1 Lebanon’s Economic Project: Lessons from the Past and Challenges for the Future A Book by Dr. Mazen Soueid

2 Lebanon’s Economic Project Why? For whom? How? What about?

3 Why? Bridge a Gap Bring back economic discussion to where it belongs. Definition of Economics Address Myths about Hariri Economic Vision – Why Hariri? – Why Now?

4 For Whom? General audience Non-experts Simple Arabic language “Democratizing Economics” Krugman/Friedman Style

5 How? Paper on Paris Reform track Back to 1992 Back to 1943

6 What about? Part I: The four foundations of the Lebanese laissez-faire 1. Private sector/ Property rights 2. The stable exchange rate 3. Balanced budget 4. Free movement of goods and capital ( no restriction on current and capital account transactions A model that worked (despite its many shortages) and produced outstanding results

7 The Lebanese Economic Model was Based on 4 Pillars 1. Private sector initiative/property rights 2. No restriction on current and capital account transactions (free repatriation of capital) 3. Stable exchange rate vis-à-vis the US dollar. 4. Balanced budget

8 Model generated high growth rate and placed Lebanon in favorable position regarding other emerging markets

9 Singapore Chose to become “The Lebanon of the East” in the early 70s

10 Challenges: Pre Civil-War Needless to say, there were several challenges that the Lebanese economic model (laisser faire) could no overcome 1. The imbalance in regional economic development (centered in Beirut and Mount Lebanon) 2. The widening of the gap between poor and rich (income distribution)

11 IRFED Study Reveals: 41% poor, 9% very poor The important reforms introduced by President Fuad Shehab ( ) to address these challenges were later hindered by tension leading to the civil war.

12 Why is it Important to Go Back? Hariri’s policies adopted in 1992 onward were an attempt to converge to the spirit of the Lebanese economic model with an objective to develop it further in the social perspective.

13 Several “endogenous” factors implied impossibility to reassert the liberal aspect of the economy (the first three pillars) without sacrificing “ temporarily” the 4 th: Balanced Budget

14 The War shook and destroyed three of the four pillars Severe exchange rate depreciation Fiscal deficit-debt: 50% of GDP by end of 1992 Private Sector impaired by destruction and damages to both infrastructure and supra structure : further deterioration

15 Part II: Reconstruction vs. Challenge What were the choices? → Pro-growth or → fiscal tightening

16 The Objectives were Numerous Eject the economy from the vicious circle of inflationary financing, dollarization and exchange rate depreciation Launch the private sector initiative to stimulate investment, growth and employment opportunities Increase the real income of the Lebanese population and reduce poverty through social spending on education, health and safety nets

17 All these objectives were inter-related Exchange rate stability essential for private sector investment Higher private sector activity essential to generate revenues Revenues were essential for social spending Otherwise more exchange rate instability ( )

18 But given that situation of the country, of the treasury, and the population it was impossible to go back at once to all pillars, and priority was thus given to the two essential pillars: – Stability of the Exchange Rate – The Role of the Private Sector which was needed to put the economy on the path of reconstruction and growth

19 Inability to Balance the Budget This suggested the impossibility of returning to the 4 th pillar: “ Balancing the budget” Due to various reasons: – The impossibility to increase tax rates given the protracted effects of the war on the middle class – The need to increase capital expenditures to repair the damage after the war, catch up with growing need and meet with future needs – The need to rebuild the Lebanese administration, hire new staff in the educational health and judicial sectors – The need to increase the size of the army and internal security forces to meet the requirement of peace (15% of total spending was on defense between )

20 Inability to Balance cont… – Need to achieve through a series of rises on wages and salaries an increase in real income that reduces the gap that has been growing between purchasing power and cost of living – Need to achieve a slow but sure reduction in interest rate, which encourages capital inflows that are needed to finance the large investment needs and generate a balance of payments surplus that could see a build up of reserves at the BDL – Higher social spending, which was increased on average by 4% of GDP

21 Division of Expenditure by Components This shows the low margin of freedom imposed on fiscal policy Margin no more than 25%!

22 Debt as of the end of 1998 Debt totaled, as of the end of 1998, $18.5 billion, and was accounted for by

23 Interest rates, overall on a declining trend, still very responsive to political and security shocks

24 Two Important Events 1. Extension of Hariri’s term “Grapes of Wrath” Israeli war Because of the second one: 1. Growth declined from 6.5% in 1995 to 4% in Revenues less by LBP 492 billion than expected 3. Expenditures were more by LBP 776 billion than expected 4. Primary deficit LBP 1039 billion instead of an expected surplus of LBP 229 billion

25 This reflects the fact that by the end of 1998, the Hariri reconstruction program was responsible for 17% of the debt: the rest was old debt + cost of financing primary deficit Primary deficit: ↑ spending on security, social spending, lack of progress in reform, security and political stability

26 Contractionary fiscal policy based on the following premise: – Economic policy adopted over “Period I” led to higher interest rate which led to a crowding out of the private sector and lower growth rate.

27 Several layers of Faults in this Approach Growth rates achieved: : growth reached over 7% : growth declined to 4% 1998: 3.6% growth declined to 3.6% - The decline in 1998 was not separated from domestic and political problems and security shocks as well as external development (the challenges facing the peace process)

28 There is no evidence of significant crowding out

29 Composition of Assets suggests that lending to public sector was at the expense of foreign assets and not at the expense of lending to private sector

30 There was no strong evidence of crowding out Loans to the private sector increased by $12.14 billion between 1992 and 2000 (460%) They increased by $21.65 billion between (820%)

31 The fallacy in the analysis led to poor results at the economic level and to disastrous results at the deficit/debt dynamic level → GDP growth declined to -0.5% in 1999 and to 1.3% in 2000 → Deficit increased from 13% in 1998 to 23% of GDP in 2000 → Debt/GDP increased from 107% in 1998 to 146% in 2000 (The government had promised to bring it down to 96% by 2003!) → Debt Service increased from 70% of revenues to 90% of revenues

32 Part III: No wonder then, when Hariri came back to power in late 2000, he reversed the course of the previous government and adopted pro-growth policies → Tariff Reform → Open Skies → Investment Law (IDAL) →Privatization Plans →Civil Service Reform Some were passed others were blocked

33 Paris I,II & III Paris I, II & III Conference Importance-covered in the Foreign Economic Policy Session- can been seen in the results recorded in terms of debt structure and costs Financing at subsidized rates totaled around $20billion In order to do the reforms that we need to do regardless!

34 Supported by tighter fiscal policy

35 That is finally generating a solid primary surplus

36 Progress achieved over the past 20 years The progress achieved in the past 20 years of reconstruction, stabilization and reform could be best seen in terms of figures and numbers:

37 From Reconstruction to Reform

38

39 Part IV: How to adapt Lebanon to the Challenges that lay ahead Define 3 big Transformations: Graduations of the emerging countries into mature markets “BRIC” → pressure on commodity market → diversification vs. comparative advantage Global financial crisis: redefine the role of the state: liberalization vs. deregulation Fiscal crisis in Europe: The issue of productivity and reforms