Bank chief warns of economic stagnation caused by aid to transitioning Arab states

Aid from the Arabian Gulf to countries affected by the Arab Spring must be accompanied by pressure to reform economies if new democracies in countries such as Egypt and Tunisia are to succeed in improving living standards, the EBRD has warned.

A man stands in front of a barbed wire fence set up by soldiers standing guard on armoured personnel carriers near Tahrir Square in Cairo. Gulf states have shovelled billions of dollars towards the governments of neighbouring Arab states. Amr Abdallah Dalsh / ReutersShow less

Emergency aid packages from Arabian Gulf states to new democracies created by the Arab Spring are impeding market reforms and could cause economic development to founder, the European Bank for Reconstruction and Development (EBRD) has warned.

The bank said funding for “unsustainable” subsidy regimes was among factors contributing to a stagnation of growth in living standards, which could take several decades to recover from, in countries transitioning to democracy.

The bank, established by the European Union after the collapse of the Soviet Union to assist new democracies towards economic development, says many of those countries and their Middle Eastern neighbours are at risk of slipping as reforms stagnate.

Recent aid packages from the Gulf were funding “unsustainable” subsidy regimes for fuel and food and could inhibit the development of stronger economies if left in their present state and not reformed, said Erik Berglof, the bank’s chief economist.

“This money is propping up unsustainable fiscal situations with very large subsidies,” he said. “We need more capital in these countries, capital that addresses macro imbalances but also the reform needs of these countries.”

Gulf states have shovelled billions of dollars towards the governments of neighbouring Arab states which have experienced revolutions, with the ouster of Egypt’s president Mohammed Morsi in July bringing further sums from the Emirates, Kuwait and Saudi Arabia.

The UAE, which called this week for an Arab “Marshall plan” to help rebuild the region, has pledged US$6 billion to support Egypt alone.

Policymakers in Europe and in the Middle East have sought to draw on experience after the fall of the Berlin Wall as a blueprint for new democracies created during the Arab Spring. The EBRD began distributing funding last year to Egypt, Tunisia, Morocco and Jordan.

But the development bank warned that economic reform had become “stuck” in many of the countries in eastern and southern Europe where it has operated for much of the past decade, a process worsened by the financial crisis but nevertheless predating it.

“Failure to acknowledge the economic conditions under which political reforms took place can often cause well-meaning reforms to founder,” said Sir Suma Chakrabarti, the EBRD president, launching a report this week.

“If these economies become stuck their living standards won’t begin to approach those of advanced economies in the next half-century.”

However, George Soros, the billionaire investor who funded movements for political change in countries across Europe before the fall of the Iron Curtain, said that the European Union had to shoulder much of the blame for pursuing policies that were harming growth across the continent.

“The economic policy that is currently being proposed has created conditions of deflation, which needs to be resisted,” he said on a panel discussing the report’s findings at the bank’s London headquarters. “The European Central Bank is determined to do it but without the support of Germany it will not be able to do it.”

Countries emerging from the Arab Spring were stuck on the “first step” of transition, becoming bogged down in questions such as the role of religion in government rather than pursuing market reforms, said Tarik Yousef, a director at the Libyan central bank and a former World Bank and IMF economist.

Without progress past this roadblock, “there will be no economic reforms and the trap of a very low development transition might persist across the region … with the consequence that these revolutions could be reversed,” he said.

While in the past former Soviet states had aimed towards joining the European Union, spurring them towards market reforms, Arab states had no such model to guide them, Mr Yousef added.