More than five years after the overthrow of then president Hosni Mubarak, the structural shortcomings that characterized the Egyptian economy before the January 2011 uprising remain in place. At the time, these contributed to the revolt against Mubarak’s rule, and today, unless they are addressed, the possibility of renewed political volatility remains very real.
For now, however, Egypt has stabilized politically relative to where it was a few years ago. This provides the government with an opportunity to embark on a thorough restructuring of the country’s model of socioeconomic development. The objective must be to establish an economic system based on inclusive growth that is capable of generating quality jobs that are sufficient in number to absorb the 600,000 new entrants into the labor market each year.
Inclusive development is not possible without addressing the position of Egypt’s economy in the global division of labor—in other words, what Egypt produces for and exchanges with the rest of the world. The country’s international economic position has been dependent throughout the last four decades on hydrocarbons, specifically oil and natural gas. Even though the weight of the hydrocarbon sector has never been dominant in Egypt’s GDP, as the principal motor of the country’s global competitiveness hydrocarbons are the main source of direct and indirect foreign currency earnings.
Egypt has been a net oil exporter throughout most of its history. This made it possible for the country to benefit from higher global oil prices, especially following the two oil shocks of 1973 and 1979. The situation changed in 2006, when declining production and increasing consumption turned the country into a net oil importer. This trend was momentarily offset starting that year by discoveries of natural gas reserves. However, by 2012 Egypt had become a net importer of both oil and gas for the first time in its history, as gas consumption, like oil before it, came to exceed domestic production and as investment in the gas sector declined.
The Paradox of Egypt’s Hydrocarbon Dependency
Egypt’s dependency on hydrocarbons is paradoxical in that lower international prices should have benefited the country but actually have not. Oil prices plummeted from $110 per barrel in July 2014 to around $50 in June 2016. Low prices are expected to persist given the decline in global demand and a glut in the oil market. The International Monetary Fund’s World Economic Outlook, published in April 2016, predicted that the price of oil will average $40.99 a barrel in 2017 and will remain unchanged in real terms in the four to five years to come.
Egypt, as a net hydrocarbon importer, should have welcomed the decline in international oil and gas prices, with lower prices bolstering economic growth and allowing a reduction in the balance-of-trade, balance-of-payments, and budget deficits. However, figures from the last two years actually have indicated the contrary. The economy has been negatively impacted by the plunge in oil prices. That is because Egypt is still highly dependent, both directly and indirectly, on oil and natural gas. The economy’s capacity to generate foreign currency remains concentrated in the hydrocarbon sector. Indeed, 40 percent of Egypt’s total merchandise exports include oil and natural gas. Remittances, which constituted $20 billion in 2014, are also closely linked to oil prices, given the large presence of Egyptian workers in Gulf Cooperation Council (GCC) countries. And foreign direct investment in Egypt has historically been focused on extractive industries, mainly oil and gas.
The recent plunge in oil prices has led to a contraction of foreign investment in the oil and gas sector, disappointing the Egyptian government’s high hopes of attracting foreign capital. It has also put considerable pressure on GCC economies, with a knock-on effect for the Egyptian economy. Lower oil prices have reduced workers’ remittances while also significantly impairing the ability of GCC countries to continue providing Egypt with the financial aid and investments needed to cut the country’s large balance-of-payments deficit, which reached $3.4 billion in the first half of the fiscal year 2015–2016, or three times what it was a year earlier.
While lower oil prices mean the Egyptian government can cut subsidies on hydrocarbons and lower its fuel import bill, this has not been enough to pull the economy out of its current crisis. The decline in the value of exported goods and services, both fuel and non-fuel, has been larger than the decline in the value of imports, creating a foreign currency shortage. The currency crisis, in turn, is taking its toll on economic recovery and job creation, pushing the economy into yet another cycle of recession after the slowdown between 2011 and 2014.
A Legacy of Failed Policies
Prior to the uprising in 2011, Egypt’s heavy reliance on oil and natural gas had negative political and economic repercussions that contributed to popular discontent. High growth rates were confined to capital-intensive, hydrocarbon-dependent sectors, the returns of which were not distributed to large segments of the working population. Hydrocarbon dependency prevented the development of a broader, more dynamic private sector, which could have created the jobs needed to absorb the expanding workforce. These structural problems aggravated the sense of marginalization suffered by millions of Egyptians, helping precipitate the revolt against the Mubarak regime.
This dismal economic situation was the result of decades-long failed policies to diversify Egypt’s external sector by encouraging non-energy-related exports and industries as alternative sources of foreign currency earnings. Indeed, during the period between 2004 and 2010, the Egyptian economy developed a hidden dependency on oil and natural gas by expanding energy-intensive industries such as iron and steel, cement, fertilizers, and petrochemicals. Egypt managed to increase its exports and attract foreign investments in these activities thanks to generous government subsidies to producers. Fuel subsidies, especially after international oil prices exceeded $100 per barrel in 2008, generated large profits for the cement, fertilizer, iron and steel, glass, and aluminum industries, at the expense of the treasury.
The downside is that this was happening at a time when Egypt was beginning to import a significant portion of the oil it consumed. One-fifth of the country’s total import bill went to paying for oil products. In turn, fuel subsidies (covering mainly gasoline, butane, and diesel) spiraled out of control, constituting one-fifth of total government expenditures during the period between 2010 and 2014—roughly equal to the state budget deficit during the same period.
This strategy of continued dependency on hydrocarbons, particularly to attract foreign investment, enabled the Egyptian economy to grow robustly at a rate of 6 percent per year between 2004 and 2010. However, a handful of capital- and energy-intensive sectors, such as natural gas and oil, cement, iron and steel, and construction and real estate, benefited most from the country’s growth. Almost all depended directly or indirectly on the provision of cheap hydrocarbons made available through generous state subsidy schemes.
The capital-intensive nature of these sectors meant their capacity to create large numbers of jobs was limited. The result was that, while growth rates were high, there was a commensurate increase in unemployment, or the employment of most workers in informal, low-paying, low-productivity jobs. Moreover, according to an International Labor Organization report published in 2014, 91.1 percent of youth (defined as those between the ages of fifteen and twenty-nine) were employed in the informal sector in 2012. This only reinforced a sense that Egypt’s economic order was continuing to exacerbate perceived inequalities and social exclusion, as it had before the 2011 uprising, with the vast majority of employees in the informal sector feeling they had been left by the wayside.
Apart from the few energy- and capital-intensive industries, the state today has not provided incentives or support measures to assist the greater part of the private sector. This has hindered its potential to grow, precluding the ability of the private sector to be competitive in the global economy while deepening Egypt’s dependency on oil and gas as the only comparative advantage it enjoys in the international division of labor.
Given the restraints on their growth, most private sector enterprises remain very small. They lack the capital, skills, and technology needed to produce goods and services of high quality, which would allow them to be competitive in the domestic and export markets. This has undermined the creation of relationships of interdependence between Egypt’s estimated 2.1 million private micro and small enterprises and larger producers and exporters. Just under 97 percent of Egyptian private enterprises are micro or small enterprises, employing less than ten employees (while only 0.8 percent of enterprises employ more than ten employees). This interdependence, referred to as backward linkages, usually consists of micro, small, and medium-sized enterprises (MSMEs) that specialize in the production of inputs required by larger producers and distributors.
The absence of these backward linkages has been referred to by Lois Stevenson as the “missing middle syndrome,” where a limited number of very large enterprises occupy the top of the private sector pyramid, while the vast majority of enterprises at the bottom are MSMEs. Whereas MSMEs represent almost 98 percent of the total number of private enterprises, their share of the private manufacturing sector in terms of value is disproportionally small at only 7.5 percent.1
The missing middle syndrome and the absence of reliable backward linkages have created a key vulnerability in the Egyptian economy, namely its absolute dependency on imported inputs. Semi-finished and intermediate goods make up 40.3 percent of total imports, according to the Central Agency for Public Mobilization and Statistics. In terms of value, imports are more than twice as large as exports, resulting in a large trade deficit that is a burden on foreign currency reserves and the Egyptian pound.
Ending a Debilitating Dependency
To put in place a more inclusive development model, the Egyptian government must end the debilitating dependency on oil and natural gas and set a long-term strategy to determine the kind of energy upon which Egypt will depend in the future. It must also define an industrial policy deciding precisely which economic activities the state will support directly or indirectly to facilitate such a process.
The missing middle syndrome is not unavoidable. For the Egyptian economy to overcome it and diversify, the state has to support non-energy-intensive manufacturing and service sectors. There is a need for an integrated industrial strategy to develop the broad base of private sector enterprises and enable backward linkages that allow for the supply of domestically made production inputs, in that way reducing the reliance on imported inputs. This can only be done by augmenting the capacity of private sector enterprises to obtain physical and financial capital (namely through land and bank credits), skilled labor, and technology.
Lately, the government has considered development schemes and incentives for MSMEs, especially facilitating access to finance and the enhancement of employee skills. The Central Bank of Egypt issued a regulation in January 2016 providing incentives for commercial banks to extend credit to such enterprises. The aim is to increase their share of total private sector credit from 5 to 20 percent in four years. Earlier, in November 2014, a law was passed establishing regulations for lending specifically to micro enterprises.
However, what is missing is integrating these support policies and regulations into a broader industrial strategy, with the aim of developing MSMEs in the specific areas required by large producers and exporters. If this strategy succeeds in the coming years, Egypt’s dependency on imports of semi-finished goods could be reduced significantly. Moreover, more productive jobs could be created as MSMEs gain broader market access both nationally and internationally.
In parallel to supporting non-energy-intensive sectors, the government has to reform its fuel subsidy policies and reallocate the money to more productive economic sectors. Fuel subsidies made up 20 percent of total government expenditures between 2011 and 2014, which was almost equal to Egypt’s massive budget deficit. Moreover, the subsidy system is untargeted, and its beneficiaries primarily belong to higher income brackets, as they tend to consume more energy. That is why fuel subsidies should be slashed in the coming two to three years and retargeted to serve the most needy. This means excluding producers (mainly large Egyptian and multinational businesses) altogether from subsidy schemes.
The cutting of fuel subsidies should answer developmental and not just fiscal needs. The government should use the money it saves to increase funding for education and vocational training. This would serve as an effective subsidy to producers in general and an investment in improving the skills of the Egyptian youth, in a way that would make them able to join the labor market and perform in high-productivity, hence high-wage, jobs that meet market demand. The government should also devise partnerships in which the state and private sector can formulate and implement training schemes jointly.
The government’s policies on fuel subsidies have been inconsistent. Fuel subsidies were reduced for fiscal reasons in 2014. However, domestic energy prices remained below global market prices, even after oil plunged in 2015. The government then suspended the cutback in subsidies following the fall in oil prices, preferring to benefit from a low oil market and avoid raising fuel prices on Egyptian consumers. In 2015, it also reversed reductions in hydrocarbon subsidies by decreasing the price of oil and gas supplied to energy-intensive industries. This created a market distortion and attracted investment into energy-intensive industries that, because they are capital intensive, did not produce jobs. In addition, subsidized prices allowed producers and investors to benefit from rent havens, further reflecting that the allocation of resources was inefficient.
A Need to Reform the Revenue Structure
Beyond controlling state expenditures, the Egyptian government needs to reform the structure of its revenues as well. That means pursuing a conscious, comprehensive, and coherent strategy to reduce its dependency on hydrocarbon revenues, while simultaneously expanding its tax base.
Expanding the tax base and raising revenues are the only ways Egypt has of reducing the budget deficit and the massive public debt that the government has had to service (averaging 25 percent of total expenditures in the period between 2011 and 2015). They are also necessary for the government to finance investment in infrastructure and human development. An increase in tax revenues requires building capacity in the agencies that collect and process information about the economy—covering income, wealth, and consumption—to facilitate direct taxation.
One-third of state revenues in Egypt accrue from non-tax sources—mainly the Egyptian General Petroleum Corporation and the Suez Canal Authority—together with foreign aid, which rose rapidly in 2013–2015 when GCC countries came to the assistance of the military-backed regime. Critically, these non-tax revenues represent the main source of foreign currency earnings for the government and are necessary to pay for imports of food and fuels. In fact, Egypt’s tax revenues remain quite low, at around 15 percent of GDP (which is less than half of the European Union average of 34 percent). Total state revenues in Egypt declined from around 30 percent of GDP during the early 1990s to around 20 percent in the early 2000s. Shortly thereafter they increased to 25 percent, before falling sharply again after the 2011 uprising and the economic slowdown that ensued. Since then, revenues have never returned to the levels of the early 1990s.
It is also imperative that the Egyptian government develop a long-term energy strategy for the country. This should define the future energy mix on which Egypt will depend in the future—whether investment will still go to hydrocarbons or whether there will be diversification into new energy sources such as renewables or nuclear energy. So far Egypt has been almost completely reliant on hydrocarbons. The increase in international oil prices between 2008 and 2014 resulted in large budget deficits and an inflated import bill. The country suffered from fuel shortages and electricity outages, especially after the instability in 2011. This led to the pursuit of energy diversification plans in which decisions were made to build a nuclear power plant with Russian aid and to import coal to replace oil and natural gas for some industries.
However, these decisions were more reactions to energy shortages than part of a well-thought-out plan. Moreover, there are signs that energy diversification plans were abandoned after the recent fall in international oil prices. This puts the Egyptian economy at great risk in the event of a rebound in oil. It is crucial that the government devise a long-term strategy regardless of short-term oil price fluctuations.
Egypt’s Regional Economic Possibilities
The diversification of Egypt’s economy also has, potentially, a regional dimension. Saudi Arabia has launched an ambitious strategy to reduce its oil dependency by 2030. Egypt, as the most populous Arab country, can play a significant role in the achievement of such plans on a regional scale. It has relatively developed infrastructural and industrial bases, and it has established an extensive web of investment and trade agreements with Europe, the United States, Russia, sub-Saharan Africa, and the Arab world. This qualifies it to become a grand recipient of Saudi and Gulf investment in non-oil sectors, and to serve as an industrial base for the low-population GCC countries. These forms of economic integration could develop in parallel to the intensive security, political, diplomatic, and military cooperation between Egypt and the Gulf states since 2013.
Egypt’s biggest challenge in the near future will be to put in place economic conditions allowing for social and political stabilization. That means more than striving to return to the economic growth rates that prevailed before the 2011 uprising. Rather, serious and sustainable stability requires a restructuring of the Egyptian development model so that the economy can absorb (and avoid political discontent among) the large numbers of young Egyptians entering the workforce every year.
While the task is difficult, it is not impossible. However, time is not on Egypt’s side. The government must introduce institutional and policy reforms, and this should be done relatively quickly. Otherwise, the country’s socioeconomic weaknesses may revive the discontent of January 2011, which exposed in a major way Egypt’s political vulnerabilities.
1 Lois Stevenson and Mohamed Abdel Aziz, Influencing Policy Key Factors in the Case of a SME Policy Project in Egypt (Cairo: International Council for Small Business, 2008), 1.