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Government juggles prices, politics

ABDALLA F. HASSAN | Business Monthly | February 2003

As the government continues to pour billions every year into its sweeping subsidy program, economists question whether clutching onto notions of social and political stability is really worth the economic price tag of not reforming the system. 


In the government’s 2002/03 budget, £E 6.7 billion—nearly 5 percent of the entire £E 141.65 billion planned expenditure—went towards funding direct subsidies on basic commodities (bread, sugar, cooking oil), housing, transportation and various exports. This figure excludes non-direct subsidies on kerosene, natural gas, electricity, gasoline and water.


In a policy statement delivered to parliament on December 29, Prime Minister Atef Ebeid stressed that the government’s underwriting of commodities would continue, despite a rise in world prices. “Abolition of this subsidy is unthinkable,” Ebeid said.


But the cost of keeping prices low is enormous—and rising. Subsidies on the popular baladi bread alone tally roughly £E 2 billion a year.


Hossam Badrawi, a National Democratic Party (NDP) parliament member, speaking at a roundtable discussion held by the American Chamber of Commerce in Egypt (which publishes Business Monthly) on December 2, said the annual cost to keep the system in working order had risen by £E 16 million.

In response, the opposition Wafd Party’s parliamentary head Mounir Abdel Nour said the cost increase was an even steeper £E 24 million.


But the government continues to resist any reform of the system. “The remaining subsidies will remain untouched for several years,” a government economic official said. “Until a better idea comes up.”


According to some economists, better ideas are plain to see.


The International Monetary Fund (IMF)’s representative to Egypt, Nadeem Ul Haque, said blanket subsidies “are no longer recommended” anywhere in the world. Rather, subsidies should focus on protecting only vulnerable groups. “If you have a properly targeted subsidy system, it will not be a huge fiscal burden,” Ul Haque said.


Ahmed Farouk Ghoneim, an assistant professor at Cairo University’s faculty of economics and political science, agreed that long-term, excessive subsidy policies were not sustainable, and would reach a limit—when budget deficits widen, and external and internal debt balloons.


Ghoneim said subsidies could be revamped by focusing on easy to identify, poorer geographical districts. “Bread in affluent areas like Garden City or Zamalek or Maadi should not be subsidized to the same extent as in a poor area like Boulaq,” he said. “But this is the case now in Egypt.”


Subsidies in some areas, such as telecommunications, have been gradually eliminated or greatly reduced. But subsidies on commodities are especially politically sensitive. According to Ul Haque, most developing countries use subsidies as an alternative to the inflationary measure of raising the low wages of public sector workers. This is undoubtedly true in Egypt, where millions of government employees make less than £E 200 per month.


Despite overstaffing throughout the public sector, the government remains committed to the status quo. “There are 5 million employees in the government, and they all want to keep things as is,” Badrawi said.


But using subsidies as an anti-inflationary measure is dangerous in the long term, Ul Haque continued. “Eventually, they have to be financed, and if subsidies keep on increasing to protect the rate of inflation, then financing will show through monetary policy, which is [also] inflationary,” he said.


Ghoneim asserted that subsidies in Egypt “have been bad for the economy, because they give wrong economic signals and help in the misallocation of resources.” Instead, “subsidies . . . should be used to correct market failures and overcome the negative impact of externalities.” 

This can be done, for instance, with state investment in projects where the social return exceeds the economic return. 


And as for feeding the masses, cash subsidies are preferred over in-kind subsidies, Ghoneim said, because “they give the consumer the right of choice, while in-kind subsidies create distortions in production and consumption.” Subsidies for bread, for instance, compel consumers to favor it over rice, which is a good nutritional substitute.


For the medium term, Ghoneim suggested that subsidies should be financed from additional taxes on “unnecessary goods,” like cigarettes. Such taxes could have the positive effect of reducing smoking and lessening health care costs. “This creates an extra burden on unnecessary goods, which are goods that are ‘bads.’ Subsidies can then be reduced when there is an increase in real wages,” he said. 


Aside from staple foods, Egypt subsidizes transportation, water and fuel—each of which entails its own problems when it comes to reform.


Public buses remain dirt cheap, and ticket prices for the metro haven’t changed in years, but the lack of adequate financial resources inevitably means the mass transportation system is mismanaged, inefficient and unsafe, Ghoneim said.


Raising ticket prices, however, would be complicated, as much of the low-income population relies on cheap transportation. “How you overcome this depends on your priorities,” Ghoneim says. “Every country has always put social and political stability among its major aims.”


For Ul Haque, a productive work force demands a mass transit system, “but that is not to say that it should be heavily subsidized.”


Similar debates surround water and fuel subsidies. Overhauling the system that provides low-cost utility water and free agricultural water could spark social uproar, while increases to fuel prices might lead to a ripple effect on the cost of commodities and services.


It’s not just a problem that affects less developed economies. According to José-María Figueres, managing director of the World Economic Forum and former president of Costa Rica, developed countries also suffer from “terrific, horrendously large subsidies,” particularly in agriculture. “One half of the European Union’s budget goes to agricultural subsidies. That cannot be,” Figueres said. “This is something where the North, the developed world, has to walk the walk.”


Egypt, he added, faced stiff competition from highly subsidized cotton growers in other countries. But even though subsidy reductions could boost Egypt’s cotton exports, Egypt’s miniscule lobbying influence in world trade prevents it from demanding that its trading partners—like the EU—reduce subsidies. 


Moreover, warned Ghoneim, a reduction of farm subsidies in Europe might lead to a rise in world food prices, which would, in turn, be harmful to Egypt in terms of its trade deficit and balance of payments. Lobbies in the West, he added, regularly resist any reforms of protectionist policies in “sensitive industries,” including agriculture, ready-made garments and steel.


According to Figueres, the step-by-step reduction or elimination of subsidies is the key to creating a level playing field for global competition. In order to stimulate trade, investment, job creation and entrepreneurship, governments should have a “clear national strategy” that is implemented gradually, he said.


Ul Haque said any country’s transition from general to targeted subsidies demands extensive preparations, including technical analysis, studies of the political economy and culture, and the compiling of accurate and comprehensive databases. “It cannot be done overnight. It takes a few years to make the transition,” he said.

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