Democracy Lab

Go Big or Go Home

Eastern Europe's lesson for the countries of the Arab Spring: economic reform is best served quickly.

In January 1977, Egypt's then-President Anwar Sadat announced a modest reform of the country's consumer subsidy programs. The government planned to reduce subsidies on items like rice, tea, cigarettes, gasoline and others, while preserving the artificially low prices on staples like bread, lentils, beans or cooking oil. The attempted reform led to riots, mostly in Cairo and Alexandria, causing around 70 deaths and injuring hundreds more. In response, the government canceled the reform plans and increased its spending on subsidies.

Since then, Egypt has attempted to reform subsidy programs in the early 1980s, 1990s, and in the second half of the 2000s. However, as of 2013, one third of government spending is still directed toward subsidy spending, pulling the country into a fiscal abyss. Perhaps because of the inflow of aid from the Gulf, the new finance minister, Ahmed Galal, affirmed that he is not planning to go beyond the announced gradual tweaks to the subsidy system, such as the introduction of smart cards for certain types of fuels.

Failed subsidy reforms in Egypt, Morocco, or Jordan are symptomatic of deeper problems plaguing essentially any area of economic policymaking in turbulent political environments. The pattern is always the same. Because of economic pressures, a modest reform is announced, and sometimes implemented, but it is later reversed. When the situation becomes unsustainable again, another attempt is made, alleviating the immediate pressure, yet leading to another reform reversal down the road.

This pattern damages the credibility of further reforms. If people realize that all policy changes are temporary, then even a sincere reformer who tries to implement a permanent change is not going to be taken seriously.

This trend is in direct contrast to the experience of Eastern European countries following the fall of communism. In early 1991, 95 percent of all consumer prices in Czechoslovakia were liberalized, never to be re-regulated again. A dominant part of the economy was transferred to private hands within a year or two, and although the fairness of the privatization was sometimes contested, no one has ever seriously considered a renationalization of any part of the economy.

Or, to take a more recent example, when the global financial crisis of 2009 hit the Baltic states, governments reacted by deploying a combination of severe spending cuts and far-reaching structural reforms. The size of the fiscal adjustment was staggering. In Latvia alone -- which fired one third of its civil servants -- the fiscal contraction was equal to over 11 per cent of GDP in just one year. Yet the policies showed results quickly as the Baltic economies rebounded and started growing at a remarkable pace -- in sharp contrast to countries on Eurozone's Mediterranean periphery, which were similarly affected by the crisis but have ended up being caught in a vicious circle of bailouts and half-hearted, fragile reforms.

To economists and political scientists, these contrasting patterns are not particularly surprising. Pro-market economic reforms survive and are effective if they are seen as credible by the population. A problem arises when the public does not trust the promises policymakers make when it comes to reform. This is particularly true during transitions or in difficult political environments in which voters lack effective means to punish politicians who renege on their promises. But how can serious reformers in such environments overcome the problem of a lack of credibility?

In a classic paper, Harvard University economist Dani Rodrik showed that one such method was "overshooting" -- i.e., making the reform more radical, farther-reaching, and quicker than necessary. By being willing to go the extra mile, the reformers can send a signal to the population that they are truly serious about systemic change. In contrast, politicians who opt for the easy way out and do the bare minimum required by a crisis situation are signaling to the public that they do not really care.

The idea that overshooting can overcome the problem of a lack of credibility has become influential in academic circles. Its rise to prominence was facilitated by the experience of Eastern Europe, where radical reform strategies led to better outcomes than partial or gradual reforms, contrary to the initial predictions of many economists who believed that gradual and carefully planned piecemeal change would outperform the necessarily messy 'big-bang' solutions.

Peter Boettke, an economist at George Mason University, writes that "the former Soviet economy has been in a state of perpetual economic crisis since 1917. One reform measure after another was introduced only to be reversed within a few years." After the short-lived economic reforms of in the 1920s, 1950s, 1960s, and 1980s, the liberalization program announced by Russian government in 1991 was received with incredulity. Russians had no way of telling whether it represented a genuine attempt at dismantling the planned economy or whether it was yet another in the series of reform gimmicks routinely seen in Soviet Russia.

The substance of reforms was not particularly reassuring either. Price regulations on consumer staples were maintained, but were only delegated to local governments. That undermined the effects of the intended price liberalization. And instead of prudent macroeconomic policies, in an attempt to address the debt problems of state-owned enterprises, the Russian central bank orchestrated a hyperinflation, effectively stalling enterprise reform in the country.

In the early 1990s, to overcome the general distrust that ordinary Russians had in their government, reformers would have had to pursue economic reforms in a way that left no doubt about their intentions, like Vaclav Klaus and Leszek Balcerowicz in Czechoslovakia and Poland respectively. Russian reformers of the early 1990s -- much like the policymakers in the Middle East -- failed to do that.

Besides sending a signal of credibility, all encompassing reforms lead to more stable outcomes than partial reforms which are easier to reverse. The transitional economies of Central Europe proceeded with reform of their pension systems, starting with Hungary in 1998, Poland in 1999, and Slovakia in 2005. All three opted for a combination of the existing pay-as-you-go scheme and private savings accounts.

When the crisis hit later in the 2000s, governments were under pressure to consolidate public finances, and the temptation to seize the assets of private pension funds grew. In 2010, the Hungarian government effectively raided private pension funds. In Poland, a renationalization of private pensions is currently under discussion. Last year in Slovakia, the government reduced the ratio of contributions to private pension funds, thereby increasing the revenue of the government-run pay-as-you-go scheme.

However, such a scenario was avoided in the country that pioneered private pensions in 1980: Chile. Though Chile has experienced a series of center-left governments over the past twenty years, the private pension system put in place by José Piñera is still running, largely unchanged. The key difference between the Chile and Central Europe cases lies in the fact that Chilean reformers privatized pensions fully, leaving no role for government other than a backstop for people who have not been able to save for themselves for whatever reason.

This insight is directly relevant to the reform challenges facing Arab countries. The current Egyptian government, for example, favors a gradual elimination of subsidies. However, such gradual moves were tried -- and failed -- many times before. Therefore, if a reform of Egypt's unsustainable system of price subsidies of fuels and food is to occur at all, it will need to be rapid and all-encompassing -- as I argue in a forthcoming Cato paper, Solving Egypt's Subsidy Problem.  

At the present time, one does not see a lot of reform momentum in the Arab Spring countries in spite of their mounting economic problems. These range from an unsustainable state of public finances to byzantine regulation and omnipresent corruption, which all cripple market competition and keep large segments of their populations in poverty. But when the time to undertake economic reforms comes, reform design will be as important as the political willingness to undertake them. Unless potential Arab reformers can convince their electorates that they are serious about putting in place institutions and policies conducive to economic prosperity by introducing far-reaching systemic changes, Arab countries will continue to muddle through, from one crisis to another.

SAID KHATIB/AFP/Getty Images

Democracy Lab

One Size Does Not Fit All

Why it's best to use every tool in the toolbox when it comes to democracy assistance.

In her FP article "Reforming the Democracy Bureaucracy," Melinda Haring describes U.S. democracy assistance as "a giant mess" and "in desperate need of reform." She bases her claim on a critique of programs in authoritarian countries, like Azerbaijan, that are implemented by for-profit development contractors and U.S.-based nonprofits like the National Democratic Institute (NDI).

Instead, Haring says that small grants from the National Endowment for Democracy (NED) to local pro-democracy groups should be the only form of U.S. assistance in authoritarian countries. She defines authoritarian as any country that the 2013 Freedom in the World index from Freedom House ranks as "not free."

It's an attractive idea. We all love democracy and hate dictators. Let's stop messing around with the oppressors and just fund the opposition activists. And let's cut out the middleman while we're at it.

The problem is that Haring forgets to ask the most basic and important question: What kinds of programs and strategies have worked in the past and are likely to work in the future? She offers some assertions to support her NED-only approach.

The evidence tells a different story. Out of the 195 countries and 14 territories on that Freedom House index, 35 countries made a transition from "not free" to "partly free" or "free" at some point between 1993 and 2012. These 35 include some significant and strategic successes for democracy promotion, such as Liberia, Indonesia, Pakistan, Nigeria, and Uganda.

In most of those 35 countries there was substantial U.S. democracy assistance during the time that they qualified as "not free." It was provided through a variety of different mechanisms and organizations: there were NED grants, political party programs, election observers, for-profit contractors, and others -- exactly the kind of messy assistance strategy that Haring wants to eliminate.

Of course, there are no permanent and unambiguous successes in democracy assistance. Some countries slipped back to "not free." Only two, Indonesia and Yugoslavia/Serbia, have made it all the way to "free."

It's impossible to definitively say what kinds of assistance played what role in these transitions. But would the results have been better if, as Haring proposes, NED support to local NGOs had been the only form of U.S. assistance? Would the transitions have been more sustainable? Would there now be more countries in the "free" category?

Even after three decades of research and experience with democracy transitions and assistance, there are not many areas of consensus. Francis Fukuyama emphasizes institutions, Fareed Zakaria highlights rule of law, and George Soros puts his money (literally) on civil society. The one thing that just about everyone would agree on, however, is that the outcomes never depend on a single factor. Michael McFaul, an academic specialist (and former NDI staffer) in democracy promotion now serving as the U.S. ambassador to Moscow, has said: "There is not one story line or a single model. There are many paths to democratic transitions and most of them are messy."

If Haring reads the evidence differently, she should say so, but even her own sources disagree with her. The article she cites by Tom Melia that coined the term "democracy bureaucracy" concludes that "pluralism in the promotion of political pluralism is a good thing" and "there is clear value associated with this diversity [among many specialized NGOs, competing USG agencies, offices and budgets], as mission-focused NGOs address complementary aspects of democratization, and different funders perceive complementary opportunities."

Another problem with the NED-only rule is that we can't wait until a country gets the Freedom House seal of approval to begin planning and implementing the assistance it will need after the transition. What happens after a democratic transition is just as important as what happens before it, but, as Francis Fukuyama recently wrote, "everyone is interested in studying political institutions that limit or check power -- democratic accountability and rule of law -- but very few people pay attention to the institution that accumulates and uses power, the state."

That's natural. Democratic revolutions are thrilling, exciting, dramatic events featuring photogenic activists battling the police on city streets and squares. Building a state is a drawn-out slog starring morally ambiguous government functionaries under flickering lights in dingy buildings. Being part of a democratic revolution is like falling in love. Governance is more like trying to make an arranged marriage work.

NED programs are not enough to lay the groundwork for that kind of work. For example: Kyrgyzstan was rated as "not free" in 2010, but in March of that year a new, democratic government appealed to the United States for support with elections and governance. USAID's response drew on diverse set of resources and experience who were already in place, including NDI, election support groups, and for-profit contractors. That would not have been possible if NED had been the only resource. Kyrgyzstan still has plenty of issues and no program is perfect, but overall that assistance was successful and effective. (Disclosure: I helped design USAID's legislative strengthening program in Kyrgyzstan at that time.)

Haring says the United States should follow the example of small East European countries that "put most of their money into Georgia, Moldova, Serbia and Ukraine, all countries where change is either underway or feasible." But her own sources suggest that these donors also support Belarus, which is emphatically "not free" by any measure.

In any case, the U.S. has strategic, political and economic interests vastly more complex than a country like Poland or the Czech Republic. Our democracy assistance programs have to reflect that complexity. If Haring's rule applied, there would be no substantial U.S. democracy assistance in the 47 countries around the world that Freedom House ranks as "not free." These include Afghanistan, Burma, the Democratic Republic of the Congo (DRC), Ethiopia, Iraq, Jordan, Rwanda, and Tibet.  

I've seen many of those programs first-hand. I even worked on the program in Azerbaijan that Haring criticizes. There are countless inefficiencies and problems. But throwing out all but one type of assistance won't fix those problems and won't move those countries any closer to democracy and good governance.

There are many points on which Haring and I would agree.  For example, her longer paper on democracy assistance attacks "cookie-cutter programs that [do] not take into account a country's specific circumstances or incentive structure..." and recounts her frustration with democracy specialists who care more about bureaucratic politics than democratic change. Absolutely right. But her own proposal also imposes one solution on all countries. And the NED -- for all its strengths -- plays the same bureaucratic games as everyone else.

More fundamentally, Haring is absolutely right that democracy assistance is central to America's values, to our interests and to our security. But in a complex world, where progress toward democracy and better government are fragile and rare, we are more likely to accomplish our goals if we have more tools and strategies at our disposal, not fewer.

Soe Than WIN/AFP/Getty Images