Peak Fragility: Why The Middle East Is Doomed

Authored by "Ehsani" - a Middle East expert, Syrian-American banker and financial analyst who visits the region frequently and writes for the influential geopolitical analysis blog, Syria Comment

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The Mideast is doomed. Egypt alone needs to create 700,000 jobs every single year to absorb the new job seekers out its 98 million population. A third of this population already live below the poverty line (482 Egyptian Pounds a month, which is less than $1 a day). The seeds of the vicious circle that the Mideast region finds itself in today were planted at least 5 decades ago. Excessive public spending without matching revenues were the catalyst to a faulty and dangerous incentive system that helped to balloon populations beyond control. A governance system that was ostensibly put in place to help the poor ended up being a built-in factory for poverty generation. Excessive subsidies helped misallocate resources and mask the true cost of living for households. Correlation between family size and income was lost.

Successive Mideast leaders are often referred to as evil dictators. I see them more as lousy economists and poor users of simple arithmetic and excel spreadsheets that can help demonstrate the simple, yet devastating power of compounding. Unless you are a Gulf-based monarchy enjoying the revenue stream from oil and gas that can postpone your day of reckoning, the numbers in nearly every single Arab country don't add up.

Image source: Middle East Eye via AFP, Egypt.

 

It is important to note that excessive population growth is not fundamental the issue here. Japan and many parts of Europe are suffering from too little population growth. The problem in Arab societies is lack of productivity stemming from weak private sector and overburdened bankrupt public sector. As students of Economics know, "Potential" Economic Growth of a country is derived by adding the growth rate of its labor force to the growth rate of the economy's productivity. High labor force growth therefore ought to be a plus for the "Potential Growth".

The Arab World's problem is that it suffers from shockingly low levels of "productivity". This may seem like a fancy word but the concept encapsulates everything that Arab economies and societies suffer from. Why does the Arab world have such low productivity? The answer lies in everything from excessive size of public sector, subsidies and overbearing regulatory system leading to corruption. As public sector liabilities grow, education, healthcare & infrastructure funding suffers.

Why is the size of the public sector coupled with excessive subsidies the problem? Because what starts as the noble cause of helping the poor ends up masking the true costs of raising family size. Governments soon go broke. Services suffer. Anger rises. We know the drill now.

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The average cost of raising a child until age 18 for a middle-income family in the U.S. is approximately $245,340 (or $304,480, adjusted for projected inflation). That is about $15,000 per child per year for a two-parent family with median annual income (college costs excluded).

Growing up in Syria, I can still recall the "Family Booklet". The more dependents you had on that booklet, the more was your allocation of subsidized rice, sugar, tea, edible oil, etc. Your home electricity was also subsidized. So was your diesel. Schooling? Free all the way. Not only almost all your food staples and energy use was subsidized, the Syrian State used to give a prize (Nishan) to women who gave birth to 12 children or more. Syria at that time had about 6 million people (and produced 300,000 barrels of oil a day and had plenty of water).

Without having to pay full price for bread, sugar, electricity, tea, fuel or education (all the way to college) and with the State becoming by far the largest employer (job guaranteed), the Syrian population doubled every 22 years. Imagine the pressures on the State coffers.

There's no need for much imagination about how Syrian State fared as its population doubled every 22 years while its oil reserves and production dropped by 50%. It was still expected to offer all those freebies to a populace that never once asked how the State was to pay for all this. Not only Syrians never asked how their state could meet those obligations while they doubled every 22 years but the State itself never explained. It is debatable that the State was even aware of the power of compounding and what that does in the outer years (50 years ahead).

As State finances (revenue minus expenses with little to no borrowing program) suffered, so did the services. Schools, hospitals, municipal services became insufficiently funded. They were examples of Paul who had to be robbed to pay Peter (subsidies & losing public sector). As the state could not increase salaries with inflation, real wages and standards of living suffered. Even Mother Teresa would have had to accept a bribe if she had 5 kids and a salary of $150 a month.

Corruption is an inevitable by-product of a broken system. When the State can't meet its built-in obligations, services suffer, corruption is rampant. The public's anger grows and fingers start to point at anyone and everyone that is getting a bigger slice of the cake that is not growing anywhere near number of mouths it needs to feed. In the end, governments that start off by offering more than they can sustainably afford in the long run, end up being criticized and even toppled for seemingly not providing enough to a population that grew beyond that capacity of the system to handle.

When Governments spend, they can fund their expenditures in three ways: 1) Collect taxes 2) Borrow (assuming Lenders are available) or 3) Print money (assuming the central bank is not totally independent of the govt). Without sustainable tax base, it's unlikely lenders will be willing to fund governments unless the latter are asked to pay unsustainably high interest rates. Similarly, printing money will soon lead to debasing the currency and rampant inflation.

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What about Collecting taxes? Inscribed over the front door of the US tax office, (IRS) are the words "Taxes are what we pay for a civilized society." As one once also said: "Countries that don't have a properly observed tax regime usually fall into chaos and corruption."

Growing up in Syria, avoiding taxes was akin to breathing. It had to be done. Often times, tax rates were impossibly high (top marginal rate was once over 70%). Not paying taxes is not just the fault of citizens but also the government's which needs to accurately calibrate those rates. Regardless of underlying factors behind poor tax collection, the fact is that the Syrian government was expected to provide services, run losing businesses (public sector) & offer generous subsidies without matching tax collection or borrowing. Something had to give - quality of services.

As spending increased with rise of the population, the government investment in schools, hospitals, roads, municipal services, civil servant salaries and human capital suffered and even froze. The public had the right to complain but the public didn't want to know how the government was funding itself. "When the children come, God will hand their fortunes along with them" - this is what we grew up hearing from families whose income did not seem to support the number of children they had. People would laugh it off as a joke. Sadly, this was Syria's ticking time bomb.

On my trip to Syria few months ago, a young gentleman at my hotel explained to me how he was finding it hard to resist the pressure from his extended family and friends to stop at 5 kids. His father had 11. His brothers had 8-9. Having only 5 himself was insulting to his manhood. Like most Arab countries, Syria's peak fertility (Avg number of children per woman) was between 1975-1980. The world's highest then was Yemen at 8.7. Syria was 9th in the world at 7.47. It was in the company of Senegal, Malawi, Niger, Kenya, Rwanda, Afghanistan & Gaza.

Even by 2005-2010, Syria's population growth rate was still in the top 10 in the world at 3.26%. It also had one of the world's youngest populations with a median age of only 15.4 years (only 4.8% was over the age of 60; these statistics are from UN'S World Population tables).

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Egypt did embark on strong population control strategy. Over two decades and by early 2000, its population growth rate dropped from 3.5% to 1.7%. Large billboards were used in rural areas. An expanded use of contraception program was also effective. Sadly, success didn't last, and by 2007, complacency set in. Mubarak also started pushing back against international NGO's administrating the programs. Once he was overthrown & Morsi came in, all contraceptions were banned. Before long, growth rate was back up to 2.55% taking country's population near 100 million.

While Egypt tried its hand with family planning, Syria never did. But this thread is not about merits or problems of population growth - it's about fiscal pressures and what this dynamic inflicts on state budgets in a world of high subsidies, excessive public spending and limited resources.

The Syrian government was either not fully aware of the unfolding dynamic or that it was aware but it found it politically difficult to embark on a serious family planning program. Was the religious minority status of the leadership a factor and how would the religious establishment react? Whatever the motivations or the excuses were, the fact remains that no steps were taken to match the baked-in future population numbers with revenues or resources. The only way was to make cuts in government investment, freeze public salaries and watch the quality of the services decline.

Many have blamed current Syrian Leadership for a long list of governance shortfalls. No one (included Assad himself) can claim otherwise. What this long explanation has to highlight is that at least empirically speaking, Bashar Assad inherited a near impossible situation.

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Ironically, when Hafez Assad took over, he wrestled the Ba’ath party to the right as he fought off the more leftist wing that took power with him first. He immediately embarked on his “corrective movement”. I recall American cars being allowed as imports (yellow dodge taxis).

Older members of my family still refer to the period between 1970 and 1976 as Syria’s golden period. Merchants saw their businesses boom as foreign trade was relaxed and the corrective movement quickly became seen as a tilt to the right from an earlier ultra leftist leaning. Regardless of your politics, Hafez Assad was a larger than life figure in modern Syrian politics. Soon after taking over, he powered forward building a top down centralized State (Syria was part of Soviet camp during Cold War) that would come to dominate Syria’s future.

Merely 6 years after taking over, sporadic assassinations became widespread. Syrians would later find out their Govt was at war with the Muslim Brotherhood culminating in Hama in 1982. This 6-year battle between Islamists & Damascus left its mark in Syria’s DNA ever since.

Having been near a death situation, Syrian Leadership abruptly reversed the trends from 1970-1976 when it opened the economy and relaxed international trade and moved almost the exact opposite direction. The old Eco corrective movement was frozen. Security reined supreme now.

Between 1982 and the year 2000 when Bashar took over, Syrian Leadership spent most of its energies making sure the Islamist and Ikhwan (Muslim Brotherhood) would never see the day of light again.Being charged with belonging to Muslim Brotherhood received the death sentence by law. Add in the collapse of the Soviet union (Syria was a big victim of this huge event), falling reserves and oil production, currency devaluation, restrictions on foreign exchange transfers using draconian laws, Syria’s economy took a beating just when its fertility was in the top 10 globally.

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Fast forward to 2000 when current President Assad takes over. Yes, expectations and hopes were high both domestically and internationally. A very young population now has one of theirs. He studied abroad. He was surely going to reverse direction both politically & economically. From the start, Bashar’s main challenge was always going to be how to meet those high expectations. Political activists and thinkers quickly set up Damascus salons to carve a new political platform where they can start to participate in political life.

Economically speaking, there was now talk about allowing foreign banks and even starting a stock market. Economic reforms of this type were always going to produce winners & losers. Those w capital made it big. They now owned banks, insurance companies and hotels. And the losers? Losers were all those one of 7.4 kids born around 1980 to mothers with high fertility rates and fathers who did not have the income to support them. Those in rural areas fared worse. They were ill prepared or educated. The state was increasingly unable to support them.

The state never implemented family planning campaign (how would Islamists have reacted to Alawi President trying to reduce the numbers of the majority?). The state also never communicated to the public that course country was on was arithmetically untenable. The clock kept ticking. This is not to say State didn’t make mistakes. Old agrarian policies were by now resulting in over-exploitation of groundwater resources (again this was an inherited legacy). What was new was 2007-2009 drought that was one of worst in recent memory.

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What about corruption? Corruption thrives in heavily bureaucratic centralized systems where civil servants suffer from frozen salaries and inflation rates that eats away at their real purchasing power. Without supplemental income, employees at all levels of the state apparatus will hardly survive As the State can't afford to raise salaries with inflation, employees at all levels are left to fend off for themselves to make ends meet. The state knows it, the public knows it & what you end up with is institutionalized corruption as inevitable consequence of broken system.

For corruption at this level to be addressed, the level of public spending and liabilities have to fall dramatically. The size of government has to be smaller. The public sector has to slim down. Those left can now receive proper wages. Taxes must all get collected as the state gets a handle on finances,

What about corruption at highest levels? What about Rami Makhlouf? As we found out recently in Saudi, this problem is not restricted to Syria. This is not to say that Rami and leadership made a mistake in occupying such visible position in Syria's economy. Rami Makhlouf seems to have turned into the lightening rod for every Syrian whose purchasing power or standard of living fell behind. While its impossible not to appreciate the reasons behind this widespread public sentiment at the time, a little bit of math helps here.

Many cite the "billions that Rami stole". Suppose that all this is true and that Rami siphoned off $1 billion every single year. Had this money gone to the public, each of 23 million Syrian would have had their income rise $43 a year ($3.65 per month). Hardly solves the issue. No one ought to dismiss the negative effects of high level corruption at the high end. Appearance and optics matter tremendously and Rami’s case is a perfect microcosm of that. But, had Rami not been around, it would make very little difference to the broader issue at hand.

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What about Western political meddling? The state department had run a democracy promotion program since September 11 (2001) and many activists were supplied with media training & equipment to help them capitalize on the moment when it presented itself. March 2011 was that moment.

What about political reforms that were expected after Assad’s arrival in 2000? This was classic case of high expectations clashing with reality on the ground and the system as a whole. What was seen as needed “reforms” to some was viewed as dangerous slippery slope by others. What was described above was the nasty cocktail mix that was waiting in the wings as events unfolded in March 2011. Those who wanted more political participation included the poor, those from the rural areas, the Islamists and the regional/western adversaries of the Syrian leadership.

Assad may not have anticipated the Tsunami early but by the summer & end of 2011, he made up his mind. This was going to be a fight till the end where losing was not an option. There would be no panic but he would stop at nothing till he ensures victory.

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In conclusion, Assad was dealt a tough hand. He inherited a legacy that was born out of years of governance challenges. How would one maintain a largely socialist structure while the population doubled every 22 years and revenues from the country’s natural resources were falling by nearly 50%?

When and if Syria’s war is over, a new chapter and contract must start. The private sector must become the engine of growth. Regulations must be streamlined. Taxes must be cut to level low enough to ensure respectable collection rate. And one final idea, or a wish list of sorts: Rather than financial handouts, Syria must ask for 20 year grace period that would allow it to get to export to the rest of the world free of duties.

Sanctions ought to also be lifted. Investments in labor intensive industries must be encouraged to help employment. If and when the economy finds its footing, it's critical that women's labor participation rises from the abysmal rates in the region. Studies conclusively show that increased women participation in the labor force is the single biggest factor behind population growth control.