Chapter

5 Adjustment and Development: The Case of Egypt

Editor(s):
Saíd El-Naggar
Published Date:
September 1987
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Author(s)
Galal A. Amin

Growth and Imbalances

The sharp fall in oil prices at the beginning of 1986 has only highlighted the growing weaknesses in Egypt’s balance of payments and in its economic structure. Over the last three years, Egypt’s balance of payments deficit on current account has increased rapidly. Further exacerbating the situation with the drastic fall in oil prices in 1986, Egypt’s oil earnings, which together with workers’ remittances constitute the most important sources of foreign exchange, are expected to fall at least by 50 percent. The decline in oil prices has also started to erode Egypt’s earnings from workers’ remittances. The decline in the oil revenues of the host countries has caused a reflow of expatriates which threatens to pressure further Egypt’s already weak performance in creating new employment opportunities. The two other major sources of foreign exchange—the Suez Canal and tourism—are also meeting changing fortune. Although the Suez Canal dues may not be significantly affected by the decline in the price of oil because they depend more on tonnage than on oil prices, they have nevertheless experienced a decline since 1983/84. Political events of the last year have had a significant negative impact on tourism. Meanwhile, Egypt is starting to fall into arrears in servicing its external debt; these arrears are estimated to exceed $1 billion in 1985/86.

The recent deterioration in Egypt’s economic conditions follows a decade of very rapid growth. Between 1973 and 1984, the average annual rate of growth of gross domestic product (GDP) was 8.5 percent, which was surpassed by very few countries,1 and real per capita income almost doubled. Gross domestic investment was increasing very rapidly (10.3 percent a year) so that by 1984, Egypt was investing as much as 25 percent of GDP. This very rapid growth, however, was associated with serious structural imbalances. While agriculture was growing at a rate well below that of population growth, manufacturing grew at a much slower rate than services and crude petroleum. Thus, while the share of agriculture in GDP declined during that period from 25 percent to 17 percent, and that of manufacturing from 23 percent to 17 percent, the share of services rose from 45 percent to 48 percent and that of crude petroleum from less than 1 percent in 1973 to 15 percent in 1984. The structure of employment showed a similar imbalance in favor of the service sectors where underemployment is most in evidence, for while the share of manufacturing in the total labor force remained virtually constant at 12 percent between 1972 and 1982, the decline in the share of agriculture was almost totally matched by the rise in the share of services in the labor force, which increased by almost 50 percent (from 30 percent to 45 percent).

The state budget has also experienced an increasing deficit over the last decade. While total public revenue grew by a factor of 12 between 1973 and 1985/86 (from LE 1.18 billion to LE 14.3 billion), it was closely followed by total public expenditure which increased from LE 2 billion in 1974 to a projected LE 20 billion in 1985/86. Thus, although as a percentage of GDP the gross deficit in the state budget declined, it continued to grow in absolute terms and constituted no less than 20 percent of GDP in 1985/86. With the increasing recourse to borrowing from the banking system to cover the deficit, the rate of inflation rose significantly during the 1970s and is now probably in the 30 percent range.

External imbalances have been reflected in the very sluggish growth of merchandise exports compared with a very rapid growth in merchandise imports (6.2 percent and 15 percent a year, respectively, during 1973–84), in the increasing predominance of primary commodities (particularly crude petroleum) in total merchandise exports (92 percent in 1983), and the failure of invisible exports to make up for the growing deficit in the balance of trade. Thus, in spite of the staggering increase in the remittances of Egyptians working abroad (from an insignificant amount in 1970, $29 million, to $3.9 billion in 1984) and a rapid growth in income from tourism and the Suez Canal, the deficit on current account multiplied 13 times between 1970 and 1984 (from minus $148 million to minus $1,978 million). The growth of imports was characterized by increasing dependence on food imports which now constitute about one third of total merchandise imports and about 60 percent of total food consumption.

External balance was achieved at the price of an alarming increase in external indebtedness. Over the past ten years, Egypt’s public external civilian long- and medium-term debt almost doubled (from $9.8 billion in 1975 to $18 billion in 1985/86). If to this are added short-term debt ($5–6 billion), private nongovernment-guaranteed foreign debt (about $6 billion) as well as military debt (estimated at $8–9 billion exclusive of Soviet military debt), Egypt’s total foreign debt would amount to about $37 billion at the end of 1985/86, which is roughly equal to Egypt’s GDP in that year. Debt service in 1985/86, including servicing military and short-term debt, amounted to about $4 billion, representing over 35 percent of total current foreign exchange earnings.

Since the launching of the Open Door Policy in 1974, Egyptian economists have warned against these growing imbalances in economic structure, and the Egyptian five-year plan for 1982/83–86/87 was formulated with the declared objective of correcting these imbalances. This plan is now in the middle of its last year, but there has been little sign of any significant progress toward reducing the dependence on oil exports and the other sources of foreign exchange which are particularly sensitive to external conditions and over which Egypt has little control. Thus, the share of oil exports, remittances, the Suez Canal, and tourism in total foreign exchange earnings, which was 71 percent in the year preceding the plan (1981/82) was still 67 percent at the end of its third year (1984/85). New entrants in the labor market, who failed to migrate, have been mainly absorbed in the service sectors so that, of a total increase of 1.8 million employed persons over the first three years of the plan, only one third were absorbed in the commodity sectors and two thirds in the service sectors. Of the latter more than a quarter of a million were absorbed by the Government (Table 2). The deficit in the state budget continued to grow during the plan years, with the anticipated gross deficit in the 1986/87 budget being 10 percent higher than it was three years earlier. External debt was not planned to be reduced during the plan years, but rather to increase from LE 13 billion in 1981/82 to LE 16.2 billion in 1986/87, and the debt service from LE 1.6 billion to LE 2 billion. The actual increase in external debt and its service has, as we have seen, already exceeded what was planned.

Table 1.Main Economic Indicators
197819791980/811981/821982/831983/841984/85
(in millions)
Population39.841.042.343.544.745.947.8
Employment10.210.611.311.712.112.512.9
(in millions of Egyptian pounds)
GDP (at constant factor cost)6,23216,843114,338219,639221,105322,160323,7853
Of which
Agriculture1,5611,6132,9103,8913,8863,9654,115
Industry, construction, and electricity1,4591,6052,6323,7134,0974,3334,838
Petroleum3785772,5042,9453,3213,5003,715
Distribution sector1,4101,4903,7545,3795,9076,2896,702
Other services1,4241,5582,5393,7103,3934,0734,415
Source: National Bank of Egypt, Economic Bulletin, Vol. 27, No. 1, 1985, p. 64.

Based on 1975 factor cost.

Based on 1979/80 factor cost.

At 1981/82 prices.

Source: National Bank of Egypt, Economic Bulletin, Vol. 27, No. 1, 1985, p. 64.

Based on 1975 factor cost.

Based on 1979/80 factor cost.

At 1981/82 prices.

Table 2.Distribution of Employment by Economic Sector(in thousands)
19771978197919801980/811981/821982/831983/841984/85
Agriculture4,1034,1354,1654,1934,2064,2474,2964,3854,464
Manufacturing and mining1,2481,2781,3331,3941,3861,4231,5141,6031,722
Oil and its products191919232124252627
Construction457538629714680664687723775
Electricity485160635864696769
Total commodity sectors5,8766,0216,2066,3876,3526,4236,5926,8057,057
Productive services1,4951,5421,5811,7591,7901,7821,8591,9131,980
Other services2,5342,6522,7732,9103,1963,4803,6603,7513,854
Of which, government2,0862,3172,4372,5122,517
Total services4,0294,1944,3544,6694,9865,2625,5196,6645,834
Grand Total9,90510,21610,56011,05711,33811,68512,11112,46912,891
Source: Ministry of Planning.
Source: Ministry of Planning.

Interpreting the Imbalances

There are essentially two schools of thought with regard to the interpretation of Egypt’s economic problems over the last ten years. One attributes the growing imbalances in the balance of payments, in domestic economic structure, as well as in the state budget, to the wide range of price distortions and excessive government interference with market forces. According to this school of thought, the blame must ultimately rest on an overvalued exchange rate, the excessive administrative control of both agricultural prices and the prices of public sector enterprises in manufacturing, as well as on excessive subsidization of consumers and public sector firms, all leading to a serious misallocation of resources. The growing deficit in the state budget is aggravated not only by an elaborate system of government subsidies but also by a continued government commitment to find employment for young graduates irrespective of their potential contribution to output. The policy implications of this view are that the essential requirements for both economic adjustment in the short run and healthy development in the long run are “to set the prices right” and to reduce the vast role of government in the functioning of the economy.

An unshakable belief, amounting almost to an act of faith, underlies both the diagnosis and the policy recommendations of this school of thought. According to this view, the more integrated an economy is in the world market, the better its performance. What this school of thought regards as “price distortions” and “excessive administrative control” are really nothing but deviations from international values and the creation of artificial barriers against the flow of goods and capital across national boundaries in the aim of protecting either the domestic producer or consumer from the impact of foreign competition. This school of thought holds that growth is encouraged by such competition while protection merely encourages the production of goods in which the country enjoys no comparative advantage, discourages initiative, and rewards inefficiency.

The other school of thought offers almost the exact opposite interpretation of Egypt’s economic difficulties. It attributes both external and domestic imbalances to the rapid integration of Egypt into the world market and to too little, rather than to too much, government intervention. The rapid increase in imports could have been checked by greater administrative control, and the excessive burden on the balance of payments resulting from debt service could have been stemmed by greater public mobilization of domestic resources and directing more investment into import-substituting industries. Greater government intervention in agriculture would significantly reduce Egypt’s dependence on food imports by enforcing an agricultural rotation aiming at greater self-sufficiency in essential food products, crop intensification, and greater public investment in land reclamation. The poor performance of some manufacturing industries could have been dealt with, not by abandoning the policy of import substitution, nor by allowing the losing industries to sell at market prices, but by greater protection against foreign imports. The growing deficit in the state budget could have been avoided, again not by eliminating subsidies to consumers and producers, nor by abandoning the policy of guaranteed employment, but by higher income taxes and indirect taxes on luxury goods, by a greater enforcement of the existing tax system, and by more serious efforts to fight the widespread tax evasion.

It seems to me that to adhere to one or the other of these two schools of thought has less to do with their relative merits with regard to economic effectiveness than with their underlying political and social philosophy. In the former view, while considerations of income distribution and economic self-sufficiency seem to be given far less importance than in the latter, there is also a basic underlying mistrust of government management of the economy in whatever form. Lurking behind this view, there is an unshakable faith in the ability of individual producers and investors to respond to price signals, as well as a much greater degree of tolerance for short-term hardships incurred by the lower-income groups and the unemployed as a result of abandoning the vast system of protection provided to them by the state. In the long run, income distribution is to take care of itself once rapid growth is under way. Self-sufficiency is regarded as neither possible nor desirable. It is not possible because of the limited resource base, and it is undesirable because of the waste of resources involved in sacrificing the advantages of specialization.

The latter school has neither that strength of faith in the response of producers and investors to price signals, nor that degree of optimism that the benefits of growth would ultimately filter through to the lower-income groups. Moreover, a greater degree of self-sufficiency is regarded as sufficiently desirable from the political point of view, to justify some sacrifice of efficiency.

I do not believe, however, that the issue needs to be dispensed with as merely a matter of a different system of political preferences and conflicting value judgments. Even when value judgments are deeply involved, a proper assessment of the facts of a situation could go a long way toward narrowing the gap separating the two apparently irreconcilable viewpoints. Two points seem to be worth emphasizing here. In the first place, a country’s economic policy is carried out in the context of a given international economic climate and a certain domestic political and social framework which are continuously changing. Under certain international economic conditions and within a particular domestic climate, an economic policy with a large dose of liberalization could have a much greater chance of success than in different international and domestic conditions. Favorable to liberalization is an international climate characterized by a high flow of foreign investment, a prospering world economy capable of absorbing increasing exports, a relatively stable political climate allowing greater attraction of both foreign and domestic private investors, and, one may add, an improving or at least tolerable pattern of income distribution. On the other hand, a higher degree of protection would make much more sense when the country is faced with a sluggish flow of foreign investment, a depressed world economy, a highly volatile political climate, and a greatly skewed distribution.

In the second place, national economic policy is unlikely to succeed unless a minimum degree of harmony exists among its essential components. There is probably no worse economic policy than one that attempts to pursue conflicting objectives simultaneously, that tries to achieve both better distribution and greater allurement to private investment, to protect its public sector at the same time as it is trying to encourage private foreign investment, or that hopes to achieve greater self-sufficiency and encourage exports at the same time.

I believe that Egypt’s economic experience over the last three decades provides excellent testimony to the truth of these two points, namely, that the two essential conditions for the success of any economic policy are a minimum degree of consistency and the correct reaction to the changing requirements of international and domestic conditions.

From Premature to Halfhearted Liberalization

During the ten years of far-reaching government intervention in the economy (1956–65), Egypt achieved both a high rate of growth and a radical transformation of economic structure, as indicated by the share of manufacturing in output and exports, while maintaining a reasonable level of self-sufficiency in food and without incurring too heavy a burden of foreign indebtedness. But this was also a period characterized by a very high degree of consistency and harmony among the various tools of economic policy. During this period, government managed the economy down to the smallest detail, planning was taken more seriously than ever before or after, prices were under government control throughout the economy, foreign private investment was reduced to a minimum, and domestic investment was confined virtually to the public sector. One may also argue that the international environment was, in certain important respects, favorable to an inward-looking strategy. Although international trade was growing at an unprecedented rate at the time, it was also the period when it was possible for a developing country to pursue its national objectives while receiving large quantities of aid with minimum political and economic strings from both East and West.

In the following decade, but particularly after 1967, not only were external conditions extremely unfavorable to any attempt at liberalization, but even with the most rigorous and efficient government control conceivable, Egypt’s economic performance was bound to suffer. A severe decline in the flow of economic assistance from the West after 1965, which was not compensated by flows from the East, was followed, as a result of the 1967 war, by the loss of Sinai oil, the Suez Canal revenues, and a decline in tourism. Under these circumstances, the economy was required to cope with the additional burden of preparing for another war in the midst of a political climate created by defeat in which no government could afford to reduce consumption of basic commodities and services. There seemed to be no choice other than a drastic reduction of the rate of investment and a very strict control of imports. This indeed was government policy in the few years following the 1967 war during which the rate of investment was drastically reduced to match the rate of domestic saving and imports were brought down to a level even lower than that prevailing before the war.2 Economic growth was bound to suffer greatly, so that for a whole decade (1965–75) it barely kept pace with the increase in population. Infrastructure was allowed to deteriorate, and virtually all the gains achieved in the preceding ten years in transforming economic structure in favor of manufacturing and even in income distribution came to a halt. The main point, however, is that irrespective of one’s own value judgments with regard to income distribution and self-sufficiency, the sudden shift toward greater liberalization in 1974 was unwarranted under the economic conditions of that time even on purely economic grounds. Not only was Egypt still deprived of her oil and Suez Canal revenues, and the economic infrastructure still greatly strained, but Egypt was faced with extremely unfavorable terms of trade with the sudden rise in the value of her wheat imports in terms of cotton exports.3 During the three years 1973–76, imports were allowed to increase far beyond the capacity of exports to pay for them. Thus, apart from the increase in the value of imports of wheat and flour, imports of intermediate goods increased by no less than 339 percent in three years, imports of capital goods by 500 percent, and consumer durables by as much as 735 percent, compared with a 249 percent increase in total exports of goods and services.4 It was also during those three years that the Government made increasing use of short-term loans at commercial rates. While in 1972, net short-term borrowing was only $28 million, it jumped to $355 million in 1973, and to $582 million in 1974. These were the years in which the seeds of Egypt’s heavy debt burden were sown. The most plausible explanation seems to lie in premature liberalization at a time in which neither Egypt’s external resources nor domestic economic conditions seemed to justify it. For while Egypt’s sources of foreign exchange were still at very low levels, the huge requirements of a strained infrastructure and the long-suppressed demand for both consumer and intermediate goods were bound to create a heavy burden on the balance of payments. A continuation of the import-control policy of the late 1960s seems therefore to have been much more rational, but was unfortunately abandoned three or four years too early.

It was indeed the following four or five years (1977–81) that offered a golden opportunity for the move toward liberalization which was, however, taken only timidly and halfheartedly. During these four years, Egypt witnessed an unprecedented increase in foreign exchange earnings, favorable terms of trade, and even a distinct tendency of income distribution to improve. Proceeds of oil exports which were only LE 162 million in 1977 jumped to LE 1.5 billion in 1981, an almost tenfold increase, thanks to the rapid increase in both output and prices, while proceeds from invisibles increased from LE 998 million to LE 4 billion during the same period, largely owing to the very rapid increase in remittances. Terms of trade showed a marked change in Egypt’s favor with an 81 percent improvement between 1977 and 1981, for the rise in the price of oil far surpassed the rise in the prices of imported consumer and capital goods. Total foreign exchange earnings thus multiplied almost four times in four years (Table 3). There are also good reasons to believe that income distribution, which seems to have remained unchanged or deteriorated between 1965 and 1975, may have improved during the following five years in spite of widespread references to its tendency to deteriorate following the launching of the Open Door Policy. By far the most important factor responsible for this improvement, which is not directly related to economic liberalization, was the increasing flow of labor migration from the lower-income groups.5 A high rate of labor migration, particularly from the rural and construction sectors, also turned a situation of labor surplus in these two sectors into one of labor shortage, further contributing to the big increase in real wage rates and to a decline in the rate of unemployment and underemployment.

Table 3.Balance of Payments(in millions of Egyptian pounds)
Current TransactionsBalance

on

Current

Transactions
TransfersBalance

on Current

Transactions

and

Transfers
Capital TransactionsNet

Capital

Transactions
SDR

Holdings
Overall

Surplus

or Deficit
VisibleInvisible
YearPaymentsProceedsPaymentsProceedsInflowOutflow
1973622396164166–2232543027218686116
19741,253654211277–533405–12744328515830
19751,691613313422–969421–5471,037342595148
19761,646630350773–593278–31567132534631
19771,766780505998–493174–3191,14976138869
19783,6981,3889942,412–892241–6501,67093373787
19794,6731,7581,0662,856–1,12462–1,0622,1056731,43221391
19805,3042,6971,5173,738–38668–3181,85494790721610
1981/826,5692,7652,0383,975–1.86736–1,8313,2199922,226395
1982/836,3822,6832,2825,210–77218–7542,5741,4291,145391
1983/847,3492,8602,5005,873–1,11618–1,0982,2411,2201,022–76
Source: National Bank of Egypt, Economic Bulletin, Vol. 27, No. 1, 1985, p. 105.
Source: National Bank of Egypt, Economic Bulletin, Vol. 27, No. 1, 1985, p. 105.

The years 1977–81 were undoubtedly those in which a much greater dose of liberalization could have been introduced with minimum social costs. With ample foreign exchange revenues, a unified and devalued exchange rate could have eliminated the own-exchange import system without creating an unduly great strain on the country’s proceeds of foreign currencies. Rationalizing domestic prices by reducing subsidies to public enterprises while allowing them to harmonize their prices with their real costs, and freeing agricultural prices from administrative control could have been much more feasible politically when all incomes were growing at unprecedented rates. The same could be said about the reduction of subsidies to essential consumer goods and the burden of absorbing university graduates in government employment at a time of improving income distribution, reduced unemployment, and growing employment opportunities abroad. Indeed, that was the time for aiming at a substantial reduction in Egypt’s external debt or at least for arresting its growth. Between 1975 and 1980, Egypt’s total exports of goods and services increased by no less than LE 5,300 million ($7,570 million), an amount exceeding Egypt’s total civilian long- and medium-term debt in 1975 ($4.8 billion) by 58 percent.

Attempts at liberalization during this period were, however, characterized by a high degree of inconsistency and hesitancy. A series of devaluations were indeed undertaken by introducing the parallel foreign exchange market, which allowed an increasing “incentive” premium over the official exchange rate on certain foreign exchange transactions, this premium rising from 65 percent in February 1975 to 70 percent in May 1976 and 79 percent in December of the same year. In 1979, the parallel exchange market was replaced by a “unified” rate of 70 piasters to the dollar but without abandoning the own-exchange import system. The gap soon grew between the official rate and the free market rate for foreign exchange as a result of the vast difference between interest rates on deposits in foreign currencies and those in Egyptian pounds, as well as a number of other government measures leading to an increase in the demand for foreign currencies. While partial devaluation did not suffice to check the growth of imports, no serious attempt was made either to rationalize agricultural and energy prices, to reduce government subsidies, or to reduce its commitment to guaranteed employment, but neither was greater use made of administrative control in checking imports nor in the reallocation of investment. Imports were therefore neither checked by the free play of market forces nor by direct government intervention, and the deficit in the state budget was similarly neither reduced by lower subsidies nor by an increased tax revenue and a more effective attack on tax evasion. Economic policy thus fell between two stools, combining a halfhearted liberalization with a halfhearted adherence to a state-controlled economy. The inevitable result was an unprecedented rate of growth of imports as well as a rapid growth in the state budget deficit. Between 1977 and 1981/82, total imports of goods and services multiplied 3.8 times so that even with an almost equal rate of growth of total exports, the deficit on current account (excluding transfers) was almost four times greater in 1981/82 than it was in 1977 (Table 3). Rather than realizing a surplus on current account to allow a reduction in external debt, net capital inflow to Egypt multiplied 5.7 times during those four years and public external long- and medium-term debt (excluding military debt) increased by 50 percent, while the deficit in the state budget continued to grow during this period until, in 1981/82, it constituted as much as 23 percent of GDP. Meanwhile, economic structure showed no sign of improvement and by far the greatest part of the increase in employment (66 percent) was absorbed by the service sectors (Table 2). This last fact could also be seen as ultimately the result of failure to adopt either a policy of wholehearted liberalization or a system of strict state control. While the private sector was discouraged by conflicting price signals and price distortions, and while many public enterprises were discouraged by rigid pricing of their output, other public firms were discouraged by insufficient protection, at the same time as public investment in both agriculture and manufacturing was insufficient to make up for the relatively low level of private investment in both sectors.

Unfavorable Conditions for Further Liberalization

With the change in political leadership in 1981, another opportunity emerged for ending the state of confusion and inconsistency in economic policy, but the changing economic conditions were starting to work against greater liberalization. Gone were the days of rapidly increasing income from oil, remittances from expatriate workers, the Suez Canal, and tourism, which had characterized the four preceding years. Between 1981/82 and 1985/86, oil revenues declined by 36 percent, but the other three stagnated. Meanwhile, the flow of private foreign investment remained virtually constant at about $ 1 billion a year, and the continuing recession in Egypt’s main export markets did not allow a significant increase in Egypt’s exports of more traditional items. Thus, the value of exports of primary commodities showed no more than a 13 percent increase over the three years 1981–84, while that of cotton yarn and woven goods, which is by far the most important of Egypt’s manufactured exports but still a very insignificant item in total exports, increased by only 25 percent over the same period. The total value of exports of goods and services in 1985/86 was therefore 11 percent lower than it was in 1981/82.

There are also good reasons to believe that the improvement which occurred in the incomes of lower-income groups during the preceding five years may have ceased or greatly diminished during the first five years of the 1980s. With the decline in the flow of migrants to the oil-rich countries, stagnant remittances, the beginning of reverse migration back to Egypt, and continued inflation, the real wage rate in agriculture and construction must have stagnated or declined and the rate of unemployment increased.

Under present conditions of declining government revenues and remittances, the burden that would be incurred by further drastic cuts in subsidies to essential consumer goods would be particularly severe. The abandonment of government commitment to guaranteed employment would be more difficult in the face of shrinking employment opportunities both at home and abroad. The inevitable impact of freeing agricultural prices from administrative control in changing the structure of agricultural output in favor of relatively luxury products and of export crops is likely to be more severely felt at a time of stagnant or falling real wage rates. The raising of interest rates to conform more closely to the opportunity cost of capital is likely to aggravate an already worsening employment situation by discouraging an already slackening private investment.

Further devaluation is unlikely to be sufficient to bring a quick relief to the balance of payments. Egypt’s major commodity exports are less dependent on exchange rates than on international demand and supply conditions (oil) and on supply elasticities at home (other primary exports and manufactured goods). With the high import content of our manufactured exports, devaluation is also likely to have an adverse effect on these exports as a result of higher import costs. The impact of devaluation in reducing imports, particularly of capital and intermediate goods and consumer durables, is likely to be more significant than its impact on exports, but the major benefit from devaluation would probably be its impact on remittances. But here again, remittances may be more sensitive to the availability of investment opportunities at home as well as to the changing economic conditions in the host countries themselves. Meanwhile, the balance of current accounts would continue to be strained by an increasing debt-service burden. With the debt-service burden already absorbing more than one third of total foreign exchange earnings, it is difficult to see how exports could be increased and imports reduced sufficiently over the next five years to deal with the increasing deficit by relying merely on correcting price distortions and manipulating the exchange rate.

The argument for further liberalization rests partly on its impact on private foreign investment. The hope is that “setting the prices right,” including the adjustment of exchange rates, would attract a greater inflow of foreign capital, which would benefit from a lower price for the Egyptian pound on entering Egypt, a reduced inflation resulting from reduced state budget, a lower real wage rate, and less protection for public enterprises. The experience of the last ten years of failure to attract a sufficiently large flow of private foreign investment may warn against excessive optimism in this regard. It can, of course, be argued that private foreign investment may have been discouraged precisely because of the slow pace of liberalization and may now be boosted by less inhibited laissez-faire policies and by a much improved infrastructure. On the other hand, one may also argue that foreign investment may be further discouraged, even under more liberal economic policies, by the dwindling export earnings and the poor prospects of oil revenues and remittances over the remaining part of the 1980s. Much of the private foreign investment that flowed into Egypt in the latter part of the 1970s was attracted by high oil prices (no less than 87 percent of total U.S. private investment in Egypt over the last ten years was in oil)6 and by increasing remittances which constituted the main attraction to foreign banking activities in Egypt since the mid-1970s. With the decline in these two major sources of foreign exchange, one may expect the present stagnation in the flow of foreign investment into Egypt to continue.

A depressed world economy and the increasing tendency toward protection in Egypt’s major export markets do not make the prospects for increasing Egypt’s agricultural and manufactured exports any brighter. To quote the experience of a few other developing countries which succeeded in capturing a growing proportion of developed countries’ markets for manufactured exports may not be very relevant as a guide to Egypt’s export prospects. One may rightly suspect that a fallacy of composition may be involved here so that what a few countries may get away with could not be achieved by all, especially at a time of slow growth in the major importing countries. One writer estimated that the generalization of the East Asian model of export-led development across all developing countries would result in untenable market penetration into the industrial countries. Such generalization “would require LDC exports of manufactures to rise seven-fold, implying a surge in their share of industrial country manufactured imports from approximately one-sixth to approximately three-fifths. Using an LDC import penetration ratio of 15% as a threshold beyond which protective response would be expected, fully four-fifths of the industrial country markets for manufactured exports from LDCs would be vulnerable to probable protective action in the face of the flood of developing country exports caused by a general adoption of the East Asian export model . . . . Other developing countries would be . . . ill-advised to expect free-market policies to yield the same results that were achieved by the East Asian economies, which took advantage of the open-economy strategy before the export field became crowded by competition from other developing countries, and did so when the world economy was in a phase of prolonged buoyancy.”7

In a lecture delivered in December 1979 in Stockholm, on receiving the Nobel Prize for economics, Arthur Lewis struck a similar note. He complained that in the 1940s and 1950s we created a whole set of theories which make sense if world trade is stagnant (e.g., balanced growth, regional integration, the two-gap model, and structural inflation) but which have little relevance in a world where trade is growing at 8 percent a year. Also, many countries, basing their policies on the same assumption, oriented inward mainly toward import substitution. The fact that world trade was growing rapidly was not universally recognized until the second half of the 1960s. Then nearly every country discovered the virtues of exporting. Now we are in danger of being caught again. Since 1973, the growth rate of world trade has halved, and nobody knows whether this is temporary or permanent. But most of our economic writing continues to assume implicitly that a return to 8 percent is only just around the corner.8

To advocate more liberalization, increased export-orientation, and greater reliance on foreign sources of finance for a country like Egypt under present international conditions is to be “caught again” in preaching what may have been more promising in better albeit bygone days. In the face of adverse prospects, a case can be made for greater government intervention in order to mobilize domestic savings, to increase self-sufficiency in food, and to encourage import substitution in manufacturing.9

The Case for Reducing the Investment Rate and a Human Resource-Oriented Strategy

To call for greater administrative control of imports is not, however, to repeat the widely circulating belief that by prohibiting or greatly reducing “luxury” imports it is possible to eliminate or greatly reduce the balance of payments deficit. The greatest burden on Egypt’s balance of payments on current account stems not from the imports of luxury goods, however defined, but from the imports of food, capital, and intermediate goods, as well as from servicing external debt. In 1984, out of a total commodity import bill of LE 7.3 billion, consumer durables amounted to no more than LE 0.5 billion compared with LE 2.2 billion of food imports, LE 2 billion of capital goods, and LE 2.5 billion of intermediate goods. Debt service accounted for another LE 1.8 billion. If food imports cannot be greatly reduced, while reducing imports of consumer durables cannot have a significant impact on the total import bill, the price of reducing the deficit on current account must be a drastic reduction in investment. It would be foolish to imagine that domestic savings, however harsh may be the measures undertaken to increase tax revenues, are likely to suffice to finance as high a rate of investment as that achieved over the last ten years. There seem to be good reasons, however, for arguing that if Egypt is to get out of its current economic crisis and to lay the foundation for a more balanced development in the coming decade, with an unacceptable burden of external debt, some sacrifice in terms of a lower rate of investment and slower growth rate is justifiable. The situation now is not unlike that of the years following the 1967 war, when a big decline in Egypt’s foreign exchange receipts required a big cut in investment. Today’s big debt-service burden corresponds to the burden of military expenditure during the earlier period.

But it would also be wrong to assume that sacrificing a high rate of investment must necessarily entail a proportionate sacrifice in the rate of growth. With widespread underemployment, particularly in the government sector, and with ample unutilized capacity in manufacturing there is wide scope for raising the overall level of labor productivity. The current economic crisis in Egypt, manifested mainly in the drastic fall in foreign exchange proceeds, only enhances the importance and urgency of a human resource-oriented strategy. When physical capital is scarce, higher levels of performance of the human factor become more necessary than ever. Hopefully, it may become even more acceptable and easier to implement. When opportunities for acquiring higher incomes from relatively unproductive activities (notably migration and oil) tend to dwindle, and the channels of personal advancement along the social ladder without productive effort are no longer open, higher levels of performance may be expected and insisted upon, if the previously raised hopes of economic advance are to be achieved.

Over the last ten years, Egyptian economists have been complaining that the high rates of growth achieved were merely “growth without development.” During this time, the commodity sectors were neglected in favor of services, self-sufficiency was allowed to decline as reliance increased on external sources of capital and food imports, and the balance of payments became too dependent on sources of income beyond Egypt’s control, while even the improvement in the standard of living of the lower-income groups has been achieved through an external factor that was precarious and highly unreliable. When we are forced to accept slower rates of growth because of the sudden fall in these foreign exchange proceeds, one may wonder whether we can turn the remaining years of this century into a period of “development with little growth,” turning the curse into a blessing.

To put it differently, the high rates of growth of the last ten years were associated with a high degree of waste of physical capital and a serious misallocation of resources which were tolerated and made possible only by exceptionally fortunate external circumstances. An overall increase in income levels was therefore paid for from largely unearned income. Now, with a shrinking or stagnating income, Egypt can afford neither. A properly conceived, human resource-oriented strategy has become a necessary condition for making up for lower rates of investment and slower growth by correcting the structural imbalances of the past ten years.

A historical parallel is to be found in Egypt’s economic development in the 1930s, when the international depression caused very low growth rates in Egypt, but was also associated with, and indeed responsible for, the change in economic structure in favor of manufacturing.

A human resource-oriented strategy could help correct these imbalances in the following ways:

  • Reducing to a minimum the unutilized capacity of physical capital in the commodity sectors and tapping to the maximum the existing opportunities in agriculture and manufacturing for raising output with little physical capital.

  • Reallocating investment in favor of those sectors and subsectors characterized by relatively low-capital intensity, low import, and high labor content. Examples include small-scale versus large-scale projects, maintenance of existing structure versus adding new ones, a much more expanded housing program using more traditional techniques and geared mainly to low-income groups to take care of the returning migrants while meeting an urgent social demand, and the freeing of investment allocation from dependence on the availability of foreign assistance, thus allowing a greater fulfillment of the employment targets.

  • Introducing basic reforms in the educational system and training programs that would correct the existing imbalance in the labor force and arrest the growth of labor supply with unwanted qualifications while serious shortages persist in many skills.

There is no doubt that several measures suggested as part of the package of greater liberalization could contribute to the fulfillment of these aims. Devaluation and the unification of exchange rates may not only contribute to a rise in remittances but would reduce the demand of imported capital and intermediate goods and encourage the use of domestic inputs with a favorable impact on employment. Higher interest rates would contribute to the rationalization of investment decisions and discourage capital-intensive projects. The reduction or elimination of subsidies to energy and other inputs may have a similar impact, while the abandonment of the policy of guaranteed employment would lead to a more rational utilization of human resources.

The trouble with these proposals does not relate to their economic rationality but to the fact that, under prevailing economic and social conditions and in the absence of other government policies, their social cost would inevitably be too high and that, in the absence of administrative control of imports and of private investment, they may even prove insufficient for curtailing investment. Devaluation and higher interest rates, rather than reducing total investment, may only favor those types of investment with exceptionally high profit rates, however socially unproductive they may be, and those geared to the demand of higher-income groups, and would particularly work in favor of foreign firms which can afford the higher cost of capital. Such firms could still prefer capital-intensive techniques, not only because these may be the only techniques available for the goods they produce but also to minimize the political danger of employing a large labor force. If other forms of protection provided for public enterprises are abandoned or greatly reduced, abolishing input subsidization would mainly work in favor of foreign firms that could afford higher input prices and offer higher quality products for consumers. The gain realized through greater competitiveness may only be reaped by that section of consumers that can afford to buy goods of higher quality at higher prices. Again, in the absence of an effective employment policy and with the decline in the share of government in total investment, as envisaged in the new five-year plan (1987/88–1991/92), to abandon the policy of guaranteed employment is bound to lead to a big increase in the rate of unemployment for a considerable period of time. And finally, in the absence of redistributive measures and continued laxity in tax collection, the elimination of subsidies to essential consumer goods would only achieve a more balanced budget at the expense of lower-income groups.

What I have been trying to argue is that, while both external and domestic economic imbalances cannot be achieved, in Egypt’s present conditions, without a big curtailment of investment, it would be unwise to rely for this curtailment on the workings of the price mechanism alone. If further liberalization of prices is not associated with an increasing government intervention in the reallocation of investment, in directing imports, but particularly in redistributing income, not only may it prove insufficient for restoring the balance between resources and requirements, but it is bound to prove too costly, socially and politically.

Table 4.Share of Wages in Gross Domestic Product and in Total Private Income, 1974–79(in percent)
YearGDP at

Factor

Cost
Total Private Income
Domestically

generated
Including

remittances
197442.452.954.3
197543.255.157.5
197644.757.461.3
197744.157.161.3
197843.056.563.1
197942.958.564.8
Source: International Labor Organization, Employment Opportunities and Equity in Egypt (Geneva, 1982), p. 127.
Source: International Labor Organization, Employment Opportunities and Equity in Egypt (Geneva, 1982), p. 127.

Among the countries recorded in the World Development Report. 1986 (Washington: World Bank, 1986), only Jordan, Hong Kong, and Botswana achieved higher rates of growth of GDP than Egypt between 1973 and 1984.

The rate of gross investment declined from 17.2 percent in 1964/65 to 1 1.8 percent in 1969/70 and imports ot goods and services were 15 percent lower in 1969/70 than they were in 1964/65. (See R. Mabro, The Egyptian Economy; 1952–1972 (Oxford: Clarendon Press, 1974), p. 177.)

See K.Ikram, Egypt: Economic Management in a Period of Transition (Baltimore: Johns Hopkins University Press, 1980), pp. 223–24.

National Bank of Egypt, Economic Bulletin, 1985, No. 1, pp. 102–104.

Even before the mid-1970s, the bulk of Egyptian migrants consisted of wage and salary earners, but migration was until then still dominated by teachers, administrators, and other professionals. Although part of their income must have included a profit element, as in the case of self-employed physicians and lawyers, most of them were employed by the state in the host countries, receiving a purely labor income. This became even more true after 1975, but particularly after 1977, when migration of manual labor started to increase at a very high rate. One must expect, therefore, that the functional distribution of income changed in favor of labor income not only because of higher labor incomes abroad but also because of the increase in the wages of those left behind. Table 4, which shows the movement of the share of wages in GDP and in total private income, tends to support this. The table excludes that part of income earned abroad but not remitted. If this was added, and it is substantial, the share of wages would have certainly been greater. Since most wage earners, taken as a whole, belong to the lower- or middle-income groups, one may expect the personal distribution of income as measured by the Gini coefficient to be affected by migration in the same way, with a movement toward greater equality although factors other than migration may, of course, have worked in the opposite direction. What is almost certain, however, is that during the second half of the 1970s, there was a decline in the proportion of households in “absolute poverty.” The International Labor Organization (ILO) sample survey of rural Egypt in 1977 indicares a significant improvement in this respect between 1975 and 1977, and further indicators to the same effect are provided by the movement of real wages in the rural and construction sectors for the remaining years of the 1970s. See ILO, Employment Opportunities and Equity in Egypt (Geneva, 1982), pp. 96–127; G. Amin and E. Awny, International Migration of Egyptian Labor (Ottawa: IDRC, 1984), pp. 130–45.

U.S. Embassy in Cairo, Economic Trends Report: Egypt, June 1986 (mimeographed), p. 28.

W.R. Cline, “Can the East Asian Model of Development Be Generalized,” World Development (Oxford), Vol. 10 (February 1982), pp. 88–89.

A. Lewis, “The Slowing Down of the Engine of Growth,” American Economic Review (Nashville, Tennessee), Vol.70 (September 1980), pp. 555–56.

The underlying assumption of the argument opposing any increase in the economic role of government, that the government is necessarily inefficient and wasteful, seems to me to rest on another assumption which is always implied but rarely spelled out, namely that the political system is to remain untouched. An effective use of the tax system and the attack on tax evasion are thus implicitly excluded as a way of eliminating the state budget deficit merely on the grounds that they are “politically difficult.” This may indeed be the more realistic assumption taking into consideration both the domestic power structure and the international power relationships. But it is important to recognize that this may be the real constraint on pursuing the desirable program of economic reform rather than the unwarranted allegation that government intervention under any circumstances is necessarily damaging to economic performance.

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