Wednesday, August 3, 2011

Supporting Democratic Movements In The Arab World: An Economist's Perspective

By Dr. Zubair Iqbal

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 of 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 countries to 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 the 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 spurring revolt against the authoritarian regimes. Estimates show that the financial needs of the non-oil Middle East and North Africa 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 governance was to come from multilateral agencies such as the IMF, the World Bank, and the EBRD. Bilateral support was also to be extended and incentives were 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.

In early June, 2011, Egypt negotiated an adjustment program with the IMF staff worth $3 billion for the subsequent 12-month period, which was meant to provide the much-needed financial support to facilitate the democratization process. The program 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 weakened resolve for domestic resource mobilization, thus potentially 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 to 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.

-This essay was published by Middle East Institute on 02/08/2011
-Dr. Zubair Iqbal is a Scholar at the Middle East Institute and a former statter in the Policy Development for the Middle East and Central Asia Department at the International Monetary Fund

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