Egypt’s new Minister of Finance, Ahmed Galal, has chosen. He prefers a strategy of stimulating the economy over a focus on austerity. This is bold. It may not seem like it, especially in the midst of the manly, grand ultimatums we have seen in the last month, but in economic terms, it is.
Pushing for stimulus over austerity, Galal is betting on the economy. He believes the way out of the current economic crisis is to focus on improving security and pumping new capital into the local market, without any sharp tax increases and reducing spending in a way that may slow economic growth even further. This is a large bet, but the larger bet is on political stability.
Before the revolution, the economy was growing at above 5%; now growth is closer to 2%. Before the financial crisis, the economy was growing at an impressive 7% per year and was strong and resilient to the external crisis. Galal’s confidence ultimately comes from this strength.
During rough economic times, governments use austerity to reduce budget deficits by implementing spending cuts, tax increases, or a mixture of the two. This was the strategy of ousted president Mohamed Morsi’s government, particularly in its unsuccessful pursuit of a proposed $4.8bn loan from the International Monetary Fund. The budget shortfall is now more than half of all government spending.
Through stimulus, the other main option on the table, Galal will aim to reduce the deficit by incentivising economic activity. The logic is that if government action is able to stimulate more economic activity that will produce more tax revenues, which will reduce the budget without directly cutting spending or raising taxes.
Both strategies come with big risks. Austerity may reduce a budget deficit, but the higher taxes or reduced spending might harm citizens and businesses so much that that it ultimately costs the country much more in well-being and reduced economic growth. Take a look at Greece. Stimulus will not work if the incentives cannot raise tax revenue enough to better finance the budget.
The tricky thing is we can never know which is better for Egypt today. Economic managers place their bets based on the realities of their economy and how they have been convinced by the experiences of their and other economies with one strategy or the other in the past. The correct choice can never be known. It can only be debated hypothetically in academic studies uninteresting to most people.
The reality is that before the revolution, Egypt had a fast-growing economy with forecasts expecting growth to continue to be strong. The economy was able to stay strong through the first years of the financial crisis with investment levels rebounding quickly, something most countries could not manage. Investors wanted to be in the market. It is a country with a big population, high consumption levels and high returns relative to other markets. But this internal crisis hit the economy very hard; not at first, but as time dragged on, growth slowly stalled. And the reality is that none of this economic prosperity will return until some sort of political stability returns.
Galal believes that the way out is to tap into that strength. He has cleary stated his approach: stimulus with no sharp tax rises or spending cuts and a strong emphasis on security. This already is an improvement to the previous government where tax law implementation was like a Facebook post: there when you went to bed, but gone by the morning. There are many big risks to his strategy, chiefly to do with the return of political stability, security and investor confidence. He is betting on the strength of the economy. The larger wager is whether Egyptians can find a process through which they can achieve some sort of political stability so that the strength of the economy can make recovery possible.