Dan Azzi
September 2018


Lebanon’s rentier economy and Creative Destruction

Dan AzziDan Azzi

(Originally published in An-Nahar September 2018)

When Judgment Day for our country arrives, and it’s very close, the results will be cataclysmic and painful, but we should stand ready to exploit this and unleash Schumpeter’s Creative Destruction process.

BEIRUT: Last week, a state of apprehension proliferated in the economic and banking circles in Lebanon, as they watched with horror Lebanese government Eurobond yields rise from 10 to up to 14% within a couple of days. Eurobonds, notwithstanding their name, are actually Lebanese government debt denominated in US Dollars. A senior banker even described the situation using the term “hushed panic.”

Simultaneously, Credit Default Swap (CDS) rates rose from 600 basis points in November (when Prime Minister Saad Hariri ‘resigned’) to 1,300 basis points last week. For those of you who don’t know what a CDS is, it is basically the cost of ensuring our debt against a government default. Let me explain it in laymen’s terms. Think of life insurance. If you were to buy $100,000 of term life insurance on a healthy ten-year-old kid, it might cost you $2 a month. On the other hand, if you try to buy the same for a healthy forty-year-old male, it might cost you $20 per month.

Sometimes, insurance companies might give you a medical exam, which invariably will raise that rate, if your cholesterol and triglyceride levels, for example, are high. Now back to the CDS; let’s just say that investment banks today are pricing these as if Lebanon were an eighty-year-old who’s had two heart attacks, a malignant cancerous tumor, and is HIV positive. In fact, our CDS levels are now higher than Argentina or Turkey … and you know what just happened there in the recent past. In Lira, the rates are even worse, at 16-17% and higher for five-year deposits, which detracts anyone with capital from investing in expanding a company or setting up a startup and employing our youth, whose unemployment rate is 37%, according to the World Bank. 

At those rates, an investor would double his money every 5 years, without the aggravation of designing a business plan or managing people or dealing with the National Social Security Fund known as Daman and the tax authorities. And this is one of the symptoms of our economy turning into a rentier, lazy economy, spreading like cancer and infecting the other, productive sectors, like manufacturing, agriculture, and innovation.

Of course, I won’t even get into the self-evident question which every depositor should ask himself (or his banker)? Where are our banking geniuses investing these deposits to earn a rate greater than 20%, which would put Warren Buffet to shame, in order to pay you, the depositor,17%?

So how did we get to this sorry state? It all started a decade or two ago, when the banking business model morphed from lending deposits to people and businesses, to lending the government to finance its budget and trade deficits. Due to their fast growth, in contrast with the anemic growth in the economy, deposits have now reached a staggering nearly four times the size of the Lebanese economy. 

This is a source of pride among the Lebanese Intelligentsia and the Not-So-Intelligentsia, who believe this provides stability to the economy and is a positive deviant relative to most other “inferior” countries. In fact, this has created the opposite effect, and addicted us to some very bad habits. Think of a waiter, Samir, who works in a fancy downtown restaurant, and who gets paid a low wage, but he can get as much free leftover food as he wants. 

Samir can’t resist all this fancy food, with an entrée costing more than a week’s salary. A bite here, a meal there, and pretty soon, Samir is obese, with some serious health problems. So what did our government do when it saw all this free fancy food, i.e. piles of dollar deposits from the expats? It did exactly the same as our friend Samir. It started to spend way more than it collects in taxes, and very inefficiently, with little to show for it.

At the same time, the real estate bubble also redistributed our financial and human capital from other parts of the economy, erecting these huge and vacant towers all over the place.

But that wasn’t the only damage caused by this idiotic and short-sighted indulgence. This also came at the expense of the environment, with our beautiful mountains systematically consumed, destroyed, and converted into concrete blocks, with business models still assuming the return of the ludicrous 2010 prices, which will never come back in our lifetime, thereby guaranteeing they’ll collect cobwebs for decades. Naturally, the real estate sector sucked in the other part of our deposits, with loans directly or indirectly linked to properties consuming 90% of bank lending to the private sector, according to a 2017 IMF report.

In short, our bank deposits have gone primarily towards financing the government twin deficits or the property sector. So what is the optimal alternative destination for us to deploy our financial and human capital? Most people normally regurgitate the obvious tourism, manufacturing, and agriculture, but that answer is appropriate for someone who graduated from high school in 1970. The right answer, without a doubt, is to invest in the knowledge economy, especially software development. We would then convert the products of our imagination into a series of zeroes and ones, to sell overseas in return for dollars and other hard currencies, instead of using financial acrobatics.

To achieve this, we would need to set up startups modeled on the likes of Google, Uber, and Facebook. Is there any intrinsic geographic advantage that the US has for all these companies to start there? Is it related to the presence of oil or minerals or other natural resources? Of course not. It’s strictly related to their culture of innovation, educational system, and nurturing culture and business environment, all within our capabilities to emulate. 

The first thing we would need to do is to increase the speed and efficiency of our internet and communications infrastructure and reduce their cost, instead of using them as a latent government tax. We would also need to reform our educational system and aspirations, from this silly cultural bias to push our sons and daughters to become physicians, engineers, or lawyers. We would also need to re-educate our youth to use the Internet to unleash their innovative capabilities, instead of porn, Facebook, and Whatsapp jokes being the biggest consumer of internet bandwidth in our country.

When Judgment Day for our country arrives, and it’s very close, the results will be cataclysmic and painful, but we should stand ready to exploit this and unleash Schumpeter’s Creative Destruction to wipe out any remnants of our old economic model represented by the following transaction: “Buy a piece of land, sell it for double the price in two years, and buy a Porsche 911. We should replace this Madoffian economic model with a modern, knowledge-based economy that creates high-quality jobs, especially for our underutilized youth.

Dan Azzi is a retired banker. He previously served as CEO of Standard Chartered Bank Lebanon.

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