Journal of Policy Modeling 30 (2008) 857–872
vailable online at www.sciencedirect.com
Lebanon’s economic reconstruction after the war: A
bridge too far?
Charles Harvie ∗, Ali Salman Saleh
School of Economics, Faculty of Commerce, University of Wollongong, Wollongong, NSW 2522, Australia
Received 1 September 2006; received in revised form 1 January 2007; accepted 1 April 2007
Available online 6 May 2007
Since the onset of the Civil War in 1975 Lebanon has experienced burgeoning ﬁscal deﬁcits and an
unsustainable public debt overhang. Much of this arose from the loss of revenues during the period of
the Civil War 1975–1990 and attempts to maintain basic public expenditure, while from 1990 to 2006
this reﬂected post-Taif rebuilding and reconstruction of key infrastructure with limited revenue capacity.
Considerable progress from the 1990s had been achieved in rebuilding the shattered economy from both
public and private international and domestic sources, but its legacy is a huge public debt and a servicing
requirement that currently absorbs alone almost 30 per cent of total government revenue and is the highest
in the world on a per capita basis. While the need to reduce this debt to a sustainable level would be daunting
enough in itself, Lebanon’s ﬁscal predicament was further compounded by the outbreak of war with Israel
during July–August 2006. The consequence of this 34-day war was the devastation of residential property,
vital infrastructure, loss of agricultural production, industrial production, exports, environmental damage,
the collapse of tourism and a further erosion of the inﬂuence and power of the central government. Estimates
of the direct and indirect costs for Lebanon of this relatively brief but devastating war conservatively vary
from US$ 10–15 billion. The implications of such reconstruction and rebuilding costs for the budget and
public debt are potentially calamitous for Lebanon which is already struggling under the weight of debt
overhang and its servicing. A key question is whether Lebanon can tackle this enormous task in insolation.
This paper explores the background to the ﬁscal crisis, identiﬁes from available literature the extent, nature
and cost of the war damage, analyses the options available to the authorities in rebuilding the economy and
highlights key policy issues and measures that will be required if a sustainable economic recovery is to be
achieved. Despite its demonstrated and remarkable resilience to past trauma the paper concludes that the
ﬁscal crisis makes it impossible for Lebanon to tackle the reconstruction and rebuilding task on its own and
particularly in the wake of the events of summer 2006. The country will require substantial and ongoing
ﬁnancial support from international lenders and donors. The success of these efforts in the case of Lebanon
∗Corresponding author. Tel.: +61 2 42 213702; fax: +61 2 42 213725.
E-mail address: email@example.com (C. Harvie).
0161-8938/$ – see front matter © 2007 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
858 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
is of particular interest as it could well be a microcosm of possible future outcomes for the region more
© 2007 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
JEL classiﬁcation: E60; E61; E62; E65
Keywords: Budget deﬁcits; Economic reconstruction; Donor assistance; Policy imperatives
Budget deﬁcits, their funding and impact upon economic performance, have attracted con-
siderable attention over the past few decades in both developed and developing economies (for
example Allen, 1977; Aschauer, 1985; Bailey, 1971; Barro, 1990; Cebula, 2003;Miller & Russek,
1997;Neaime, 2004;Ramirez & Nazmi, 2003;Saleh, 2003;Saleh & Harvie, 2005;Sargent &
Wallace, 1981 among others). In the context of Lebanon, which forms the focus of this study, the
budget deﬁcit and its funding has attracted considerable attention from politicians, international
organizations and domestic policy makers, stemming from its size and longevity (see, for example,
Al-Rifai, 1999; Darweesh, 1999;Eken & Helbling, 1999;Korm, 1999; Makdissi, 1999; Saidi,
2003; Wakim, 1999, among others). Budget deﬁcits ﬁrst occurred in Lebanon during the period of
the Civil War (1975–1990), and were subsequently maintained during the post-war reconstruction
period (1990-present). As a per cent of GDP it increased from only around 3 per cent in 1975 to
a peak of 33.8 per cent in 1990, one of the largest in the Middle East at this time, subsequently
declining to under 10 per cent by 2003–2005. Bolbol (1999b, p. 442) argues that these budget
deﬁcits were “a symptom of a weak economy”.
Consequently, Lebanese public debt increased precipitously after 1975, with gross public debt
reaching 99.8 per cent of GDP by the end of 1990 of which 80.6 per cent was domestic and
19.2 per cent external. Post-Taif reconstruction focused upon rebuilding the country, providing
infrastructure and services, making Lebanon’s services sector competitive with other countries
such as Israel, creating a business friendly environment and reconstituting and reasserting state
power. Subsequently, after 1993, there was a further acceleration in government capital and
current expenditure which resulted, in tandem with a slow recovery of the government’s revenue-
generation capacity, in a perennial ﬁscal crisis. Between 1992 and the end of 2000, for example,
the Lebanese government spent some US$ 5.7 billion on public infrastructure that included the
electricity grid (US$ 1.371 billion), post and telecommunications (US$ 769.5 million), roads and
public transport (US$ 566.8 million), ports and airports (US$ 636.3 million), and the water sector
(US$ 636.3 million). Budget deﬁcits increased from 9.2 per cent of GDP in 1993 to 20.6 per cent
in 1996, declining to around 8.5 per cent in 2005. State spending initially increased GDP growth
arising from the construction and real estate boom it triggered, but heavy reliance on funding
through domestic and foreign borrowing contributed to a further rapid accumulation of public
sector indebtedness, higher interest rates and its servicing represented a huge drain on public
resources. This culminated in 2002 when the country faced a severe ﬁnancial and economic crisis
as national debt reached US$ 25 billion, equivalent to 150 per cent of GDP, and GDP growth
stagnated. By April 2006 total public debt stood at US$ 38.8 billion (183 per cent of GDP)
with debt servicing absorbing any additional revenue increases, and yields on government bonds
Chami (1992) theoretically analysed the macroeconomic performance in Lebanon during
1975–1990 (Civil War). He argued that “the central government has become completely par-
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 859
alyzed and unable to collect tax revenue but continues to spend in order to maintain essential
services, pay wages and salaries and subsidize some basic imported goods” (Chami, 1992,p.
325). This led, as a result, to substantial budget deﬁcits ﬁnanced by the central bank and com-
mercial banks. This study concluded that the budget deﬁcits contributed to a massive increase in
money supply, high inﬂation rates and a severe depreciation of the Lebanese currency.
The assassination of former Prime Minister Raﬁq al-Hariri in February 2005 plunged the
country into a further period of political and ﬁnancial turbulence. Signiﬁcant deposit withdrawals
and a sharp rise in dollarization put pressure on international reserves, which declined by around
US$ 2 billion in the ﬁrst quarter of 2005. By mid year the ﬁnancial situation had stabilized and
conﬁdence was restored and, with a resumption of deposit inﬂows, liquidity conditions improved
markedly. New Prime Minister Siniora announced in July 2005 that the government would pursue
an ambitious economic reform and adjustment program. But the program was delayed due to
renewed political tension. GDP growth, after a decline in both public and private demand in the
wake of the political crisis, slowed to only 1 per cent in 2005 after achieving 5 per cent growth in
2004. The strong growth in 2004 occurred due to a surge in tourism, export growth, which helped
to reduce the current account deﬁcit to 13 per cent of GDP, and construction activity. The budget
deﬁcit declined slightly in 2005, due to a decline in debt service payments on the public debt, a
direct contribution of the Paris II conference, by 12.1 per cent. Overall net debt increased from
151.5 per cent of GDP at the end of 2004 to 158.8 per cent by end 2005, and gross debt increased
further from 164.7 per cent of GDP at end 2004 to 175.1 per cent of GDP by end 2005. Tax
revenues declined by 6 per cent overall in 2005 due to a drop in revenue from international trade
taxes and to a lesser extent from lower domestic taxes on goods and services and ﬁscal stamp
While severe the ﬁscal crisis was further compounded by the traumatic developments during 12
July–14 August 2006, when Israeli bombing of key infrastructure and other facilities resulted in
severe damage,1a dysfunctional economy and further erosion of already weak central government
authority. Once again the economy faced an enormous reconstruction challenge on a par with
that after the 1975–1990 Civil War. Damage to the economy was widespread across numerous
sectors—in particular residential buildings and infrastructure (roads, ports, water and sewerage
treatment, electrical plants, bridges, factories and farms). Total damage to residences has been
estimated at US$ 2 billion and transport sector damage at US$ 404 million. Oxfam estimated
that up to 85 per cent of the country’s 195,000 farmers lost all or some of their crops valued
at between US$ 135–185 million, and suffered a livestock loss of one million poultry, 25,000
goats and sheep, and 4,000 cattle. These losses have serious economic implications as 35 per
cent of the Lebanese population either directly or indirectly rely for their livelihood on farming.2
In the industrial sector 10 large factories and more than 700 small and medium industrial units
were completely or partially destroyed.3Damage to industrial factories was estimated at US$ 190
1The Khiam Centre, funded by the Canadian Embassy, listed the following destruction on 22 July 2006: “28 vital points
(airports, ports, water and sewerage treatment, electrical plants, etc.), 600 km of roads, 23 fuel stations, 73 bridges, 72
overpasses, 6,800 private houses/apartments, 160 units in the commercial sector (factories, markets, farms, etc.)”. By the
end of the hostilities on 15 August, the damage had increased substantially: government sources quoted 15,000 destroyed
homes and 80 bridges hit (French newspaper report).
2Some 12 per cent of the total workforce is directly employed in agriculture, and it contributes approximately 11.7 per
cent of the country’s GDP.
3Industry in Lebanon is mostly limited to small businesses concerned with reassembling and packaging imported parts.
In 2004 it employed 26 per cent of the Lebanese working population and contributed 21 per cent of GDP.
860 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
million with the loss of up to 10,000 jobs.4The closure of these factories resulted in a loss of
export revenue and foreign markets, contributing to a loans crisis as many destroyed businesses
were unable to meet their debt repayments. This problem is compounded by the fact that many
businesses that have taken out loans had also lost their collateral, mainly their now destroyed
property. Given that 30 per cent of Lebanese commercial banks’ outstanding loans are to the
private sector, this has implications for the ﬁnancial health of the banking sector. Tourism has also
played an important role in the services sector however an oil spill from the destruction of ﬁve
fuel storage tanks at the Jiyeh power plant affected 100km of coastline resulting in the country’s
worst environmental damage, and added an estimated US$ 50–100 million to the overall cost of
reconstruction. This severely impacted upon the tourism sector, which had anticipated receiving
1.6 million visitors in 2006 (see Fattouh & Kolb, 2006).
State reconstruction ofﬁcials argued that the direct damage arising from the 34-day war
amounted to US$ 3.5 billion, including US$ 1.5 billion for bridges, roads and other infrastructure5
and, of traditional importance to the economy, the electricity (US$ 208 million in damage),
telecommunications and water sectors. This compared to a ﬁgure of US$ 2.5 billion by the
Lebanese government on 16 August 2006 for total damage to the country’s infrastructure. Even
the latter ﬁgure represented a massive 10 per cent of the country’s GDP for 2005 (US$ 21.2 billion).
If indirect costs are also included, such as loss of tourism revenue, export revenue, government
revenue, loss of FDI, the cost of stabilizing the currency and loss of GDP during 2006, total war
damage could be as high as US$ 10 billion (see Table 2). The UN offered an even bleaker picture
of the direct and indirect costs, suggesting a higher estimate of “at least US$ 15 billion, if not
more”.6Jean Fabre, a spokesperson for the UN Development Program (UNDP), suggested that
“The damage is such that the last 15 years of work to rebuild the country and revive its economy
after the problems suffered by Lebanon (the 1975–1990 Civil War) are now completely wiped
Other costs include the permanent loss of human capital through death and migration (some
500,000 skilled Lebanese ﬂed during the war), the permanent loss of both foreign and domestic
investment (capital ﬂight during the war amounted to around US$ 2.5 billion) that could result
in: lower future growth; rising poverty; increased unemployment costs; loss of export revenue;
loss of tax revenue; undermine the stability of the currency; reduce foreign exchange reserves;
and undermine the stability of the government.
The impact of these developments on the budget deﬁcit, and its ﬁnancing, is now of critical
signiﬁcance to the country. Increased government spending to deal with immediate emergency
needs has been estimated at around US$ 13.3 million while the loss of direct and indirect govern-
ment revenues is estimated at around US$ 66.3 million. These developments exert further intense
pressure on the government’s already precarious budget deﬁcit.8In addition, the government’s
privatization reforms are likely to be put on hold due to a loss of investor conﬁdence in the econ-
omy, and the likely decline in revenues generated from the sale of damaged assets. Consequently,
4Some 99.3 per cent of damaged factories were uninsured against war damage and 70 per cent indebted to a bank or
ﬁnancial institution (Bank Audi, 2006,p.3).
5Lebanon has traditionally been reliant on transit and seaborne trade, consequently the destruction of bridges, roads,
ports and airports constituted a major problem to the economy. The destruction of bridges, roads and trucks also affected
transit trade to the Gulf both directly, by limiting national exports, and indirectly as freight forwarders were not able to
ship goods to Persian Gulf countries via Beirut.
6As reported in Spero News (2006).
7As reported in Spero News (2006).
8The implications of this for the ﬁscal crisis are explored in the following section of the paper.
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 861
in the immediate term at least, such a policy does not present a viable option as a source of
Perhaps even more precarious is the situation facing an already weak central government. The
fragile foundation upon which it has been based during much of the Taif reconstruction era has
become even further eroded, making it even less well equipped to tackle, alone, the enormous
economic rebuilding challenges. The legacy of an already weak budgetary position and high
indebtedness before the war in July–August 2006, as well as increased political and economic
risk, has compounded and intensiﬁed this problem. This restricts the government’s access to
further domestic and, in particular, foreign borrowing, and existing debt servicing absorbs most
of any additional revenue sources. Consequently, gaining access to international donor funding
will be pivotal, requiring a concerted and coordinated effort by the Lebanese government and the
international community—international investors, governments and international development
and donor agencies.
In this context the paper proceeds as follows. Section 2examines the evolution of budget
deﬁcits and public debt in Lebanon since 1970. Section 3elaborates in more detail potential
policy responses to the ﬁscal crisis and pertinent lessons for the current post 2006 situation.
Finally, Section 4provides a brief summary of the key ﬁndings from the paper.
2. Budget deﬁcits, public debt and GDP performance in Lebanon
2.1. Pre August 2006
Prior to 1975 the Lebanese government’s ﬁscal budget was always balanced and it had never
resorted to borrowing. Borrowing and budget deﬁcits are, therefore, relatively recent phenomena
for the country. From Table 1 it can be observed that budget deﬁcits occurred primarily after
1974. These deﬁcits were sizeable and persistent throughout 1975–2005. In particular, the period
1975–1990 was one of deepening economic crisis for the economy, as evidenced by a marked
deceleration in economic growth and private investment activity. The budget deﬁcit, as a per cent
of GDP, increased from only 2.9 per cent in 1975 to 33.8 per cent at its peak in 1990 (Table 1),
becoming one of the largest amongst the Middle East countries. Increased government expenditure
and declining government revenue were both responsible for this steep increase. Total government
expenditure as a percentage of GDP increased from 15.4 per cent in 1972 to 39.4 per cent in 1990.
The dramatic increase was mainly made up of current expenditure, arising from the generous
wages and salaries paid to government employees and interest payments on the public debt. On
the other hand budgetary capital expenditure declined from 6 per cent of GDP in 1980 to 1.7 per
cent in 1990, contributing to the overall deterioration in the public capital stock.
Government revenue, on the other hand, remained very low as a proportion of GDP during
1975–1990 (around 6 per cent), due to: the slowdown of economic activity; and the inability of
the government to collect revenue, due to the Civil War, as most of this was in the form of indirect
taxes and customs and trade taxes which became difﬁcult to collect with the loss of control over
legal ports of entry and a consequent surge in illegal imports.
During 1970–1975 the average annual growth of nominal gross public debt registered only
3.5 per cent, and the nominal gross public debt averaged 5.4 per cent of GDP. In the pre-war
period public debt was not, therefore, a major concern. Subsequent large budget deﬁcits during
1975–1990 signiﬁcantly changed this situation with gross public debt rising sharply and peaking
in 1983 at 137.8 per cent of GDP (see Table 1).
862 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
Real GDP growth and key ﬁscal indicators in Lebanon: 1970–2005 (in % of GDP)
Years Real GDPa
growth rate (%)
Budget deﬁcit Domestic public debt External public debt Gross public debt
1970 6.6 −0.5 2.6 4.3 6.8
1971 9.2 0.8 34.4 3.9 6.0
1972 12.4 0.7 2.6 2.9 5.5
1973 5.3 −0.5 3.3 1.9 5.3
1974 3.1 0.6 3.9 1.4 5.3
1975 −16.1 −2.9 2.0 1.5 3.5
1976 −57.6 −11.9 19.8 2.8 22.6
1977 67.7 −7.0 18.4 1.4 19.8
1978 −2.6 −9.7 21.7 1.6 23.3
1979 2.4 −8.9 23.8 2.8 26.6
1980 1.5 −9.8 32.1 5.1 37.1
1981 0.5 −11.8 41.8 6.8 48.5
1982 −36.8 −21.9 111.9 6.4 118.4
1983 22.7 −21.3 131.2 6.6 137.8
1984 44.5 −13.7 111.4 4.2 115.6
1985 24.3 −26.1 75.7 7.3 83.0
1986 −6.8 −26.1 75.7 7.3 83.0
1987 16.7 −16.7 26.1 16.8 42.9
1988 −28.2 −18.8 38.5 13.6 55.0
1989 −42.2 −34.5 72.8 19.0 91.8
1990 −13.4 −33.8 80.6 19.2 99.8
1991 38.3 −16.3 63.9 12.9 76.8
1992 4.5 −14.8 53.4 4.6 58.0
1993 7.0 −9.3 44.2 4.3 48.6
1994 8.0 −20.5 61.1 8.5 69.5
1995 6.5 −18.4 66.5 12.1 78.6
1996 4.1 −20.6 84.4 14.6 99.0
1997 3.9 −20.2 86.5 16.4 102.9
1998 3.0 −14.1 88.5 25.9 114.4
1999 0.6 −14.4 102.3 33.6 135.9
2000 0.0 −23.7 109.5 42.3 151.8
2001 2.0 −13.4 112.3 57.3 169.6
2002 2.0 −11.8 97.1 84.3 181.4
2003 3.0 −9.5 98.9 86.1 185.0
2004 5.0 −9.2 80.4 84.3 164.7
2005 1.0 −8.4 87.7 86.9 174.6
Source.Saleh and Harvie (2006),BDL (variousyears),Ministry of Finance (various years),Cashin, Eken, Erbas, Martelino,
& Mazarei (1995),Eken and Helbling (1999), Authors’ calculations.
aData for the years 1970–1996 was obtained from Cashin, Eken, Erbas, Martelino, & Mazarei (1995) and Eken and
Helbling (1999). For the years 1997—onwards data was obtained from Bank Audi (2006),Bank Audi and the Ministry
of Economy and Trade, Lebanon (2006).
Over the post-war Taif reconstruction period (1991–2005) infrastructure rebuilding, together
with large and expanding current expenditure and slow recovery of the revenue-generation capac-
ity, resulted in further ﬁscal imbalances and rising public debt. Budget deﬁcits increased from
9.3 per cent of GDP in 1993 to 20.6 per cent in 1996 before declining to 8.4 per cent in 2005,
while domestic public debt, in particular, as a per cent of GDP increased from 44.2 per cent in
1993 to 86.5 per cent and to 87.7 per cent in 1997 and 2005, respectively. In nominal terms gross
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 863
Direct and indirect costs of the war on Lebanon as of end July 2006
Sector Estimated cost of destruction (US$ million)
1. Direct costs
Housing and trade 1,464
Industrial establishments 90
Military installations 16
Petrol stations 10
Total direct costs 2,266
2. Indirect costs
Loss of government revenue 66.3
Loss in FDI and portfolio investment 2,000
Tourism revenue 3,000
Stabilization of the currency 2,500
Total indirect cost 7,566.3
Total direct and indirect war costs 9,832.3
3. Other costs more difﬁcult to quantify
Loss of human capital No estimate at present
Loss of permanent investment No estimate at present
Fattouh and Kolb (2006).
public debt increased from US$ 3.7 billion in 1993 to about US$ 32 billion in 2003. External
public debt increased from US$ 0.3 billion to about US$ 15 billion in 2003 as a result of the
Paris II conference in 2002, where the government met with international donors to seek bilateral
assistance and lower interest rates by restructuring its higher interest rate bearing domestic debt
obligations. An aggregate amount of US$ 4.4 billion was pledged in 15-year loans at reduced
rates to support the government’s effort to reduce public debt Banque du Liban (Central Bank of
Lebanon) (2003). The majority of public debt is in the form of domestic public debt, although
the gap with external public debt has closed noticeably since 2000 and particularly so since 2002.
Money creation remained the primary method of budget ﬁnancing with the issuance and sale
of treasury bills mainly to commercial banks. Other subscribers, but with a much lower share,
were other ﬁnancial institutions, the general public, and public entities. It has been argued (see,
for example, Bolbol, 1999a, 1999b; Chami, 1992; Makdissi, 1999; among others) that the main
effects of the large budget deﬁcits, and the way in which they have been ﬁnanced, have been
through: an increase in the structural budget deﬁcit; higher interest rates; increased money sup-
ply; rising inﬂation; a depreciation of the Lebanese pound; stagnation and a slowing of economic
2.2. Post August 2006
The damage arising from the July–August 2006 war was widely spread across a number of
economic sectors, but most acutely in residential housing and infrastructure. This has profound
implications for government spending and the budget deﬁcit. Table 2 summarizes the potential
864 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
direct and indirect costs arising from the war that can be gleaned from the literature and government
sources, as well as additional effects that are difﬁcult to quantify. These estimates obviously contain
a sizeable margin of error, and it will take some time before they can be veriﬁed on the ground, but
the magnitudes are clearly substantial. The estimated direct costs are equivalent to 10.7 per cent of
2005 GDP, while estimated direct and indirect costs are equivalent to 46.4 per cent of 2005 GDP.
This does not include other costs such as that arising from the permanent loss of human capital
and investment which are extremely difﬁcult to quantify. If the UN ﬁgure mentioned previously
of US$ 15 billion is closer to the mark this is equivalent to 70.7 per cent of 2005 GDP. These are
staggeringly high and would appear to be insurmountable for the present government acting in
2.3. Status of international assistance
The ﬁscal crisis and past policy failures have resulted in the current weak central government
of Prime Minister Siniora being heavily dependent upon the benevolence of international donors,
and the wealth of prominent supporters, to enable it to conduct and implement the massive
reconstruction task at hand. The government now needs to convince donors that it has the ability
to conduct this task, although its past performance is not encouraging. This has been further
exacerbated by the current political turmoil and instability. The post-Taif reconstruction effort
contained both public and private sector components, although this became increasing opaque at
times due to the signiﬁcant contribution of Raﬁq al-Hariri. As the Prime Minister of the country
from 1992 to 1998, and again from 2000 until his resignation on 20 October 2004, Hariri played a
crucial role in regard to the public sector effort. He also spearheaded a comprehensive private sector
reconstruction effort, arising from three dimensions: he possessed vast personal wealth9and was
the initiator and major shareholder of Solidere10; he possessed considerable personal prestige
particularly with Saudi investors; and he possessed considerable ability, in general, to attract
international ﬁnance. In the foreseeable future, however, such public–private funding mechanisms
that were important in the 1990s will not be available in the future without an expanded role for
Some confusion exists over the amount pledged for Lebanon’s reconstruction and how much
is needed. Security and humanitarian assistance is often included with reconstruction pledges,
adding confusion about the totals. Among the major reconstruction, and economic recovery,
contributions that can be identiﬁed are the following. First, at an Arab League meeting on 20
August 2006, Saudi Arabia (US$ 500 million) and Kuwait (US$ 300 million) pledged a combined
total of US$ 800 million in reconstruction assistance. Second, a UN sponsored early recovery
donor conference in Stockholm on 31 August 2006 raised US$ 940 million in pledges with some
of this for expanded humanitarian aid.11 Qatar alone pledged US$ 300 million speciﬁcally for
reconstruction assistance. The Lebanese government insisted that it maintain control over any
9In the 1970s Hariri established his own construction company, CICONEST, which was a major beneﬁciary of the oil
price boom at this time and the construction boom which it triggered in the Middle East. He accumulated vast amounts
of wealth in a short period of time and emerged as a powerful construction tycoon.
10 Solidere is a private joint-stock company worth about US$ 2 billion that almost single handedly, due to being awarded
a government monopoly, transformed and revived the central business district of Beirut following the Civil War.
11 The amount was nearly double the US$ 500 million that organizers of the donors’ conference had requested to assist
Lebanon to recover. Adding previous pledges and commitments for longer-term reconstruction projects, organizers said
a total of US$ 1.2 billion had been promised to help Lebanon back on its feet. Other major pledges included US$ 175
million from the United States and US$ 54 million from the European Union. The U.S. ﬁgure was part of the US$ 230
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 865
ﬁnancial aid provided. Third, Saudi Arabia and Kuwait provided US$ 1.5 billion to support
Lebanon’s reserves in a bid to stabilize the country’s currency. This money, however, could not
be spent and, therefore, could not be counted as reconstruction assistance. Fourth, private donors,
including investment funds such as that developed by the Association of Islamic Banks,12 have
also contributed funds. Such commercial funds, however, are most likely to be invested in income
generating business, and were unlikely to contribute to the ﬁnancing of core reconstruction costs.
Fifth, the US President, a week after the ceaseﬁre, announced an aid package of US$ 230 million
but without detailing disbursement modalities. Sixth, Hizbullah has demonstrated the potential to
play a leading role in the reconstruction of the economy, with ﬁnancial backing by Iran. Finally,
it can be expected that additional funds from the Gulf countries will also be forthcoming.
Other factors will also make an ongoing contribution to the reconstruction efforts. Speciﬁcally,
the Paris I and II13 donor conferences contributed to a reduction of debt servicing costs and to
keeping the public debt at less than it otherwise would have been. The government is also waiting
for Paris III, to be held in early 2007, which is a continuation of both the Paris II and Stockholm
meetings, and where the Lebanese government will submit a new economic reform program. Paris
III will also focus upon the need to implement reforms agreed under Paris II but not implemented
due to prevailing circumstances. The government will be looking for two major outcomes from the
conference. First, to obtain long term soft loans and grants with at least a 15 year maturity period
and a 5 year offset period. Ofﬁcials and economists suggest that Lebanon needs close to US$ 8
billion, or more, in order to complete the reconstruction drive and reduce the budget deﬁcit.14
Second, to obtain loans at an interest rate lower than 5 per cent, and preferably between 3 and 4
per cent. In addition, other forms of assistance and donations from the international community
will also be sought to facilitate recovery from the war and to achieve its economic program and
reform agenda. The government is relying heavily on attaining these objectives, with failure to
do so likely to deteriorate further the country’s economic situation and result in a severe and
unsustainable debt problem. The public debt in Lebanon could reach over 200 per cent of GDP
by 2010, with unsustainable debt service costs, if the government does not succeed at the Paris
III round in achieving its objectives.
3. Policy imperatives for sustained economic reconstruction and recovery
3.1. Policy priorities
In the wake of the summer 2006 war the country faces a number of urgent economic imperatives
that require an effective policy response. These imperatives, and policy response, will form the core
of the government’s economic recovery program to be presented at the Paris III donor conference.
Key imperatives relate to: infrastructure reconstruction; tackling the ﬁscal crisis and large public
million already offered by U.S. President George W. Bush. For more details on the key outcome of the conference see
Lebanon under Siege (2006).
12 Wealthy Lebanese and Arab businessmen also offered to rebuild designated bridges and other speciﬁc infrastructure
13 At Paris II former Prime Minister Raﬁk al-Hariri was able to secure US$ 4.4 billion in soft loans from donor states
to help reduce Lebanon’s debt servicing, but only US$ 2.5 billion of the pledged money came to Lebanon. This allowed
the government to reduce the budget deﬁcit and cut interest rates. Eight donor countries participated in Paris II, namely
Malaysia (US$ 300 million), Sultanate of Oman (US$ 50 million), United Arab Emirates (US$ 300 million), Kuwait (US$
200 million), France (US$ 540 million), Kingdom of Saudi Arabia (US$ 700 million) and Qatar (US$ 200 million).
14 Of which US$ 1 billion is required, speciﬁcally, to support the budget.
866 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
debt overhang; attending to environmental damage and encouraging the recovery of tourism; and
strengthening the role of the private sector.
Reconstructing the country’s infrastructure15 will be crucial to rebuild the economy, unify the
country, meet social needs, stimulate private activity and re-generate exports. In comparison to the
post-Taif public and private sector reconstruction efforts, under Prime Minister Hariri, the current
reconstruction efforts need to be: truly nationwide in scope rather than focused primarily upon
Beirut; be more transparent; and insulated from political interference. For example, more focus
should be given to the poorer parts of the country where increased income from infrastructure
expenditure has the potential to exert a higher multiplier effect arising from an associated expan-
sion in consumption expenditure.16 As mentioned previously Saudi Arabia, Kuwait and Qatar
have already pledged between them US$ 1.1 billion for reconstruction, but more will clearly
be required. The ﬁrst step, however, will be to work out the modalities for project develop-
ment and disbursement, and the Lebanese government has proposed that countries adopt speciﬁc
projects—such as for speciﬁc roads and bridges. Many basic decisions relating to the reconstruc-
tion and rebuilding of the economy, however, remain at an early stage with many crucial decisions
still to be made.
3.1.2. Fiscal crisis and public debt overhang
The Lebanese authorities, as a matter of urgency, also need to tackle the ongoing and intensiﬁed
ﬁscal crisis and large public debt overhang. First, and of immediate concern, is the need for US$
1 billion in budget support for the current ﬁnancial year to compensate for revenue losses. The
war caused a direct loss of about US$ 650 million in revenues that could not be collected. It
also caused the economy to contract from a projected 6 per cent growth rate by mid 2006 to
−2to−3 per cent growth for the year (Bank Audi, 2006), causing another US$ 350 million in
revenue losses.17 The budget will go from a projected primary surplus (before debt service) to
a primary deﬁcit. The government’s only alternative to ﬁnance this deﬁcit is to print money but
this would have a deleterious effect on inﬂation and adverse impact on the health of the Central
Bank’s balance sheet. On the other hand taking on more debt to ﬁnance the deﬁcit would further
exacerbate the country’s existing public debt, which is the highest per capita in the world. Second,
is the need to reﬁnance the existing public debt of US$ 36 billion.18 Private Lebanese banks hold
US$ 20 billion of this debt, and they have indicated that they will reﬁnance. A key issue will be
their willingness to allow a grace period at a minimal interest rate. The remaining US$ 16 billion
will require help from international ofﬁcial and private creditors and the working out of a debt
relief scheme, although this will be complicated. The third issue relates to the electricity sector.
Subsidies to the sector cost the government about US$ 1 billion annually, equivalent to around 20
15 Top priorities are electricity plants and grid, water supply and sewerage, roads and bridges, with preliminary estimates
suggesting required expenditure in the order of US$ 3.5 billion. Also required will be the reconstruction of airports, ports,
telecommunications, and residential property.
16 The gap between rich and poor widened in the 1990s, resulting in grassroots dissatisfaction over the skeweddistribution
of the reconstruction’s beneﬁts and leading the government to shift its focus from rebuilding infrastructure to improving
17 Other estimates of GDP growth for 2006 suggest 0 per cent according to the Central Bank of Lebanon, −5 per cent
by the International Monetary Fund and −8 per cent by the Economist Intelligence Unit.
18 Finance Minister Jihad Azour expected public debt to reach US$ 41 billion by the end of 2006.
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 867
per cent of its revenues and around 5.3 per cent of GDP (Anonymous, 2007).19 Between electricity
subsidies and debt service the Lebanese government spends half its annual revenues, crowding
out other investment in infrastructure or expenditure in the social sectors. Ending the electricity
subsidies will produce an economic shock and hardship among the poor that will require in its
place a targeted subsidy program. This is the type of initiative where donor grant funding for
feasibility studies and technical assistance could generate a considerable multiplier effect.
Tackling the ﬁscal imbalance will require fundamental improvements on both the revenue and
expenditure sides. On the revenue side an increased VAT rate, introduction of a more efﬁcient
and progressive income tax system, and the return to a tax on petrol to its 2003 level need to
be considered. Recently, the government announced that it was planning to increase the current
rate of VAT from 10 per cent to 12 per cent in 2008 and then to 15 per cent in 2010. By the end
of 2010 the government is expecting VAT revenues to be worth around 2 per cent of GDP. The
proposed increase in the VAT rate is still quite low in comparison with many other developed
and developing countries. Tax reform is one of the most important and effective policies to tackle
the deﬁcit and debt problem in Lebanon. For example, property tax in Lebanon accounts for
only 3 per cent of GDP in comparison with 4.5 per cent in OECD countries (Anonymous, 2007).
Hence, tax reform in this area has the potential to signiﬁcantly improve government revenue.
Another potential source of expanded tax revenue is tax on interest income. The government is
planning to increase the rate of such tax from 5 per cent to 7 per cent by 2008, and is expected to
generate revenues equivalent to around 5 per cent of GDP. This again has the potential to enhance
government revenue and reducing the public deﬁcit, but the government needs to be aware of its
potentially adverse effect on attracting overseas investment. In the short term at least, increases in
taxation of the sort suggested here are unlikely to be part of the government’s economic package at
Paris III due to the current precarious position of the economy, and are more likely to be medium
to long term objectives.
Speeding up the process of privatization of certain public sectors—especially telecommunica-
tions and electricity20 is, therefore, the only other option for the government to tackle the budget
deﬁcit in the short term. A key issue here is whether to use the funds generated from privatization
to reduce the public debt or to utilize these to ﬁnance investment expenditure. The total returns
from privatization are anticipated to generate a reduction in debt equivalent to 15 per cent of GDP
(Anonymous, 2007). Hence, privatization is a step in the right direction to reduce the public debt
and deﬁcit but has to be supported by many other economic and tax reforms policies. The war
of 2006 will, however, stall the privatization process due to: the damage to many public sector
assets; the reduced revenue that would be generated from the sale of these assets at this time; a
general loss of conﬁdence, and higher perceived risk, in the economy by domestic and foreign
On the expenditure side emphasis needs to be placed on reducing non productive and poorly
targeted outlays, as well as tackling the cost of debt servicing. In terms of the former, priority
needs to be given to reducing electricity subsidies. This will have an adverse impact on the poor
19 It has also been suggested that at least 500 institutions are not paying their electricity bills.
20 In 2002 the government emphasized privatization,initially in the telecom sector and electricity, with continued planning
for sales of the state airline, Beirut port, and water utilities in line with Paris II. In reality only the telecommunications
sector has generated proﬁts and was potentially attractive to investors. The government pledged to apply the proceeds of
sales to reduce public debt and the budget deﬁcit. In addition, it projected that privatization would bring new savings as
government payrolls are reduced, interest rates decline, and private sector growth and foreign investment are stimulated.
However, progress on privatization has been much slower than anticipated.
868 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
and will require the development of appropriate and targeted hardship alleviating measures. At
the forthcoming Paris III donor conference the Lebanese government will be required to argue
vigorously for further concessional terms on existing and prospective loans from international
lenders and donors. Debt servicing represents a huge drain on government revenue. This will also
need to be supplemented by a voluntary contribution by the domestic private sector, speciﬁcally
the banking sector, to reduce the interest burden on the public debt. Successful privatization
would also facilitate the reduced need for government to provide subsidies to loss making sectors.
However, even if all of these measures were successfully implemented it will take many years to
reduce the debt to GDP ratio to a sustainable level.
In a recent study by Saleh and Harvie (2006) a dynamic macroeconomic model for Lebanon
was developed, estimated21 and simulated to analyse the effects of exogenous shocks arising from
increased government expenditure upon key macroeconomic variables. They ﬁnd that a restruc-
turing of government spending from current to capital expenditure has the potential to produce
a number of potential advantages for the economy. First, an expansion in capital expenditure
produces a larger favourable impact on private sector investment (crowding in effect), which the
country desperately requires after the recent war destruction, enhancing the supply side of the
economy. Expansionary capital expenditure is also found to enhance international competitiveness
and improve the trade and current account performance (due to depreciation in the real exchange
rate) as well as resulting in an accumulation of foreign asset stocks (reduction in external debt).
An expansion in government consumption expenditure, on the other hand, produces unfavourable
external developments with the trade and current account balances both deteriorating in line with
a decline in foreign asset stocks (equivalent to an increase in external debt). This ﬁnding suggests
that improved productivity of government spending can best be achieved by restructuring it from
current to targeted capital expenditure.
Saleh and Harvie (2006) also ﬁnd that government capital and current spending produce similar
outcomes in terms of the interest rate and inﬂation, and are best funded, where possible, through
bond ﬁnancing rather than through monetary accommodation as this is non inﬂationary and results
in considerably less interest rate volatility. They also conclude that a gradual ﬁscal expansion is
preferable to that of a rapid expansion as it results in considerably less volatility in terms of major
In addition to the need for government to enhance its revenue capacity and spending produc-
tivity, other measures will also be required by the government in its economic recovery program
including: reducing red tape and corruption in the public sector; reactivating the liberalization
and privatization of the telecom sector; lowering the high costs of business entry and exit; and
strengthening contract enforcement. These represent reinvigorating the structural reform agenda
agreed at the Paris II donor conference, but which the government has been very slow in acting
upon due primarily to inauspicious economic and political circumstances.
3.2. Environmental damage and tourism
One of the major sectors affected by the war has been the tourism sector. The sector plays a cru-
cial role in the economy due to its strong linkages with other service sectors such as transportation,
construction, real estate, banking and ﬁnancial services and retail. Tourism directly contributes
21 The parameters of the model were estimated using the Full Information Maximum Likelihood and Error Correction
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 869
between 10 and 12 per cent of GDP (World Tourism Organization, 2006), and employs around
300,000 people with one third of these working in catering businesses.22 The Ministry of Tourism
predicted 1.6 million visitors in 2006 that would generate some US$ 2 billion in revenue, and
reﬂected the major advance in economic and political stability achieved by the country before
the outbreak of war in mid 2006. This prediction was on track during the ﬁrst half of the year
with record tourist numbers, registering a 49.3 per cent increase over the 2005 ﬁgure. However
the war precipitated: a dramatic decline in tourist numbers by 58.6 per cent in the third quarter of
the year; the cancellation of festivals and concerts; and the closing down of restaurants, hotels,
nightclubs and beach resorts. This resulted in an overall decline of 8.6 per cent in tourist numbers
for the ﬁrst 9 months of the year.
Early recovery efforts at the end of the war in mid August 2006 focused upon cleaning up an oil
spill off Lebanon’s coast and clearing unexploded bombs. This reﬂected the need to re-generate
this sector and of its considerable importance for the country in terms of employment, GDP, and
the generation of foreign exchange. However, the country will not be successful in attracting back
tourists, investment and returnees without achieving sustainable peace amongst its various secular
factions and with regional neighbours.
3.3. Promoting the private sector
The sustained recovery of the Lebanese economy will require strengthening of the private
sector. This sector has the potential to generate jobs, growth, exports and to integrate the coun-
try’s poorest communities with the rest of the country. Economic recovery after the Civil War
(1975–1990) was strongly facilitated by private activities in the agriculture sector, construction
sector and banking system as well as by resilient private sector small and medium sized manufac-
turers mainly concerned with reassembling and packaging imported parts. The main sources of
foreign exchange are generated by the private sector in the form of family remittances, banking
services, manufactured and farm exports, supplemented by assistance in the from of international
Lebanon has a competitive and free market regime and a strong domestic laissez faire com-
mercial tradition. The economy is service-oriented; the main growth sectors include banking and
tourism. There are no restrictions on foreign exchange or capital movement, and bank secrecy is
strictly enforced. Lebanon has recently adopted a law to combat money laundering, and there are
practically no restrictions on foreign investment. Lebanon also beneﬁts from its large, cohesive,
and entrepreneurial diaspora, and the many Lebanese who live and work abroad generate consid-
erable remittances for the country. The country is also in the process of ﬁnalizing its membership
of the WTO which it hopes to have completed by the end of 2007. Hence the government is trying
to further liberalize the economy and to ease trade restrictions. Perhaps this will enhance further
Lebanon’s trade with its neighbouring countries, and especially within the Middle East and with
European countries. Lebanon is also trying to enhance further its capital and stock markets.
After the Civil War the private sector was seen as the engine for economic revival and sustain-
able growth. A similar role will be required in the wake of the summer 2006 war. In this regard
a number of policy initiatives will be required. First, the role and contribution of the banking
22 Lebanon’s service sector has traditionally been based upon tourism and banking, and the sector itself is the most
important pillar of the Lebanese economy. Nearly 65 per cent of the workforce is employed in the sector and it contributes
67.3 per cent to GDP.
870 C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872
sector will be crucial. The banking sector achieved a healthy performance over the ﬁrst 9 months
of 2006 despite the summer war and its adverse repercussions for overall economic activity and
implications for its business clientele base as mentioned previously. Assets, deposits, loans and
especially shareholders’ equity all reported strong growth in the ﬁrst 9 months of the year. Bank
proﬁtability also increased and appeared to be unaffected by the adverse economic developments
as both interest and non interest income increased. Banks’ assets grew by 4.5 per cent over the
ﬁrst 9 months of 2006 primarily driven by customer deposits. Total loans increased by 7.1 per
cent over the year to September 2006, and capital adequacy strengthened throughout 2006. Hence
the ﬁnancial sector remains strong in Lebanon but there are major problems in the real sector.
Consequently, an important contribution to recovery of economic growth and employment
generation, particularly in the private sector, needs to be made by the commercial banking sector.
Lebanon’s strong commercial banks have experience in administering micro and small business
ﬁnance, and they have considerable liquidity. However, the current lending risk is high, and, con-
sequently, interest rates and lending terms are prohibitive for many of Lebanon’s small businesses.
To get the business sector moving it is essential that Lebanon’s small and medium sized enter-
prises have access to funding. Consequently, the government has an important role to play as a
conduit between liquidity constrained small businesses and the liquidity abundant banking sector.
Government agencies and the commercial banking system need to work in close collaboration to
devise innovative and effective means of meeting the funding and rebuilding requirements of small
businesses. The government could provide partial or full loan guarantees and ﬁnancial assistance
to reduce lending risk and lower borrowing rates, provide a repayment grace period and extend
the lending term. While ﬁnancial assistance, including subsidies, would need to be eventually
phased out, they would open the credit market to a wide range of small entrepreneurs whose
businesses have been destroyed or disrupted by the war. In addition to increasing the availability
of ﬁnancing for micro and small businesses there is also a need to expand large scale private sector
ﬁnancing that would facilitate investment in new business opportunities and support restructuring
and modernization of medium and large scale enterprises.
Apart from ﬁnance another key obstacle for small and medium enterprises in Lebanon is the
very high cost of production (especially for electricity, transport, telecommunications and that
arising from red tape and corruption, etc.). The government must tackle these issues as a matter of
urgency. The government needs, as mentioned previously, to reduce red tape and corruption, reac-
tivate the liberalization and privatization of the telecommunications23 and other sector sectors as
quickly as feasible, lower the costs of business entry and exit, and strengthen contract enforcement.
Hence there is a need to reinvigorate the Paris II structural reform agenda. While privatization of
sectors such as telecommunications, electricity, the state airline, Beirut port, and water utilities
have been on the agenda since 2002, little progress has been made. The events of summer 2006,
however, have made the privatization task extremely difﬁcult at present, and progress is likely to
be further slowed due to war damage that will considerably reduce the revenue generated from
their sale and the reluctance of international investors to invest at this point in time. A success-
ful re-invigoration of the private sector has the potential to make an important contribution to
reducing the debt overhang. According to a recent government report in Lebanon a 1 per cent
increase in GDP will lead to a reduction in debt, as a percentage of GDP, by 5.1 per cent. Hence,
the government in Lebanon should focus more on maintaining sustainable economic growth in
Lebanon by all means as this is an important step in tackling the public sector deﬁcit problem.
23 This remains the most attractive and proﬁtable sector for private investors.
C. Harvie, A.S. Saleh / Journal of Policy Modeling 30 (2008) 857–872 871
Measures also need to be implemented to encourage the return of some if not all of the US$
2.5 billion in foreign and domestic investment that ﬂed the country during the war, and of some
of the 500,000 skilled Lebanese who ﬂed during the war. Such ﬁnancial and human capital could
play a key role in revitalizing the private sector. They can facilitate Lebanon regaining its place as
a hub for business and ﬁnancial services in the Gulf; and restore its engineering and construction
companies to the role as major builders in the Gulf countries.
4. Summary and conclusions
Devastated by Israel’s bombs, threatened by the increasing economic and political inﬂuence of
Syria and Iran, divided from within, facing substantial ﬁscal and current account deﬁcits and the
need to rebuild its fragmented economy, Lebanon faces many difﬁcult tasks ahead. The process
of economic recovery will not be easy and will be heavily dependent upon the benevolence
of international donors. Despite this, history has demonstrated that the country has remarkable
resilience. However, recovery such as that experienced in the post-Taif reconstruction period will
be more difﬁcult in the wake of the war of summer 2006. The government is much weaker and
subject to considerable secular divisions, access to funds from public and private sources for
reconstruction will be much more difﬁcult and there will be much greater dependence on the
benevolence of international donors, there has been considerable capital ﬂight and migration of
skilled labour that could be permanent. Nevertheless, as one of the Middle East’s few functioning
democracies, its pivotal role in trade and ﬁnance in the region and its important role for the
attainment of lasting peace in the region suggests that, while small economically, the success of
the country’s reconstruction efforts this time around are of much wider regional signiﬁcance.
Key to the country’s future growth and development will be the need to reconstruct the country’s
war damaged infrastructure, tackle the unsustainable ﬁscal deﬁcits and debt overhang, reinvigorate
its private sector focusing upon tourism and enhancing the recovery of small and medium sized
enterprises by tapping into the strength of its banking sector. However, there are clear limits to what
the country can do in isolation. Its future now depends very heavily on international lenders and
donors, and in this regard outcomes at the forthcoming Paris III conference will be pivotal. What
happens in the future for Lebanon could be a microcosm of what will happen, more generally, in
the Middle East region.
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