Main Image Credit Protests in central Beirut. Courtesy of Anna Om/AdobeStock
Ill-served by a faulty constitutional arrangement and a venal political class, the country stands on the brink of collapse.
While Lebanon is grappling with the adverse effects of the coronavirus pandemic, a financial crisis and hyperinflation, the country’s economy has received yet another blow with Saudi Arabia imposing an import ban on Lebanese agricultural products – a decision that has recently come into effect. To an outsider, Lebanon may seem to be the victim of unfortunate external circumstances. Yet, Lebanon’s politics of disarray and severe economic crisis – the worst since the country’s 1975–1990 civil war – are nothing but the result of political, economic and social dynamics that were set in motion by political decisions and structures adopted in the war’s aftermath. As the country stands on the brink of total collapse, it risks destabilising an already fragile region even further.
The 1989 Taif Agreement that marked the end of the civil war constitutionalised the power-sharing regime of the 1943 National Pact and established Lebanon’s current political system – corporate consociationalism. The agreement implemented equal representation of Muslims and Christians in parliament and a form of proportional representation among the different religious denominations, with the presidency, premiership and speakership designated to a Maronite Christian, a Sunni Muslim and a Shi’ite Muslim, respectively. Not only was this intended to ensure a voice in political decision-making across all religious denominations, but the strong focus on decision-by-consensus in parliament was thought to foster political cooperation and inclusive policies.
In practice, however, Lebanon’s consociationalism created a system dominated by political elites with little interest in the common good. Several factors resulted in adverse incentives for policymakers and enabled elites to consolidate their power for personal gains by favouring sectarian over national interests – the opposite of what the Taif Agreement had aimed to achieve.
Today, Lebanon’s sectarian system is deeply rooted in the country’s political, social and economic structures. The electoral system makes it virtually impossible for candidates without sectarian affiliation to win elections. At the same time, political and sectarian elites operate in self-managed communities, where sectarian quotas are often exploited and public offices and resources are assigned to loyalists and family members to further extend political influence.
Kinship alliances have secured political as well as economic power in the hands of a few families. In what has been described as ‘the politics of clans and dynasties’, Lebanon’s elites frequently pass on political power to their children to maintain ‘the monopolisation of politics’ within the family and in turn the sect. For example, the leadership of the Progressive Socialist Party was passed from Kamal Joumblatt after his assassination in 1977 to his son Walid Joumblatt, who in turn is currently planning a transition of power to his son Taymour Joumblatt. Another example is Rafic Hariri, who founded and led the Future Movement until his assassination in 2005, with the leadership then moving to his son Saad Hariri. Both Rafic and Saad Hariri held Lebanon’s premiership – each serving for two terms – in the period between 1992 and 2020.
Furthermore, since the end of the civil war, state authorities and institutions have been unable to provide a consistent supply of clean water, electricity and other basic services, leading to a strong dependence on privately-owned companies that are controlled by sectarian and political elites. Consequently, these elites have a vital interest in ensuring that state organisations remain inept and open to nepotism and kinship alliances. Such a system is self-reinforcing. Weak state institutions emphasise sectarian dependence and erode trust in the state. In turn, this increases the power of sectarian elites and strengthens their ability to extract public resources for their and their supporters’ gain, which in turn further erodes the functioning of the state.
It’s the Economy, Stupid
While these political and economic conditions have laid the groundwork for the current crisis, there is another crucial element that has contributed to the country’s current economic turmoil. In the late 1990s, Lebanon fixed the exchange rate of the Lebanese lira (or Lebanese pound) to the US dollar. While such a peg ensures the stability of exchange rates and prices, especially in a country that relies heavily on imports, it curtails the economic freedom of the central bank and renders the domestic currency susceptible to appreciations or depreciations of the US dollar.
The peg to the dollar at a rate of 1,507.5 to 1 did have one fundamental advantage: the overvalued exchange rate boosted the purchasing power of Lebanese citizens across all religious affiliations and social strata by reducing the cost of imports such as oil, food and luxury goods. It seemed like a win-win solution, which the political elite used to send a strong signal that everyone benefits from consociationalism. Yet simultaneously, the peg rendered exports more expensive, especially after the post-2011 appreciation of the dollar. With prices increasing, the Lebanese agricultural and manufacturing sectors could no longer compete on the world market, which reinforced Lebanon’s already strong dependence on imports and services.
Moreover, an overvalued exchange rate comes at a cost. A central bank (Banque du Liban in this case) has to artificially create demand for its domestic currency by buying the latter in exchange for foreign reserves. Luckily, remittances into Lebanon increased significantly in the early 2000s. Additionally, commercial banks offered creditors excessive interest rates for their foreign currency. In the period between 2007 and 2019, a time when European banks offered a real interest rate of close to zero (or even negative rates), Lebanese commercial banks beguiled customers into depositing foreign funds at an average real interest of 4.7%.
While the continuous inflow of remittances and deposits into Lebanon seemed to provide enough foreign reserves for some time, the Great Recession of 2008 put a spoke in the wheel of the overvalued fixed exchange-rate regime. Initially constituting about a quarter of Lebanon’s GDP, remittances started to fall after 2008. Meanwhile, the economy was supported through a largely debt-financed economic stimulus. In desperate need of foreign reserves to keep the fixed exchange rate and service its debt, Banque du Liban undertook financial engineering operations that led to significant losses in 2016. Meanwhile, commercial banks converted dollar accounts behind the scenes into Lebanese lira and passed on the much-needed foreign currency to the central bank.
The temporary outflow of foreign deposits after Saad Hariri’s resignation announcement in late 2017 was the first conspicuous sign of the financial system’s fragility. Yet, commercial banks poured oil on troubled waters by offering customers higher interest rates. Ultimately, the financial edifice collapsed in 2019. Amid nationwide protests against the corruption of Hariri’s cabinet, the US threatened to impose sanctions on commercial banks after the latter’s involvement in money laundering for Hizbullah, and – more critically – pushed for capital controls.
To prevent an outflow of foreign reserves that Banque du Liban could not cover, commercial banks restricted the withdrawal of foreign currency. However, Lebanon’s dependence on imports created an excess demand for hard dollars, and the black-market exchange rate for dollars soared. Merchants and producers passed on these higher costs to their lira-paying customers. Subsequently, consumer prices peaked, leading to inflation which in turn eroded trust in the Lebanese lira and increased the demand for dollars. This set in motion a spiral of inflation which at its peak created (annualised) inflation rates of 600%.
A Country on the Brink
With the country hit by the pandemic and the Beirut explosion in 2020, confidence in the system and the ability of political elites to manage the ongoing crises is quickly fading. Today, the country stands on the brink of collapse. High inflation has impoverished the majority of Lebanese citizens, and lifetime savings have become worthless. Meanwhile, with no end to the political deadlock in sight and the unwillingness of the political elite to implement reforms to Lebanon’s corporate consociationalism, it is unclear whether the country’s systemic problems can or will be resolved. Eventually, Banque du Liban will deplete its foreign reserves and complete collapse would then be inevitable. In the worst case, the current crisis is the prelude to another civil war that will further destabilise the region.
For a more detailed analysis of Lebanon’s political economy and the factors leading to the current crisis, readers may refer to the authors’ recent publication in the Economics of Peace and Security Journal.
Sebastian Ille is an Associate Professor of Economics at the New College of the Humanities at Northeastern. He is also the Editor-in-Chief of the International Social Science Journal.
Dina Mansour-Ille is Senior Research Editor at RUSI.
The views expressed in this Commentary are the author's, and do not represent those of RUSI or any other institution.
Dr Dina Mansour-Ille
Senior Research Editor