Egypt’s Post Revolution Development Path

From A Dynamic Economy Wide Model

“A Three-Year Economic Recovery Plan”

MotazKhorshid

Professor, Cairo University

Former Minister of Higher Education

and State for Scientific Research

Cairo, Egypt

Mobile: +(20122)2440988

Tel. Work: +(202)33358241

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Asaad El- Sadek

Ph.D. Student

Faculty of Computers and Information

Cairo University, Cairo, Egypt

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The international Conference

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Abstract

The Egyptian revolution broke out in January 25, 2011, a revolution that sparked the national movements in the Arab world and impressed the world as a model of an unprecedented popular peaceful uprising included all the spectrums of Egypt’s society. The revolutionaddressed corruption and tyranny and lift the banner of freedom, justice and democracy.In June 30, 2012 Mohamed Morsiwas elected as a president of Egypt for a mandate of 4 years. Despite people’s aspiration for a better future, the continuation of the politicalinstability, social injustice and economic problemsduring the year following the election have generated an increasedfeeling of insecurity and discontent. In June 2013, the Egyptian people decided to rebel against the unsatisfactory performance of the new political regime and succeeded to isolate the president with a support from the national military force.

Since January revolution of 2011 and during the following transition period, Egypt continued to witness a considerable slowdown of its economic activity, a drop in domestic and foreign direct investments, a sizable decline in industrial production, a notable deterioration in foreign reserves and foreign exchange revenues and a growing government budget deficit. In 2014, Egypt’s socioeconomic indicators are still showing a declining trend reflected in; i) less than 2 percent increase in GDP coupled with a stagnated per capita real income, ii) an investment rate fluctuating around 16% of GDP compared to 22% in 2008, iii) a continuing low rate of national savings, iv) a sizable decline in the foreign direct investment flows - which amounted to about 2 billion US Dollars per year, compared to an average of 13 billion dollars during the 1990 decade and the begin of the current century, v) acritical unemployment situation, especially among youth and educated women with an average unemployment rate of more than 13% compared to 9% or less five years ago, vi) a high poverty rate accounting to more than 25% of the total population compared to less than 17% at the beginning of the third millennium, vii) a continuing budget deficit and unprecedented levels of domestic public debts exceeding 80 percent of GDP in June 2013, viii) A trade deficit in the current account of the balance of payments showing a continuous declining trend and ix) an upward rising trend of inflation derived by the prevailing increase in the state budget deficit.

Against this background, the Egyptian Cabinet approved in 28/08/2013 an urgent plan to stimulate the economy during the period from July 2014 until June 2017 (3 years). The overall objectives of this short/mediumterm plan is to achieve aGDP growth rate between 5% and 7% and reduce the unemployment rate to less than 9%, which represents therate prevailed before January 25, 2011.The plan primarily depends on improving investments environment by relying on private, public and foreign direct investments (FDI). The plan suggests also an increased role of government in revitalizing the economy, with respect to investment spending, public consumption and employment strategy.

To support the development and follow up of the three year stimulating plan of the Egyptian economy and to formulate alternative socioeconomic development policies and scenarios related to investmentallocation and government spending policies,a three-sector five-institution economy wide model is constructed andimplemented. The developed model reflects the structural features of the Egyptian economy and its modes of functioning and it is implemented using the general algebraic modeling system (GAMS) software. The Planning model is viewed as a consistent economy wide analytical tool following the general equilibrium tradition. To ensure the generation of the future path of the economy, it is equipped with a set of dynamic adjustment mechanisms. The development planning accounting framework of the model represents a Social accounting matrix (SAM) with three productive activities (primary, industrial and services activities), six institutions (urban and rural households, private and public corporations, and general government) and the outside world. Domestic institutions have both current and capital accounts. Factors of production include labor and capital services. Labor factors (or compensation of employees) are broken down by economic activity (private, public and government labor) and household area (urban and rural areas). Capital services include both public and private accounts. Commodities are composed of domestic, imported, exported and composite goods and services (merging domestically produced with imported goods) with each of them divided into primary, industry and services activities. Gross fixed capital formation is composed of private (households and private companies) and public (government and public enterprises) investments as well as foreign direct investments (FDI). Government accounts disaggregate tax income into direct, indirect taxes and subsidies. Finally, the rest of the world account includes exports, imports, net transfers from abroad (in the form of worker’s remittances, investment income, foreign direct investments and other current transfers).

The purposes of the paper are: (1) to assess the economic impact of the revolution and highlight the principal economy wide challenges facing the Egyptian economy, (2) to develop the accounting framework, economic rationale and mathematical structure of the economy wide model used to test the development policies of the stimulating plan, (3) to use the developed model to simulate the behavior of the economy under the selected development choices of the three year plan with the purpose of identifying appropriate policy measures needed to achieve the purposes of the three-year economic recovery program.

Despite the short/medium term nature of the planning period, the results show that a sizable increase in annual growth rate of investment spending from 7.4 to 13 percent coupled with similar growth in government spending ranging from 5 to 7 percent per annum as well as an appropriate policies for attracting foreign direct investments (FDI), would significantly improve the growth prospects of real GDP. Based on the results of model, GDP is expected to increase from 3.4 percent in the reference path to around 4.7 percent when the stimulating scenario is applied. It should be noted howeverthat, the failure to achieve a growth rate that exceeds 5 percent annually – based on the objectives of the recovery plan - is due to the negative impact of the selected stimulating policies on Egypt’s trade balance or net exports. Export promotion measureswould be strongly requested in this respect to overcome this difficulty. Finally, the adopted three-year recovery plan succeeds to improve the per capita indicators and the welfare measures of Egyptians as well as to reduce the average unemployment rate from 13 percent in 2013/14 to around 9.9 percent in 2016/17.

Based on the above rationale, the paper is organizedaroundseven sections.After this introductory part, the next two sections describe the post revolution economic performance and outline the accounting framework of the model. Sections four briefly describes the economic rationale, overall structure and disaggregation level of the modelas well as the policy measures amenable to analysis based on its structure. Section five summarizes the components of the plan scenarios to be tested by the model. The sixthsection describes the results and summarizes the main findings of applying the three year stimulating plan with special emphasis on the capacity to reach the planned targets and the feasibility of the selected policy measures to the Egyptian context. The final section includes the references.

Post revolution economic performance

Since January 2011 revolution, the Egyptian economy is witnessing a significant decline in its overall performance [14, 15, 16]. The evolution of the rate of economic growth over the three years - following the outbreak of the January 25th revolution- displays a deteriorating performance. The rate of GDP growth in real term collapsed from a peak value of 7.2% in 2007/2008 to just 2.1% in 2012/2013 because of the political stress and security unrest resulting generally in adverse consequences on economic and development performance. The growth rates of most of economic sectors followed the same declining pattern of the economy. However, on the positive side, the fiscal year 2012/2013 witnessed a significant increase in the rate of real growth (6.6%) in the tourism sector, compared to the year immediately following the revolution (-5.9%). This is mainly attributed to the decision of a lot of countries, led by Germany to ease degrees of travel warning to Egypt. The construction sector also saw a notable growth during the same year (5.9%) as the work in many of the giant real estate projects have resumed. On the negative side, in 2012/2013 there was a decline in the income from Suez Canal (-3.8%) because of the security unrest. The following table shows total resources and uses of GDP over the last two yearsin real terms.

Item / 2011/2012 / 2012/2013 / % to GDP
2011/2012 / 2012/2013
GDP / 1575.5 / 1608.6 / 100.0 / 100.0
Imports / 407.2 / 402.8 / 25.8 / 25.0
Total resources / 1982.7 / 2011.4 / 125.8 / 125.0
Private consumption / 1271.0 / 1307.0 / 80.7 / 81.3
Public consumption / 179.0 / 185.2 / 11.4 / 11.5
Total consumption / 1450.0 / 1492.2 / 92.0 / 92.8
Investments / 258.1 / 233.3 / 16.4 / 14.5
Exports / 274.6 / 285.9 / 17.4 / 17.8
Total uses / 1982.7 / 2011.4 / 125.8 / 125.0

At current prices after reaching 22.4% in 2007/2008, the last three years witnessed a decline in the rate of investment from 17.1% to 14.2%, with low domestic savings rate, which led to an increase in the savings gap from about 4.1% during the year 2010/2011 to around 8.4% in 2011/2012, and then a decline to 7% in 2012/2013. The Egyptian economy also experienced a dramatic decrease in net foreign direct investment over the three years following the revolution. From a peak value of $13.1 billion in 2007/2008, the net FDI decreased to only 3 billion dollars in 2012/2013. This significant decline in the rates of investment and net foreign direct investment explains the deteriorating economic growth over the last three years.

Over the last four years, the deficit in the balance of trade increased from $25.1 billion in 2009/2010 – a year before the revolution - to $31.5 billion in 2012/2013. Although exports of goods over this period increased by 8.8% from $23.9 billion to $26.0 billion, the problem was in the large rise in imports of goods. Because of the drop in domestic production – resulting from the political uncertainty and the unprecedented labor strikes requesting the adjustment of their salary level, imports of goods increased by 17% from $49.0 billion to $57.5 billion. The surplus in balance of services, on the other hand, decreased from $10.3 billion in 2009/2010 to just $6.7 billion in 2012/2013. The only exception to the deteriorating performance of the foreign exchange indicators is the net worker’s remittances from abroad that increased from $10.5 in 2009/2010 billion to $19.3 billion in 2012/2013. This might be explained by the desire of Egyptian citizens living abroad to participate in redressing the Egyptian economy and helping in overcoming its current difficulties, despite the increasing level of uncertainty facing their country. In balance, these unfavorable changes in external economic transactions resulted in an increase in the current account deficit from $4.32 billion in 2009/2010 to $5.6 billion in 2012/2013. The deteriorated current external balance in the post revolution period, has led similarly to a serious decline in the foreign reserves in US $. The net foreign exchange reserves declined from $36 billion in 2009/2010 to values ranging between $13.4 billion (March 2013) and $16 billion (May 2013). The steady decline in the net foreign exchange reserves during the past three years is attributed to the decline in both the revenues of tourism sector and foreign investments, in addition to the use of international reserves to finance imports and to prevent the deterioration in the value of the Egyptian pound.

Despite the declining economic growth since the outbreak of the revolution, consumer spending in current prices continues to occupy a large proportion of GDP. Final consumption expenditure at current prices reached during the year 2012/2013 LE1.6 billion, which represents 92.8% of GDP at current prices, compared to LE1.0 billion in 2009/2010, equivalent to 85.7% of GDP at current prices. With the decline in investments and net exports, the increase in final consumption is still the main source of economic growth.

The impact of January revolution on the deficit of general government budget was considerable. During the financial year 2012/2013, total deficit in the state budget reached LE240 billion compared to LE98 billionin 2009/2010- the year before the revolution, with a 145% Increase. This resulted in an increase in public debt. Total domestic public debt reached to LE1404.7 billion in 2012/2013, representing 81% of GDP at current prices compared to LE 663.8 billion in 2009/2010, representing 55% of the GDP at the same year. Foreign debts have also become a problem, increased from $34.4 billion in June 2011 to $43.2 billion in July 2010, an increase of 25.6%.

Finally, the slowdown of Egypt’s economic activity has aggravated the unemployment problem since the unemployment rate increased from 9 percent during the two years preceding the revolution to around 13.3% in 2012/2013. It also resulted in 8% inflation.

The Accounting Framework of the Model

The accounting structure and parameters of the model is broken down into two main components; a) an aggregate social accounting matrix (SAM) constructed for the year 2008-09 to support the within-period static part of the model [1,6,9,19] and b) a non SAM socioeconomic indicators needed to adjust the inter-period module ensuring the dynamic path of the economy.

In this specific SAM, activities are broken down into three distinctive accounts; primary, industry and services. This classification is the one adopted in the International Standard Industrial Classification of all economic activities (ISIC), Revision 4 [9]. The disaggregated three productive activities of the SAM are shown in the table below. Commodities are classified into; composite, domestic, imported and exported with each bundle of commodities broken down into primary, industry and services. Factors are represented in the SAM by two groups of accounts; labor compensation accounts and capital services accounts. Labor compensation accounts are broken down by economic activity into; private, public and net worker remittances representing those who work in the private corporations, public corporations and abroad, respectively.

The same applies to capital services accounts that are classified into; private, public and investment income representing capital employed in private corporations, public corporations and abroad, respectively. The economy includes three domestic institutions; households, firms and government. Households are represented by two accounts; urban and rural households. Firms or organized corporations are broken down into two separate accounts; private and public corporations. Government is broken down into three accounts; one account for general government income and spending and one account for taxes and another for subsidies. Savings are broken down into two accounts; private savings (households and private corporations) and public savings (public corporations and public government). Investments are also broken down into two accounts; private and public. Finally, there is one current account for the rest-of-world. In total, this will give us (3434) SAM matrix.

Economic activities as disaggregated by Egypt’s National accounts / The proposed scheme of disaggregation
  1. Agriculture
/ Primary
  1. Extraction of crude petroleum & natural gas

  1. Other extraction

  1. Petroleum refinement
/ Industry
  1. Other manufacturing

  1. Electricity and gas

  1. Water

  1. Sewerage

  1. Building & construction

  1. Wholesale and retail trade
/ Services
  1. Financial services

  1. Insurance

  1. Transportation & storage

  1. Communication

  1. Information

  1. Suez Canal

  1. Restaurants and hotels

  1. Real estate ownership

  1. Business activities

  1. Social insurance

  1. Education

  1. Health

  1. Other services

  1. Government

  1. NPISHs

The SAM is constructed for the fiscal year 2008/2009 in LE millions.

Model Structure and Economic Rationale

To support the socioeconomic development planning process in Egypt following the revolution of January 25,2011 and its second wave in June 30, 2013, the Ministry of Planning (MOP) developed two socioeconomic plans. A 10-year long term plan to capture both the recovery period needed to reach the normal performance of the economy and analyze as well its growth prospects in the post recovery period up to 2021/22 [12]. This long term plan mainly adopts a comprehensive set of policy measures with a target to double the real per capita income as a wayto improve the living standards of the Egyptian citizens. Furthermore, to overcome the short/medium term difficulties resulting from the devastating impact of the revolution, the government of Egypt decided to adopt a three-yearrecovery plan to stimulate the economy in order to accelerate the returnback to its normal functioning [18].To achieve this short term objective, a three-sector five-institution medium term economy wide model was constructed, implemented and used to formulate and test alternative socioeconomic development options and scenarios. The constructed model reflects the structural features of the Egyptian economy along with its modes of functioning and it is implemented using the general algebraic modeling system (GAMS) software [7,10 ,11,12].

The model is particularly designed to project Egypt’s socioeconomic indicators and assess the impact of alternative policy measures and external conditions such as: (1) Investment spending policies reflected in the private and public gross fixed capital formation, (2) foreign direct investment (FDI) flows needed to complement domestic investments in supporting the growth prospects of the economy, (3) government spending policies such as government wage bill and employment policy, final consumption spending as well as public transfers to domestic and foreign institutions, (4) government fiscal policy including various taxes and subsidies, (5) export promotion and subsidy policy, (6) total factors productivity and labor efficiency policies, (7) external balance policies reflected in changes in investment income from abroad, worker remittances, interest on foreign assets and other foreign transfers from abroad , (8) wage rate and commodity pricing policies and (9) alternative population, labor force and unemployment reduction policies.

The development planning model represents an economy with three productive activities (primary, industrial and services activities), six institutions (urban and rural households, private and public corporations, and general government) and the outside world. Domestic institutions have both current and capital accounts. Factors of productioninclude labor and capital services. Labor factors (or compensation of employees) are broken down by economic activity(private, public and government labor) and household area (urban and rural). Capital services include both public and private accounts. The markets of goods and services in the model arecomposed of domestic, imported, exported and composite commodities(merging domestic with imported goods), with each of them divided into primary, industry and services. Gross capital formation is composed of private (households and private companies) and public(government and public enterprises) investments as well as foreign direct investments (FDI). Government account disaggregates net tax income into direct and indirect taxes and subsidies. Finally, the rest of the world account includes net transfers from abroad in the form of worker’s remittances, investment income, foreign direct investments, current transfers to domestic institutions as well as imports and exports of goods and services.