressed: large transaction costs push SMEs into informality; private sector starved for finance

• Artificially created political/security instability leading to low and foot-lose investments and loss of savings (capital flight:$5b in Egypt, $1b in Tunisia/yr over past decade).

• Misallocation of effort into rent seeking rather than productive activities

RepressiveAutocracies

timid Capitaltimid

Capital

weak State

Capital flightCapital flight

rentsrents

•Low econ. Transformation•Low investment

•Corrupt privatization•monopolies

CorruptionCorruption

Poor quality services

Subsidies

•Low growth

• Rising middle class

• Demographics

•Education

•Unemploy-ment

•Youth frustration

•Inequality

MigrationMigration

A vicious cycle of state decay and low growth …

3. Looking more carefully at Egypt

Low investment

Means low growth

Source: World Bank 2009

Shrinking credit to the private sector

One of many constraints

Most loans go to large firms

• .

But they did not deliver the jobs!

Source: Asaad 2007

SMEs predominate

.

And mostly go to the rich

Egypt: subsidies+military= 2.5 times health plus education

4. RebellingQuestions:• Unlike Latin America (1980s), Eastern Europe and

Africa (1990s), Asia, South Europe, direct causes not clear

• Economic reforms? Why did the revolutions start at the end of 2010 rather than in 1990s?

• Recent literature – 1980s-90s: the autocratic bargain; oil rents; 2000s: how autocrats adapt, coopt middle class; repress PI; external alliances

• Why experts did not see the revolution coming? Why did it start in Tunisia and Egypt? Why is it spreading to whole region?

Interpretation• Predications of classical autocratic bargain (Ghandi and Prezeworski

2006; Desai,Olofsgard, and Yousef 2009) do not apply• Political bargain since 1990s based on protecting liberals and West

from Political Islam -- it sustained autocracies until now – Political Islam: radicalization, but also rapprochement with middle

class – By 2000s, most Arab regimes openly repressive and increasingly

corrupt • Revolution when MC equation tipped from support for autocrats

against PI insurgency, to new democratic settlement wt PI • Mechanisms:

– economic liberalization under repression led to increased corruption – over-repression in order to radicalize PI and scare liberals – nature of support from donors biased policies (social, external

relations)

Implications of tipping point perspective

• Concessions by the autocrats under pressure to keep Liberals in coalition – Includes: more space for media, “Islamization” of

social policies, rise of subsidies • Tipping point: when changes take place on both

sides of the equation– how attractive is it to remain in autocratic coalition – how attractive it is to enter into political settlement

wt PI• Imperfect information • Regional contagion effect

regional variations..

• A kingdom factor? Jordan, Morocco, SA, Gulf• Ethnicity: Lebanon, Syria, Iraq, Maghreb• External relations + the Israel factor –

especially active in Mashrek• The role of armies + security forces• Level of oil and other rents/ migration

remittances

5. Transition issues• Constitutional choices will determine shape of future

majorities– Quick vs slow change to give time for parties to come to

life? – alternatives voting systems (district based, proportional,

to bring in lots of new parties; which parties to legalize• Economics

– Revolutions represent a macro shock – capital flight accelerated, lower FDI, tourism, larger deficits – lead to ST losses

– Economic choices: how much to expand, borrow, vs leaving more choices for the future

Average growth performance during typical transition (percent)

Freund and Mottaghi (2011) based on 32 transitions

6. The future: can political change lead to better outcomes?

Q: can new settlement preserve some of the achievements of the past (eg macro stability) and provides for improvements?

• Security and stability based on legitimacy of ballot, much better than repression from an economic perspective too

• Transparency, checks and balances, and social accountability can create extra accountability mechanisms

• Is it possible to include the youth more centrally in the economy as a source of entrepreneurship and skilled jobs?

Democracy not automatically better for growth

Source: Besley, Timothy J. and Kudamatsu, Masayuki, Making Autocracy Work (June 2007). , Vol. , pp. -, 2007. Available at SSRN: http://ssrn.com/abstract=1136696

Creating more jobs• How to increase investment and jobs?

– Reduced corruption , capital flight, leading to higher investment, better allocation

– Labor intensive jobs – how to rehabilitate large private concerns?– Big push on supporting young entrepreneurs?– SME development: can Islamic finance help?

• Supporting policies: competition, SMEs support, democratization of finance, pro-active labor policies

• Political challenges: – Big capital accept new rules -- more investment , less capital flight,

more competition – middle class embraces entrepreneurship – better regulation and

access to capital, not public sector jobs; – poor accepts unskilled jobs wt inter-generational deal on education – State reduce intake of national savings

Fixing the state

• Better services require more financing esp. higher public sector wages

• Can this be financed by reducing subsidies?• Opening up to social activism and social

accountability mechanisms• Ambitious bet, requires a new social contract:

– middle class accepts lower subsidies before improvement of services

– Civil servants work harder (for higher wages) and give up corruption rents

No social accountability

Research:how to improve state services and root out state corruption? the role of higher wages vs social accountabilityThe political role of state subsidiesThe influence of rents, foreign aid

Active social accountability

issues:how to improve state services and root out state corruption? the role of higher wages vs social accountabilityThe political role of state subsidiesThe influence of rents, foreign aid

Rents: Oil, SuezTourism

Foreign policy/AidMigration/remittances

Rents: Oil, SuezTourism

Foreign policy/AidMigration/remittances

StateState

Low wages Corruption

Poor servicesSubsidiesBad economy

RepressionRepression

State failures and rescueState failures and rescue

Good economy

X

Good wages -> Higher

performance

Effective social services and

social protection

Effective social services and

social protection

Towards new national pactsProspects and constraints• Coalition building difficult: tight fiscal constraints, diverse ideologies, scope of

economic challenges. • Hard-won change brings momentum for institution of new National Pact around

widely shared aspirations – democratic politics can break the status quo Democracies make coalitions possible. Which coalition needed for complex reforms?• w/o capitalists: a jobs gap (left?)• w/o youth/middle class : a democratic gap (populism?)• w/o workers: a security gap (right?)Risks :• Democracies initially likely to be messy (and clientelistic), but risk of populism

worse as it will not solve old problems• radicalization: failure leading to chaos, a return of the old order, perhaps in

alliance wt the army (a Pakistan scenario); or chaos leading to fragmentation.• New aspirations likely to include regional postures that may not be of the liking of

the West, but external support for unpopular causes will strengthen radical causes.

PE s More

productivePE s

* low supply response, informalization

Challenges: - democratizing the financial sector- regulating capitalism: Capital flight, corruption, “supply response”- fixing the public enterprises- the youth and entrepreneurship- how promising are the emerging labor intensive industries?- Improving SMEs’ efficiency and linkages

State deficits

RentsRents

CapitalLarge firms politically connected

Army controlled sectors

SME, Informal sectorSME, Informal sector

•Tourism• labor intensive

Industry• Construction

•Tourism• labor intensive

Industry• Construction

Capital flight

Capital flight

Capital: failure and rescue

X

XLarge firms invest in jobs &

productivity

State shrinks – informality rises

Source: Asaad, 2007

Not much fiscal space to respond to popular demands

Wage bill and public investment low

From ECES December 2010

Are public sector wages too low, or too high?

Must not compare apples and oranges..

Subsidies super large