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How Public Debt Explains Lebanon’s Protests

How Public Debt Explains Lebanon’s Protests

(Bloomberg Opinion) -- The street demonstrations wracking Lebanon come on the heels of socioeconomic protests in several other Middle Eastern countries this year, most notably in Iraq and Egypt. The protests have diverse national political and economic contexts, but the protesters have many grievances in common: rampant corruption, the deterioration of public services, as well as the heightened pain inflicted by government austerity programs and higher indirect taxes.

The countries where the protests have broken out all have political and economic elites of contested legitimacy, which have conspicuously failed to deliver development to a majority of citizens. This is especially true for young women and men, who find themselves economically excluded and politically disenfranchised.

Foreign investors wondering what to make of the protests should look closely at the public-debt burdens of these countries. For several years now, public debt has been the main attraction for investors in many Middle Eastern and North African countries; in contrast, foreign direct investment net inflows have been stagnant or declining. Governments in the region, struggling with historically low tax revenues and persistent balance-of-payments deficits, have come to depend on external and domestic borrowing for fiscal sustainability.

Egypt and Lebanon are especially illuminating examples. In Egypt, massive foreign borrowing has driven an economic recovery, but harsh austerity measures imposed by an International Monetary Fund loan package have resulted in rising poverty levels and an overall decline in purchasing power of middle-class and poor Egyptians. Lebanon has a longer history of debt dependency: the state has a limited capacity to tax productive sectors, which have atrophied since the end of the civil war in 1990, leaving the economy reliant on debt, remittances and other external transfers. This is reflected in speculative and rent-driven activities in the real-estate and financial-services sectors.

Access to foreign borrowing is thus central to both economies. This is predicated on the state’s ability to deliver macroeconomic stability by cutting expenses and raising tax revenues, usually by levying value-added and sales taxes.

But this is becoming harder to sustain for political reasons. Facing streets protests, governments have already made concessions—by rolling back plans for more austerity or higher taxes, or both. In Egypt, the government froze further fuel-subsidy cuts and lowered gas prices. It also relisted 1.8 million citizens on the food-subsidy program after having removed them some months earlier. In Lebanon, the so-called “internet tax” that ignited the recent protests was rescinded and the government announced the freezing of plans to raise consumption taxes.

The lesson for governments is that it is becoming harder to tackle fiscal problems by the traditional means of suppressing public expenditure and raising indirect taxes. This could result in less macroeconomic discipline in the near future, raising the risks for those investing in public debt while raising borrowing costs for governments. This, in turn, would lead to further deterioration in their financial positions, internally as well as externally.

Lebanon is currently much more vulnerable than Egypt, given its substantially higher debt-to-GDP ratio. But Egypt’s overall dependency on public debt also make it vulnerable on a number of fronts, albeit through different dynamics.

The protests demonstrate that countries in the region cannot stay on a debt-dependent path for growth or survival. They need to tackle structural fiscal problems by raising their tax-to-GDP ratios, which have been dismal and declining. They need to raise revenues through direct taxes, especially on wealth like property.  They are easier to register and collect, and do not negatively impact investment, growth or employment. What’s more, such taxes limit speculation and incentivize the use of assets for investing in productive activities, capable of creating jobs and generating real growth.

Reducing the reliance on public debt would also free capital for productive, private-sector investment, a welcome break from the pattern of banks lending to governments seeking to finance recurrent expenses. Much better to put those resources in tradable sectors such as manufacturing, agriculture and high-skilled services, which would not only generate growth and employment, but also improve the balance-of-payments positions of these economies.

In the long term, this will also reduce governments’ heavy dependence on foreign debt to keep their economies afloat.

This may not be an easy message to sell in the Middle East and North Africa while the streets seethe with rage. But it is one political leaderships should take to heart.

To contact the editor responsible for this story: Bobby Ghosh at aghosh73@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Amr Adly is an assistant professor at the American University in Cairo. He is the author of "State Reform and Development in the Middle East."

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