A democratic system of government, if it is successful in taking hold in Egypt, will have to deal with many problems created by the old regime. Two of the most difficult will be reducing subsidies and creating jobs

When Hosni Mubarak stepped down as President of Egypt on 11th February, the markets that were still open in the Western hemisphere celebrated with at least a bit of the enthusiasm shown by the people in Tahrir Square. The Egypt Index ETF (Exchange Traded Fund) rebounded by almost 8%, erasing three-quarters of its previous decline.

Although I dislike discouraging any celebration, the markets should perhaps remember the words of Alexis de Tocqueville, "In a revolution, as in a novel, the most difficult part to invent is the end."

This is not the first revolution in Egypt, far from it. The first uprisings in Cairo and Alexandria date from 1882. Then as now, the Egyptian army helped to foment revolution, which only failed after a defeat by the British. The Egyptians tried again in 1919 and again failed. It was not until 1952 that the Egyptians succeeded in installing their own government.
 
Revolutions and regime changes are never as smooth or as beautiful as the idealistic youth who helped create them like to believe. The Communist takeovers in Russia and China ultimately resulted in millions of deaths. The transitions to democracy in the former Soviet Union and in Eastern Europe have certainly been uneven. The theocracy created in Iran after its revolution intends to ensure that the popular uprising, which placed it in power, will not be repeated.
 
De Tocqueville pointed out another truth about revolutions. Contrary to popular belief, revolutions are not the result of dire poverty, but rather, they are the result of rising prosperity.

This is certainly true of Egypt, where reforms begun in 2004 have helped drive growth above 5% for the past few years. Although Egypt is still one of the poorest countries in the world, its per capita gross domestic product recently hit a new high of $3,295.

Still, the promise of growth has not reached very far. According to the World Bank, roughly 20% of Egyptians live below the poverty line and another 20% just above it. A government survey in 2008 showed that four-fifths of Egyptian families earned less than the mean.
 
A democratic system of government, if it is successful in taking hold in Egypt, will have to deal with many problems created by the old regime. Two of the most difficult will be reducing subsidies and creating jobs.

The subsidies in Egypt have to end. Food and energy subsidies eat up to 7% of the gross domestic product and prevent other spending on essential social & infrastructure projects. They also prevent the government from reducing its 8.1% budget deficit-half of which is consumed by energy subsidies. Egyptians presently pay for fuel at prices that are 30% to 75% below international prices.

This has distorted market signals for energy, and has led to the purchase of over 1 million air-conditioners by an emerging middle class. It also acts as an impediment to further development of potential natural gas supplies.
 
The other problem will be to create jobs. Egypt, like other Arab countries, has a very young population with a median age of only 24. While a 10% unemployment rate in the United States is considered a major disaster, it has been the norm in Egypt for much of the past 20 years. Youth unemployment is much higher.

The Mubarak regime used jobs as well as subsidies to hang onto power. It created a huge civil service that employs seven million people, over a third of the workforce, three times the number in OECD (Organisation for Economic Co-operation and Development) countries. Yet, unemployment among college graduates still tops 30%.

To transform this system will require that Egypt adopt major reforms to improve its business environment, including a bankruptcy law, land registration, bureaucratic procedures, a reformed foreclosure framework, cleaning up conflicting regulations and a financial system that makes loans to small businesses easier and profitable.

Making these modifications will be difficult in a country where business is viewed with distrust.

Some feel that a democracy is not sufficient to solve these problems. Ding Gang, a senior editor of the Chinese government's official news outlet, the People's Daily, wrote that the "problem in Egypt in fact is the problem of competitiveness." He felt that a country's competitiveness was the result of "history, traditions, culture and education, closely related to its competitive advantage in the global economy. It can only be internal and cannot be freely chosen, nor could it be reformed through revolution or solved through a change of systems."

In other words, the Chinese are competitive. The Egyptians are not. The form of government does not matter.

Still, despite the messiness of democracy, it does have one redeeming feature that Ding Gang fails to recognise and Mubarak could not accomplish: change. As De Tocqueville points out, "The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults."

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])