Egypt Needs Free Trade, Not More Aid

Easy foreign money has allowed Cairo to put off necessary reforms of its distorted, inefficient economy.

Egypt is racing toward dictatorship. Gen. Abdel Fatah al-Sisi even arrested opponents of the proposed constitution in the January referendum. However, Washington always has been more interested in maintaining influence than encouraging democracy or promoting development in Egypt. Toward that end the U.S. provided more than $75 billion in “aid” over the years. In fact, the cash bought little leverage. Hosni Mubarak spent decades oppressing Egyptian citizens and persecuting Coptic Christians despite Washington’s advice to the contrary. Israel’s military superiority, not America’s money, bought peace. Cash for fancy weapons may have won privileged access to Egyptian airspace and the Suez Canal, but today the Egyptian military needs the U.S.—for maintenance on and spare parts for those same weapons—more than the U.S. needs the Egyptian military.

Unfortunately, as elsewhere in the Third World, foreign “assistance” actually hindered economic development, effectively subsidizing Cairo’s inefficient dirigiste policies. Most undeveloped rural states attempted state-led development strategies to modernize, with disastrous results. Yet access to foreign cash reduced pressure to make politically painful economic reforms. So it was in Egypt. As long as enough money was available to pay off important interest groups, most notably the military, even a dictator like Mubarak saw no reason to risk political unrest.

A decade ago the government finally recognized the need to open the economy. Rebecca Nelson and Jeremy Sharp of the Congressional Research Service reported on “wide-ranging structural reforms, including tariff reductions, privatization of state-owned enterprises, and reductions in regulation of the private sector, among other policy measures, that aimed to improve the business environment and make Egypt’s economy more competitive.” Meredith Broadbent of the Center for Strategic and International Studies cited corporate tax reductions and insurance regulation modernization. The result was international recognition for Cairo’s efforts, increased foreign investment, and increased economic growth.

However, Egypt then began to fall behind other reformers. According to the Economic Freedom of the World index, Egypt ranked 53 of 123 in 2000, fell to 94 of 127 in 2003, rose to 78 of 141 in 2007, and then fell back to 99 of 144 in 2010. Important problems remained. For instance, Broadbent pointed to the survival of “significant elements of a heavy-handed statist bureaucracy.” The banking system was opaque, monopolistic and inaccessible. A joint report by the Carnegie Endowment and Legatum Institute pointed to the need to give poor Egyptians clear title to their property, reform the bankruptcy law, and reduce costs of opening, operating and closing businesses.

Corruption was pervasive: Transparency International ranked Egypt at 114 out of 171 countries in 2013. Writing for the Carnegie Middle East Center last June, Ibrahim Saif and Ahmed Ghoneim cited as problem areas “allocations of land, freezing of anti-trust laws, and dubious privatization deals.” They set forth a reform program based on more reliable policies and regulations, minimal intervention in the credit markets, greater transparency in public finance and military economic activities, and reform of investment policy, along with political and judicial improvements.

The economy remained dominated by cronyism and privilege. The military controls anywhere between 15 percent and 40 percent of the economy. Other influential individuals and interests also benefit from state favors. Saif and Ghoneim observed that larger private firms “have disproportionate access to decision makers and may be skewing policy in their direction.” In fact, members of the business elite are suspected of having helped orchestrate artificial shortages to intensify public dissatisfaction with President Mohammed Morsi in order to help justify a coup.

The most serious economic hindrance was extensive and expensive consumer subsidies, particularly for food and fuel. Most of the benefits did not go to those in most need. Alas, explained my Cato Institute colleague Dalibor Rohac: “Not only are subsidies highly ineffective in helping the poor, they are also an increasingly unsustainable drain on the country’s public finances and its foreign reserves.” The cost accounts for roughly a third of the government’s budget and 14 percent of GDP.

Thus, even after the Mubarak reforms unemployment and inflation remained high while Cairo ran large deficits. The benefits of reform failed to reach many people, especially the extreme poor. The situation worsened after the 2011 revolution.

The Morsi government cut gasoline subsidies and raised taxes, only to reverse course under public fire. Cairo also hiked government employment and salaries. The public deficit increased to 11 percent of GDP. Worse was the business environment. Observed Nelson and Sharp: “Continued insecurity stemming from deterioration in law and order has hampered investment.” Other analysts pointed to the lack of certainty of even the direction of policy.