World Bank to the Left of Lebanese Government

A World Bank team has identified five key reforms which could dramatically transform the Lebanese economy, assuming the political will to implement them can also be found.

The reforms that are required to enable Lebanon to exploit its economic potential are familiar to everyone: start with the infrastructure and go on to spend public funds more effectively.

But people tend to forget that the longer reforms are delayed, the worse things become and the harder it gets to put them right. Indecision will keep the economy functioning in accordance with an unsustainable model that does not meet the needs of the country’s citizens, sees productive activity steadily decline, and is constantly crisis-prone. This model cannot be the basis for a more prosperous society.

This is precisely what the World Bank warns of in a recent report: Using Lebanon’s Large Capital Inflows to Foster Sustainable Long-Term Growth. The study looks at the strengths and weaknesses of various sectors of the Lebanese economy, proposes a package of badly needed reforms, and projects what conditions could look like in 15-20 years time if the reforms are or are not applied.

It concludes that reforms are feasible and would have a far-reaching positive impact that would become fully apparent within five years. But they would require clear political decisions, as the team which drafted the paper are well aware.

The five key reforms the paper calls for are: higher public investment in infrastructure, improved efficiency of public spending (especially on education and infrastructure), protection of intellectual property rights, reducing macroeconomic imbalances, and improving competition.

The Lebanese should not be fatalistic about their country’s endemic economic underperformance, says Chadi Bou Habib, the World Bank economist who headed the team that drew up the report. “It is a matter of choices. We are choosing not to make use of the economic advantages we have. Even indecision is a choice.”

A key consequence of that is that the skilled people the country needs to develop and prosper emigrate in large numbers. Bou Habib stresses that the large capital inflows stemming from emigration, while advantageous, are no basis for sustainable long term growth.

Political Obstacles

In identifying impediments to reform, the World Bank report breaks new ground by pointing to vested interests that resist reform because it reduces their access to state rents. It stresses the need to reassure these groups that the losses they stand to make as a result of reform would be offset by the long-term overall public gain.

“Lebanon’s political economy is characterized by a political system based on confession, and by the existence of powerful interest groups in key economic sectors,” the report explains. “This mix leads to frequent conflicts between political leaders from different sectarian groups to capture the decision process in the areas of economic and social policy.” It indicates that “the most powerful groups are in the banking and real estate sectors” and that “the electoral system is playing a major role in perpetuating [the] political, economic, and social dominance” of these groups.

Thus “the allocation of rents within the public sector corresponds to sensitive political equilibrium,” and, as a consequence, “no reform will be successful in any sector if it reduces the political rent of one sectarian leader while other leaders keep their rents in other sectors.”

The report goes on to say that because it “might be difficult” for Lebanon to implement the five proposed reforms due to its political system, “international organizations might therefore play an important role in facilitating coordination and conveying the sense that reform is not a zero-sum game.”

Elaborating, Bou Habib suggests that this role could include representing the interests of educated youth and skilled workers, who for whatever reason are unable to do so adequately themselves in the face of a powerful minority which fears it interests will be damaged by change. But he stresses that one side’s interests need not conflict with the others’. “Those who think of themselves as losers from reforms need to be made aware that this is only an immediate loss, and that it will bring important gains to the country and future generations.”

The report sounds the alarm for Lebanon with reference to the wider region, saying that “recent developments in the Arab region and in host countries of the Lebanese diaspora have underlined the urgency for decision makers to build an economy more resilient to external shocks, in a context of a growth strategy that promotes employment.”

Bou Habib believes Lebanon can learn from the experience of South Korea since 1962, which at that time was poorer than Lebanon. That year, it became clear to the ruling elite in Seoul that the country was heading for collapse. They decided the time had come for change, and there was a wholesale reform of public finances and institutions which nevertheless kept the old guard in place, under the slogan of cooperation for a new social contract. Today, South Korea has become a major player in the global economy with one of the world’s highest standards of living.

There are many similarities between Lebanon and Korea: the conflict as an incentive for economic mobilization and resistance (anyone remember Israel?), the availability of skilled manpower, and the acceptable education system. But Lebanon enjoys a major advantage over most economies that have developed rapidly: the huge inflow of capital from expatriate Lebanese.

The report makes a number of observations in this regard.

1 – There is a solid relationship between foreign financial inflows and other determinants – such as oil prices, the accumulation of foreign currency reserves, and bank deposits in Lebanon.

2 – Foreign inflows have strongly benefited Lebanon but have also generated costs in terms of distortions and increased volatility. In a context of political polarization and lack of decision-making, these inflows made possible the financing of the huge fiscal and trade deficits, thus delaying important reforms to reduce distortions in the economy.

3 – There are several constraints that reduce the ability of Lebanon to benefit from financial inflows for the implementation of an innovation-based long-term strategy. Lebanon’s core infrastructure – electricity, roads, and sanitation etc. – remain deficient in many respects. Access to cost-effective infrastructure services remains a major constraint on economic activity.

4 – The projections made by the Word Bank team indicate that the rewards of structural and macroeconomic reforms in terms of economic growth would indeed be large. Taking the five proposed areas for reform individually:
- A 50 percent increase in public investment would add 0.6 percentage points to a benchmark GDP growth rate of 4 percent.
- A 25 percent improvement in the efficiency of public spending on infrastructure and education would generate an additional 0.5 percent of growth.
- A reduction in volatility and macroeconomic imbalances (as measured by an 80 increase in foreign direct investment) would add 0.08 percentage point to long-term growth.
- An improvement of the enforcement of property rights (by 40 percent) would stimulate foreign investment and generate up to 0.8 percentage points of additional growth.
- An increase in competition in the intermediary goods market may raise GDP growth up to 0.1 percentage points.

Taken together, these reforms, would add up to 2.9 percentage points to the average yearly long-term GDP growth. According to the report, while this “can start materializing at the first year of the implementation of reforms, the full growth impact will not materialized before the completion of all reforms, which may take up to five years.”

Mission Possible

But what is five years in the life of a people who suffer the twin afflictions of lacking public services and high emigration at a rate of some 15-20,000 people per year? The obvious answer to that question becomes more compelling when the report looks further down the road. It estimates that after 15 years, implementation of the reforms would make real GDP per capita 21 percent higher than it would be without reforms.

Moreover, if this were to include the enforcement of property rights in the research and adaptation sector, the rise in long-term GDP would go up to 2.9 percentage points, which would mean that real GDP per capita would be at least 50 percent higher.

“Such a qualitative move into an innovative and productive era, together with the quantitative jump in GDP growth, would have important consequences for the developmental indicators of Lebanon and on the general welfare of the population,” the report says.

“We would be a completely different country,” adds Bou Habib. There would not only be more employment and prosperity, but established work and social relationships would change in turn, with new groups with new ambitions emerging to participate in the economy. “We are talking of a completely different society,” he says.

This article is an edited translation from the Arabic Edition.