Since its economic crisis in the late 1980s, Jordan has pursued an economic reform program with several inter-related objectives: controlling inflation, cutting the government's budget deficit, fostering exports, supporting private sector development, and rebuilding foreign reserves. Jordan largely succeeded in achieving these goals until the outbreak of the Iraq war in 2003. Since then, however, ripple effects of the war have caused rising inflation, undermining efforts to cut the deficit and promote exports.

Jordan's inflation rate from 1999-2003 was below 2 percent each year, but it has now risen to over 6 percent. Higher food prices have accounted for half of the total inflation over the last three years, partly because Jordan is exporting many of its fruits and vegetables to the U.S. army in Iraq. The end of subsidized oil shipments from Saddam Hussein's government, rising world oil prices, and reduced government subsidies have combined to cause fuel prices to Jordanian consumers to rise 54 percent since 2002. Real estate and housing prices in Amman have also risen due to the influx of some 800,000 Iraqis, though this contributes less to overall inflation than is commonly believed. In addition, the Jordanian dinar's weakness relative to the Euro since 2002 has made imports from Europe more expensive for Jordanians, reinforcing the other inflationary trends.

Inflation is causing widespread discontent among Jordanians as it reduces their purchasing power. The opposition press frequently features stories about rising food prices, faulting the government for curtailing food subsidies over the last fifteen years. Inflation is actually worse in rural areas than in Amman, because it is driven by rising prices for food and fuel, necessities that form a greater percentage of poorer Jordanians' consumption. This poses particular problems for the Jordanian government, which counts on East Bank Jordanians from outside Amman for much of its political support.

Sensitive to this constituency, the government responded by raising the salaries of public sector employees (who are mostly East Bank Jordanians), to compensate for their eroding purchasing power. This wage hike is a major driver of the government's fiscally expansionary budget for 2007, the first time that a Jordanian government departed from the contractionary fiscal policy that was central to Jordan's economic reform. The 2007 budget was 11 percent larger than the previous year's budget, significantly outpacing Jordan's real GDP growth. While the political logic of boosting civil servants' salaries and public sector spending is clear, the expansionary budget is likely to boost inflation even further and to increase the budget deficit to a potentially unsustainable level.

Inflation also threatens to harm Jordanian exporters. Some Jordanian economists fear that the influx of spending from Iraqis who have moved to Jordan, in an environment of rising oil and food prices, risks sparking a form of “Dutch Disease” in Jordan. In such a situation, the foreign exchange and other inflationary factors would combine to overvalue the Jordanian dinar's real exchange rate relative to the U.S. dollar, making Jordanian exports less competitive in the U.S. and the Arab world, Jordan's two main export markets.

Early signs of the impact of the increasingly overvalued real exchange rate on exports are already visible. Exports grew from 23 percent of GDP in 2003 to 29 percent in 2004, but as inflation picked up, Jordan's export growth relative to its GDP correspondingly disappeared. As of 2006, Jordan's exports remained stable at 29 percent of GDP. Jordan's exports are no longer growing more quickly than the economy in general. First quarter figures for 2007 show that Jordan's manufacturing exports, after driving Jordan's export growth the last several years, have now stagnated. (The export figures overstate Jordanian manufacturers' international competitiveness in any case, as they include clothing and textile exports from Jordan's Qualifying Industrial Zones, which have preferential access to the U.S. market.)

To control inflation while maintaining an expansionary fiscal policy, Jordan is relying upon a tight monetary policy. But even if raising interest rates is able to keep inflation to tolerable levels, high rates risk stifling investment that is needed by many sectors of the economy and will only exacerbate the difficult situation of those seeking to buy real estate.

Jordan has, since its brief political opening in the late 1980s and early 1990s, sought to defer democratization in favor of economic reform. Now, inflation largely caused by the Iraq war threatens to undermine the pillars of Jordan's economic reform agenda. Jordan faces a severe challenge of creating new jobs and lowering its unemployment rate, which cannot be done sustainably by public sector spending. If the private sector does not close that economic gap, discontent with the country's economic situation could be felt as soon as this month's municipal elections and parliamentary elections scheduled for November.

David M. DeBartolo was a Fulbright Fellow in Jordan in 2006-2007.