Egypt’s Economy of Dependence

Egypt may have dodged a bullet last month when a handful of Gulf states pledged $12 billion in emergency aid to prop up the country’s flagging economy, which has been battling inflation while running dangerously low on foreign currency reserves. But the bailout underscored the extent to which perverse political incentives have become Egypt’s biggest economic problem. As long as the country can count on foreign revenue streams, its leaders will continue to put off much-needed economic reforms — a dangerous dynamic that sets Egypt on the path to financial ruin.

Flush with cash from the Gulf, Egypt’s military-installed leaders have already signaled they will not pursue negotiations with the International Monetary Fund over a long-planned $4.8 billion loan that would require painful tax hikes and subsidy cuts.

“The time is not appropriate to begin a new round of negotiations with the I.M.F.,” the interim planning minister, Ashraf al-Araby, said last month. “Aid from Arab countries will help Egypt get through the transitional period.”

From a political standpoint, Araby would be crazy to say anything else. No incumbent in his or her right mind would take on the political risk of economic reform in the face of such easy cash.

Every time Egypt’s foreign reserves fall to a critical threshold and there is pressure on its currency, rich Gulf neighbors come to the rescue. During Mohamed Morsi’s tenure as president, Qatar was the chief patron, extending some $8 billion in assistance since the removal of Hosni Mubarak in 2011. Following Morsi’s ouster, it has been Saudi Arabia, Kuwait and the United Arab Emirates that have shored up its finances.

As a result, Egypt has been able to avoid making hard choices. In particular, it has been able to sustain a bloated subsidy regime — mostly devoted to fuel and wheat — that eats up as much as 25 percent of total state expenditures and overwhelmingly benefits rich urban residents. A recent African Development Bank report estimates that in urban areas, more than 90 percent of gasoline subsidies go to the top 40 percent of the population.

Likewise, the leaders have been able to put off financial and regulatory reforms that would make the economy more competitive in the long run. Two-and-a-half years after Mubarak, finance still remains inaccessible for small firms (though numerous donor initiatives have sprouted up). Meanwhile, Egypt’s archaic bankruptcy laws impose a heavy penalty for business failure, effectively discouraging experimentation. Declaring bankruptcy can land a merchant in jail, barred from doing business in the future and still liable for the debt.

Despite Egypt’s brief experiment with Muslim Brotherhood rule, the underlying balance of economic power has changed very little since Mubarak’s day. Many of the old crony capitalists have been sidelined (and a few are in jail) but the basic rules of the game remain skewed in favor of a tiny elite — chief among which is the Egyptian military.

The privileged position of the Egyptian armed forces has been maintained through another, equally destructive, revenue stream: $1.3 billion in annual direct military assistance from the United States. That aid, which has come under increased scrutiny since the July 3 coup, consists mostly of defense procurement contracts that keep Egypt’s military well stocked with shiny M1A1 Abrams tanks and F-16 fighter jets — hardware with little strategic value, but considerable importance to the military’s prestige.

The technology transferred through direct U.S. military assistance has also played a central role in bolstering the military’s economic empire (sometimes estimated to be as high as 40 percent of Egypt’s G.D.P.).

At the same Egyptian plant where the U.S.-made M1A1 Abrams tanks are assembled, for example, the military produces commercial construction vehicles that are sold on the domestic market. These commercial spinoffs enjoy special privileges and monopoly concessions that crowd out possible competitors from Egypt’s already moribund private sector.

As long as the military is in charge, the distortions caused by its economic privileges are likely to remain in place. What the interim government could do, however, is meet Egypt’s fiscal problems head-on, replacing the current subsidy scheme with a more progressive system of targeted cash transfers and widening its tax net to include even those with political connections.

On the regulatory front, it could overhaul the bankruptcy code, dismantle nontariff barriers that are used to protect political insiders from competition, and extend financing to smaller companies by making the country’s banking system more competitive (four banks control about 50 percent of the market right now).

Such reforms would help remove barriers to entry for new companies, kick-starting private sector development and improving Egypt’s long-term economic prospects.

Ironically, the Egyptian economy has been picking up since the countrywide protests on June 30 that served as a pretext for the military putsch. Fuel and food prices have fallen, the pound has stabilized, and the country’s stock exchange has posted substantial gains.

But Egypt’s leaders should not mistake these developments for indicators of long-term economic health. On the contrary, they reflect forces beyond Cairo’s control — a new credit line from the Gulf — and serve to underscore Egypt’s deep vulnerability as one of the most aid-dependent economies in the Middle East.

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