Subsidies, Rationality, and Revolution: An Alternative Perspective

Economists and businessmen are generally expected to exhibit a blind faith in the virtues of individual self-interest and the absence of government intervention.  However, such faith also often blinds policy makers and other free market advocates to the reality that there often exist very reasoned, politically necessary, and more foresighted economic justifications for petroleum subsidization or at least an exceptionally long period of time over which these subsidies might be reduced.  Egypt’s economic and political history since 2005, and the experience of the global food crisis in 2007/2008, efficiently serve as the background for such an argument and yield a policy prescription that focuses rightly upon proper timing as an element of any future action in the sphere of subsidies.

Food, Fuel, and Economic Idealism
Subsidization has obviously been an element of Egyptian political reality since at least the bread riots of 1977.  More recently, the issue of subsidies again rose to prominence between 2005 and 2007 with the focus again squarely upon the issue of food.  While today petroleum is at the center of our discussion, it is nonetheless important to look toward the past in order to gain insight into our present difficulties.  Most importantly, one must recognize that the trend in global commodity prices, and indeed many commodity price index levels, are today more closely resembling 2007 and early 2008 than the trends and levels extant during the depths of the financial crisis.

Of course, the period immediately preceding the global financial crisis saw Egyptian subsidy costs rising in the face of dramatically increasing international prices.  Then as now, rather monochromatic economic concerns resulted in calls for liberalization largely emanating from local research fora, university classrooms, and the international financial sector. 

The misguided sense at the time seemed to be that the domestic and international economic realities of growth and expansion could be projected infinitely into the future.  I am reminded of one particular incident during which I met a prominent local economist and casually noted over dinner that, while economic concerns were important, further liberalization was neither socially nor politically affordable for Egypt.  I was relatively new to the country and was quite surprised when this person literally turned red and began boorishly shouting the reasons I was incorrect.  I relayed this story weeks later to an Egyptian colleague and noted how the reaction surprised me…that it was, “as though I had insulted his mother’s virtue.”  My colleague’s response was to simply laugh and state, “You did much worse than that, you insulted his ideology.”  This single incident still highlights for me the degree to which Egyptian political realities and idealized economic notions can sometimes be completely divergent.  I believe we are experiencing the same sort of disconnect today.

Of course, such economic fundamentalism in favor of fiscal responsibility is understandable as, on the eve of the financial crisis, WTI and Brent crude oil were selling for over $145 per barrel (up from $60 just two years earlier) and there was obviously a great deal of ink wrongly spilled about the contemporary existence of “peak oil”.  Simultaneously, wheat was selling on the international market for nearly $450 per metric ton (up from $175 just two years earlier).  At the time, Egypt was also importing over seven million tons of wheat per year to feed its food subsidy system and that nearly 3.5 billion dollar imported wheat bill in 2007 is roughly the inflation adjusted equivalent of the 4.6 billion dollar petroleum subsidy bill incurred in 2012.  Given that, it is no wonder that many Egyptian policy makers are repeating the calls for liberalization today.

Peak Oil, Peak Wheat, and Subsidy Justifications
Unlike today however, in the years leading up to 2008, the global economic system was surging forward, a great many commodities had been effectively “financialized”, and Egyptian growth rates were above 7% allowing the country to serve as what many perceived to be an idealized model for the region and indeed for the developing world.   Some assumed that the miracle of “liberalization” and “privatization” had brought economic growth and mistakenly perceived this as yielding development or at least the immediate promise of it.  For a great many, the decision to therefore reduce or eliminate subsidies was an easy one as the price of their maintenance increased and Egyptian growth could apparently justify the increased costs to the population.  The counterargument however, was to be found in the reality that average Egyptians, in the years leading up to 2008, had not experienced the benefits of extant political and economic systems.  In fact, the speculative fervor being driven by “financialized” commodities had all but guaranteed that welfare in the newly liberalized Egyptian economy could not keep up with rising international prices.

In the years immediately leading up to the financial crisis, inflation in Egypt oscillated between an apparently moderate 2.5% and 8.8% but food price inflation in the same years, spurred by global commodity speculation, was spiking at nearly 20% annually.  Real incomes for the vast majority had been collapsing, as wages were slow to adjust upward to price changes.  Even slightly reducing subsidies, in an environment of such dramatically rising household costs, would have been catastrophic absent a more just and egalitarian distribution of income and wealth.  Indeed, the events of January 25 highlight the reality that even the presence of subsidies could not overwhelm the inequities that existed within Egypt at the time.

At its foundation, economically inefficient subsidization was and is made necessary by the relatively stagnant nominal wages paid to the vast majority of workers ensuring the collapse of real wages during a speculatively driven global expansion.  Earlier evidence of this collapse is to be found in the 2008 Mahalla riots and the broader general strike on April 6 of that year.  Somewhat ironically, at roughly the same time Hosni Mubarak’s police forces were repressing wages in the Nile Delta, “free market” economists were calling for subsidy elimination that, if enacted wholesale, would have almost certainly ended Mubarak’s regime roughly two years sooner than its actual demise.   What’s more, one might in fact make the argument that, even with subsidization, the financial crisis actually offered Mubarak what amounted to a two year reprieve, essentially a historically rare “second chance” to repair domestic inequities and economic inefficiencies during a period of lower costs.

Present Obstacles and Policy Imperatives
Given the above political, social, and economic background, it is important to realize that Egypt faces a petroleum subsidy crisis similar to that faced with food subsidies in the pre-crisis era.  While both subsidy spheres have been unpopular politically, and it is wise to note that both are expensive and also irrational according to economic theory textbooks, both are also simultaneously necessary given current economic and social conditions.  In fact, the rationale to maintain some fuel subsidies now is the same as the rationale used to maintain food subsidies in 2007.  Wholesale liberalization is quite simply not an economic luxury that Egypt can politically or socially afford.

Practically speaking, the time to reduce subsidies is not when they are the most costly to the government budget.  In fact, this is actually the time when subsidies are most necessary.  The “sweet spot” during which the Egyptian government might have targeted subsidies for reduction was neither immediately before the financial crisis nor presently but at the depths of the crisis after global commodity prices had plummeted.   Even then however, concomitant wage flexibility would have been a necessary complement to subsidy reduction.
We have, in short, long since passed the time during which Egypt’s economic problems can be easily remedied.  Hosni Mubarak passed up his “second chance” between 2008 and 2010 and global commodity markets have long since started to recover as investors divert a percentage of available cheap money from equities and most government debt in favor of more tangible assets.  Four years ago would have been the time to liberalize labor markets, allow wages to rise dramatically, and simultaneously (on an announced and credible schedule) allow subsidies to evaporate over a period of months or even years.  This may have even been socially and politically acceptable when the cost to consumers and wage payers were at their minimum as determined by lower international oil and other commodity prices.  These changes might also have taken place over time such that, as international prices eventually increased, the perceived individual costs would have been gradual and much less painful than the economic shock therapy being proposed presently. As a result of this missed opportunity, Egypt is now better off politically and economically to simply endure currency devaluation.

Egypt’s present subsidization bill of $22 billion is obviously being paid in a depreciating currency as the hopes for an IMF loan could potentially disappear into a background of political and social unrest.  Simultaneously that depreciating currency has created inflation that could be nearly as socially damaging as subsidy elimination.  Ironically, the current foreign exchange issues facing Egypt also effectively reduce the possibility of subsidy elimination as the prices for all imported goods and services are rising and increasing the social need for some refuge in the spheres of cheaper fuel and food.  However, the experienced real wage decreases are much less immediately perceived by the population over time than even a gradual elimination of subsidies might be.  Further, the Morsi government has also exhibited great wisdom to sidestep accountability for this rather passive policy of devaluation relative to the degree to which they would be strongly held accountable if adopting a policy of overt subsidy elimination.  Of course, devaluation will still hurt but almost certainly not as much as subsidy elimination and certainly not as immediately.

Further, the above-described action will ensure a more egalitarian distribution of the costs associated with our return to economic equilibrium.  Everyone will pay more for necessities and luxuries as the pound inches toward 7.00 or even 7.50 to the US dollar.  To eliminate subsidies absent the unlikely existence of labor market liberalization would simply places the entire burden of that return to equilibrium upon the shoulders of those most unable to bear the cost.  I sincerely doubt that Egypt can afford the short run social and political instability caused by such a policy. What’s more, if we are to be concerned with foreign investment in the petroleum sector, I firmly believe that it is easier for investors to contract and act upon the relatively calculable expectation of even moderate currency devaluation over time than to act upon the ethereal likelihood of an undetermined level of social and political unrest resulting from subsidy elimination.

As described above, and in spite of a lingering and persistent financial crisis, there exists an equally persistent justification for prolonging the presence of subsidies in Egypt.  This is largely due to the fact that the current phase of our economic crisis is not characterized by falling prices internationally but prices that have, in spite of broader stagnation, risen rather dramatically since 2008.  In this present case, Egypt can learn something quite valuable from southern Europe: that fiscal austerity may appear a logical solution on paper but the long-term economic, social, and political costs are great.  In short, Egypt has the luxury of devaluation that Greece would very likely prefer.

By John Pastrikos


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