[Steffen Hertog] The perils of economic populism in the Mideast

The first signs of a post-revolutionary hangover are everywhere in the Arab world. Where unity of purpose once defined the reform movements in Egypt and Tunisia, now particular interests are coming to the fore. Forces for change are fracturing.

Conflicts revolve not just around the constitutional framework of the transition away from dictatorship or the place of Islam in public life, but increasingly around bread and butter issues. Demands for jobs, higher wages and lower prices are becoming more prominent, and they often come from specific and sometimes rival constituencies.

It is socio-economic frustration that made the Arab Spring a mass movement. This same frustration could now lead the Arab world in a fatally wrong direction as weak governments, in revolutionary and anciens regimes, respond to popular demands with ill-conceived economic populism.

Austerity isn’t an option, politically or morally. However, the wrong kinds of spending not only undermine fiscal sustainability, but also tend to widen income disparities and set the stage for zero-sum struggles over the resources of the state. Unfortunately, this is what is happening across the Arab world.

At the heart of the matter is the buying of patronage ― something that is typically accomplished in the region by creating surplus jobs in the public sector and subsidizing transport fuel and electricity. Yet it is hard to imagine more inadequate tools of welfare. Surplus public sector jobs are an exclusive good ― allocated to some, not to others, and often according to political or personal preference. They distort private labor markets and often reduce the efficacy of already bloated bureaucracies.

Energy subsidies encourage overconsumption and waste, with limited benefit to individuals but at huge expense to the state. They usually cost more than other, potentially more defensible subsidies of food or transportation, more even than conventional welfare programs. The International Monetary Fund estimates the total cost of energy subsidies in Egypt at more than 5 percent of the country’s gross domestic product ― exceeding the government’s entire public investment expenditure as well as its budgets for health and education. Also, energy subsidies disproportionately benefit richer households, which tend to consume more; they are equivalent to a regressive tax.

Despite these perverse outcomes, Arab governments have reacted to popular pressure by drastically expanding existing subsidies. On June 22, the Egyptian transitional government, trying to avoid the need for an IMF loan, put forward a second budget for 2011-12. This slimmed down version included a 35 percent increase in fuel subsidies and 23 percent growth in public salary outlays.

The provisional Tunisian government has also created new public sector jobs as a sop to protesters. Its budget for 2011 is 11 percent larger than the one originally planned under the regime of deposed President Zine El Abidine ben Ali, largely due to increased subsidies. Both Egypt and Tunisia expect to run large deficits in 2011.

The reaction to popular pressure by incumbent authoritarian regimes has been similar. The Syrian government has substantially increased its heating oil allowance for public workers and has given state employees their biggest raise in four decades. Jordan has increased fuel and food subsidies as well as public-sector salaries and pensions. Morocco has almost doubled its subsidy budget. On the Arabian Peninsula, where energy is already cheap, regimes have stepped up the pace of public job creation.

So how should Arab governments use public money to promote the general welfare? Instead of adding to an unsustainable payroll, governments should focus on creating meaningful social security systems. This would include unemployment assistance and minimum-income guarantees for the less fortunate. Governments could enact wage subsidies for the private sector to make the low salaries there acceptable to more people. In the long term, re-engineering Arab public sectors from bloated tools of income redistribution to lean and efficient administrations would significantly improve the business climate.

Energy subsidies should also be phased out. They could be replaced by direct cash grants. Such grants could be means-tested or unconditional ― either would be fairer and less regressive than the system used now. Alternatively, the money could be used to boost general social security and income maintenance systems. Ironically, it is populist Iran that has taken the lead on this. It is replacing subsidized domestic energy with a system of unconditional cash grants to all Iranian households, a policy that will potentially deliver huge savings to the government.

How do you scale down regressive, and entrenched, patronage? The quickest solution, and one with wide political resonance, would be unconditional cash grants to all citizens. Such payouts could be supplemented by more sophisticated means-tested support programs. Latin America, another region with huge problems of poverty and inequality, has had encouraging experiences with direct cash grants to poor families. These are conditional, tied to sending a child to school or getting regular medical checkups.

Compensation for reducing old-school patronage will need to be offered right away and not as part of a distant vision of social modernization. It will also require money.

This is where Western partners could make a real difference through targeted financial support. Significant aid payments have already been pledged, and some could be earmarked for the purpose of setting up more equitable and less distorting social support systems. The means for foreign powers to assist in democratic transitions are usually limited. Re-engineering the distributional bargain in the Arab world is one area where the West could have a large and beneficial impact. 

By Steffen Hertog

Steffen Hertog is a lecturer at the London School of Economics and the author of “Princes, Brokers and Bureaucrats: Oil and the State in Saudi Arabia.” The opinions expressed are his own. ― Ed.

(Bloomberg)