Summary :

South – MED countries are characterising by non-diversified economic structures. Some are heavily dependent on oil resources to support their economic growth and development; while others are relying disproportionately on real estate, tourism and low-value added export products. This makes them vulnerable to external economic conditions. Together with the wider geo-political situation of the region, which fuels economic uncertainty, this creates significant threats and problems, including with regard to trade deficits and the current account (external imbalances). The domestic political situation is also not conducive to economic stability. Governments in South – MED countries are rather centralised and often lack –transparent and good-quality institutions. In the economic sphere, this contributes to exacerbating budget deficits and escalating government debts (internal imbalances). In conjunction, internal and external imbalances both reflect and reinforce the inability of these economies to climb up the value-added ladder, developing more competitive products and specialisations that will help them achieve more sustainable economic growth, balanced fiscal stances and trade account surpluses.

Within this context, and largely in response to the new risks that emerged in the financial sphere, with regard to both internal and external imbalances, after the global financial crisis, government policies in the South – MED adopted – sometimes harsh – economic reform programmes as a way to stabilise their economies and manage the associated risks. Adjustment programmes, however, are socially painful and may also have adverse effects on the economy, thus increasing further the fragility of these economies and threatening a further deterioration of their external position. This raises two analytically interesting and, in policy terms, very pressing questions about, on the one hand, the extent and nature of internal and external imbalances in these countries and, on the other hand, the appropriateness of the adjustment policies that were pursued.

This study provides an extensive analysis of these issues, focusing on the case of six South – MED countries, namely Algeria, Egypt, Jordan, Lebanon, Morocco and Tunisia. It examines in detail the internal and external imbalances of these countries, over the last three decades, both descriptively (through the use of graphs) and econometrically (through time-series econometric techniques). It subsequently reviews the range of adjustment programmes, austerity policies and other macro-economic adjustment mechanisms (e.g., exchange rate policies) that were deployed in these countries to deal with the internal and external threats to stability and, by reflecting on these two lines of research, it provides useful insights about the effectiveness and appropriateness of these policy responses in addressing the problem at hand.

Stabilising economies with significant economic disadvantages and political-institutional weaknesses – let alone upgrading their comparative and competitive advantages – is not an easy task. Fiscal, financial and economic threats often combine with and reinforce each other, while on the other hand attempted policy solutions tend to be much less synergetic. For example, implementing fiscal consolidation (e.g., in order to fix a borrowing-costs or liquidity problem holding investment back) may actually reduce investment by depressing domestic demand and/or by lowering the provision of public goods that stimulate investment (e.g., infrastructure). Similarly, market and trade liberalisation policies, which are meant to increase competition and productivity and generate positive market-size effects, can often lead to a disproportionate increase in imports, thus destabilising the current account balance and, through this, perhaps also the government’s own fiscal stance. The same adverse effect may result from policies aiming at reducing currency uncertainty (e.g., to stimulate foreign direct investment) via maintaining a fixed (or pegged) exchange rate.

In recognition of this, it has come to be established in the international literature that an important pre-condition for successful policies, for both stabilisation and development, is the existence of good-governance institutions. This is of course a big challenge for countries such as those in the South – MED, which are still undergoing a transition process from economic and political centralisation to economic and political liberalisation and have relatively young democratic-capitalist institutions and relatively weak policy-making capacities. In this context, understanding the full nature of the challenges imposed by the external and domestic environment (e.g., as reflected in the values and trajectories of aggregates related to internal and external imbalances) becomes even more important as a precondition for successful and effective policy-making. The guidance that can follow from such an analysis can allow the development of a relevant and realistic policy vision and, consequently, the design and implementation of an appropriate strategy that will try to address the identified problems and achieve the targets set by policy.

As our review of the adjustment programmes and other policy measures show, the six South – MED countries studied here did not have the ability, or perhaps the time, to take such a policy approach. Threatened by fast deteriorating external and internal imbalances, in an international environment of heightened risks and uncertainty, the countries implemented rather hastily austerity programmes which combined tax increases with significant cuts in expenditures, including in price-subsidies which – in comparative terms – seem to play a large part of government policy in these economies. Under the direct or indirect advice of international financing institutions such as the IMF, the removal of price (and other) subsidies was considered as a positive measure seeking to remove distortions form the economy which block the economy’s modernisation by lowering the returns to productive investments. However, it also had negative consequences, both distributive-social (as it hurt most those who most needed the subsidies) and economic (as it depressed domestic demand). Thus, although in most of the cases stabilisation policies (i.e., policies aiming at reducing budget and current account deficits and stabilising the exchange rate) were relatively successful, the economic structures and main fundamentals of these countries remain largely the same – and, importantly, so do the overall external vulnerability of these economies and the domestic socio-economic problems of inequality and unemployment. Notably, also the general trajectories of the aggregates underpinning the internal and external positions of these countries do not seem to have changed drastically with the implementation of the adjustment programmes.

Overall, our empirical analysis presents a picture of large and persistent external imbalances, concerning the foreign debts of all countries and the net foreign asset positions of all but one (Egypt). However, and although they are broadly rather large, current account imbalances do not appear to be uniformly unsustainable across the six countries. Non-sustainability appears to characterise the cases of Algeria and Tunisia; but for countries such as Egypt and Morocco the evidence of current-account unsustainability is mixed, while for Jordan and Lebanon current account unsustainability is econometrically rejected. More importantly, internal imbalances, in the form of budget deficits and public debt, also do not seem to be an issue of major concern for the six South – MED countries. Non-sustainability in these aggregates seems to concern only Morocco and Egypt (for the fiscal balance only), while for Algeria, Lebanon and Tunisia there is only some very limited evidence of non-sustainability. Further, the causality analysis indicates that the fiscal positions are, not only broadly sustainable, but also not a cause (in a temporal sense) of external imbalances. Rather, the causality runs in the opposite direction, specifically from current account imbalances to fiscal derailments and from net foreign assets imbalances vulnerabilities destabilising government debt in the majority of cases.

Thus, although some cases do emerge, where fiscal risks became particularly heightened immediately after the global financial crisis and fiscal policy responses were relatively successful in controlling the rising deficits and debts, on the whole the analysis of internal and external sustainability presented here does not seem to justify the attention paid by many countries in the region to fiscal consolidation. Instead, emphasis on correcting currency misalignments and addressing issues of international competitiveness, exports and foreign investment appear much more relevant in relation to the identified threats to these economies. But in the longer term the critical set of policies concerns not so much the monetary or fiscal domain but rather the set of interventions that can be applied in the real economy, to strengthen the skills-base there and to push towards economic diversification towards higher added-value activities; as well as with regard to the legal and institutional system (addressing problems of corruption, public management inefficiencies, economic informality, etc).