Down to a Trickle

As journalists like to put it, "experts disagree" on the prognosis for the Egyptian version of Arab Spring. But pretty much everyone does agree that the chances for a happy ending – i.e., a liberal democratic one – turn heavily on Egypt’s ability to get the economy back on a rapid growth track. And while that is certainly possible, it won’t be easy in the nation where trickle-down isn’t working.

Bear with a little history here. The Nasser years were a disaster in economic terms; Egypt’s experiment with full-throttle central planning led nowhere, slowly. Anwar Sadat’s successor regime was able to tap foreign banks to augment spending. But this financial house of cards collapsed in a tangle of IOUs, and the economy stagnated through much of the 1980s.

Thereafter, Egypt caught a break. Much of its crushing external debt was forgiven by western governments in return for Egypt’s participation in the Gulf War. And the IMF restructured much of the rest in return for promises (largely kept) to restrain spending and contain inflation. Between 1991 and 2001, per capita GDP calculated in terms of purchasing power rose by almost half – albeit to a still-meager $3,700.

With the introduction of serious market-based reforms in the last decade – privatization of most state-owned industry, deregulation of agriculture, encouragement foreign investment — the pace of growth picked up considerably, reaching near-Asian (7 percent) rates. This was especially impressive in light of the fact that Egyptians save a far smaller proportion of income than East Asians and thus depended on foreign investors to meet the demand for capital.

Mubarak’s technocrats also deserve credit for skating through the global recession without a pratfall, responding in timely fashion with domestic stimulus (mostly in the form of accelerated infrastructure investment) that largely offset declines in private investment and exports. The growth rate never fell below four percent. In 2010, per capita GDP (again, in purchasing power terms) exceeded $6,000, which bumped Egypt up to "lower middle income" status in the World Bank’s pecking order.

Tahrir Square knocked the stuffing out of projections that Egypt would return to pre-2009 growth rates in 2011/12. Tourism, a mainstay of both employment and foreign exchange earnings, has taken a huge hit. And nobody with serious money has been in the mood to bet on the outcome of the revolution. The big question is whether the economy can get its mojo back once investors can be reasonably certain that the political rules won’t change anytime soon.

Viewed from a proverbial 40,000 feet, the economy looks to be in a pretty good position to manage that. Egyptian manufacturing, aided by preferential access to the U.S. textile market, is sufficiently productive to be reasonably competitive at home and abroad. Trade and investment ties with both Europe and the Arab states are strong. Domestic oil and gas production aren’t adequate to make Egypt a net exporter of fuels, but do protect the economy from energy price spikes. Consider, too, that some four million Egyptians live abroad (most of them in the U.S. and the Gulf), delivering some $8 billion or so annually in remittances.

But there’s a darker side to this coin. For while Egypt made great strides in the last two decades in building a diversified market economy, it did not shed many of the liabilities that typically dog developing countries. Corruption pervades every aspect of economic life: Egypt’s public sector ranked 112^th of 183 countries on the Transparency International’s Corruption Perceptions Index in 2011, behind ethically challenged countries such as Gabon, Albania and Jamaica.

Not coincidentally, Egypt ranked 110^th out of 183 countries on the World Bank’s 2012 Ease of Doing Business index. It takes an average of 214 days to obtain a building construction permit, and a typical contract clash requires almost three years to settle in the courts. Indeed, one has to wonder how the economy made it this far.

Actually, one need not wonder. While corruption and red tape undermine the potential for innovation and business creation, they create a paradise for insiders. Like their counterparts in countries ranging from Mexico to Russia, crony capitalists benefited enormously from privatization, preferential access to foreign capital and technology, and unenforceable labor laws – and benefited again from the reality that the difficulty of doing business protected incumbents from competition.

It should not be surprising, then, that the rising tide of income and productivity has not carried all boats. To be sure, the quality of life has risen for most Egyptians: The UN’s catchall Human Development Index suggests considerable improvement since 1980. But "development" is relative: In the report published last November, Egypt ranked 113^th among 187 countries on the HDI index, ahead of Syria and Morocco, but behind all the major emerging market countries.

Poverty is especially serious in the Upper Nile region, where millions of Egyptian farmers must share far too little arable land to make a decent living. And since the Nasser era, Egyptian governments have kept a lid on trouble by heavily subsidizing wheat, sugar, edible oils and bottled cooking gas. Stark hardship is less common in the cities, but economic frustration is high – and has apparently increased in recent years. The obvious reason is unemployment, which has been stuck around 9 percent through the years of rapid growth. But there are other barriers to economic mobility.

One is the aforementioned difficulty of doing business. For while Egypt cities are brimming with small family enterprises, the non-profit Global Entrepreneurship Monitor estimated that, thanks to the daunting obstacles to expansion, only one in nine of them could be expected to grow to more than 10 employees.

Ironically, another barrier was created by the government’s withdrawal from the role of employer as last resort for educated young. In pre-reform days, notes Christine Binzel of the University of Heidelberg in a recent paper, jobs could always be created to accommodate degree-holders in bloated government agencies and state-owned enterprises. But privatization, combined with far greater budget discipline, has left newly minted graduates to fend for themselves in a business culture in which who you are related to largely determines whether you’ll get a job.

The revolution has thus exposed a weakness inherent in top-down economic restructuring. The only way Egypt can provide opportunities for the millions who have yet to benefit from market reforms is to grow rapidly. But the mechanisms of growth that have favored the rich and well-connected are not likely to remain politically tenable in a more democratic Egypt. And reforms that level the economic playing field by suppressing corruption, streamlining bureaucracy and opening the door to greater competition would be quite a stretch for any government – let alone one that must contend with an entitled military, well-heeled incumbent industrialists and newly empowered Islamic fundamentalists.

There’s also the problem of what to do about the aforementioned food and fuel subsidies, which cost the government some $5 billion a year it cannot afford to spend and displace more productive uses of foreign exchange. Targeting the subsidies to the very poor would save a lot of money – roughly two-thirds of the benefits go to less needy households. But the urban middle-class that fueled the revolution isn’t likely to stand for the loss of one of its few government entitlements. Egypt’s next rulers are not to be envied.