Egypt’s economy: Light, dark and muddle

the shakiness of the economy could undermine progress towards democracy - Published on The Economist, June 23, 2011.

FOR almost a month after the fall of Hosni Mubarak, the police vanished from the streets of Cairo. Integral parts of the reviled regime, they did not want to show their faces. Thanks to the self-discipline of Cairenes, there was little public disorder. But one thing did change: the traffic got even worse. With most of the traffic lights out and no cops, cars slowed to a crawl at every intersection.

Inadvertently, Egypt was trying out an idea from Dani Rodrik, a Turkish economist. Mr Rodrik compares a crossroads in Hanoi (but it could be Cairo) with one in Russia. In Hanoi, there are no traffic lights; cars and carts crowd into an impenetrable tangle, yet everyone gets through somehow. By contrast, in Moscow the lights work; columns of cars stop and advance in turn—right up to the moment some idiot in a truck runs a red light and smashes into the waiting queue. This happens again and again and again. 

Egypt is now testing the merits of informality. The old corrupt rules are discredited. The government is running the economy from hand to mouth. It has no real mandate and lacks the confidence to tackle Egypt’s deep-seated problems. It is getting by, more or less. But nobody knows if muddling through will work … //

… The state’s role is too large. Despite fitful periods of reform, the public sector still accounts for over 40% of value-added outside agriculture—higher than in most former communist economies. The state controls some prices directly and influences others through subsidies. The army controls an estimated 10-20% of the economy (no one really knows), including things like olive-oil and pest-control factories which serve no military purpose. And the government is hooked on deficit spending. Though the deficit has not risen much, it has long been too large, and is now 11% of GDP. Turkey’s is 3%. Egypt needs to cut its deficit to near that level—which requires subsidy cuts.

Yet where a strong government is needed—as regulator, enforcer of contracts and guarantor of competition—it is weak. Its welfare provision is a shambles, with an incomprehensible tangle of entitlements which still leaves gaping holes in the safety net. The quality of state provision is an even bigger problem than its quantity. Only in the external sector (reducing barriers to trade and foreign direct investment) and, partially, in banking have reforms been successful.

One result is that private firms are knotted in red tape. Egypt comes 94th in the World Bank’s “Doing Business” measure of regulations. Small and medium-sized companies cannot get credit from state banks. Many small firms do not even have bank accounts. The new government is planning to create a financial instrument for small firms. It is a start, but the next government will have to do a lot more.

It will also have to reverse the long-term failure of Egypt’s education system, something beyond the remit of an interim administration. Once a centre of Arab learning and an exporter of teachers to the Arab world, Egypt has seen its education standards decline alarmingly. This is partly for lack of money—the country spends a smaller proportion of GDP on education than most Arab states—but is also a result of bad organisation. The quality of everything, from schools and equipment to teachers, is appalling. The ministry of education employs as many bureaucrats as teachers, and there is no national teaching accreditation system. Educational failures cast a shadow over the quality of the workforce.

What are the chances that Egypt can rise to these challenges? In the long run, reasonable. The country has real advantages. It is the most populous Arab country and, because it is not dependent solely on oil, offers a bigger menu to investors. As a location—on the Suez Canal linking Europe, the Middle East and Africa—it is hard to beat. In common with other Arab countries, it has favourable demographic trends, with a growing labour force and a declining dependency rate (children and pensioners as a share of the working-age population). On the rare occasions the government started to liberalise—in 1974-79, 1991-98 and 2004-08—the economy boomed. “This is an economy that can bounce back,” says Ratna Sahay, the head of the IMF’s delegation to Egypt.

Destination Istanbul—or Karachi?

The big uncertainty is politics. Many Egyptians are optimistic, arguing that the removal of Mr Mubarak and plans for elections and a new constitution remove the biggest source of political doubt: what happens after the pharaoh. They also argue that there is a broad consensus supporting private-sector-led growth. A group called the Coalition of Revolutionary Youth, formed by Tahrir Square demonstrators, has a market-oriented economic policy to which all the main parties—including the youth wing of the Muslim Brotherhood—has signed up.

Yet this seems over-optimistic. Political uncertainty is everywhere. It is unclear whether post-Mubarak Egypt will have a presidential or a parliamentary system. It is not certain whether the elections will take place before the constitution is agreed (as the army says) or after (as liberals want). No one knows how much support the Muslim Brotherhood and the old-fashioned left have. No one knows how strong the temptations of populism could be.

On balance, if the politics stays stable, the economy should do well enough to consolidate democracy eventually. But that is a big if. As Mr Heikal says: “If we get things right, we could be Turkey in ten years. If we get them wrong, we could be Pakistan in 18 months.” (full long text).

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