In support of an unpopular economic policy

There seems to be a near consensus that the twin policies of floating the Egyptian Pound and cutting subsidies were bad decisions.

Everywhere you go, people blame the government for taking those two bold decisions. Unfortunately, people do not seem to understand the economics behind the decisions.

I will therefore take it upon myself to explain why both these decisions are in the long-term best-interest of Egypt. I’ll then mention the one mistake that I think the government has committed in this issue.

First, we need to remember that Egypt is a net importer of many goods, including basic food items such as wheat. In order to buy all the things we need, we need a source of hard currency.

Traditionally, our major sources of hard currency have been tourism, the Suez Canal and hydrocarbons. Following the political turmoil of the revolution and the subsequent terrorist attacks, our tourism industry is a very pale shadow of its former self.

In addition, global economic growth has been less robust than in the years preceding the global financial crisis. This reduced economic growth led to a decline in Suez Canal traffic. Hydrocarbons have not suffered as much, but the shale “revolution” in the US and the subsequent attempt of OPEC to undermine shale producers by increasing output caused a huge drop in oil prices in previous years.

All these factors combined together to reduce Egypt’s foreign currency earnings. At the same time, the Egyptian government was propping up the price of the Egyptian Pound in international markets by buying it using our currency reserves.

This caused significant downward pressure on our foreign reserves to the extent that it became obvious that it could not sustain consumption at current levels for very long.

So the government decided to ask for a loan from the IMF to cover the shortfall. Of course, anyone lending money to any entity would first have to make sure that that entity would be able to pay back the money. Therefore, one of the conditions of the loan was that the money not be squandered on quixotic attempts to prop up the artificial price of the Egyptian Pound and on regressive blanket subsidies — more on this later.

So the decision was made to float the Pound, and it has currently settled at its natural market value.

Regarding the subsidy cuts, I’ve previously mentioned on this blog that blanket subsidies are regressive. Without going into too much economic details, we can illustrate this with a simple example. If the rich owner of a gas guzzling SUV and the poor owner of a motorbike both traveled the same number of kilometers, the SUV owner would benefit more from fuel subsidies since he would be burning up more fuel per kilometer than the motorbike owner.

Thus, blanket subsidies are never a good idea. On top of that, the government was using our dwindling foreign reserves to subsidize a whole range of goods, putting the solvency of the government at risk.

Thus the need to cut subsidies. Both these decisions are correct from an economic point of view, and those who oppose them do so from either a position of lack of proper economic knowledge or from ideological beliefs that the government should use debt and become insolvent to maintain populist handouts.

Now to come to the part of the policies that I have issue with. We have a large portion of our population who live below the poverty line, and the billions saved from cutting subsidies should have been at least partially used to give them a minimum living wage.

Also, while the government is keen on reducing waste caused by propping up the pound and maintaining blanket subsidies, it seems blind to the waste caused by corruption, crony capitalism and pure incompetence. That is my only beef with the current policies. To really gain the trust and respect of the citizens, the government should tackle those issues too.