Vox’s Alex Ward, when reporting on the Beirut explosion early last month, noted in passing that Lebanon’s post-civil war economic policy “was to attract investors and tourists, and bolster its services sector. After all, Lebanon wasn’t big enough to have agricultural or industrial prowess, but it did have an educated population, skilled labor, and lovely sights for foreigners to visit.”
As many commentators have noted, Beirut’s port explosion is one disaster among many currently afflicting Lebanon. Riots, a financial collapse, and a currency crisis, along with the negligence behind the explosion, exist in front of an economic backdrop that informs all of these crises.
The Beirut explosion was shocking and devastating not only because of the loss of human life, but because the decisions made by Lebanon’s leadership were so misguided that it pains one to think of what the country could have been had different decisions been made. Lebanon’s reconstruction after its 1990 civil war was the inciting incident for all of the country’s current maladies, and they stem from the belief that Lebanon must not build itself up the way economies traditionally have because, “after all,” it was small and heavily reliant on labor.
There is no guaranteed path towards successful economic development. However, it’s difficult to conclude that Lebanon had no options other than the ones it selected.
Lebanon didn’t need to trick itself into thinking that having an economy dominated by a service sector was the only way to rebuild. In fact, among the most successful East Asian countries are those who began their development with few natural resources but an abundance of unskilled labor.
The two best case studies are Taiwan and South Korea, nations which, as the late economist Gustav Ranis wrote, “typified the case of the relatively small-to medium-sized, heavily labor-surplus economy, relatively poor in natural and relatively rich in human resources.” The decisions their governments made allowed them to force their way into the international markets and rise their respective tides using protectionism, heavy-handed state intervention, and long-term thinking.
Lebanon chose to focus on making itself a regional financial and commercial center, building up its infrastructure which was destroyed in the civil war, but placing most of its emphasis on reviving banks. With no focus on domestic production, the economy soon became reliant on importing goods for their domestic market, and at least 65% of GDP is currently made up of services. The government cut taxes as a way to encourage investment, and inevitably found itself drowning in public debt; the subsequent budgetary austerity ended up discouraging investment (a remarkably consistent pattern among countries that embrace austerity).
South Korea and Taiwan, along with Hong Kong, Singapore, and Japan, chose instead to heavily invest in their manufacturing sectors. These countries’ paths of development all came after periods of serious political tumult (and devastating war, in some cases) and while international aid had a large role to play in many of their stories, they started from a much more destitute place than 1990s-era Lebanon.
Duke University sociologist Gary Gereffi writes that the East Asians’ “rapid growth was founded on light, labor-intensive industries.” Taking advantage of their wealth of labor, East Asian nations chose to shift away from staying reliant on foreign imports and replace them with domestically produced goods, starting with the simplest items (produce, minerals, oil), and then moving into items like textiles, footwear, food-processing, and consumer electronics. This is done by investing heavily in domestic manufacturing industries, which are then protected by import controls, tariffs and quotas. Manufacturing as a share of GDP skyrocketed to at least 25% in each case, with some reaching as high as 37%.
Eventually, these industries turned to exporting the goods they were previously producing for their domestic markets, flipping their balance of payments from a deficit to a surplus. Once again, they started with simpler goods and eventually progressed to exporting more technologically advanced ones.
This makes sense; for a country to continue to grow, serving their domestic market is a necessary limitation, which is why economist Christopher Ellison writes that the East Asians had “little choice” but to pursue export promotion, and political economist Tun-jen Cheng wrote that it was the “economically logical choice” for a “small, resource-poor yet labor-surplus economy.”
The Lebanese government did not make economically logical choices.
One of the benefits of pushing exports onto the world market is that it supplies the country with foreign exchange. Lebanon chose to chase foreign exchange by constantly increasing interest rates in order to attract US dollar deposits at Lebanese banks by promising higher and higher returns. This strategy, appropriately compared to a Ponzi scheme, was necessarily limited in its longevity. It further strangled the Lebanese federal budget, and has left the government to go and beg to the IMF for debt relief, along with forcing the banks to institute incredibly unpopular limits on dollar account withdrawals to protect the US dollars desperately needed to pay for imports.
It’s generally advised that interest rates either be kept low to ensure favorable terms on business loans, thereby encouraging investment, or be kept high as a means to encourage domestic savings. Lebanon did neither; it kept rates high, ensured that Lebanese banks served the government rather than local businesses, and saw its savings rate plummet since the 1990s. It appears as if the government used surgical precision to eliminate any potential benefits of its interest rate policy.
Furthermore, Lebanon’s economy has a strong laissez-faire tradition, limiting government intervention in the market and relying much more on private enterprise than other countries in a similar position. Any developing economy that chooses to prioritize this is severely limiting itself.
Ranis writes that East Asian development was facilitated by “direct government actions.” Specific industries (such as those producing for the domestic market to replace imports) are “selected for direct encouragement via public sector tax rebates, differential interest rate and export subsidies, or via enforced private sector cross-subsidization — that is, by assuring companies of continued high windfall profits in protected domestic markets in exchange for compliance with rising export targets.”
Political economist Robert Wade writes, “In textiles a whole battery of market-distorting and even market-replacing methods were used to establish the industry quickly,” including tariffs, import restrictions, controls on the entry of new producers into the market, government-run supply of raw materials, and in some cases “the buying up of all production.”
Finally, South Korea, Taiwan, and Singapore (along with a whole host of other countries outside of Asia, including France, Austria, and Finland), used government-run enterprises to build up specific industries. These institutions aren’t often permanent; rather, they’re temporary tools that are selectively applied to boost growth during a specific phase of development.
None of this is compatible with a laissez-faire approach to economic development.
Countries that did follow laissez-faire, Argentina and Chile being the two most notable examples, exist in a vastly different reality than South Korea, Taiwan, and Singapore.
As economist Rene Villarreal writes, government regulation and control of economic direction had multiple implications for Chile and Argentina: “First of all, uncertainty is created with regard to the changes in economic policy. Secondly, the productive sector is less profitable due to greater competition with foreign imports. Third, since the rise in interest rates increases the cost of capital for new investments and reduces the range of profitable projects, the only justifiable investments are marginal adjustments to plants and equipment.”
Furthermore, in the 1970s, liberalized international trade meant that cheap manufactured imports flooded domestic markets. The manufacturing sectors, which had been the initial spark that led the explosion of growth in East Asia, collapsed in Argentina and Chile.
Villarreal writes “The neoliberal monetarist model in effect was replacing the manufacturing sector with a service economy.” This is exactly where Lebanon sits today; steeped in uncertainty, few prospects for investment, a barely existent manufacturing sector, and an economy heavily reliant on its service sector.
By continuing with their interest rate Ponzi scheme, Lebanon forewent an opportunity to wean itself off of imports or use exports as a way to generate foreign capital, which would have allowed the economy and general population much more breathing room, as well as built up a domestic manufacturing base. The lack of US dollars, and subsequent decision to restrict bank deposit withdrawals, is what’s driven the riots and economic collapse that Lebanon has suffered through since last year.
There are a myriad of other factors at play in these decisions, and this piece is necessarily simplifying a very complicated process. Lengthy essays could be written exclusively focused on debt, interest rates, savings rates, or the role of the financial sector in Lebanon. Development economists readily stipulate that there is no blueprint for either destroying or strengthening an economy. But undeniable patterns exist.
Reflecting on what could have been is not what the Lebanese people need right now. But rebuilding a postwar or impoverished economy is not a unique issue for any country, continent, or time period. Economic policymakers around the globe would be wise to study this history in order to preempt the type of stagnation and distortion that comes when development is short-sighted and ill-informed.
Image credit: Peggy Choucair