Why Egyptian Fiscal Policy Should Not Succumb to Economic Populism

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Egyptian bread protest

"Bread, freedom and social justice,” was one of the slogans chanted in Tahrir square and elsewhere in Egypt during the January 2011 revolution. The slogan captures the economic, political and social aspiration of the Egyptians, after decades of deprivation and authoritarianism.

At first glance, one would be surprised to hear that the first demand is bread, a subsidized commodity that is sold to all Egyptians, rich and poor, at the ridiculous price of 5 piasters (0.008 US cents). Indeed, food subsidies absorb around 2 percent of Egypt’s GDP in a universal subsidies system that consumes around 8 percent of total government expenditures and has made the country the world’s number one wheat importer. This is not to mention the inefficient and wasteful energy subsidies program that costs more than 6 percent of Egypt’s GDP and accounts for around 17 percent of public spending. Despite the negative budgetary implications of the subsidy system, the public demand for food subsidies is entirely understandable given the strong symbolism attached to the Egyptian word “aish” (bread), which also refers in its broader sense to “living” and was a rallying cry for underprivileged Egyptians who took to the streets demanding a better life.

Now that they have toppled their thirty-year dictator, Egyptians have to start putting their economy on the right track, especially after the hardship of the past few months. The government couldn’t but realize that it needs cash inflows to compensate for the drop in tourism revenues and foreign investment and, consequently, the decline in foreign reserves held within the Central Bank of Egypt. Hence, the government’s decision this week to resume negotiations with the IMF for the $3.2 billion IMF loan it had previously rejected in June 2011 is understandable. Maybe the biggest advantage of getting finance from international financial institutions is its contribution to foster other donors’ confidence. 

The question of how the funds will be used remains, however, of higher importance. Egyptians expect the economic policies of the new Egypt to correct the errors of Mubarak’s successive governments, mainly through social measures to compensate for the inequalities prevalent in Egyptian society and the economy. Not only is there anger against those policies favoring an elite class that seems to be living in an entirely different country, but also the majority of Egyptians – particularly the young and unemployed – see little prospect of joining that elite without having the right political and social connections, or at least having gone to the right schools.

Social justice cannot be achieved, however, by hiring more public employees or through other special benefits and privileges that initially look nice but will eventually leave Egyptians with a hefty bill, simply because the government cannot afford its welfare spending. The battle over minimum wage is representative of a legitimate demand that is difficult to achieve. A poorly paid employee in the overstaffed public sector, who struggles every month to make ends meet, rarely understands the relationship between wages and productivity and often thinks that governments can raise living standards by raising wages.

Likewise, calls for adopting an expansionary fiscal policy to stimulate the economy should be analyzed with caution. Increasing government spending is not always conducive to strong economic growth and full employment. While such an expansionary policy can stimulate aggregate demand in times of slowed economic activity, there are doubts that such a policy would yield these results in Egypt’s case for the following reasons:

1.       The government borrowing from the domestic market creates higher demand for credit in the financial markets, leading to higher interest rates and crowding out the private sector which offsets the stimulating impact of spending.

2.       Increasing interest rates would normally attract foreign capital from foreign investors who could benefit from higher rates of returns and should contribute to easing the strain on the local currency and slow its depreciation. However, the uncertain political climate, the ongoing protests, and the lack of security have kept foreign investors from committing additional resources before establishing a clearer vision of the country’s future.

3.       Last but not least, the considerable inflationary effects of an expansionary policy would likely outpace wage increases, leaving the wage earners in the same unsatisfied position, if not worse.

Austerity in the current political and socio-economic environment is not an option. However, reckless and unwise spending not only undermines fiscal sustainability, but it can also negatively impact political stability and the course of the country’s transition once the easy solution – public sector expansion and welfare benefits – becomes too costly for Egypt’s government to sustain. These adverse effects become increasingly likely as the government’s debt spirals out of control.

Instead of undertaking short-term measures that are unsustainable over the long run, economic policy should be rationalized to refocus spending priorities on measures to improve labor and capital productivity alongside the implementation of efficient and equitable social safety nets. To do this, the government should invest in public goods and services that have positive externalities, particularly with regard to human capital. Examples include investing in productive infrastructure, clean energy, access to capital for small and medium sized enterprises, education, vocational training, health care and innovations in science and technologies. At the same time, the government should should refrain from expanding measures that distort the labor and commodities markets, and start introducing serious reforms into these markets. The government should also strive to improve the business climate and protect free competition against abuses of power and monopolies.

Although sound policy may not be popular, when adopted within a credible and well-communicated framework and when implemented in a transparent manner and environment, it becomes indispensable and is the only sustainable path towards economic prosperity and a better standard of living.

Hoda Youssef is a postdoctoral research associate at the Woodrow Wilson School of Princeton University. She holds a Ph.D. in Economics from Sciences Po Paris school. Her research work focuses on monetary and fiscal policy, and on the political economy of the MENA region, with a focus on Egypt. 

Photo credit: BBC