Following the sudden collapse in oil prices over the last six months, Algeria is facing its greatest economic challenge since the 1990s, when it was torn apart by civil war. How the country responds in the coming months will be watched closely by other countries in the Middle East and North Africa facing similar challenges. I’ve just returned from a visit to Algiers, and I was encouraged by what I heard.
Unlike many of its neighbors, Algeria did not experience an Arab Spring moment, even though the key ingredients were present—notably high youth unemployment. As a major oil exporter, Algeria built up a nest egg when oil prices tripled in the years leading up to the global financial crisis. In the wake of the crisis, and amid popular uprisings in the region, the government drew on its ample savings to increase spending on public sector wages, housing, subsidies, and other programs aimed at maintaining social stability.
Although the government’s economic program was arguably a success, the resulting strains on the system were beginning to show even before the oil price dropped. Current account surpluses began to shrink and fiscal surpluses turned to chronic deficits—even though oil prices reached new highs. At the same time, the economy was growing too slowly to significantly reduce unemployment. Oil production was declining, and subsidies were leading to energy overconsumption, reducing the amount of oil available for export. When oil prices began falling precipitously, these economic vulnerabilities became acute, and the need for change more urgent.
During my visit to Algiers, I sensed a recognition among senior policymakers and economic analysts alike that Algeria’s current growth model needed to change. The government has long had the objective of reorienting the economy away from oil and public spending toward a model that is more diversified and dynamic, one that realizes Algeria’s tremendous potential. The reality of lower oil prices could perhaps be the moment to accelerate these efforts.
Change will need to start with fiscal consolidation. Like other countries in the region, Algeria will have to curb its spending both to balance the books at the new lower oil prices and to preserve wealth for future generations. Over the past five years, spending on public sector wages doubled to about 20 billion US dollars. Simulations by IMF staff suggest that restoring fiscal sustainability will require cutting this rate of growth in half over the next five years. Fiscal consolidation will also require raising more revenues, particularly revenues that do not depend on volatile oil exports.
Yet fiscal consolidation is only half the answer. Fiscal consolidation alone will not create the jobs needed in a country where a quarter of the youth population is unemployed. In our discussions with the Algerian authorities, we discussed the urgency of moving in parallel to implement reforms to stimulate private sector activity and generate new sources of growth. This means improving the business environment, opening up the economy to more trade and investment, and reducing labor market rigidities.
Algerian society has always rightly prided itself for a social model that takes care of the vulnerable. And as it embarks on these reforms, Algeria must ensure that this continues to be the case. One area where this will be important is by phasing out generalized subsidies on energy and other products, which are costly and benefit primarily the well-off, and replacing them with more targeted transfers to the most vulnerable. This is a notoriously difficult and sensitive area of reform, yet other countries in the region have already begun to reform subsidies, and so can Algeria.
Finally, Algeria’s economy would vastly benefit from improving economic governance. According to the World Economic Forum’s Global Competitiveness Report, businesses consider corruption and government bureaucracy to be major constraints. To gain support for its reform program, the government will have to convince its citizens that it can operate more effectively. This will require a great effort to eliminate corruption and bureaucratic red tape and become a facilitator of private sector initiative.
In my discussions with Algerian policymakers, there was no illusion that the road ahead will be easy. But we should remember that in some respects, Algeria is an enviable position. When oil prices crashed in the 1980s, the country experienced economic hardship, successive political crises and, ultimately, a civil war. Today, because of its substantial financial resources, the country can afford to implement reforms gradually, but it cannot afford to let this moment pass without taking action.