Articles
National Dialogue: Beyond The Pseudo-Rentier State: A Basic Framework For A Sustainable Economic Recovery
By: Omar Abdelhady
For the past few years Egypt has been grappling with a multitude of complex economic issues that have had extremely adverse effects on its citizen’s welfare. From high inflation that reached in excess of 30%, youth unemployment that reached 25% and shortages in basic commodities such as rice and sugar. In addition, the country is also facing many structural problems that are represented by a large fiscal deficit, high external debt obligations and a shortage in foreign currencies. These issues are the result of the long-term structural issues colliding with the recent global shocks such as the covid-19 pandemic, the Russian Ukrainian war and recently, Israel’s offensive against Gaza.
There are three main pillars to the economic crisis in Egypt. Shortage of foreign currency, high inflation and high external debt obligations. In particular, it can be said that the shortage in foreign currency is the main symptomatic problem ailing the economy as it is the a major source of both the inflation and debt problems. The shortage has necessitated further devaluation of the pound which has led to imported inflation. The devaluation also means increasing the burden of repaying the dollar denominated loans.
One may trace the origin of the current crisis to the foreign shocks, but the problem goes much deeper, to the basic structure of the economy that has made the economy greatly susceptible to these foreign shocks in the first place. To understand this one must first understand the concept of a rentier state as first formulated by Dr. Hazem Beblawi in his 1987 article “The Reinter State in the Arab World”. A rentier state is a state that derives a majority of its income on a regular basis from the rent (i.e., sale) of its natural resources. This term is best exemplified by the oil rich gulf states. However, Egypt can also be classified as such, at least partially. A large portion of the country’s income comes from four importance sources. Suez Canal passage fees, Oil exports, Tourism (also an export) and worker remittances. These four sources of foreign currency income have one thing in common. To a lesser or greater extent, they are very sensitive to foreign shocks and since the economy greatly relies on these sources of income, the economy also is sensitive to foreign shocks. The over-reliance on these sources of income has made the country more concerned with the allocation of this income rather than be concerned with creating increasing income through production. Therefore, when one of these or multiple of these source of income falls, the productive capacity and general productivity level is not enough to pick up the slack.
Therefore, no simple program that aims to solve the symptoms of this structural problem will get the country out of the economic crisis it finds itself in right now. The problems that Egypt faces right now are a result of deep structural problems in the economy that came to the surface when the country could not cover them up with more borrowing, as a result of external factors out of its control. To get out from under the current crisis without the help of external forces. The country will need to solve its structural problems, which will take time and a considerable amount of effort from all of the possible stakeholders. The role of the government in this period would be to coordinate these efforts by setting a clear ideological framework for coordination with the stakeholders for how the economy should be run and more importantly show a complete commitment to it.
Since the open-door policy of the 1970’s the country has been towing the line between capitalism and socialism which caused enormous confusion for everyone involved. It is illogical for a now supposedly market oriented economy to have almost 5 million of its around 30 million labor force employed by the government. For comparison the USA has only 2.87 million employees of its 170 million large labor force working for the federal government. The government should clear this confusion once and for all and start to finally have a clear economic ideology that transitions the country gradually, yet deterministically towards a real market-oriented economy. By solving the structural issues preventing this transition. The country cannot continue to operate as a rentier state with the booms and busts depending on the income from the Suez Canal, the number of tourists or the whims of risk loving investors. Rather, the country should start to rely on its productive capacity. This is a necessary step for the country to get the short-term help it needs to get out of this current crisis. It cannot only just rely on its status as “too big to fail” or we will remain in the same cycle.
Consequently, this paper is not a set of steps that the government should undertake to get out of the crisis. This is generally the work local government entities executing on the directives and incentives created by the central government. In addition, a set of a disparate solutions with no clear ideology – as currently being implemented by the government – will only work to achieve disparate goals and will therefore will get us nowhere. Rather, this remainder of this paper proposes and advocates for the optimal direction for the central government to adopt and work on implementing by effectively delegating them to local governmental entities with sufficient oversight.
Having a transparent, well formulated and well communicated strategy is a crucial step in solving the problems that the country is currently facing. Beyond the self-evident benefits of improved coordination and direction. A clear well communicated strategy is the first step in regaining the confidence of both the domestic and international audiences. Which will go a long way towards facilitating the implementation of the necessary steps to resolve our structural challenges. Even in the scenario where the problems are solved through external backers such as the IMF or through the sale of government owned assets. By fostering confidence in the government’s commitment and ability, the country can negotiate more advantageous loan or asset sale agreements.
Measures to Curb Inflation
A complete and utter halt on all non-essential government spending
Government spending impacts inflationary pressure in two major ways. The first and most direct effect is by increasing aggregate demand in the economy. The second and more indirect manner is in the way in which high government spending, that is in excess of government revenue (budget deficits) is financed through debt monetization.
Over the last couple of years, more specifically since 2016. The government has increased its spending drastically. Especially on large national projects. These investments while they are projected to have an overall positive return on the productive capacity of the economy in the term. In the short to medium term however, they have yet to be proven successful in providing a return on their investment. A temporary halt on all non-essential investments made by the government is a powerful tool to mitigate inflation. The 2023/2024 budget allocated 586 billion Egyptian pounds just for investments. That is almost 20% of all expenditures (around 3 trillion pounds) and 31% of the remaining allocated expenditures after removing interest payments (1.8 trillion pounds left). Therefore, cutting investment spending even by half will reduce if not eliminate the budget deficit and will prevent the inflationary pressure created by these investments. While some investments are necessary a large portion could be cut down. The budget allocated 387 billion pounds of the 586 billion pounds allocated for investments for new construction projects. These construction projects should partially be halted (the non-essential ones) until the crisis is averted.
The government’s budget deficit is another major source of the inflationary pressure that the country has been facing. Just as of 2023 The Central Bank issues 238.09 billion Egyptian pounds to conduct an open market purchase of government bonds. Which increases the monetary bases through a process called monetizing the debt.
These are only examples used to illustrate a point. There are still many actions that the government can undertake to mitigate inflation. The main one is to aggressively cut down on spending.
A complete and utter halt on all non-essential government borrowing
As of September 2023, the government has borrowed over 2.466 trillion Egyptian pounds. This borrowing represents around a quarter of the GDP for the fiscal year 2022/2023. This gargantuan amount of indebtedness, in addition to adding to the already high inflationary pressure created by the devaluation as mentioned above through the process of debt monetization. Crowds out the private sector. The continuation of such a policy direction signal to both domestic and international investors that the government is intent on remaining on the same path and is still not ready to clear its position as the main player in the economy making foreign investors timid about making direct investments in the country at a time where the country that needs the stability of such investments. A halt of such borrowing will send an important signal, to foreign investors especially, that government is ready to take real steps towards a true market-oriented economy.
The situation described above is characteristic of a phenomenon called “fiscal dominance”. The basic goal that both fiscal and monetary policy must try to achieve is the stabilization of the inflation at a target rate. This can be done by either having the central bank (monetary policy) actively use its tools to keep inflation at the target level while the government (fiscal policy) passively adjusts its level of indebtedness accordingly, this is called monetary dominance where the monetary policy directs the manner in which inflation is managed. The other situation is fiscal dominance where the government (fiscal policy) adjusts its level of indebtedness independently and the monetary policy adjusts its rates accordingly in a manner so as to allow the interest payments on the government’s debt to remain manageable, this is called fiscal dominance. The issue with the use of fiscal policy to manage inflation is that the government has other priorities to manage and in the case that these priorities take precedence over managing inflation. The government may – as with the Egyptian case – continue to borrow, growing its debt along with inflation while the monetary policy is unable to use its tools (increasing interest rates) so as to prevent the government from defaulting. This is what caused Germany’s hyperinflation in the 1920’s and what caused the rise in inflation in Turkey recently.
Fixing Structural Problems: Facilitating a Transition to a More Market-Oriented Economy
The government has been the main player in the economy for the past few years. This has crowded out the private sector considerably. As pointed out by professor Alia El-Mahdi (former dean of the faculty of economics and political science at Cairo university), This can be shown by the share of total credit extended to both the government and private sector from 2010 up and until 2023 shown in figure 1 and figure 2.
The private sector’s share almost halved from 2010 to 2023, from 39% in June of 2010 to 22% June of 2023. On the other hand, the government’s share increased by around 60% of its original share in 2010 over the same period. Rising from 42% of total credit extended in June of 2010 to 67% of total credit extended in June of 2023. This is emblematic of the change in business environment that has been dominated by the government.
Beyond the obvious ramifications of having the public sector be the main director the allocation of resources in the economy. Which has been demonstrated both theoretically and practically to be inefficient, recalling the experiences of socialist economies and contrasting them to market oriented economies with the same natural resources, culture, geographical location. West and East Germany, North and South Korea etc.
As mentioned by Dr. Alia El-Mahdi, the private sector in Egypt employs the majority of the labor force. It is responsible for the majority of job creation in economy. It is responsible for the vast majority of the production of goods and services. Therefore, the health of the private sector and the number of resources it has at its disposal is paramount to the welfare of every Egyptian. Not to mentioned the ramifications of a weak private sector on FDI prospects. All of these considerations lead us to the need for the return of the private sector.
Reducing the role of the government as a player in the economy and amplifying its role as an adjudicator and a facilitator
Government intervention in the economy has likely reached an all-time high since the transition to a market-oriented economy in the 1970’s. Government intervention in this case does not refer to the legitimate role of the government in setting and applying the rule of law, issuing licenses etc. The government intervention talked about here is of two types 1) The production of goods and services that would be more efficiently produced by the private sector 2) Crowding out the private sector in the credit market. On the other hand, the government has barley improved on its role as an adjudicator and a facilitator of commercial dealings. In the latest ease of doing business index scores, Egypt ranked 166 when it comes to enforcing contracts. Whereby it takes on average 1010 days (almost 3 years) to enforce contracts, costs reach 26.2% of the claimed value and the quality of the judicial process scores 4 out of 18. This has contributed to a weak private sector at home and more importantly has led international companies to remain hesitant on entering the market with FDI remaining extremely modest reaching a maximum of only 3.1% of GDP in the period between 2016 and 2022. With the figure falling to a low of 1.2% in 2021 which is barely above the level FDI was at in 2012 after the events in 2011 at 1% of GDP. This is all to say that the government’s expansionist policies have come at the expense of the private sector and market efficiency which is sorely needed in these times.
The government should therefore try to the greatest extent to stop its interventions in the market. It should strive to be on the path towards only producing goods and services that cannot be efficiently produced by the private sector and only intervening in the case of a market failures. The first step should be the sale of almost all of the government’s owned and operated companies.
Creating an attractive business environment
An attractive business environment is a very important step towards creating a modern truly market oriented economy. The first step, as mentioned beforehand is the exit of the government from the market. An important factor that creates an attractive business environment is an element of fair competition. The government is not a fair competitor by any possible measure. The government does not have a profit motive, it can use resources (taxes) inefficiently, losing money in the process and yet it can continue to operate, unlike a private business. Additionally, the government is also responsible for enforcing the law on its own businesses and ventures which creates a conflict of interest that opens the door its abuse of power. It also does not help that the judicial system is weak and underfunded. In addition to the excessive bureaucracy which creates an environment that expels the private sector.
Given all these negatives there are many positives to the market generally. A large market with many potential customers, relatively cheap labor and excellent access to international shipping routes allowing for great access to the global market, that is in addition to the massive local market.
All of these positive elements of the market are not utilized in part as a consequence of the terrible business environment. For example, the benefits of the great access to international shipping routes are greatly diminished when operating in the country involves considerable costs associated with navigating the excessive bureaucracy, the need to pay high import tariffs etc. It is important to mention that the government has been working on streamlining and reducing the amount of bureaucracy that the importer has to face through the one window system but still there is a lot more that the government can do.
From Fixing Structural Problems to Practical Solutions, an example: Export led growth
Many commentators have lamented the theoretical approach to solving the current problems facing the country and have advocated instead advocating for the exclusive reliance on practical solutions. While these practical solutions are necessary, they lose their effectiveness as long as they are not guided by a sound theory. Theory and practice must go hand in had to truly solve the issues at hand and not just their symptoms. As an example, the government has been for years aiming at attracting foreign direct investments through incentives such as formulating laws specifically for foreign companies, the one window initiative, golden licenses etc. All of these initiatives are excellent but they have yet to bear any fruit. This is because they only aimed at solving the symptoms of the structural problem of excessive bureaucracy for foreign companies only. Rather than solving it from its roots for the economy as a whole.
This section will illustrate how theory should guide practice in the example of using exports as a means to solving the current currency shortage problem. Applying it to the agricultural sector in which the government has made excellent strides towards facilitating the export of Egyptian produce.
The devaluation of the Egyptian pound has had disastrous effect on the level of inflation and on the economy as a whole. However, the devaluation provides us with an extremely worthwhile opportunity that is one of the keys towards an economic recovery. The devaluation has made goods and services made in Egypt more competitive in international markets by making Egyptian products cheaper for foreigners. In addition to making imports more expensive for domestic buyers which means that domestic producers face less competition at home from their foreign counterparts. This provides a great incentive for domestic producers to increase their production and more importantly their exports which are an important source of foreign currency.
These developments work towards reducing the chronic current account deficit by reducing the trade deficit that Egypt has been dealing with for the past couple of years. Whereby, these deficits are in part responsible for the currency shortage. The deficits caused the shortage when they could no longer be covered by inflows of dollars into the country as a result of the flight of portfolio investments towards the increase in interest rates in safer economies such as the United States, reduced tourism income etc.
Therefore, exports provide an advantageous way to reduce that deficit and thereby, the shortage in foreign currency.
Now, what is stopping the private sector from taking advantage of this opportunity?
The structural problems mentioned before.
- The marginalization of the private sector which is the main exporter.
- The currency shortage borne in part due to excessive reliance on external sources of income and the excessive government borrowing in foreign currencies necessitating the delay of the transition to a flexible exchange rate.
- Inflation borne in part due to excessive governmental spending
- A business environment that repels private investments, rather than attract it
The incentive for domestic producers is there. The devaluation of the currency made sure of that. Clearing the roadblocks ahead of them which are represented by the structural problems mentioned above is the next step. This is where practical solutions come in, in clearing these roadblocks. This is how theory should guide practice.
Practical short-term solutions:
- Identify key sectors for competitive exports
- Reduce governmental spending and divert a portion of the savings towards creating more incentives for domestic producers to export.
- Eliminate/greatly reduce import tariffs for capital goods and raw materials for companies producing locally, under the condition that these intermediate goods are used in production of exports.
- Provide tax breaks/rebates that are proportional to the amount of exports by the producer
- Clearing bureaucratic hurdles for exporters
Application to the agricultural industry
The agricultural industry provides an excellent model for how the government should go about incentivizing exports as the devaluation of the currency went hand in hand with excellent policies, programs and projects to result in a record year for agricultural exports, reaching $3.7 billion in fresh product exports and $9 billion in revenue for both fresh and manufactured products in 2023 alone.
The government has been steadfast on improving the agriculture sector. The land reclamation project has added million of feddans of arable land. In addition, the government has implemented a new program in 2021 (منظومة التكويد و التتبع ) this program helps agricultural producers that want to export their produce abroad by helping them abide by the health and quality regulations of the country of export. Whereby, producers register in the program and they get a full inspection of their premises and are allowed then to export their products. This has opened new markets for Egyptian agricultural producers such as Japan and China in this last year.
This shows the model upon which the government should “intervene”. In this case the government was a facilitator and not a competitor working hand in hand with the private sector to help clear the roadblocks in their way.
Sources
- Inflation rates
- Youth Unemployment
- Fiscal deficit
- External Debt
- “The Rentier State in the Arab World”, Dr. Hazem Beblawi
- External sources of income
- Egyptian governmental employees
- Egyptian labor force
- US federal employees
- US labor force
- Egyptian budget expenditures
- Bank notes issued for purchase of government bonds
- Government borrowing
- Share of domestic credit extended to public and private sector
- Ease of doing business report
- FDI as % of GDP
- Agricultural exports