A framework for understanding Tunisia’s economic crisis

The Arab Spring started in 2010-11 in Tunisia and until now Tunisia has been highlighted as basically the only country, where the Arab Spring has not ended in disaster. Unfortunately over the last couple of days social unrest and violent confrontation between demonstrators and police have erupted across Tunisia.

I this blog post I will have a look at the Tunisian economy and try to give my take on what is wrong with the economy. There is of course a lot of ground to cover and I can naturally not cover it all in one blog post, but I will try provide an overall framework for how to understand the economic situation in Tunisia.

The economy has been in crisis since 2011

A look at real GDP growth in Tunisia shows that the economy essentially has been suffering since the outbreak of the Arab Spring in 2010-11.

tunisia-gdp-growth

Prior to 2011 real GDP growth was averaging 4-5% a year – not very impressive given the high growth rate of the labour force and compared to for example Turkey, but nonetheless fairly robust and stable growth.

However, during the 2011 revolution GDP drop in around 2% and after initially recovering in 2011-12 growth have once against slowed significantly and as a consequence the level of real GDP today is more or less unchanged compared to early 2011.

It is hard not to see the latest social unrest and demonstrations in the light of this lackluster economic performance.

AS/AD – a framework for analyzing the crisis

Whenever I want to analyse the economic situation in any country in the world I find it very useful to start out with a simple AS/AD framework. I particularly like the AS/AD framework described in Tyler Cowen and Alex Tabarrok‘s textbook Modern Principles.

This gives us the possibility to think of three kind of shocks to the economy – An Aggregate Demand (AD) shock (essentially a monetary demand shock), a short-run Aggregate Supply (SRAS) shock and a shock to the long-term growth rate of the economy (this is also supply shock). Cowen and Tabarrok terms the long-term growth rate the Solow growth rate after Robert Solow’s famous growth model.

ASAD framework

We can relatively easily apply this model to the Tunisian economy and by looking at the development in inflation and real GDP we can assess whether the development in the economy is driven by supply shocks or demand (monetary) shocks.

Don’t blame monetary policy for the crisis

If the economy is hit by a negative demand shock – either a contraction in the money supply/base or a drop in money-velocity – the AD curve shifts to the left causing both inflation and real GDP to drop and hence therefore also nominal GDP to drop.

The graph below shows the development in real GDP (y), nominal GDP (y+p) and the GDP deflator (p) in Tunisia.

RGDP NGDP P

The graph shows that over the past 15 years nominal GDP growth has been relatively stable about 8% and even though there was a slowdown in nominal GDP growth in the period 2008-11 we have since seen a rebound in NGDP growth back to the old trend about 8%, which indicates that there has not been a major negative demand shock to the Tunisian economy.

This is further confirmed by the fact that inflation – measured by the GDP deflator – has in fact shifted upwards since 2010-11. If there had been a negative shock to aggregate demand (AD) we would have expected inflation to drop rather than to increase.

This all indicate that the we cannot blame the the present crisis on monetary policy failure and in fact the Tunisian central bank deserves some credit for – knowingly or not – to have kept nominal GDP on a pretty “straight line”, which in my view certainly is the preferable monetary policy.

NGDP trend

This obviously does not mean that monetary policy is perfect – far from it – and I certainly think that monetary reform is badly needed to ensure that monetary policy failure is avoided in the future, but at least over the past 15 years the Tunisian central bank very broadly speaking has got it more or less right.

The biggest risk as I see it now is that the central bank will be tempted to focus on inflation rather than nominal GDP growth and that that might cause the Tunisian central bank to tighten monetary conditions unduly in response to rise inflation caused by non-monetary factors (a negative supply shock).

The best away of avoiding this is to communicate and explicitly target nominal GDP growth at 8% as de facto has been the policy for the past 15 years. Alternatively the central bank could target nominal wage growth as a proxy for NGDP growth.

The real problem is a real problem

As the discussion above slows the main problem in the Tunisian economy right now is not a lack of demand and monetary policy failure cannot be blamed for the marked slowdown in growth particularly since 2011 and the crisis can therefore not be resolved through an easing of monetary conditions.

As a consequence we have to conclude that the problem is one of real factors (the supply side of the economy) rather than nominal factors (monetary conditions).

The question is, however, whether the the slowdown in growth is permanent or temporary. Said in another way has the crisis been caused by a shift to the left of the Short-run Aggregate Supply (SRAS) or is it rather the Solow growth curve, which has shifted to leftwards?

Whether it is the SRAS curve or the Solow growth curve, which has shifted leftwards does matter in terms of the impact on the economy presently, but only a shift in the Solow growth curve should be expected to cause a permanent decline in the long-term growth rate of the Tunisian economy. Below I will argue that it is a bit of both, but that it likely is short-term shocks that has dominated in the last couple of years.

The horrors of terror 

Tunisia has been hard hit by a number of terror attacks in recent years and particularly in 2015 a number of horrible terror attacks hit Tunisia.

One can think of a terror attack both as a demand shock and a supply shock. Hence, it is obvious that a terror attack will tend to scare tourists away and this is certainly also what we have seen.

This obviously is a negative demand shock. However, as we have seen above the Tunisian central bank has more or less kept nominal GDP growth on a 8% growth path. This means that any drop in tourism revenues will be compensated by higher demand growth other places in the economy. This essentially is a version of the so-called Sumner Critique, which says that if a central banks targets nominal GDP or inflation then it will keep aggregate demand growth stable and this will offset other shocks to aggregate demand.

Obviously Tunisian nominal GDP growth has not been completely stable at 8% and we have indeed seen a drop in NGDP growth over the past year, which do indicate some contraction in aggregate demand growth, which could indicate that the Tunisian central bank has not fully offset the shock to aggregate demand from the drop in tourism revenues, however, if the Tunisian central bank – hopefully – continues de facto to target 8% NGDP the effect on aggregate demand from the tourist attacks should prove to be short-lived.

More worryingly is, however, the fact that the threat of new terror attacks and more generally speaking the rise of islamist extremism is causing a more permanent increase in the cost of doing business in Tunisia.

It is hard to quantify just how big these effects are, but it is notable that real GDP slowed from around 2% to 0% during 2015 so the effects have certainly not been small. Whether they are permanent is another question.

The untold story of the ‘Phosphate Crisis’

When I started to think about the slowdown in the Tunisian economy I initially thought that it mostly was about the terror attracts in 2015 and I was unaware of something, which in reality is at least as important – namely what we could term the ‘Phosphate Crisis’.

This is from an article from Al-Monitor from May 2013:

While phosphate is a pillar of the Tunisian economy, it also represents a social time bomb that nearly ousted the regime of former President Zine El Abidine Ben Ali in 2008, when the residents of the mining basin in southwestern Tunisia rose in rebellion, demanding their rights to employment, development and equitable distribution of wealth. Post-2011, protests paralyzing phosphate production became so rampant that the government announced in April the suspension of negotiations with the protesters. It also began a mass media campaign to explain the “phosphate crisis,” stressing these statistics:

The struggles faced by Tunisia’s economy following its 2011 popular uprising have been exacerbated by a decrease in phosphate production, one of the country’s most lucrative resources.
  • Production fell from 8 million metric tons a year to 2.7 million metric tons in 2012.
  • Financial losses reached 3 million dinars ($1.82 million) a day, amounting to a loss of nearly 2 billion dinars ($1.22 billion) in 2011 and 2012.
  • The phosphate company’s workforce tripled from 9,000 to 27,000 workers over the course of three years.

The government even went so far as to threaten to shut down the Gafsa Phosphate Co. The threat baffled [Tunisians], as the company serves as the only operator in mining basin cities and because phosphate is considered a significant source of hard currency in the country. Additionally, the government is currently experiencing several crises of its own, so this sort of escalation would not balance in its favor. Is the threat a political maneuver or an official admission of failure? If the latter is true, does the admission pave the way for the state to give up on “reforms” in the phosphate sector?

Even though the official rhetoric considers the Jan. 14, 2011, Revolution, which toppled Ben Ali, a societal revolution whose flame has been sparked inside the mining sector, all of the post-revolution governments have only shallowly looked into the problem, resulting in the adoption of ineffective administrative solutions.

The government regards the “phosphate crisis” as a mere blip in the flow of production caused by protests that are first and foremost demanding employment. Through the lens of the government, the crisis is temporary, isolated, and related to a lax security and social situation. Some officials even believe that the crisis has “separatist” aspects, and is even a political conspiracy fomented by “extremists who aim to sabotage the economy for political purposes.”

While this is from a 2013 article the crisis continues to this day. Just have a look at this graph of the output in the Tunisian mining sector.

tunisia-gdp-from-mining

Hence, mining output dropped sharply in 2011 and has remained more than 30% lower since then. This obviously is a major negative supply shock to the Tunisian economy and it seems of outmost importance to solve this crisis to get the Tunisian economy out of this crisis.

Corruption is just getting worse and worse

At the core of the protests in 2011 was anger over the widespread corruption in Tunisia and corruption remains a main problem for the Tunisian economy and it is certainly something, which is causing long-term growth to be lower than it could be been (permanently shifting the Solow curve to the left).

The graph below illustrates this.

tunisia-corruption-index@2x

The graph shows Transparency International’s so-called Corruption Perception Index. A lower score in the index indicates more corruption. The development is far from uplifting. In fact of nearly 15 years corruption has been constantly rising in Tunisia as seen by the consistent drop in the Corruption Perception Index.

And the business environment has become less friendly

Another factor that is contributing to shifting the Solow growth curve to the left – permanently lowering real GDP growth – is the fact that despite of the democratic revolution in Tunisia the general business environment has become less friendly.

A way to illustrate this is to look at the World Bank’s Ease of Doing Business survey.

tunisia-ease-of-doing-business@2x

A rise in the index indicates a worsening of the general ‘ease of doing business’ in Tunisia. The picture since 2010 is clear – the business environment has become less friendly in Tunisia. This surely is something, which is lowering Tunisia’s lower term growth potential.

A similarly negative trend is seen in for example Fraser Institute’s Economic Freedom of the World survey, where Tunisia’s overall ranking also have been declining in recent years.

Conclusion – reform is needed to unleash Tunisia’s economic potential

Tunisia is in the midst of a serious political, social and economic crisis. In this blog post I have tried to give an overview of what I believe are the main causes of the economic crisis.

Based on this analysis I would like to offer the following general recommendations for reform and crisis resolution in Tunisia:

  1. Despite the fact that the that Tunisia monetary policy overall has been successful in maintaining nominal stability in the past 15 years monetary reform is needed to ensure that nominal stability is also maintained in the future. A starting point for reform should be to the succes of monetary policy in the past 15 years – that means any new regime should continue to ensure nominal GDP growth around 8%. That would also ensure low and stable inflation in the future.
  2. The threat from terrorism and extremism should to be reduced. That is partly a question of law enforcement, but much more likely it is of outmost importance to empower low-income Tunisians so they to a larger extent are in control of their economic and social destiny and to create economic opportunties for all Tunisians. Other than general economic reform I also think that Tunisians should be given direct ownership of Tunisia’s many government owned companies for example through a Citizen’s account framework.
  3. Bold steps are needed to end the crisis in the Tunisian mining sector. Here privatization of the mining sector should be at the core of these efforts.
  4. Long-term economic growth needs to be increased through massive structural reforms with the purpose to reducing government intervention in the economy and empowering the Tunisian population.

Overall, I think Tunisia has an enormous economic potential – the country has a young and growing population, relatively low public debt, a historical and geographical closeness to (Southern) Europe and by Northern African standards a relatively open economy and access to (some) natural resources.

However, Tunisia cannot unleash this potential without reforms. We have had political revolution – now we need an economic revolution to free up the Tunisian economy.

—-

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

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3 Comments

  1. Economic indicators reflecting Tunisia economic challenges | Tunisia: News in English Picked by Jonathan Widell
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  3. My take on last week’s protests in Tunisia | Tunisia: News in English Picked by Jonathan Widell

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