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Egypt's Economy Needs a Lift

Author: Bruce Stokes
February 8, 2003
National Journal

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CAIRO-In the cavernous atrium of the renowned Egyptian Museum, tour groups jostle with casual visitors amid an eclectic collection of ancient stone sarcophagi and pharaonic funeral vessels. Tourism certainly seems to be booming. But first impressions can be deceiving. The majority of tourists viewing the antiquities in late January were Egyptian school children on holiday, not foreigners. And indiscreet eavesdropping revealed that many of the overseas tour groups were Russian, visitors whose wallets aren't as thick as those carried by Americans or Western Europeans.

Tourism, Egypt's principal source of foreign exchange, has stalled, a victim of the ominous war clouds building over nearby Iraq. And the fallout from this uncertainty-fewer jobs in hotels and restaurants, and weaker demand for locally made handicrafts-has been debilitating.

The tourist industry is only one of the Egyptian casualties. Foreign and domestic firms throughout Egypt have delayed investments, and companies have postponed introducing new products. Moreover, remittances from Egyptians overseas, the country's second-largest source of hard currency, are in danger because the coming war in Iraq threatens to hold up construction projects in the Persian Gulf states, where many Egyptians now work. The Egyptian economy is in limbo, still growing but woefully underperforming.

"Seventy percent of our [current economic] problem is international instability," said Hisham Ezz Al-Arab, chairman of Commercial International Bank, one of Egypt's largest private banks.

It's little wonder then that many Egyptians, even those who reject President Bush's rationale for an invasion of Iraq, just want the Bush administration to get on with the war. They see an end to the current political uncertainty as the only way to restore confidence among investors, consumers, and tourists, so that Egypt can begin to fully develop its economy.

As the largest market in the Arab world, with the largest population, Egypt is critical to America's diplomatic and security interests in the Middle East. But a quick U.S. victory in Iraq is only a necessary, not a sufficient, condition for Egypt's well-being. In the long run, Egypt's health depends on fundamental domestic economic reform.

In focusing on a possible war with Iraq, Bush administration officials should not fail to press Egypt to get its economic house in order. And the White House should not be shy about offering greater access to the lucrative U.S. market if Cairo does institute reforms. For, regardless of what happens in Iraq, Middle Eastern stability will ultimately depend upon a vibrant regional economy, with Egypt as the cornerstone.

Egypt has suffered greatly from the triple whammy of terrorism, fears of war, and the global economic slowdown. After averaging 3.7 percent growth over the previous decade, the Egyptian economy saw its growth rate slow to 2.2 percent in 2002. The economy is expected to expand by no more than 2.6 percent in 2003 (assuming there's no war in Iraq). "It seems to us that we have reached the bottom, and that in the near future we will pick up again," said a hopeful Mahmoud I. Abul-Eyoun, governor of the Central Bank of Egypt.

He had better be right, because slow growth has political ramifications in Egypt. Nearly a quarter of the population lives below the poverty line. Unemployment among those under age 26 is estimated to top 28 percent. Egypt must generate more than 600,000 jobs per year just to keep up with the growth of its labor force. But recently, the economy has come up nearly 200,000 jobs short. Economists estimate the economy has to grow by 6 percent a year to close that gap.

The government's recent short-term fix was to allow the Egyptian pound to float in value, effectively devaluing it in an effort to make both exports and tourism more attractive. But fiddling with the currency, as justifiable as it may be given Egypt's deteriorating economic fundamentals, is merely a palliative. To position itself to take full advantage of a postwar return to stability, wrote Ahmed Galal, executive director of the Egyptian Center for Economic Studies, in a recent report, "Egypt needs to implement a round of significant reform measures, as it did in the early 1990s," when Egyptian President Hosni Mubarak privatized some state holdings and opened the economy to more competition from imports.

New reforms must begin with tourism. "We are not an industrial country," said Ezz Al-Arab. "We are very much a service economy. There is no doubt that tourism is the future of the economy." Tourism accounts for 3.9 million jobs and 11.6 percent of the economy, directly and indirectly. Each year, Egypt attracts roughly the same number of tourists as the much smaller Arab countries of Tunisia or Dubai-even though both lack Egypt's fine year-round weather and strong cultural attractions. This suggests that Egyptian tourism has room to grow. "For 400 million sunseekers in Europe," said Ezz Al-Arab, "Egypt is the place. But we don't attract even 1 percent of those people, and most [we do attract] are not the big spenders."

The Pyramids notwithstanding, Egyptian officials think that the nation's beaches-in the north along the Mediterranean Sea and in the Sinai-are an underused attraction. And they acknowledge they need foreign investors to develop resorts that will draw rich Swedes and Germans, not budget-conscious Russians. Such investments presume peace. But they will also require a thinning of Egypt's notorious bureaucratic underbrush. (One study found it took 77 procedures in 31 different government offices just to register property.)

Egypt's second hope for the future is trade. Manufactured products currently account for less than half of all Egyptian exports and only about a fifth of foreign earnings. Economists think that increasing trade with Europe, the United States, and the Arab world could add 1.8 percent to Egypt's annual growth rate. But trade expansion will require wide-ranging reforms.

Egypt has one of the most closed economies in the Middle East. This reflects an anti-export bias and a legacy of protectionism and an ideology of national self-sufficiency from the 1950s. Tariffs on imported parts needed to produce many exports are nearly twice as high as the average in developing countries. Taxes on corporate profits, a concern of foreign firms thinking of setting up shop in Egypt, are significantly higher than those in many other developing nations. Labor regulations and lengthy labor disputes make workers relatively expensive and encourage investors to hire workers on a temporary basis whenever possible and to favor capital-intensive manufacturing techniques.

Removing such obstacles will meet stiff resistance from labor unions and traditional industries-knitting mills, footwear makers, leather producers, and pottery and china makers-that currently benefit from a protected home market.

Moreover, reform is only the first step Egypt needs to take to improve its export performance. It also needs to find markets for its goods. The government has already signed a free-trade deal with the European Union. But the accord will be phased in over two decades and, thanks to quirks in the agreement, it will actually raise Egyptian protection in the short run.

The markets of other Arab countries are just too small to be very attractive. And their companies are even less productive than most Egyptian manufacturers, so increased competition with them would spur little innovation in Egypt. Israel would be a perfect regional trade partner, a rich market with competitive firms. But that marriage is out of the question, at least until the Palestinian situation is resolved.

The U.S. market offers Egypt its greatest opportunities. But America supplies more of Egypt's imports than it buys of Egypt's exports, creating a trade imbalance that Cairo would dearly like to correct. The potential is there. Econometric models in Cairo suggest that Egyptian trade with the United States is only two-thirds of what it could be, given the nature of what Egypt produces and America imports.

Since 1999, Cairo and Washington have had a Trade and Investment Framework Agreement, a forum used to negotiate away commercial impediments. But the Egyptian government is now pressing the Bush administration to launch formal free-trade negotiations. A team of Egyptian officials was in Washington the first week in February to make that case. Meanwhile, business leaders in Cairo aren't shy about reminding visiting Americans about Egypt's support in the war on terrorism. Moreover, they question how the United States could have free-trade deals with Israel and Jordan, and one in the offing with Morocco, but somehow ignore its ally Egypt. U.S. trade officials, however, argue that Cairo must travel a long road of domestic economic reform before a free-trade deal would be feasible.

Egyptians still pin a great deal of hope on tourism. "If we have peace in Iraq and Palestine, you won't be able to find a room in Egypt," said Ezz Al-Arab, underscoring the importance of peace to Egypt's short-run economic recovery.

But regional stability is out of the Egyptians' control. Peace depends on decisions made in Washington and Baghdad and Jerusalem. Instead, Cairo can do several things to prepare for that peace and lay the groundwork for its own long-term economic growth. Rather than be content simply to refill existing hotel rooms, it can create an investor-friendly climate that will lead to the building of more resorts and enhance tourism's contribution to the Egyptian economy. Cairo can also accelerate the opening of Egypt's economy, giving Washington no more excuses to delay a free-trade deal.

Many Egyptians are fatalists by nature, so it is easy for them to play the role of economic victims of the impending war with Iraq. They need to be opportunists, seizing this chance to accelerate economic reform to ensure that their nation will lead the economic revival of a postwar Middle East.