Commentary

Egypt: Europe’s Economic Cousin

The first fair presidential election in Egypt’s history has ended disappointingly, with the top two finishers being Ahmed Shafiq, a former Mubarak prime minister who represents the old elites, and Mohammed Morsi, a Muslim Brotherhood candidate.

Not surprisingly, therefore, much of the attention, both within Egypt and in the outside world, is being focused on issues such as the role of political Islam, crime, political openness, and the rivalry between the military and the Muslim Brotherhood. Yet there has been relatively little discussion of the issue that may ultimately have the most long-lasting impact on Egypt’s future — the need for economic reform.

There is no doubt that Egypt’s economy is in tatters. Real GDP growth was just 1.8 percent in 2011, and is projected to be lower still this year. Unemployment is 10.4 percent and rising. Youth unemployment tops 25 percent. Inflation runs well above 10 percent per year.

As is true of the welfare states of Europe, Egypt’s economy is being crushed by the burden of big government, taxes, and debt. The budget deficit is expected to reach 10 percent of GDP this year, a greater burden than Greece’s, while the official debt is roughly 80 percent of GDP. That is a lower percentage than, say, the U.S.’s, but it is still approaching the level that scholars warn seriously impedes economic growth. And, no doubt, the debt would be far higher without the $3 billion in foreign aid that Egypt receives every year — $1.5 billion of which comes from the United States. The country’s credit rating has been downgraded three times in the past year.

As is true of the welfare states of Europe, Egypt’s economy is being crushed by the burden of big government, taxes, and debt.”

Moreover, these debt measures understate the problem. According to the Muhanna Foundation, Egypt’s real level of indebtedness, if one includes the unfunded liabilities of the country’s pension and social-security system, runs three to four times higher. Egypt had started to reform its pension system — it was supposed to transition to a Chilean-style system of personal accounts beginning this year — but those reforms have been indefinitely postponed because of the ongoing turmoil.

Some of Egypt’s economic problems are obviously aftershocks from the fall of former president Hosni Mubarak and the Arab Spring. Since the revolution, for example, tourism has fallen by a third, and foreign investment has declined by two-thirds. Exports, too, are down considerably. Street demonstrations, the potential rise of Islamic extremism, and uncertainty over future government policies have all contributed to this slowdown.

But Egypt’s economic problems existed long before the recent political upheaval, and begin with the crushing burden of a vast and intrusive welfare state. The Egyptian central government consumes a third of all goods and services produced in the country over a year. The tax burden exceeds 23 percent of GDP.

Though Egypt’s direct welfare benefits are generally modest, indirect payments abound. The government subsidizes nearly all basic staples, including food and fuel. Indeed, the government spends nearly 10 percent of GDP on such subsidies, which are in many ways worse than transfer payments because they distort prices and benefit the rich as well as the poor. In addition, state-owned enterprises, especially those run by the military, dominate large areas of the economy. Military- and government-run businesses are involved in everything from poultry farming and hotel administration to pest control and automotive repair. These government-run businesses are not fully accounted for in measures of government expenditures (revenues from military companies are a state secret), but are estimated to make up roughly a third of Egypt’s economic activity. When this is combined with direct government expenditures, nearly two-thirds of Egypt’s economy is under government control.

Further, one of the world’s most oppressive regulatory environments stifles entrepreneurship, business growth, and the development of civil society. The most recent Economic Freedom of the World Report ranked Egypt 80th out of 141 countries.

Unfortunately, neither candidate coming out of the first round of voting seems to fully appreciate the need for economic reform.

Shafiq clearly represents the crony capitalism and welfare statism of the old regime. He calls Egypt’s current economic situation “stable” and opposes any drastic changes. He has pledged to maintain government and military ownership of businesses. He has pledged to reduce the budget deficit to no more than 6 percent of GDP, though he has provided no details of how he would do so. He talks of subsidy reform, but again without details.

As on so many issues, the Muslim Brotherhood candidate, Morsi, has spoken about economic policy in wildly contradictory ways. On one hand he has proposed a more market-oriented agenda, promising to “limit the state’s role to basic services.” He would reduce and redirect many subsidies, and says he supports free trade. He too would cut deficits to roughly 6 percent of GDP. He would establish an independent central bank, with price stability the major goal. On the other hand, he has called for expanding the number of Egyptians eligible for social assistance, seeks to cancel debts for small farmers, and wants to create a system of Islamic finance parallel to traditional banking and finance systems.

Both candidates also pose potential threats to the type of open society necessary to promote real growth and opportunity. Either a turn to sharia law or a continuation of the Mubarak security state would dim Egypt’s prospects for prosperity.

The need for economic reform is not unique to Egypt, of course. Countries across the Arab world desperately need to open their economies. Every non-oil-exporting Arab country is running a significant budget deficit, and if unfunded pension liabilities are included, their debts run to several hundred percent of GDP. Typically, government expenditures consume much if not most of the economy, subsidies are omnipresent, and the regulatory burden is massive. With the exception of Oman and the United Arab Emirates, not a single Arab country cracks the top 50 nations in terms of economic freedom.

Whatever the outcome of the June 15–17 runoff, it is apparent that Egypt needs a healthy dose of economic liberalism. Egypt must begin to cut the size and cost of government, reduce its tax and regulatory burden, end subsidies, and privatize its state- and military-run enterprises. Pension reforms should be resumed. And economic liberalization should go hand in hand with personal liberty. Without such reforms, the economy will continue to stagnate, poverty and unemployment will grow worse, and the door to extremism will open wider.