Egypt and Saudi Arabia are embracing capitalism. Next step, democracy?

Four weeks ago, Egypt floated its currency for the first time. Markets made a swift and brutal judgment: within a week, the Egyptian pound had halved in value against the dollar. It’s nearly six years since the overthrow of Hosni Mubarak, the dictator who ruled Egypt for three decades, and three years since a military coup removed Egypt’s first democratically elected president, the Islamist Mohamed Morsi. All of these events are related. Having tried and rejected democracy, Egypt’s ruling elite are now planning to try out another Western idea: capitalism.

Egypt is not alone. Since the Arab Spring toppled dictators all over the Middle East, those rulers who survived have been scrambling to avoid a similar fate. And after relying on state handouts to quell dissent for years, the monarchy of Saudi Arabia has come to the same conclusion as Egypt’s government: meaningful economic reform is the only way to stay in power.

Both countries have undergone massive economic shocks that make the status quo unsustainable. The crash in oil prices, although triggered by Saudi Arabia, has turned a government surplus into a huge spending deficit. In Egypt, investors and tourists took fright after the revolution, removing crucial streams of cash. A quarter of the population is now below the poverty line.

These crises present existential challenges to the economic models favoured by despotic Arab regimes. Both Egyptian and Saudi governments have relied on handing out billions in food or fuel subsidies to their people every year. Two thirds of Saudis and Egyptians in the formal economy have government jobs. Many people operate in the informal economy, with no legal property rights or business licences, forced to pay bribes and contend with arbitrary and corrupt bureaucracies. The most significant national assets are under the control of government elites – the Saudi monarchy or Egyptian military. Meanwhile, birth rates are sky high, creating more mouths to feed and citizens who need jobs.

With government finances teetering, there is only one way to create those jobs: investment. But, unlike protesters, investment can’t be beaten in with a stick. It has to be lured with a carrot. That is a fundamental shift.

And so, in different ways, the governments of these two Arab countries are attempting reforms that will make themselves more attractive to capital, at home and abroad. Forty years after the nationalisation of its oil assets began, Saudi Arabia is embarking on a privatisation programme of incredible scale. It plans to raise $1.7 trillion for its national investment fund by selling off stocks of assets like airports, banks, government services in 13 ministries and even a slice of its national oil company. It has vowed to clear away administrative barriers for small businesses and grow their share of the economy. Oil, according to the crown prince leading the reforms, won’t sustain the country forever.

Egypt, in parallel, has embraced a three-year IMF programme in return for a $12 billion loan. Floating the Egyptian pound was the first step. The government has agreed to tighten monetary policy to dampen inflation, slash subsidies and the public payroll, introduce a sales tax, improve business licensing and bankruptcy law, and reform the labour market and energy sector. Egyptian MPs, meanwhile, are trying to push the government to spend more on health and education rather than handouts. The prize, if the government succeeds, is to turn a failing economy into manufacturing hub that exports energy and goods around the world.

But these reforms face enormous hurdles. Cutting government wage bills and subsidies, even if they are poorly targeted, is massively unpopular. Enshrining property rights, cracking down on corruption and controlling the arrogance of an overbearing state creates losers who will fight to keep their privileges. Conditions are going to get worse before they get better.

And none of this involves giving out political freedoms. Democracy is as far away as ever. If a large and educated middle class emerges from these economic reforms, however, the pressure for political reform will grow.

It’s bitter medicine, but Arab governments are running out of alternatives. Their established model of state domination and pervasive welfarism won’t be able to save them from revolution. Capitalism, on the other hand, might. At least for now.