Feb. 22 (Bloomberg) -- Cairo’s six-story Arcadia Mall, a symbol of modern commerce on the Nile River, is a charred ruin. Military officers now rule in place of Western-educated businessmen. Spending by a government that is already in debt is heading up, not down.
This is Egypt after the Feb. 11 fall of Hosni Mubarak, and if its future is uncertain, it has nonetheless drawn investor cheers as officials promise to pursue market-oriented policies. The Market Vectors Egypt Index ETF, an exchange-traded fund that holds Egyptian shares, has risen 11.5 percent since Jan. 27, when the Egyptian Exchange was shut down as protests intensified.
Yet a history of on-again, off-again economic reform and the rise of forces, including the military, that have resisted liberalization suggest that the path to a competitive economy integrated with the world will be a difficult one, according to experts on the region.
“In the near term, the impulse is to beat up on the capitalists not reward them,” said Jon Alterman, a former member of the State Department’s policy planning staff, now at the Center for Strategic and International Studies in Washington. “I don’t see a champion of economic reform arising out of this process. The go-go privatization period will be blamed for the breakdown of order.”
Post-Mubarak Egypt inherits a legacy of incomplete attempts at change, including privatization of state assets and a redo of the tax system. The political costs of needed steps such as shedding state workers or levying new taxes likely will challenge the country’s next leader. Likewise, little action is expected to correct inefficiencies, including the fuel subsidies that devour more than 5 percent of gross domestic product.
“This is not the time to scale back on subsidies,” said Samer Soliman, assistant professor of political economy at the American University in Cairo. “If anything, they may increase.”
For two decades, officials from the U.S. and Washington-based International Monetary Fund and World Bank encouraged Egypt to overhaul its statist economy, betting that prosperity would foster stability.
Instead, Egypt imbibed just enough globalization to enrich an elite, though not enough to become broadly prosperous. About 18 percent of the population -- including 40 percent of rural dwellers -- lives below the poverty line and one-third of Egyptians are illiterate, says the World Bank.
Simon Johnson, former chief economist of the IMF, calls the Egyptian approach “trickle-down economics without the trickle.”
Despite its position astride trade routes in Africa, Europe and the Middle East, Egypt has failed to secure a role in global supply chains. Nike Inc., for example, buys shoes and clothing from 42 Vietnamese manufacturers, which employ more than 198,000 workers, according to the company’s website. Egypt, with a similar population, is handicapped by numerous taxes, uncertain contract enforcement and insufficient supplies of skilled labor. Just five Egyptian companies, employing 5,129 people, supply finished products to Beaverton, Oregon-based Nike, the largest maker of athletic shoes.
“The opening was half-hearted, reluctant,” said Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics in Washington, who was the IMF’s resident representative in Cairo from 1995 to 1997. “The Egyptians understood that while the U.S. wanted reforms, they could get away without reforming.”
News From Tunisia
Seven years after beginning the most recent push for change, Egypt remains a nation with one foot planted in the global economy and one stuck in a state-dominated past. Even as globalized information flows via social-networking sites such as Facebook and Twitter brought Cairo residents news of protests in Tunisia in January, their country lagged behind in global commerce.
Between 1990 and 2009, Egypt’s per capita exports of goods and services rose at an average annual rate of less than 5 percent -- about half India’s annual average and one-third that of China, according to the IMF.
By 2020, the Middle Eastern nation, with unemployment above 8 percent for more than a decade, must create 9.4 million jobs to absorb the out-of-work and anticipated new entrants into the labor force. To do that, the IMF says, the economy will need to grow at an annual rate of almost 10 percent, about twice the average since 2000.
The ambivalence about transforming the economy was evident during Mubarak’s final days as president, when he attempted to appease protesters by increasing government workers’ salaries and deferring cuts in fuel and food subsidies. He also jettisoned Cabinet and ruling party officials regarded as pro-business, such as the housing minister, Ahmed El-Maghraby, the former chairman of Accor Hotels Egypt.
El Maghrabi and other prominent members of the Egyptian business elite, such as Ahmed Ezz, chairman of Ezz Steel, the country’s largest steel producer, were barred from traveling and had their bank accounts frozen by the public prosecutor’s office, which said it was investigating claims of “public funds embezzlement” against the former officials. Ezz dismissed any suggestion of wrongdoing as “groundless allegations” in a Feb. 14 statement.
‘More Populist Take’
“Going forward, there’s going to be a much more populist take on where the economy should go,” said Michele Dunne, an analyst at the Carnegie Endowment for International Peace in Washington, who served in the U.S. Embassy in Cairo and on the National Security Council between 2000 and 2003. “They’ll have to be much more sensitive to public opinion.”
The military officers now in control are no fans of selling off state assets. Retired generals operate military-owned companies in several industries, including cement, construction, hotels and olive oil. And the Egyptian military regards privatization as a “threat to its economic position,” according to a classified cable from U.S. Ambassador Margaret Scobey dated Sept. 23, 2008 that was disclosed by the anti-secrecy group Wikileaks.
Egypt’s caretaker civilian ministers insist they will shrink the state’s role in the economy.
“There is no rolling back of reform,” Finance Minister Samir Radwan, a London-educated economist, told Bloomberg News Feb. 14. “There is no relapse into state intervention.”
Radwan, named to his post Jan. 31, said Egypt now has “a fantastic opportunity to have a new phase of reform, to deepen the reforms that have taken place.”
Egypt’s efforts at economic modernization began in the early 1990s, shortly after the fall of the Berlin Wall inaugurated an era of global economic integration. Encouraged by the World Bank and IMF, Egypt began creeping from its traditional state-centric economy -- where the public sector claimed 70 percent of GDP -- toward greater market openness.
“Egypt was a centrally administered economy with an implicit promise that the central government could control everything, organize everything, distribute everything and essentially eliminate uncertainty from the lives of all,” said Youssef Boutros-Ghali, then-minister of finance, in a 2006 speech.
Early transformations cooled inflation topping 21 percent and reined in a public deficit of more than 15 percent of GDP. While the U.S. and the international financial institutions supported economic change, the top U.S. priority was always the Arab-Israeli peace process.
In 1987, C. David Finch, the head of the IMF’s department of exchange and trade relations, resigned after the U.S. objected to IMF demands for economic policy changes that Egyptian officials feared would spark a popular backlash, according to a 1993 book by Anne Krueger, the former first deputy managing director of the IMF.
In a 1996 speech, Robert Pelletreau, then-assistant secretary of state for Near Eastern affairs, put economic transformation last in a list of U.S. objectives in the Middle East, behind Israel’s security, stability in the Persian Gulf, counter-terrorism, assistance to U.S. business and political change.
Egyptian hopes for a comprehensive bilateral trade accord with the U.S. were dashed in 2006 by the administration of President George W. Bush after the government jailed the dissident Ayman Nour, who ran against Mubarak in 2005 presidential elections.
‘Root of Extremism’
In February 2006, according to another Wikileaks cable, the Egyptian intelligence chief, Omar Suleiman, confided to a visiting U.S. official that “insufficient educational and economic opportunities were at the root of extremism in Egypt.”
The threat to stability was so alarming, Suleiman told the U.S. official, FBI Director Robert Mueller, that the Egyptian government was embarking upon a five-year plan “to shore up and modernize Egypt’s economy.”
Almost precisely five years later, on Jan. 25, 2011, the clock ran out on the Egyptian government’s chances of preserving the status quo. Tens of thousands of anti-government protesters filled the streets of Cairo demanding Mubarak’s ouster.
Suleiman’s 2006 acknowledgement of the need for Egypt to tune its economic engine occurred almost two years after the start of the most recent and most successful reform phase. In 2004, market-oriented Egyptian officials affiliated with the president’s son Gamal enacted policies that more than doubled the economy’s annual growth rate to about 7 percent.
State-owned enterprises, including the Bank of Alexandria and the Omar Effendi department store, were sold to private investors. Regulations were streamlined and tariffs reduced. Foreign investment from companies such as Houston, Texas-based Apache Corp. and Cincinnati-based Procter & Gamble Co. rose to more than $12 billion annually from less than $1 billion at the turn of the century.
Left undone were tasks such as political transformation, pruning the bureaucracy, and encouraging competition in the domestic economy. Privatization of state enterprises, which began in 1990, inched forward. By 2008, just 20 percent of the public sector had been sold off to private investors. The budget deficit remained around 8 percent of GDP.
“They essentially dealt with the low-hanging fruit, the easy stuff,” said George Abed, director of the IMF’s Middle East department in 2002-03.
Outpaced by Vietnam
Egypt was evolving at a crawl while other nations, especially in East Asia, rode export booms to prosperity. From 2004 to 2009, per capita income rose 20 percent in Egypt. That fell well short of export-oriented dynamos such as Vietnam, which posted a 34 percent income gain over the same period.
“They really need to penetrate global industrial supply networks. They’ve had trouble gaining a foothold,” said Marcus Noland, author of “The Arab Economies in a Changing World.”
Liberalization sometimes carried political and financial costs that undermined prospects for additional changes. The IMF and World Bank prodded Egypt to open its markets to imported grain, a move that undercut local farmers and left Egypt dependent upon volatile global markets for staples, according to Marie Brill, senior policy analyst at ActionAid, a Washington-based nonprofit organization.
In April 2008, rising food prices were blamed for anti-government riots in Mahalla, a textile town in the north. In response, Prime Minister Ahmed Nazif rushed to the town and Mubarak ordered a 30 percent pay raise for public-sector workers. Plans to phase out food and fuel subsidies in favor of payments targeted to the neediest Egyptians were quietly shelved, then-U.S. Ambassador Frank Ricciardone wrote in an April 16, 2008 cable disclosed by Wikileaks.
“Egyptians are in a sour mood and their frustration seems more vocal than just a few months ago,” Ricciardone wrote.
The Egyptian government was able to repeatedly defer economic improvements thanks to financial flows that continued regardless of the economy’s competitiveness. Over the past two years, the government reaped almost $5 billion annually from Suez Canal transit fees and an additional $1.5 billion in U.S. aid. Remittances from Egyptians working in Saudi oil fields or hotels in Bahrain brought in around $8 billion, while the country’s oil wells contributed about $9 billion. Combined, these passive flows amount to about 12 percent of GDP.
Though Mubarak is gone, those sources of revenue remain. So at least for now, there is little reason to expect reinvigorated reforms.
“I don’t think there will be any significant change in economic policies,” Soliman said. “This is a transitional period.”
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