Economic Research Forum (ERF)

Lebanon: sectarianism and cronyism stifle economic reform

How did Lebanon’s economy collapse – and what happens now? This column from The Washington Post outlines what you need to know.

In a nutshell

Lebanon’s government issued a comprehensive economic reform programme in April, but is largely following a policies-as-usual approach.

The new government, like previous governments, appears unable to act independently from sectarian elites who dominate economic and political decision-making.

Foreign donors face a tough choice; without their immediate support, the country could fall deeper into crisis; but if foreign money trickles in without a credible commitment to reform, the funds may offer a temporary fix – but leave Lebanon in the same situation again in the future.

Lebanon is facing its gravest economic and political crisis since the end of civil war in 1990 – and the situation was already dire before the pandemic hit. In early March, the country defaulted on $1.2 billion in foreign debt, the resulting free-fall of the Lebanese lira adding to a deep financial crisis.

Lebanon now faces a major food crisis, and a shrinking middle class. The International Monetary Fund (IMF) has indicated it is ready to help Lebanon deal with its urgent economic challenges. But the government has been slow to respond to this offer of assistance.

How did Lebanon’s economy collapse, and what happens now? Here’s what you need to know.

Sectarian politics have stifled economic reforms

The core of Lebanon’s problem lies in its division of power along sectarian lines, with a parliament that must accommodate set numbers of seats for ten recognised and other minority religious sects. The 1989 Taif Agreement ended the country’s prolonged civil war – but also entrenched a political economy that reflects these sectarian divides. This system allows competing oligarchs to turn political connections and access within government institutions into economic privileges for Lebanon’s elites, at the expense of economic policies that benefit the broader population.

Last October’s mass protests represented a widespread public pushback against this system. While the immediate trigger for these protests was a proposed tax on the WhatsApp messaging app, public grievances also included long-standing concerns about poor public services, lack of job opportunities and endemic corruption.

Lebanon’s new government, formed in January, promised to carry out structural economic reforms and ease the transition to a political system that supports transparency and accountability. But the country’s political elite has prevented the government from enacting change.

Cronyism shapes Lebanon’s economy

Lebanon’s oligarchs have little reason to welcome economic reforms, as politically connected businesses benefit from the government licences and monopolies that enrich around 43% of all large firms. The research shows this type of cronyism also means lower job creation.

This system of privileges has stayed afloat thanks to the continued inflow of foreign resources – through external aid, remittances and foreign capital attracted by high returns that the country’s influential banking sector has historically provided. As these sources of foreign capital dry up due to a loss of confidence in the banking system, Lebanon’s economy is falling like a house of cards.

Previous governments did not enact reforms

The country’s governing elites have strong incentives to promise economic reform – but as soon as an external bailout is in hand, they have every reason to renege on these commitments. Here’s why: any serious reform effort would probably undermine their political power, which is based on the distribution of public sector jobs, government licences and procurement contracts to their respective clients and electoral constituencies. For example, recent research shows 60% of the value of procurement contracts for development projects went to ten firms, many of which are linked to oligarchs.

International donors have also expressed doubts about the credibility of reform commitments made by previous governments, which did not deliver on their promises. From 2002 to 2006, the government did not succeed in undertaking necessary reforms following the Paris II Donors Conference that was convened to support Lebanon’s fledgling economy through grants and soft loans. And during the reporting period that followed the 2007 Paris III Donors Conference, the government was able to implement just 26 out of 117 specific economic reforms.

This poor track record helps to explain why the IMF, the United States and other donors hesitate to commit further funds without meaningful changes. If the IMF provides funding to Lebanon before reform implementation, some analysts predict existing economic problems will only be exacerbated, with external funding effectively serving as a bailout to Lebanon’s elites.

What happens now?

Lebanon’s government issued a comprehensive economic reform programme in April, but is largely following a policies-as-usual approach. The new government, like previous governments, appears unable to act independently from sectarian elites who dominate economic and political decision-making.

Top-level administrative and financial appointments serve as an example. The government recently appointed a physical therapist to the position of director-general of the Ministry of Economy and Trade, rather than choose someone with economics or trade qualifications. With apparently little thought about potential conflicts of interest, the government also appointed a former commercial bank employee as the government’s representative at the central bank, responsible for monitoring the commercial bank’s performance.

The government’s failure to address some of the demands from last autumn’s protests may also escalate poverty, already at an alarming rate and now exacerbated by recent restrictions on bank withdrawals. The government has yet to recover stolen public funds and implement long-due reforms of the country’s electricity sector, for instance. Other measures that might signal a commitment to economic reforms include an independent forensic audit of the central bank and all ministries, introducing transparent processes for public procurement that promote fair competition, and requiring public officeholders to disclose any business interests.

The lack of concrete reforms to date reduces Lebanon’s ability to secure IMF support. In this milieu, foreign donors face a tough choice. Without their immediate support, Lebanon could fall deeper into crisis. But if foreign money trickles in without a credible commitment to reform, the funds may offer a temporary fix – but leave Lebanon in the same situation again in the future.

This post originally appeared as ‘Why do foreign donors face a tough choice in dealing with Lebanon’s economic crisis?’ in The Monkey Cage at The Washington Post on 29 July 2020.

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