Matt Bradley of the Wall Street Journal wrote a good article on the Egyptian economy but a few points need to be clarified to make it better. The article has the title: “Egypt's Brewing Crisis: Subsidies” and it has the subtitle: “Cairo Faces Public Wrath if it Reforms Bloated and Corrupt System, but alternative Is a Budget Morass”. It was published on March 23, 2012 in the Journal.
It has been a little more than a year since the start of the revolution in that country, and about this much time that some people have been predicting the meltdown of the economy there. They wrote their predictions using negative superlatives that would give the impression the country was obliterated not by a tsunami but a meteor like the one that almost wiped out life from the face of the earth in the age of the dinosaurs. The reality, however, is that the Egyptian economy was mildly stricken but not amputated, and is now convalescing nicely.
The newly elected parliamentarians in Egypt know this, which is the reason why they are not rushing to accept the deal that the government has worked out with the IMF for a 3.2 billion dollars loan. Of course, this sum in itself is paltry compared to the 120 billion dollars worth of trade that Egypt does with the rest of the world each year. But the idea is that the moment this deal goes through, as much as 30 or 40 billion dollars will pour into the country as a result of the Deauville agreement, and all the pledges that were made immediately after the fall of the old regime.
There is also the matter of foreign investment which almost dried up for a while, and many predicted that it will not return till the IMF loan and the pledges materialize. Well, there may be a few investors waiting for that to happen but the fact is that foreign companies from Asia, Europe and the Americas are returning to Egypt. One example worth noting is that of Apache, the American petroleum company. It made a deal in Australia, an act that triggered massive and jubilant headlines in some publications to the effect that Apache was pulling out of Egypt to go into other places. Before the editors of these so-called business publications had the time to jump into the streets below and dance for joy, Apache had signed a deal of several billions dollars with Egypt to explore for hydrocarbons and develop projects that will last several decades. Other companies ranging from food processing to shipbuilding also opened new manufacturing plants in the country.
Thus, the question to ask is this: What did really happen to the economy of a country that was growing at the rate of 6% and had a revolution? To answer this question intelligently, we must begin with the premise that the Egyptian economy is one of the few in the world which are truly diversified. What this means is that it is made of all the sectors that make-up a modern economy, and that there exists a rough balance between the sectors. How is that? Well, when things were simple as they were in the pre-computer age, the economies were divided into 4 industrial sectors for the purpose of evaluation: agriculture, textiles, chemicals and machinery which also included transport equipment. And when you had an economy that hummed with all these sectors, you also had the services that usually go with them. By the time the computer had become prevalent everywhere, other sectors such as high-tech were added. The transport and equipment sector was subdivided into its two parts, and electronics was added to equipment. As to agriculture, it was combined with food processing to become the agrifood sector. But nothing is sacrosanct because other approaches for classification were invented, and they keep changing with time.
In any case, as far as the Egyptian revolution is concerned, agriculture was not touched. There have been a few demands for a higher wage in the food processing business but nothing happened there that was very disruptive. As to the textiles, there had been trouble on this labor front even before the revolution, and it continued after it but very little that is serious happened there. As to the chemicals, which are mostly the petrochemicals and include the exploitation of mines, minerals and quarries, there was no disruption at all.
This said, the serious disruption that happened in manufacturing came in the transportation sector where some of the auto assembly plants were shut down. Also, because construction suffered in the big urban centers like Cairo, Alexandria and Suez, the building material companies -- such as those in cement, steel, ceramics, doors and windows -- experienced a slowdown. As to the services, there was disruption in tourism, trade, education and in the financial services. What this did to the economy is slow it down to 1 or 2 per cent growth, but it did not send it into negative territory. And this is remarkable considering that there had been a revolution where the normal thing to happen would be a drop in the GDP of as much as 25% – a depression level.
But what is it that went on inside the mind of the idiots who almost danced in the street at Egypt's woes? What happened was that these people were too ignorant to know the difference between economic woes and financial woes. If a tsunami or a meteor had hit Egypt, had wipe out most of its plants and mines and had killed most of its labor force, the economy would have been severely debilitated or even killed, and the idiots would have had a good reason to celebrate. But none of this happened because the economy got sick for a while, and it is getting better now. To extend the analogy, you can perceive the economy as having lost some weight, it may still look sluggish in its movements but it is no worse than that.
Where the would-be street dancers went wrong is in the fact that they fantasized about a country that will soon fall on its knees, thus giving them the opportunity to remote control it financially, politically and even militarily. And all this hinged – in their tiny, little, miniscule brains -- on the foreign reserves that they knew the country had accumulated. There were 36 billion dollars in there of which 10 billion had come as a result of foreigners buying treasury bonds. Thinking that the revolution was going to plunge the country into a depression, these people cashed the bonds and took the money out of the country, which is a perfectly legal and legitimate thing to do.
But seeing the reserves diminish, the companies that usually import raw material from abroad were prompted to buy and hoard foreign currencies. In turn, this prompted the central bank to spend another 10 billion dollars to prop up the local currency. This brought the reserves at the central bank to 16 billion dollars but 10 billion are still in the country, and going nowhere. In addition, the commercial banks have huge sums invested abroad and would repatriate some of that to save the economy that keeps them in business if the need will arise. But there is no sign that something like this will happen. Too bad for those who got dressed up to go dance at the party that was never given.
Coming back to the Matt Bradley article, there are three main points I would like to discuss: the matter of subsidies, the country's trade in hydrocarbons, and its trade in the agrifood business.
First, the subsidies. The countries that experienced the Industrial Revolution two or three centuries ago went from an agricultural feudal economy to an industrial one over several generations. The disparity between the very rich and the poor was maintained because industry was largely controlled by the landowners who added to their wealth. But there was no serious disparity between the rising classes, all of which were peasants moving into the middle class roughly at the same pace. Yes, there were some frictions but these were no worse than what existed before the start of the Industrial Revolution.
By contrast, when an agricultural country begins to industrialize in an age that is already industrialized, the potential exists for the peasants who move from the farm to the cities to become much richer than those who remain behind. They acquire the purchasing power to send prices sky high, and thus further impoverish the already poor. For this reason, the government feels compelled to institute a system of subsidies where the essential staples, especially in food and fuel, can be had by everyone. It also happened that because of wars and other reasons, shortages were created in some industrialized countries where subsidies that range from food stamps to direct welfare payment were instituted. The Egyptian government looked at all these programs and has not yet found the system that would suit Egypt. But things are getting serious as noted in the Bradley article, and a decision will have to be taken sooner rather than later.
Second, the country's trade in hydrocarbons. We must understand that crude oil is rarely used in its crude form. Instead, it is refined where half the volume becomes fuels that range from the high octane gasoline to the heavy fuel oil, passing through the diesel, the jet fuel and so on. As to the other half, it is refined and separated into various chemicals that range from the wax to the asphalt, passing through the plastics, the vinyl and so on. No country in the world that has refineries uses petroleum products in the exact proportions that crude oil breaks into. For example, they sometimes use more gasoline than plastics because they have a healthy auto industry; sometimes they use more plastics than gasoline because they have a healthy construction and furniture industries. Thus, what happens is that these countries sell what they have in surplus, and buy what they are shortage of.
Egypt is no exception. It produces about 700 thousand barrels of crude petroleum a day, refines all of it, uses the products that it needs, which is most of them, and sells what it does not need, such as the high octane gasoline and some chemicals. The country also imports diesel fuel and butane gas. But what Egypt does not do is import crude oil in any physical sense. What does that mean? It means that Egypt has agreements with foreign oil companies that do business in the country and getting paid with a share of the crude. About 60% of the oil that is pumped from the ground belongs to Egypt; the other 40% goes to the foreign partner. But the contracts have a clause that gives Egypt the right of first refusal which means that the country has the right to buy the oil if it is willing to pay the world price for it. And this goes into the financial ledgers as an import even though the oil was produced locally and consumed locally.
When you convert all those numbers into tons per year, it works out that Egypt produces 35 million tons of crude oil of which 21 million belong to the country and 14 million to the foreign companies. However, the latter do not take the oil out of the country but leave it in place and get paid in cash instead. Given that Egypt also produces 54 million tons of natural gas and sells 18 million of them abroad, the country registers a net surplus in hydrocarbons and products of more than 10 billion dollars a year.
Third, the country's trade in the agrifood business. Egypt has 8 million acres of arable land which translates into 15 million acres when you consider that most of the land produces 2 crops a year, even 3 in some instances. This is a small patch when you compare it to what other countries of the same size have, but given the amount of water that is available, this is the best that the country can do. However, the smallness is compensated for by the high yield that the agronomists have been able to achieve in Egypt.
When you add to the export of the processed foods, rice, fruits and vegetables -- the export of non-edible products such as cotton, flowers, spices, herbs and furniture made of wood produced with recycled sewage water -- you find that the total sales of the country roughly balance out the total purchases in staples such as the wheat, sugar and cooking oil that the country imports.
Putting all this together, the picture that you see of the Egyptian economy is not one that should worry you unless you're all dressed up and looking for a reason to dance in the street.