What was the impact of the new economic strategy and how did the economy perform in the decade after 1973? The second question is easier to answer than the first. Ikram (1980) and Handoussa (1990) describe areas in which economic performance improved sharply. The growth of GDP in 1975–86 averaged over 9 percent a year in real terms; even in the face of an annual population growth rate of 2.8 percent between 1976 and 1986, real per capita incomes increased at an average of 6 percent a year.
The investment rate doubled from 13.7 percent of GDP in 1973 to 28.7 percent in 1985. The growth in investment was paralleled by a rise in gross domestic savings from 8.3 percent of GDP to 17.8 percent in the two years.
Social indicators also progressed. The number of absolute poor rural households declined from 51 percent in the early 1970s to 30 percent by the early 1980s; the infant mortality rate declined from 117 per thousand to 93; life expectancy at birth rose from 50 to 58 years; the average caloric intake per capita increased from 100 to 128 percent of minimum standard requirements; and the primary school enrollment ratio improved from 72 to 78 percent.
However, these improvements owed little to policy changes informed by the infitah. The economic resurgence was based on a combination of serendipitous events that enabled Egypt to access a much larger volume of resources. This made possible a simultaneous increase in investment and imports, both for consumption and for intermediates that permitted fuller utilization of installed capacity. But fundamental structural issues remained unaddressed.
There was an absence of policies that would have increased competi-tiveness, or which would have improved the economic rationality of decisions by correcting distorted price signals. Nor was there a pursuit of institutional changes that would have reduced transactions costs. The enlargement of the economic cake by the fortuitous inflow of resources (oil exports, Suez Canal earnings, worker remittances, tourism receipts, and external assistance) masked serious rigidities in the economic struc-ture. Bruton (1983: 682) argued that the foreign exchange windfall did
little to affect the productivity of the “real” Egyptian economy, and that the elimination of the foreign exchange constraint enabled the govern-ment to avoid taking the difficult decisions that were necessary to raise the efficiency of resource use. The cost to the economy of such rigidities became especially marked after 1982, when falling oil prices caused foreign exchange earnings to decline, but the overvalued exchange rate and the price distortions continued the bias towards nontradables.
Some commentators contend that the sudden growth in foreign exchange availability created a variant of the “Dutch disease” phenome-non. “Dutch disease” models predict that a heavy influx of foreign cur-rency (generally caused by sharp increases in primary product or natural resource export prices) can put upward pressure on the exchange rate and erode the competitiveness of industrial exports. Because means of production do not have to be allocated to earning them, revenues from worker remittances, foreign aid, and oil can produce a similar effect. It has been held that the surge of such windfall resources during this period was particularly damaging to the competitiveness of Egyptian industry.
An alternative view is that of Cottenet (2003), who argues that the behavior of the industrial sector during this period can better be explained by an “allocation of talents” mechanism. The boom attending upon the infitah created a politico-institutional environment that made rent-seeking activities more profitable than productive activities, and thus attracted the best talents towards the former. Under either explanation, access to a large amount of resources not related to the productivity of the economy created serious distortions in the incentive structure.
The GDP increased rapidly during 1974–87, but these years are best divided into two subperiods, because of important differences underlying the growth. In the first subperiod (1974–81), the growth rate averaged over 9 percent a year, and was based on a conjuncture of three events.
First, the return of oil fields and the increase of international oil prices in 1973 and 1979 provided Egypt with large windfalls in foreign exchange earnings. The main oil fields in the Gulf of Suez resumed production after the 1973 war, and revenues from oil exports in 1981 reached $3,013 million compared with $44.8 million in 1972. In 1974 oil had accounted for less than 3 percent of GDP, 11 percent of exports, and less than 1 percent of government revenue; in 1981 it reached nearly 13 percent, 59 percent, and 20 percent respectively. Concurrently, non-oil exports dropped because the demand generated by rising oil incomes and the expansionary fiscal stance diverted commodities from the foreign to the domestic market. Thus, the value of cotton exports dropped by 50 percent in constant prices over the 1974–81 period, textiles by 40 percent, and manufactured exports as a whole by 46 percent. As a result, the Gini index of the concentration of exports increased from 0.442 to 0.483 (a value of 1.0 shows maximum concentration), suggesting an increased exposure of export earnings to external shocks.
Second, the vast increase in purchasing power that higher oil revenues gave to the Arab oil producers created an enormous demand for Egyptian workers in all fields. This not only eased the unemployment problem in Egypt, but also led to a very substantial flow of remittances from these expatriate workers. The flow of remittances surged from $189 million in 1974 to $2,855 million in 1981.
Third, there was a rapid escalation in external assistance. Arab coun-tries, which had already provided major support, stepped up their aid pro-grams. An immediate effect was the formation of the Gulf Organization for the Development of Egypt (consisting of Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates) in April 1976, which quickly disbursed about $2 billion to pay off most of Egypt’s short-term debt and to permit the freer import of consumer and intermediate goods. As part of their support of movement towards peace in the Middle East, the main Western countries (particularly the United States) and Japan commenced very sub-stantial programs of economic assistance to Egypt. A large pipeline of aid commitments was soon built up, and in 1981 the total disbursement of official loans and grants into Egypt was put at $1,602 million, or 7 percent of GDP.
While this deluge of funds radically eased the foreign exchange con-straint, it did nothing to ensure a more effective use of resources. Owen and Pamuk (1998: 137) remarked that “Once the regime found itself in possession of huge new funds towards the end of the 1970s, all pressure for public sector reform evaporated.” Serious structural reform did not begin until the 1990s.
The period immediately after the announcement of the “open-door”
policy was particularly difficult for policymakers, who had little experience in managing a market economy. They did have access to analytical support from institutions such as the World Bank, the International Mon-etary Fund (IMF), and the USAID, but some degree of wariness in the relationship between the Egyptian authorities and the donor agencies was only to be expected.
Egyptian ministers repeatedly voiced the opinion that outside advisors did not quite understand the Egyptian situation and were unrealistic in their expectations, particularly concerning the pace at which reforms could be undertaken. There was also the feeling that the international agencies could be insensitive: as one minister said, “They are too eager to announce the crime and to pronounce the sentence.” These remarks applied more to the IMF and the World Bank; the USAID appeared to be more circumspect in pressing for economic reforms because its business, quite patently, was to provide financial assistance in exchange for political support. For their part, the international financial institutions (IFIs) expressed frustration with what they politely termed “missed opportun-ities.” To the IFIs, it appeared that the Egyptian authorities accepted their analyses of the problems, but did not want to follow through on the
required policies. “They [the Egyptians] wanted simply to waive the penalty, not to rescind the judgment,” minuted an IFI discussant.
For a variety of reasons, the World Bank was constrained in pressing for wide-ranging reforms. Over 80 percent of the Bank’s lending to Egypt at this time was for specific projects; this type of financial support permitted the Bank to propose conditions on that particular project or at times for the sector in which the project was located, but did not give it much scope for requiring economy-wide conditions. Moreover, the World Bank had already come in for a great deal of criticism in Egypt because of its role in the Aswan High Dam incident. The Bank was therefore anxious to mini-mize friction when it resumed lending to Egypt in 1973. Thus, of the bilat-eral and international organizations, the IMF remained the most active in proposing conditions on macroeconomic policy.
The political economy of decision-making during this period is the story of a complex interaction between the views of the Egyptian govern-ment, of bilateral donors, and the multilateral agencies. World Bank and IMF reports of this time highlighted three weaknesses in Egypt’s economic management. First, the lengthy period of socialistic control and central direction had left few officials in senior positions who were wholly com-fortable with the functioning of a modern market economy; there were just not enough persons qualified to devise policies for and to manage the changed economy. Second, the coordination of policies between the dif-ferent ministries remained unsatisfactory, and on more than one occasion the international agencies proposed that a unit be set up in the Prime Minister’s Secretariat to harmonize economic policies. Third, perhaps as a result of the first two inadequacies, Egypt had not managed to articulate a clear economic strategy, and its thinking and actions tended to be reactive rather than proactive. In the view of international agencies, this created a certain defensiveness in the Egyptian response to donors’ recommenda-tions, and tended to make negotiations more difficult than they need have been.
An economic issue with important political overtones cropped up quite early after Egypt’s opening to the West, and highlighted the effects of the foregoing weaknesses. Since this incident – the handling of policies that led to the bread riots of January 1977 – continues to resonate even today with policymakers, it might be worthwhile to look behind the scenes at the political economy of the decisions leading to it and the dynamics of the policymaking process.
Egypt required a substantial infusion of external funds and the IMF and the World Bank were prime candidates for providing much of these resources. However, the resource transfer from these institutions is accompanied by policy conditions. Broadly speaking, the reasoning is that in the absence of some unavoidable shock, a country’s predicament is the result of poor policies. A new set of policies is therefore recommended to move the country out from its difficulties. The IMF imposes economy-wide
conditions on its lending, because it is responsible for helping countries to maintain macroeconomic balance. In the nature of things, it is quite likely that the policies recommended by the IMF lead to greater austerity and hardship before they begin to improve matters. However, no politi-cian wins kudos for imposing austerity, even if it is intended only for the short run. Soon after the reactivization of links between Egypt and the international financial institutions, a critical issue faced by the Cabinet was the classic one of how to obtain the maximum resources from the Fund while minimizing the accompanying policy conditions.1
For most of 1975 and 1976, the IMF’s attention centered on the budget deficit and especially the weight of the cost of living subsidies. The Fund’s main condition for agreeing to a program was a reduction in subsidies.
This prescription was resisted by the Egyptians, but by July 1976 the bud-getary situation had deteriorated to an extent that it appeared impossible for the country to hold out any further. It became known in Cairo that Egypt was about ready to sign an agreement with the Fund. It also was known that substantive differences existed in the Cabinet on the merits of completing the agreement. The Ministry of Economy was said to be leaning towards an agreement while some other ministries, notably Finance, had serious reservations.
The Ministry of Economy’s position was based on three main considera-tions. First, Egypt needed the Fund’s resources to plug the gap in the country’s budget. Second, the Ministry reckoned that under the spur of Fund-recommended policies, Egypt could make quicker progress in redu-cing its reliance on external funds and it would thus be able to lessen its vulnerability to external donors (even though in the immediate term, of course, it would have to borrow more from the IMF). Third, the Ministry felt that Egypt required the Fund’s “good housekeeping seal of approval”
in order to reassure foreign investors; it preferred foreign investment to Egypt’s borrowing from abroad.
The Ministry of Finance emphasized a different set of concerns. In its view, the terms of the agreement would adversely affect growth, impact harshly on the poorer sections of society, and mire the government in political difficulties. The Ministry contended that the budget deficit could be brought down gradually by eliminating the more egregious subsidies, reducing some of the others in a phased manner, and increasing revenues by improving the efficiency of tax administration. The Minister (Dr Ahmed Abou Ismail) pointed out that this process had already begun: he had can-celled the subsidy on halaawa (a dessert) amounting to about $45 million, and had made other cuts that had reduced the subsidy bill by some $185 million. He was as keen as the Minister of Economy (Dr Zaki Shafei) to see a lessening of Egypt’s vulnerability to external pressure; the issue was of attaining this goal while minimizing risks to the country’s stability.
Dr Abou Ismail argued that after 1973 Egypt had made a political choice in deliberately orienting its foreign policy towards countries that
were economically much stronger than the Soviet Union. These countries were willing to support a measured restructuring of Egypt’s policies and institutions. In his view, it would be irresponsible for an Egyptian policy-maker not to call on these countries for assistance so that change could be brought about at a socially tolerable pace. He was also skeptical about whether the Fund’s policy package would actually encourage foreign investment; such investors would be unlikely to derive much cheer from the “revolution” (his word) that was certain to follow an abrupt reduction in food subsidies.2
These two positions reflected very different assessments of the impact of the Fund’s proposals on the economy and of the actions that ought to be taken to deal with the budgetary problems. However, the Cabinet debate on these issues did not remain confined within an economic framework.
Dr Ahmed Abou Ismail and his Undersecretary showed me the letter of policy drafted by the Fund that Egypt would have to sign. They asked whether the terms looked reasonable, or whether Egypt should press the Fund for adjustments, especially to the credit ceilings, the interest rate, and the actions expected on subsidies. The Finance Ministry was also interested in examining whether an exchange rate adjustment would be better handled as an across-the-board devaluation, or whether a system of dual exchange rates would better suit Egypt’s circumstances. The idea was that one of these rates would be more depreciated and flexible and apply to exports, such as manufactures, that were supposed to be price-elastic, while the other would be retained for exports that conventional wisdom regarded as less responsive to exchange rate changes.
I replied that, first, the agreement was between Egypt and the Fund, and thus the World Bank could not properly take a position on it. I also sought to discourage the view that simply because a proposal originated from the Fund, it must inevitably be silly or necessarily inimical to Egypt’s interests. Second, I did not see much merit in a system of dual exchange rates. Experience had shown that irresistible pressures would rapidly build up to move items to the more favorable rate and to create intermediate rates, and a dual system would soon become hopelessly multiple.
Third, there was little point in parsing the draft policy letter for loop-holes. The more effective course was for Egypt to formulate a coherent position reflecting its own priorities, such as reducing poverty and increas-ing employment. This would have implications for the growth of the GDP to absorb labor, the level of investment needed to produce this growth, and the policies that would create an environment most likely to elicit this investment. Furthermore, the impact of cuts in food subsidies on the real incomes of the poor would have to be examined. Egypt might be able to accept a selective modification of the system while resisting proposals for sweeping or untargeted reductions. Research by the Bank suggested that for the poorest groups the subsidy system augmented family incomes by
about 15 percent. Cuts of the magnitude implied by the Fund’s Letter of Intent could devastate families at the lower ends of the income distribu-tion. Once the Egyptian authorities had developed their own perspective, it could be compared with the Fund’s recommendations and an exchange initiated on the merits of the rival approaches.
The officials responded that the schedule of negotiations with the Fund had been accelerated and did not allow time for Egypt to develop a com-prehensive position. The Cabinet was to finalize matters that afternoon.
The Ministries of Economy and Finance would submit their contrasting evaluations of the Fund’s proposals and present their recommendations, and the Cabinet would have to adjudicate the disjunction between the two readings. Dr Ismail recognized that there were cogent arguments in support of both positions, but he was apprehensive that a debate focusing exclusively on economic costs and benefits would miss the really import-ant issues. His Ministry opposed the Fund’s proposals because they were likely to create serious political problems for the country. Since the eco-nomic content of the Fund proposals was inseparable from its political implications, the latter should be explicitly discussed at the Cabinet meeting.
The Ministry of Finance had three main concerns. First, a calculation by the Ministry of Planning showed that the Fund’s package was likely to increase consumer prices by at least 30 percent. (I had these estimates examined by Professor Lance Taylor of the Massachusetts Institute of Technology and by the World Bank’s economic mission, who both broadly accepted the Ministry of Planning’s conclusions.) Was the Prime Minister prepared to take the government into an election in three months’ time with a 30 percent increase in the price level? Second, President Sadat’s major achievement was to change Egypt’s alliances from the communist bloc to the West. The Fund was seen as a Western institution and the
The Ministry of Finance had three main concerns. First, a calculation by the Ministry of Planning showed that the Fund’s package was likely to increase consumer prices by at least 30 percent. (I had these estimates examined by Professor Lance Taylor of the Massachusetts Institute of Technology and by the World Bank’s economic mission, who both broadly accepted the Ministry of Planning’s conclusions.) Was the Prime Minister prepared to take the government into an election in three months’ time with a 30 percent increase in the price level? Second, President Sadat’s major achievement was to change Egypt’s alliances from the communist bloc to the West. The Fund was seen as a Western institution and the