Lebanon: A Broken Country — Macroeconomic Overview and Crisis Analysis
Abstract
The state of Lebanon, located in the levant region of the Middle East, is undergoing one of the world’s worst economic collapses since the 1800s. Plagued with war, political instability, violent sectarianism, corruption, mismanagement, and foreign intervention since the Civil War outbreak in 1975, the country has seen deep economic fluctuations time and time again. The post-1990 Civil War recovery period was short-lived, as the economy endured many business cycle interruptions due to various impactful events coupled with severe corruption and mismanagement of fiscal policy, monetary policy, debt, trade, and banking. Fast-forward to today, and Lebanon is ranked the fourth most miserable country in the world due to its collapse, according to the economic misery index. Despite grim current conditions, Lebanon’s economic problems are simple to reform, but only with necessary political changes to eradicate corruption. If this can be done, the country has hopes of recovery to higher levels than before.
Introduction
Lebanon is a small country in comparison to others in the Middle East. Interestingly, since 2019, the country has experienced many economic crises including a banking collapse, liquidity crisis, sovereign default, and the destruction of its main port. These crises along with previous struggles due to the Syrian War has led to Lebanon becoming the third most indebted country in the world. The country has a strong laissez-faire economy tradition. Lebanon’s major economic sectors are metal products, banking, agriculture, chemical production, and transport equipment. The most growth comes from the banking and tourism sectors of the economy.
Natural Resources
Lebanon has an incredibly beautiful natural environment. However, unregulated development and exploitation has ruined some of these natural elements. The Mediterranean Sea hosts cities, suburbs, and some banana, citrus, and olive groves. Mountains are located 20 miles inland with impressive terraces and cultivation. The famous pines of Lebanon are now more sparsely populated in small groves. The country experiences long summers with temperatures rarely exceeding 90 degrees fahrenheit, short fall and spring seasons, and mild winters. Majority of the rainfall comes in December through March. The most abundant natural resources are limestone, iron ore, salt, water-surplus state in a water-deficit region, and arable land. There are natural hazards like sandstorms and dust storms. There are environmental concerns such as deforestation, soil erosion, air pollution in Beirut from vehicle traffic and burning of industrial waste, and pollution of coastal waters from oil spills and sewage.
Historical Context
The 1975–90 Civil War was detrimental to Lebanon’s economic infrastructure. It cut national output by one half and ruined Lebanon’s position as the Middle Eastern banking hub. Conflict among Lebanon’s Christian and Muslim populations was exacerbated by socioeconomic disparities and the Palestinian Liberation Organization (PLO). Muslims supported PLO and wanted political power while Christians opposed PLO and sought to maintain political dominance.
Lebanon became divided; Christians held power in the north and Muslims in the south. Israel and Syria intervened, the PLO was forced out, and the Arab League mediated a peace deal. Following the civil war, Lebanon rebuilt much of its infrastructure by borrowing heavily from mostly domestic banks which left the country with a large burden of debt. Many of the economic reform pledges during the 2000s have gone unfulfilled. Conflict within Syria has led to a major market being cut off and a large influx of refugees that has led to increased social tensions and more competition for low-skill jobs and public services.
Demographics
Lebanon has a population of 6,695,544 people. The country has experienced a great population increase since the 1980s growing from 3 million to approximately 7 million in 2020. The median age of the Lebanese population is at 29.6 years in 2022, with a total life expectancy of approximately 77.8 years of age. The unemployment rate is 14.5% (although likely much higher due to the recent economic crisis and a lack of good census techniques — some statistics say ~30% as of January 2022). The official language of Lebanon is Arabic, but recognized languages include French, English, and Armenian. The Muslim population is 54% of the total population with the Christian taking 40.5%. The remaining religions consist mostly of Druze.
Inflation & Interest Rates
Along with political corruption, the outbreak of Covid-19, and the explosion in Beirut, the inflation rate in Lebanon has risen sharply. In 2020, the average inflation rate in Lebanon amounted to about 84.86 percent compared to the previous year. A record year-on-year high inflation rate of 224.39 percent was measured in December 2021 (World Bank). Lebanon’s inflation has skyrocketed in the past two years as the country’s financial and economic crisis spiraled out of control, with politicians doing very little to mitigate its impact. The currency has lost approximately 98% of its value and plunged three quarters of residents into poverty. In response to such a situation, the Lebanese government increased the interest rate to 13% in 2020. Such high interest rates could help Lebanon attract investment. However, Lebanon reduced interest rates after 2021 in order to spur economic activity and ease the burden on public finances.
Prior to 2019, the Lebanese Pound/USD rate was 1,500. As of February 17, 2023, it sits at 81,000 Lebanese Pounds/USD.
Consumption
During the inflation, the Lebanese minimum wage did not change; with currency devaluation, Lebanese income and wealth decreased respectively. The decrease in income and wealth lead to low consumption after 2020. Besides, as inflation maintains a high level, and high levels of corruption and political chaos, people’s confidence about the future is low, which also causes low consumption. According to the World Bank, the final consumption expenditures dropped from $72.44 trillion in 2018 to $56.94 trillion in 2020, and this trend is continuing. Consumption and overall economic activity is in free-fall.
Agriculture and Industrial Sectors
As the two most important sectors of the Lebanese economy besides tourism and banking, agriculture and industry have also declined significantly in the past two years. In addition to primary agriculture production, the sector is a key contributor to Lebanon’s important agri-food industry which contributes an additional 5 percent of GDP and constitutes a major and growing employer in the economy. Despite having the highest proportion of arable land in the Arab world with more than 200,000 hectares (494,000 acres), Lebanon’s own agricultural sector has gone underfunded and underdeveloped for many years, hindered by a lack of modern equipment and inefficient production techniques. According to data from the World Bank, the rural population decreased from 13 percent in 2011 to about 10 percent in 2020 due to the economic crisis impacting agriculture.
Productivity and Manufacturing Growth Rate
The political instability and economic decline of Lebanon has led to key indicators showing the decline of productivity, as well as manufacturing. To begin, the productivity growth rate of a country can be indicated through the unemployment rate.
According to the Economist Intelligence Unit, unemployment rates were as high as 25% in 2021. Evidently, the sharp hike in unemployment rates from 2018 to 2021 indicate that the productivity growth rate of Lebanon was in fact negative. This situation has since deteriorated since May 2022, when the Lebanese presidential elections failed to elect a new president. As of now, the country’s presidential seat is still vacant, which has stifled foreign investment and support from the International Monetary Fund. Thus, productivity rate and unemployment has likely declined more since 2021.
Apart from the productivity growth rate, Lebanon’s manufacturing sector has experienced instability as well. From the economic instability, as well as the reduction of Beirut’s port operations, net imports are higher than net exports. According to an article written by Bloomberg in 2021, the Beirut Port still lacks proper reconstruction and only currently operates at a fraction of its previous capacity due to failing machinery and lack of funds to rebuild (Bloomberg). Until political stability arrives in Lebanon, the allocation of funds to support manufacturing exports for the country will not exist. Therefore, the manufacturing growth rate has fallen and will continue to fall in Lebanon until political and economic stability are restored.
Capital Market Dynamics, Foreign Exchange Rate, and Current Account Component of Payment of Balances
As of early May 2022, Lebanon’s economic structure, foreign economic power, and governmental structure are in extreme disarray. The hopes for economic prosperity rely on the end of governmental and bureaucratic gridlock, in addition to the IMF’s program agreement, which was originally set to occur in late 2022 contingent on Lebanon electing a new president. Although the country is still experiencing a presidential vacancy, Lebanon’s prime minister says an IMF bailout is a possibility.
Currently, Lebanon’s capital market dynamics experience high fluctuations and a lack of stability due to the currency crisis and lack of cash flow in the economy. For example, Lebanon’s foreign exchange reserves are almost nearly depleted, resulting in higher inflationary pressures on the Lebanese Pound. Due to a decrease in supply, the capital market dynamics for Lebanon indicate extremely high demands for foreign investments and funds. However, due to a lack of international funding and the country’s high debt to GDP ratio, the financial sector of Lebanon is isolated from a majority of potential funds due to the high risk the economy poses.
For example, the current foreign exchange regime of Lebanon has been the Peg foreign exchange regime, where a fixed currency price is denoted and attached to a foreign currency. For Lebanon’s case, the Lebanese lira (LBP), is pegged to the U.S. dollar at an exchange rate of 15,000 LBP per U.S. dollar (1,500 LBP/USD was the rate for decades prior to 2019). However, the staggering currency crisis and hyperinflation has resulted in secondary markets selling U.S. dollars for up to 81,000 LBP per U.S. dollar.
Indicative of the hyperinflation experienced from 2019 to 2023, the foreign exchange rate of Lebanon has skyrocketed throughout the past few years of up to 5,400%. While the foreign exchange regime dictates a determined, set price on the LBP, secondary markets drastically differ for those who wish to purchase foreign currency.
Lastly, Lebanon’s current account component of payment of balances remains at high risk due to the deficit currently faced. Reported in 2020, Lebanon’s current account showed a deficit of 2.96 billion dollars, indicating a lack of domestic power and an increase of foreign power over the economy. Furthermore, due to the fixed exchange rate of the foreign exchange regime, the deficit is indicative of a lack of competitiveness of Lebanon compared to the rest of the world’s economies. Ultimately, due to the currency crisis, Lebanon’s capital market dynamics, foreign exchange rates and regime, and current account component of payment of balances results in high uncertainty and risk for the economic status of the country.
Business Cycles
Since Lebanon is a small country which is heavily dependent on foreign investment, outside tourism, and expat remittances (money sent from Lebanese living abroad), its traditional business cycles are heavily influenced, and almost cyclically trending, with remittance sending/investing countries in Europe and the United States. While this is true during normal times, Lebanon’s history of political instability and war has actually influenced its business cycles the greatest, as ongoing events impact consumption, saving, foreign investment, etc. For example, the 2005 Syrian occupation protests and 2006 Hezbollah war with Israel caused a drop in GDP growth, as seen in the chart below. It is also evident that the current economic crisis, spurred by political corruption and instability, entails a massive drop in GDP growth as well.
Thus, Lebanon is currently experiencing an unnatural but severe economic contraction due to ongoing political and monetary issues in the country, which will be discussed later. This shows that, although Lebanon has correlation with business cycles of large western countries, its issues are more of a driving factor. Many believe that a recovery from the current recession will not be likely until after the next round of elections and important reforms to fix the economic crisis.
Great Recession and COVID-19 Pandemic
Unlike the rest of the world, Lebanon did not experience much GDP decline during the great recession, which correlates with the positive prospects of 2005 independence from the Syrian occupation and post-Israel-Hezbollah war recovery.
An economic crisis that began in 2019 was heavily exacerbated by the COVID-19 pandemic, which was one of the recent decline’s factors. The crisis, which will be explained later, was actually caused by deeper underlying political and economic problems, but the pandemic added to the already severe collapse. From 2019 to 2021, Lebanon saw a 50% decline in GDP, from approximately 50 billion to below 25 billion (World Bank).
Lebanon’s Current Economic Crisis
The corrupt, post-civil war, and sectarian political system caused a twenty year spree of heavy borrowing by the state. For the past twenty years, the government has maintained a severe budget deficit and public debt, and the Debt to GDP ratio has consistently remained above 130%.
Interest payments for these pre-existing debts, alone, account for 50% of Lebanon’s budget, not leaving much room for other spending. As a result, the country had to borrow more to keep up its expenditures, resulting in more debt to pay off.
The Lebanese government Central Bank borrows money from Lebanon’s large private banking sector, which boasts assets 440% of Lebanon’s GDP. This is a consequence of attractive secretive banking laws and a large diaspora of wealthy expats sending remittances back home. Interestingly enough, banks have lent 70% of their assets to the state. They did so for high interest rates that the central bank had little chance of ever repaying, and both parties knew about this. This mismanagement of the banking system and irresponsibility on both ends is what eventually caused a sovereign default in March of 2020 — the government could not keep paying off its debts, and people no longer wanted to leave their money in the private banks that were lending such a large majority of their assets to a faulty government. As a result, a slowdown of investment and saving in the banking sector and country overall led to the dollar shortage, which eventually caused the currency crisis.
This system is in essence a massive, governmental ponzi-scheme. The central bank attracted lending dollars to finance old debt repayments by offering exorbitant interest rates to lenders (including the private banking sector). Since they couldn’t pay back these interest rates, they had to borrow more to keep going, generating even more debt — a default was inevitable. In turn, the banking sector lended so much to the government because many politicians and bankleaders cooperated to steal money out of the whole cycle (45% of private banks in Lebanon are owned by politicians or their acquaintances).
Another aspect of the Lebanese economic crisis is the currency crisis. Lebanon has been a highly dollarized country because it uses USD as a reserve currency and there is low confidence in the Lebanese Pound (LBP/Lira). Eventually, there was a large dollar shortage due to decreased domestic/foreign savings and investment in the country and its banking sector, which got worse after the sovereign default. This dollar shortage led to banks freezing up all bank accounts in 2019 to prevent bank runs, which wiped out many citizens’ life savings.
Since 1997, the LBP has been pegged to the USD at a rate of 1500 LBP/USD. However, this peg is completely artificial and could not keep consistent after the 2019 collapse, especially since there was no longer enough dollar liquidity to hold up that rate. As a result, most of Lebanon is operating on a black market dollar rate that changes daily, currently sitting at 81,000 LBP/USD, making for a colossal inflation rate. Inherently, the “guaranteed” currency peg (which was actually artificial) that protected against devaluation actually prevented the economy from ever becoming a competitive market.
To sum up a timeline of the economic crisis, we must go back to where it began — political instability and financial mismanagement by the ruling elite destroyed the short civil-war recovery, thus causing foreign investment to slow down. Operating the country on trade deficits and budget deficits dragged Lebanon into deeper debt that the government knew it could not repay, and all of these financial issues were made worse by exacerbating factors such as the 2011 spillover of Syrian war and Syrian refugee crisis, 2019 mass riots against government for the current crisis, 2020 COVD-19 pandemic, and the 2020 Beirut port explosion. Resulting from all of this, the Lebanese pound has lost around 98% of its value, going from 1500 LBP/Dollar to ~80,000 LBP/Dollar on the black market, and CPI has experienced hyperinflation. In this economic depression, shortages of food, fuel, medicine, and electricity all have an impact.
Needed Economic Reforms
The two core, underlying economic problems for Lebanon are the trade deficit and government spending deficit — both led to severe debts that collapsed the economy and monetary system. With all the economic problems considered, excluding political issues, creating a reform plan to stabilize the economy is simple. First, the government must engage in debt restructuring by separating the bad banks (those that lend 70% of their assets to corrupt politicians) from the good ones and supporting good banks to restart the economy. This will eradicate corrupt lending systems. Then, the government must cut corrupt spending and hold politicians that steal accountable — government spending should now only be on absolute necessities in order to lower trade and spending deficits. Finally, the solution to the monetary crisis is to let the currency rate be determined by the market. There should no longer be a dollar peg or multiple exchange rates (i.e. Central Bank rate, Ministry of Economy rate, and Black Market). This is because multiple rates allow politicians to benefit from arbitrage or cheaper rates, and they also scare away foreign investors. In general, a pegged rate that guarantees a certain value disincentivizes economic competition/innovation.
Overall Outlook
From an economic perspective, Lebanon’s problems are significant, but they are understandable and easy to fix with the right reforms. The problem is not that the economic issue is complex, but instead that the political mismanagement issue is complex. The hardest solution will be to replace the corrupt sectarian political system and relieve the government of perpetual patronage networks that permitted current corruption & economic problems. Since parliament is split among religious lines, a top one-percent patronage network of religious-warlords-in-suits have decided to use the excuse of religion to steal from the people. Once a new system or set of politicians is in place, it will be easy to enact the needed economic reforms.
