By
Zubair Iqbal[1]
- Overview
The global community was surprised by the suddenness and intensity of democratic movements in the Arab countries. While universally welcomed, the global response in support of these movements has so far been reactive, uncertain, and slow to build up. The only coherent rendering of such an initiative is the declaration ofthe Deauville Partnership by the Group of 8 countries on May26-27, 2011. Under the Partnership declaration, long term collaboration will be offered by G-8 member countriesto facilitate a “transition towards free, democratic, and tolerant societies” in “Partnership Countries” of the Middle East, beginning with Egypt and Tunisia. It recognizes that democratic revolutions would—at least in the short run—result in sharply lower growth and unemployment which could heighten internal conflicts and, if not addressed decisively, could scuttle democratization. It presumes that if people did not see democracy creating conditions for quick prosperity, the democratic process would fail. Hence, it was felt that an early injection of economic stimulus would be beneficial.
The G-8 countries have agreed to provide substantial financial support to ease short term economic burden and develop strategies for the medium term, thus facilitating transition to democracy. International financial institutions and UN agencies, regional oil exporting countries, the private sector, and civil society have also been invited to work with the G-8.The International Monetary Fund alone is targeting to provide up to $35 billion for this purpose to the region. It is understood that GDP growth rate of at least 7 percent per annum over the medium term would be needed to address unemployment– a primary factor spurringrevolt against the authoritarian regimes. Estimates show that the financial needs of the non-oil Middle East and North African countries would be about $160 billion over 2011-13.
The experience so far with Egypt, the first country targeted under the Deauville Partnership, highlights the need for a fresher look at the underlying strategy. While some bilateral financing (including debt relief) was promised by G-8 countries, the bulk of financing needed for quickly restoring growth, employment opportunities, and better governancewas to come from multilateral agencies such as the IMF, the World Bank, and the EBRD.Bilateral support was also to be extended and incentiveswere to be offered for private foreign investment.It stipulated that improving social conditions, including through substantially higher spending for promoting social justice—higher subsidies and wages, e.g.,—was an important precondition for democratization.
The program agreed with the IMFstaff in early June, 2011 in order to assist the process would have provided $3 billion over the next 12 month period. It was intended to promote social justice through higher social spending while ensuring macroeconomic stability, thus easing the immediate economic costs of the political upheaval, but with limited policy conditionality.The World Bank was also expected to provide about $2billion for the same period, in part for budgetary support.
However, the Egyptian authorities decided to(at least for the time being) forego the arrangements with the IMF and the World Bank, in part, under pressure from the pro-democracy movement which considered such assistance as‘foreign interference’ but, possibly, also for sound economic reasons. In particular, such financing would have not only increased external debt burden but, more importantly, would have– by shifting government expenditures to a significantly higher path, ostensibly for social development, without a commensurate increase in domestic revenues —worsened the fiscal imbalances over the foreseeable future. Such a development would have increased dependence on external financing at a time when the capacity to service such debt remained uncertain, and could have weakening resolve for domestic resource mobilization, thuspotentially harming governance. The likely increase in subsidies for employment generation would have sowed seeds for stunted growth over the longer term. Moreover, there would have been little shift in the distribution of costs and benefits between the ruling elites and the common man, the primary objective of democratization.Finally, by forcing a dramatic dilution of the IMF’s conditionality for adjustment lending, such an arrangement would have established a dangerous precedent for subsequent IMF lending with serious implications for this institution’s ability to ensure prudent policies in other countries, including other Partnership countries.
A few lessons can be drawn. First, while addressing economic deprivation is crucial for democratization, increase in external assistance up front and before political reforms are underway may not be the most appropriate approach. Second, external support should supplement—rather than supplant—domestic initiatives. Third, pursuit of democratization will fail if it encourages irresponsible economic policies such as higher subsidies, excessively higher public sector wages, subsidies to establish uncompetitive industries, and unproductive expenditures to generate employment opportunities. Such policies would lead to financial imbalances, including a higher path of fiscal deficits and increased external indebtedness, without improving prospects for sustainable rapid growth. Fourth, the success of democratic movements depends more crucially on domestic economic reforms which reallocate economic power more equitably, thus, reducing economic rent collected by the elites while increasing domestic capacity to mobilize resources for investment and growth. Finally, establishment of institutions to ensure equity, rule of law, and effective dispute settlement must go hand-in-hand with economic reforms—one is not a substitute for the other.
It is therefore important to carefully sequence reforms to cement the democratic process. In this context, domestic measures, in particular, aimed at resource mobilization, which are “owned” by the society must not be weakened by external support. External financing should be tied to the needed domestic reforms aimed at improving economic efficiency with equity—the primary pre-condition for democratic rule– and at promoting sustainable growth without weakening domestic “ownership”. Support from multilateral lending institutions like the IMF must not be conditional on democratic reform benchmarks; rather objective economic criteria should continue to guide such institutions’ lending practices.Ideally, external public support should be integrated into a medium term national reform program which calls for a decline in such assistance over a well-defined period as domestic resource mobilization catches up with needs while concurrent political reforms make it possible for the country to take the difficult—but necessary—measures to more equitably mobilize such resources.
- The Deauville Partnership with the Middle East and North Africa.
The Partnership extends long term support to countries in the Arab world to help them transition toward free, democratic, and tolerant societies. This is to be achieved through a dual path: a political process to support the democratic transition and foster governance reforms by eradicating corruption and strengtheninginstitutions to ensure a transparent and accountable government; and economic reforms for sustainable and “inclusive” growth—allowing all segments of the population to produce and to benefit from growth– by broadening of economic opportunities to create jobs under economic stability.
These commendable broad objectives are to be achieved mainly by expanding economic opportunities to all and improving support for the vulnerable elements of society; supporting private sector to facilitate job creation; helping develop human capital and skills to increase productivity and thus competitiveness in the globalized economy; and supporting regional and global integration, through, amongst others, the liberalization of trade. In the short term, macroeconomic stability and social cohesion would need to be ensured so as to facilitate politically difficult reforms.
The Partnership declaration calls for a strategic shift in the approach of the international community centered on a substantial increase in financial support by bilateral donors—G-8 countries—combined with a transformation of economic and political framework in the recipient countries. It also calls upon the IMF to meet external financing needs of reforming countries; and multilateral and regional development banks and regional partners—major oil producers– to help address the disruptions of private capital flows and to restore market access. It is expected that the IMF would allocate $35 billion while development finance institutions would allocate another $20 billion for this purpose. Other G-8 bilateral support is targeted at the equivalent of $20 billion, with about $10 billion expected from the major oil exporting member countries of the GCC. Regional and global integration through trade and private investment would be expected to play an enhanced role. The Partnership declaration also posits broad intentions for fostering the creation of political space for democracy to flourish through institution-building, freer press, and training. Collaboration with Partner countries will evolve overtime and would be country-specific.
Implementation of such an ambitious undertaking would, in the donor countries, call for a sharply scaled up financial commitment, a new institutional setup for the donor-recipient country interactions, and transparent rules linking disbursements to performance. The Deauville Partnership declaration is largely silent on these aspects. Even before the so-called Arab Spring, the external financing requirements of the non-oil Arab economies for achieving at least an average growth rate of 7 percent to contain the burgeoning unemployment problem, was estimated by the IMF at $160 billion for 2011-13 alone. Given the unanticipated short term effects of the democratic movements and the medium term needs, the financing requirements are likely to be even larger. So far only about $50 billion—from multilateral finance institutions—have been identified with some firmness. Given that private capital inflows will remain cautious, it will be difficult to mount a credible reform initiative without a clearer view of the available funding from bilateral sources. The ongoing financing difficulties in many of the potential donor countries will make such commitments difficult.
Institutional structures connecting the disparate donors/lenders and recipient countries would also be a challenge. While the declaration very commendably calls for the recipient countries to lead in formulating their transformation strategies and policy frameworks for reform, questions remain as to how domestically-driven reforms in these countries will be linked to donor disbursements. Moreover, It is unclear as to how would the private sector respond to domestic reforms. In addition, there may be merit is addressing the immediate political challenges to democratization before economic reforms are addressed; throwing unconditional money prior to the establishment of a generally accepted government may unintentionally weaken the democratic process. Finally, what will be the role of multilateral financing agencies and their espoused objectivity vis-à-vis bilateral donors.These are uncharted waters. How these challenges are addressed will determine the fate of the Partnership.
- An Illustrative case—Egypt.
The Partnership is designed to initially support Egypt and Tunisia, followed by other Middle East and North Africa countries in the “economic and social reforms that they undertake, particularly to create jobs and enshrine the fair rule of law, while ensuring that economic stability underpins the challenge of transition to stable democracies”. Both Egypt and Tunisia presented their reform programs at Deauville which were endorsed by the G-8. These programs aim at expeditiously introducing democratic governance through elections under a new constitution. Recognizing the heavy economic toll of the democratic revolt—sharply lower growth rates in both the countries– which may have worsened poverty and the entrenched economic challenges limiting growth, particularly high and rising unemployment, stagnant competitiveness, and macroeconomic imbalances, the reform programs aim at fundamental economic restructuring and increased domestic investment, easing the burden on the poor through subsidies and wage adjustments, and maintaining macroeconomic stability. However, the sequencing of political and economic reforms has not been clearly articulated.
Egypt’s experience so far can provide important insights for the needed evolution of the process underlying the Deauville Partnership. With the political reform track assigned to the newly installed and military-controlled ruling council, the economic response involved modest bilateral assistance including debt write off (with limited immediate benefit), but a major planned infusion of financial support from the IMF and the World Bank. The 12-month program with the IMF worth $3 billion was supposed to promote social justice—the overarching goal– and support economic recovery. It contained measures for generating jobs and subsidizing low-income households through higher government spending, while maintaining macroeconomic stability. The program was expected to lay foundations for a more “inclusive” economic growth in the period ahead. Targeting a sharp increase in government spending on higher wages, subsidies, and human capital while encouraging some tax measures, the budget deficit was projected to balloon to over 11 percent of GDP in 2011/12. It was to be financed largely by external sources, both bilateral and multilateral, thus protecting the external reserves position. More fundamental reforms to facilitate self-sustaining growth were to be undertaken in the future, ostensibly subject to political support following the restoration of a representative government. It was also presumed that an arrangement with the IMF would enhance global market’s confidence in the Egyptian economy, thus facilitating the resumption of private capital inflows.
The popular Egyptian response to such assistance was predictable and prompt. Given the continuing political uncertainty and the declared desire of the “street” as expressed during and after the revolt against the previous authoritarian government and its supporters, Egypt declined to accept the arrangement with the IMF and chose to reduce the budget deficit. In effect, Egypt also decided to forego support from the World Bank which would have helped finance the widening fiscal deficit. In addition to the perceived increased international interference in Egypt’s internal affairs which such an arrangement would have implied, the arrangement could have had unintended consequences with serious implications for economic management in the medium term without benefiting democratization. It would have entrenched higher government expenditures without firmly establishing mechanism to generate domestic revenues to sustain them, thus either increasing dependence on external debt or increasing inflation following higher domestic borrowing with serious implications for income distribution and market confidence. It would also have helped entrench the current ruling elites which would have not only increased resistance to political change, but also worked against more “inclusive” economic growth. Moreover, given the highly concentrated ownership of economic power in Egypt, it would indeed be unrealistic to expect a quick shift toward “inclusive” growth to be orderly and without a temporary increase in unemployment.In addition, such an arrangement could have tied multilateral financing to as yetundefined non-economic“reform efforts”, which would have weakened these institutions’ neutrality and thus their effectiveness insupporting sustainable and equitable global growth.
The fallout has been swift; the highly respected Egyptian ministers of finance and foreign affairs have been dropped from the cabinet and the pace of reform has become uncertain. The authorities have chosen to keep the fiscal deficit within manageable limits( about 8.6 percent of GDP) and have accepted offers of non-debt-creating grants from major Arab oil exporting countries like the UAE, Saudi Arabia, and Qatar to finance the fiscal deficit and supportgrowth, a part of which has already been disbursed. Of course, it remains to be seen whether such a shift in financing—even if sustained– would support or circumvent the democratization process and the needed economic reforms.
- Concluding Remarks.
A number of lessons can be drawn from the above. First, political reforms should lead rather than lag economic reforms. At least a minimally representative government should be in place before economic reforms are considered, specially where reforms will entail redistribution of economic benefits and costs such as wage and subsidy policies, taxation and government spending, privatization, and corrections of prices of public goods and services.
Second, economic reform packages must be objective and aimed at achieving purely economic objectives. Any saddling of political objectives to economic programs could result in conflicts between democratization and sustainable growth; the latter is an important requirementfor the former. Therefore, financing for the promotion of democratic process should be kept independent of that for economic reform and subject to different conditionality requirements.
Third, while the Deauville Partnership quite appropriately endorses the need for the beneficiary countries to develop their own paths for reform, guidelines are yet to be developed to ensure consistency with certain objective criteria of efficiency. Unless care is taken, the inherent “flexibility” could lead to the so-called moral hazard problem and a potential diminution of multilateral agencies’ ability to ensure efficiency and equity.
Fourth, recipient countries would be well-advised to avoid populist measures such as increases in subsidies and wages of public sector employees without a commensurate increase in efficiency. Otherwise, economic costs would rise, worsen competitiveness, and could (paradoxically) increase unemployment in the medium term, thus, hurting democratization. It is also critical that any such steps should be financially viable or they would increase dependence on increasingly costly external sources or cause inflation.
Finally, ground rules should be developed for “pooling” bilateral and multilateral financing for the most effective use of such resources and without political strings.
[1] The writer is an Adjunct Scholar, Middle East Institute.
