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Mounir Mahmalat and Sami Atallah, respectively doctoral fellow at LCPS and LCPS director


October 2019
Recession Without Impact: Why Lebanese Elites Delay Reform

The survival of Lebanon’s political elites is highly dependent on the wellbeing of the economy. Why, then, do they delay necessary reforms to avoid crisis? This column examines the role of politically connected firms in delaying much-needed economic stabilization policies.
 
Lebanon’s post-war financial and economic woes are perennial. Initially triggered by the spillover effects of Syrian crisis in 2011, macroeconomic and financial indicators were set on an utterly unsustainable path. Government debt exploded after prolonged political gridlock led public spending to skyrocket to what is forecasted to be more than 158% of GDP by 2021. Combined with increased exposure to external debt and rising interest rates, economic growth may tip into recession this year.
 
In short, crisis looms.
 
In an effort to rally support for painful reform to stabilize the country’s gloomy finances, the government of Prime Minister Saad Hariri recently declared a ‘state of economic emergency’. President Michel Aoun accommodates the efforts and calls for ‘sacrifices to be made by everyone’. Lebanon’s elites finally seem to be eager to reform.
 
Understandably so, because in Lebanon the personal wellbeing of the political elites is highly dependent on the wellbeing of the economy. A recent analysis by Ishac Diwan and Jamal Haidar shows,[i] of the firms with more than 50 employees, 44% are politically connected and have a board member who is a relative or close friend of a member of the political elite.
 
The few reforms that passed, however, involve little structural change that could, for example, improve the competitiveness of the private sector or curb tax evasion. Instead, the costs of economic distortion continue to be socialized via tax exemptions, the ex post approval of appropriation of public lands[ii] or high interest rates. Despite the economic challenges, political actors still benefit excessively from the status quo.
 
In July, for example, seven months into the new year, the parliament ratified what it called an ‘austerity budget’ for 2019. It introduced a number of expenditure cuts and revenue increases that aim to restore the confidence of investors and the international community into a government eager to reform.
 
But as recent research by LCPS shows, the budget law only formally curbs the budget deficit. It leaves untouched the structural conditions that gave rise to the economic deterioration in the first place, such as a regressive tax regime that exacerbates existing inequalities and crowds out much needed public investments.
 
Proposals to tax the salaries, benefits, and pensions of current and former politicians were dismissed during the political bargaining. Amendments to increase the fees on tinted car windows and the licenses to carry guns, widely used among the security entourage of politicians, vanished in the final documents. Expenditure targets are achieved by simply deferring the bill of investment projects to the upcoming years.
 
But when the wellbeing of political elites, in fact their very survival, is so highly dependent on the wellbeing of the economy, why would they delay more structural efforts to contain the budget deficit or make the tax regime more efficient? The high degree of their entrenchment in key sectors of Lebanon’s economy calls into question how political elites calculate the opportunity costs of political gridlock.
 
In other words, why is Lebanon’s stabilization delayed?
 
Research on the political economy of reform explains the delay of stabilization as a consequence of the struggle of powerful interest groups to shift the cost of reform onto each other. Precisely because reform comes at a cost for elites, they prolong political bargain by embarking on a ‘war of attrition’.[iii] Stabilization, or a change in the status quo, occurs when economic conditions deteriorate sufficiently so that one of the groups concedes and bears a higher burden of the costs.
 
To understand the war of attrition among Lebanese elites, one must look at the structure of their entrenchment with the private sector. Politically connected firms concentrate in sectors that are not—or are relatively less—affected by a downturn of the overall economy. Economic conditions, at least until recently, simply exerted little pressure for actors on a personal basis to concede and to bear the costs of reform.
 
Disaggregating the data provided by Diwan and Haidar (2019) shows that economic downturn leaves those sectors comparably well-off in which more than half of all firms are politically connected (we excluded sectors with less than 10 firms in total).
 
Take the hospitality sector, for instance. Firms running hotels and waterfront resorts are, respectively, 61% and 55% connected to political elites. Passengers at the Beirut airport increased constantly over the past years, while the number of tourists increased by almost 45% from 2012 to 2017. Accordingly, hotels and waterfront resorts recorded a major improvement in their booking records. The occupancy rates of four and five-star hotels in Beirut reached 69.2% (up from 58.9% in 2018) while the average room yield rose by 29. 
 
The banking sector is another example. Profiting heavily from the huge margins paid by treasury bills, the profitability of domestic banks remained, until recently, almost unabated. In 2017, Lebanese commercial banks significantly expanded their profits, reaching a return on average equity of above 11.2% for the group of major banks. Despite the challenging macroeconomic environment and the difficulties sky-high interest rates impose on the Ministry of Finance’s ability to repay its debt, the return on average equity for the sector as a whole (10.8%) is on par with the 11% average of banks in the Middle East and North Africa.[iv]
 
Other sectors are structurally less affected by economic downturn and exhibit a low elasticity of demand. Security companies, for example, are employed by politicians, business people and other public figures, for whom security remains a necessity in the face of prevailing political and security uncertainty.[v] The same holds for garbage collection, which continues to be collected at sky-high rates.
 
Shipping lines are also spared much of the effects of Lebanon’s economic woes, since foreign trade activity must be done by ship after the closure of land routes through Syria in 2011. In fact, the number of vessels at Beirut port remained almost constant between 2012 until 2018. Public works and investments enjoy rosy prospects due to internationally funded major capital investment programs worth almost 40% of GDP.
 
The game-changer, however, may be the real estate sector. It is the only major sector with a high share of politically connected firms that suffers from a gradual decline in activity and output. Since the boom year of 2010, the area of new construction permits has almost halved until 2018: From 17,625 to 9,020 thousand square meters.
 
Slowing demand lowers the value of sales transactions, which plummeted by 40%, from $4,504 million to only $2,726 million in the first six months of 2017 to 2019. Given the central role that the real estate sector plays in Lebanon’s economy—the largest contributor to national GDP at 15%—a collapse of major real estate developers can well be the tipping point for the economy to crash.
 
History might repeat itself. On several occasions in the past, Lebanon was bailed out by international support when conditions became untenable. Lebanese elites seem to assume that the country remains ‘too small to fail’ for influential regional players.
 
But with declining interest in the country from Europe and the Gulf countries, this time might well be different. This time, the war of attrition would not only be lost by Lebanese citizens by suffering through prolonged periods of economic stagnation. As other crucial sectors started to follow the declining trend, uncertainty about the integrity of the pillars of the Lebanese economic model threaten both economic and political stability. Without concerted effort, Lebanon’s elites cannot win this war either.
 
 
This article was first published by the Economic Research Forum.
 
Further reading
 
Alesina, A., and A. Drazen. 1991. ‘Why Are Stabilizations Delayed?’. American Economic Review.
 
Diwan, I., and J. Haidar. 2019. ‘Do Political Connections Reduce Job Creation? Evidence from Lebanon’ in Ishac Diwan and Adeel Malik (eds) Crony Capitalism in the Middle East – Business and Politics from Liberalization to the Arab Spring, Oxford University Press.
 
Mahmalat, M., and S. Atallah. 2018. ‘Why Does Lebanon Need CEDRE? How Fiscal Mismanagement and Low Taxation on Wealth Necessitate International Assistance.’ Lebanese Center for Policy Studies.
 
Salti, N. 2019. ‘No Country for Poor Men: How Lebanon’s Debt Has Exacerbated Inequality.’ Carnegie.
 

[i] Diwan, I. and J. Haidar. 2019. ‘Do Political Connections Reduce Job Creation? Evidence from Lebanon.’ in Ishac Diwan and Adeel Malik (eds) Crony Capitalism in the Middle East – Business and Politics from Liberalization to the Arab Spring, Oxford University Press.
[ii] Atallah, S. and M. Mahmalat. 2019. ‘Tax Exemptions Would Undermine Faith in New Government’s Pledge to Reform.’ Al Akhbar.
[iii] Alesina, A., and A. Drazen. 1991. ‘Why Are Stabilizations Delayed?‘ American Economic Review.
[iv] Barakat, M. 2018. ‘Banking Industry 2017: An Analysis of Activity Performance, Risk Profile and Return Indicators.’ Bank Data. 
[v] US Commercial Service .2016. ‘Doing Business in Lebanon: 2016 Country Commercial Guide for U.S. Companies.’
 








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