Egypt’s Moral Hazard

My good friend Ashraf Swelam provides further insight into Egypt’s economic woes and the country’s relationship with the IMF. Enjoy!

Egypt has been deemed “too big to fail.” That’s the overwhelming logic in the corridors of power around the world. It is the most populous country in the Arab world and a lynchpin of American and Western interests in the Middle East. Its revolution was the capstone event of the so called “Arab Spring”. As a result, international support for bailing Egypt out couldn’t be stronger. Egypt’s new rulers – the Muslim Brotherhood and its Freedom and Justice Party - are not only aware of it, they are betting on it. But, like executives of “too big to fail” companies, they are taking risks they wouldn’t otherwise take.

Bailing out Egypt is a two-step process, we are told. First an agreement with the International Monetary Fund (IMF) needs to be reached. This will extend to the Muslim-Brotherhood-led-government a $4.8 billion lifeline in return for a home-grown program of reforms with the aim of putting the country on a path toward financial stability and economic growth. The agreement would in turn unlock a larger package of financial support (supposedly some $14 billion from the United States, Europe, Arab countries, the World Bank, and regional development banks) to help Egypt deal with the dire state of its public finances.

Yet bailing out Egypt is just half the problem.  The Nobel Prize winning economist Paul Krugman has advocated bailing out banks deemed too big to fail, but he has also recommended regulating them.  But how do you regulate a country, so that it is no longer a risk to itself (and its people), its neighbors, and the international system in general? Krugman’s “bailout and regulate” remedy would dictate that Egypt’s reform program (which requires IMF’s approval) be one that meets two requirements: 1) It must steer Egypt away from the edge of the abyss and onto a path of economic sustainability and financial stability, if for no other reason than to minimize the international community’s need for additional bailouts down the road, and 2) to purge moral hazard, i.e., eliminate Egyptian executives’ (rulers) incentives to take risks it should not otherwise take.

So, are these two requirements being met? The first requirement is definitely not. In designing its reform program, the Egyptian government had two options, either to settle for merely reining in the budget and balance of payments deficits, or to pursue the much more ambitious objective of turning its seemingly unsolvable problems into an opportunity to unshackle the economy and to lay the foundation for growth that is inclusive, sustainable, and creates productive good-paying jobs for its fast-growing labor force, while shielding the most vulnerable. It had a choice between trying to keep the ship afloat and trying to prepare it to sail. Unfortunately, it opted for the former.

The information made available by the Egyptian government, discussions with experts familiar with the negotiations, and earlier versions of the program, all point to the following shortcomings of the government’s vision for reviving the economy:

Aiming Low

Egypt’s reform program is either silent or goes only a short distance in addressing critical issues such as management of public finances, land reform, improving the business environment, cutting red tape, dealing with inadequate competition in the domestic market, improving transparency, and ensuring good governance. That is a serious problem, because while financial stability is a necessary condition for achieving the desired growth path, it is by no means a sufficient.

Leaving out the biggest of beasts

A program whose objective is to rein in the budget deficit focuses on cutting wasteful subsidies and raising taxes, but does not utter a word about the seven-million strong public sector employees, whose wages consume more than one-quarter of total government spending. That is shocking, to say the least. I will be the first to admit that dealing with this particular challenge is a long term endeavor and a painstaking one, but it has to start.

Falling behind the curve

At a time when the economic situation in Egypt is going from bad to worse, every new draft of the reform program submitted to the IMF - in the endless rounds of negotiations dating all the way back to February 2011 – has been a watered down version of its predecessor. The end result, according to most investment experts I have spoken to, is that “Egypt’s reform program is falling behind the curve.” Consequently, hopes that an IMF-stamped clean bill of health for the Egyptian economy would send a strong signal to foreign investors to return are vanishing, especially with the country’s miserable security situation and the clouds of doubts surrounding the rule of law.

The second requirement for a successful bailout is that it must purge moral hazard, i.e., eliminating Egyptian executives’ (rulers) incentives to take risks they would not otherwise take. The Muslim Brotherhood-led government of Egypt is meeting this requirement externally. By restraining Hamas, destroying tunnels on the Egyptian-Israeli border, and other foreign policy positions, it is garnering enough international support for the bailout to go through. What it is not doing is showing the slightest interest in building the broad domestic political support for the reforms (or for anything else for that matter) necessary to mitigate the implementation risks involved (and they are many) not the least of which is the impact of even the weakest of reforms on the livelihood of almost sixty percent of the population (according to a recent governmental poll) who are already failing to make ends meet. Judging by its unwillingness to compromise on any of the demands of some of its Islamist allies, let alone Egypt’s secular/liberal opposition, it seems that the Muslim Brotherhood is taking the incredibly high risk of going it alone, a serious moral hazard.

In "Is Egypt Too Big To Fail," Steven Cook describes the IMF-Muslim Brotherhood negotiations as a “game of chicken.” That is definitely the case. But, here is a question worth asking: Is the Muslim Brotherhood playing “chicken” with the IMF, the United States and the world only because it is arrogant, as Steven seems to suggest, or is it the case that the IMF, the United States and the world have given the Muslim Brotherhood every reason to believe that they will blink first? I would say it is the latter. The Muslim Brotherhood is playing “chicken” with the world because the world’s bar has been set too low. It is playing “chicken” with the world because everyone is turning a blind eye to the game of “Doom” it is playing at home.

Ashraf Swelam was senior policy advisor for former Presidential candidate Amre Moussa. He is the editor and chief contributor of the candidate’s presidential platform “The Second Republic: Rebuilding Egypt.” He is currently Senior Advisor to the Egyptian National Competitiveness Council. He tweets at @Swelamiat.