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Choiceless Democracies: From Arab Revolution to Austerity

Manuel F Montes1 19 April 2013

1. In the Arab region, there are two things at stake at the same time: (1) political transition and (2) economic recovery. There have been similar situations in the past of these two things having to happen at the same time. Will one support the other? Will the nature of the economic recovery facilitate or hinder political transition?

2. Whether and what kind of political transition will in turn depend on – though not only on – the economic program. Will the economic recovery program actually result in an economic recovery? Will the economic recovery be consistent with a change in growth dynamics that will avoid a repeat of the economic crisis?

3. In the whole mix are the external donors with geopolitical and commercial interests, with the international financial institutions serving as the techno-policy channel for these interests.

4. On the domestic side, old order with control over economic assets, companies, and jobs versus a wide range of political persuasions among the new forces. The new government has a not-so-stable

5. We experienced such a transition with the 1986 overthrow of Ferdinand Marcos in the midst of the 1982 debt crisis (which swept through Latin America and many African countries) in which the Philippines was the only participant from Asia. The WB and the IMF come in to meet the new government for the economic program.

1 Senior Advisor on Finance and Development, The South Centre. Speaking notes for panel on “From the Arab Revolutions to Global Austerity Trends,” 20 April 2013, the World Bank. I am solely responsible for all errors, opinions and analyses. Email: [email protected].

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6. Our program which became part of the lexicon of the new government was “selective debt repudiation” – choosing to service only legitimate debt inherited from the previous government. Because of cross-default clauses, we expected at least best-faith negotiating efforts on the part of creditors. More important, the proposal could certainly have made economic recovery possible without spiralling domestic and foreign public debt which later became a millstone on investment and growth.

7. In the Philippines in 1986, having been intimately connected with the previous government, IMF and WB staff made strenuous efforts to rehabilitate the reputations of their agencies. At the same time, the US stands behind their recommendations which is critical to unlock financing that will be needed to keep the economy going.

8. The World Bank and the IMF justified the reform program they presented as the solution to The corruption of the Marcos regime, including the money that its officials had deposited abroad. Less government interference with the economy, means less opportunities for government corruption. Despite the fact that the new government eagerly undertook IMF-WB reforms more than 26 years ago, corruption has stayed and worsened, even after liberalization. The main impact was a short few years of growth with even greater debt load than that left by the Marcos government, then a long period of weak growth, heavily dependent on aid and external financing.

9. The major “Arab spring countries” – Morocco, Tunisia, Egypt, and Jordan – all face balance-of-payments crises. They have had current account deficits in the order of about seven per cent at least in the last three years or so and have elevated debt levels.

10. The problem with the word austerity is that it implies that everyone is having their spending curtailed. What it actually means is that households, factories and their workers, and the public sector are having their spending curtailed while the financial companies are able to receive the debt service at market rates that are contractually due. Unlike in developed countries where perhaps austerity has some element of social psychology to try to motivate a well-developed private sector to begin risking and investing again, in the

\C:\USERS\BUTCH\DOCUMENTS\~TRAVEL\1304 WASH DC\ARAB AUSTERITY.DOCX VERSION: 21 APR 2013 07:42 3 developing countries austerity is not done for its own sake – it is done to set aside resources for debt service.

11. The public sector takes responsibility for servicing debt owed to foreign creditors and must reduce spending on social sectors to make the resources available. Often, even when there were not explicit guarantees on foreign borrowing, the government is forced to accept private exzternal debt as its own. This happened most recently in Spain, Portugal, and Ireland, but this has been happening for decades now to developing country governments.

12. New financing from the IMF and other external donors is meant first of all to contribute to the external debt service; this is what is meant that the IMF is helping country. It is helping the country to meet its external debt service obligations. It also means that it is not the country that is being rescued. The foreign creditors are being rescued because if there is a delay in their receiving debt service they must begin setting aside reserves against the “non-performing loans,” thus severely curtailing their profits.

13. In the meantime, under these programs, the government must undertake policy reforms whose long-term impact on investment and growth has proven to be highly doubtful in previous experiences. I have no time to discuss how ambiguous but large- scale terms such as “enabling environment” found in these programs actually translate into blanket investor protections and straitjackets on capital controls that unduly restrict growth oriented domestic policies. Such policies tend only to elicit short-term, speculative investments from abroad. Not the kind of long-term, patient investment that creates jobs and new economic activities. In any case, it is most important to promote long-term investment, and the impact on policy restrictions in favour of “enabling environments” means loss of control over domestic interest rates and lending and the exchange rate, which amplifies risk and obstructs long-term investment.

14. There is also a set of austerity measures. For example, arguments on removing fuel subsidies are based mainly on the equity considerations; the subsidies benefit the rich

\C:\USERS\BUTCH\DOCUMENTS\~TRAVEL\1304 WASH DC\ARAB AUSTERITY.DOCX VERSION: 21 APR 2013 07:42 4 benefit but not the poor. If there are any lessons learned from previous political transitions, the elimination of such subsidies is properly a medium-term and long-term effort. Only if resources saved from the immediate elimination of such subsidies are guaranteed to be applied to employment and job creation, and not debt servicing, can these be reasonably part of an emergency strategy.

15. IMF programs are based on “backward calculation.” Backward calculation starts with the question: What is the financing gap in the coming 12 to 24 months - in which the most important claim on resources is how much debt service is needed - assuming there is no restructuring of the external debt? Of this required debt service, how much can be taken from public revenues, how much from domestic private savings? After these questions have been answer, it can then deal with the question: How much from domestic growth that can be afforded? In this approach, economic recovery and the absorption of unemployed capital and labor, are the residual result of debt service.

16. The alternative is to calculate forward: How much of the factories and workers are idle? Then a rough calculation of what kind of macroeconomic growth rate would be required to (1) to re-absorb unemployed resources and (2) an investment rate that will absorb new entrants into labor force and improve the competitiveness of the economy over the medium term.

17. This will determine the resource requirements which can be funded by domestic savings, public revenues, and the residual can be applied to debt servicing.

18. Countries can also consider monetary easing, in the same way that advanced economies are doing it. However, for developing countries, this will require imposing or re-imposing capital controls to maintain adequate control over exchange rates and domestic interest rates. The IMF allowed Iceland and Cyprus to do this; Iceland has its own currency but Cyprus does not. The government can re-nationalize certain companies if they cannot be restarted with private financing, and collect the profits for its own revenue stream, since for the most part it was the profitable government companies that

\C:\USERS\BUTCH\DOCUMENTS\~TRAVEL\1304 WASH DC\ARAB AUSTERITY.DOCX VERSION: 21 APR 2013 07:42 5 had been privatized by the dictatorships under the aegis of the World Bank and IMF. (The term for this is “crony capitalism.”)

19. To be clear this is a heterodox program and it will require debt restructuring up front given the debt load of many countries in the Arab region. But such a heterodox program could be better than joint procrastination between Arab countries and their donors, because the orthodox programs just kick the can down the road, while local populations suffer within a the limited scope of choices in the political transition. A friend of mine, Malawian Thandika Mkandawire, who now heads the Africa program at LSE, called this post-dictatorship situation “choiceless democracies.” After a lot of sacrifices, the population has managed to introduce democratic processes. However, they are presented a very limited set of choices for economic programs, which are often a continuation and acceleration of the program of the government that had been overthrown.

20. Orthodox economic strategies result in governments which are more politically and economically dependent on the donor community. Heterodox strategies at least have the possibility of opening up political space and a reordering of relations with external financiers.

21. What kind of arguments for forward as opposed to backward calculations?

22. Commercial argument: Restructuring early ensures the viability of domestic growth and the eventual repayment of debt. Not restructuring the debt now will mean a restructuring again later one even though it will allows private external creditors to continue to book profits now.

23. Change of regime argument: Debt were incurred by the previous regime. Like the fall of the Marcos regime which was seen all over the world on CNN, the change in Arab governments were seen everywhere. Why should the old economic model be married to the new democracy?

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24. Is there a cost? Yes, there is an important cost. The cost is slower growth over the medium-term, but with increased probability of more steady, employment protecting and creating growth. For example, Iceland is currently subject to criticism that it is growing “too slowly,” after the sea change with external creditors because of its capital controls and a return to reliance on domestic financing. Both Iceland and Cyprus now require a new economic model, except that Iceland has the advantage of its own currency. One can argue, as the movements that succeeded in overthrowing the old order agrue, that the Arab countries require a new economic model.

25. The old economic model tells us: One can always grow faster with greater inequality and higher or more vulnerable unemployment by reassuring financiers their short-term profits and transferring the risk to labor and households. One can always grow faster with short-term, highly volatile, external capital financing. However, we know from experience in the past that the cost of the bust (which also lasts many more years) exceeds the benefits from the boom. Twelve years after the financial crisis, Southeast Asian investment rates have not recovered the levels they averaged before the crisis.

26. What is the alternative to fast growth, as is the implied promise in IMF program? The alternative is slower growth, with less vulnerable employment and sustainable growth, less subject to large booms and busts and most protective of the livelihoods of the poor and middle classes. Such growth protects domestic policy space and permits the government to implement policies to protect employment and simulate investment in new more productive jobs.

27. It can provide the political space for a genuine democratic transition, where the government must take responsibility for its actions and not blame outside forces about not having a choice in alternative policies. There are alternative policies, but only afunctioning democracy will allow these alternative policies to emerge.

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