Adel Mhadhebi/Demotix. All rights reserved.

The attack on the Bardo Museum in Tunisia risks putting much needed economic reforms on hold. Arguably, addressing high youth unemployment is as important as security efforts to mitigate the terror threat.

The freely elected non-transitional government has the legitimacy to embark on these reforms. There are three key reforms that can increase employment, which pertain to the overvaluation of the Tunisian exchange rate, the protection against imports, and the role of the State as an investor.

In addition, the relative political and macroeconomic stability the country has enjoyed—key positive elements since independence—must be retained in the process. Finally, in order for the economic reforms to succeed, the probable winners and losers must be identified. The losers should be compensated; the winners simply informed so as to garner their support.

Take care to keep what works

The relative strength of Tunisia in the past was primarily due to four factors: an adequate volume of investment, massive spending on education, a good deal of political stability, and a good deal of macroeconomic stability. 

The adequate volume of investment was in large part due to these twin stabilities. Therefore, the new government should take care to secure them. Education should continue to be a focus, but spending itself is no longer the problem, but rather the quality. At any rate, it is economic growth that will create the jobs and opportunities for graduates.

Political stability has, until 2011, been achieved undemocratically and as such was of poor quality and unsustainable. However, it should be clear that civil war and anarchy are not good for growth. The challenge will be for the government to reach consensus with as large a majority as possible.

As hard as it might be, continuing to build consensus among secular parties, the moderate Islamists of Nahda, civil society, business owners (UTICA), and the main worker's union (UGTT) must continue. The time it takes to achieve this consensus, as was done with the constitution, provides the political stability that investors require.

Macroeconomic stability has been largely maintained thanks to overall prudent fiscal management, an equally prudent monetary policy, and unfortunately, through pervasive controls.

The late Hedi Nouira, who was the first head of the Tunisian central bank and later prime minister, began this tradition of prudent fiscal and monetary policy. Looser monetary and fiscal policies would invariably lead to inflation, and though the developed world fears deflation, inflation for emerging (or almost emerging) economies means uncertainty, which is very bad for investment and growth.

Macroeconomic stability will be harder to maintain than before. In the current political environment, the government is unlikely to try to cut consumer subsidies, raise taxes or introduce or raise user's charges. Moreover, the aging of the Tunisian population will be a new fiscal burden.

Three economic reforms to consider

Maintaining political and macroeconomic stability will not be easy, but by themselves they have not been and will not be enough to prevent high unemployment. This is because the policy framework remains unsatisfactory, despite some attempts to improve it.

Tunisia grew at about 4-5 percent per year on average over about four decades (which might suggest that for growth, the twin stabilities are more important than good economic polices). Unfortunately, this was not enough to significantly bring down unemployment (still estimated at 15.3 percent according to the World Bank) and alleviate regional disparities.

The overvaluation of the Tunisian exchange rate is a key issue that is not helping employment. Tunisia has abundant labour and a narrow domestic market. At the same time, the dinar is overvalued. 

The foreign exchange controls in place bear this out. The controls only exist because the price of the dinar is set too high by the government. At that price, there isn't enough foreign exchange to satisfy the demand for it. Or more precisely, no one on the free or black market would buy or sell the Tunisian dinar at the government rate.

Another sign confirming the overvaluation is the need for customs to protect domestic producers against imports, which are cheapened by the strong dinar. So the strong dinar plays against domestic producers and investors and plays against job creation.

It is even worse for the export sector, actual and potential. The strong dinar means that Tunisian goods are too expensive when converted to other currencies. Again, this discourages investment and job creation in the export sector, where the potential for expansion is practically infinite compared to the narrow domestic market. Therefore, the overvaluation of the dinar is a major cause of unemployment.

Based on the above rationale, Tunisia should plan to move towards the full convertibility of the Tunisian dinar. This will allow for a true pricing of Tunisian labour and production, and make Tunisia competitive.

Tunisia would then be able to progressively dismantle the protection against imports. This will push Tunisian entrepreneurs to be more efficient to compete with imports. They will also be forced to produce for export, as well as, for the domestic market. Producing for export is the only way to reach full employment as the domestic market is simply too small.

A third reform to consider is the reduction of the role of the state as an investor. This would include privatisation of state holdings. The State could sell a third of the stock to employees of the enterprise and the rest to the public.

The right environment to succeed

The three economic reforms proposed will appear rather extreme to many. That they will help address unemployment may not be convincing enough. It should also be clear that the convertibility of the Tunisian dinar is fraught with danger and should not be undertaken lightly.

Large foreign reserves will need to be built up and the readiness of the IMF and others to help protect Tunisia from possible unscrupulous speculators is required. Nevertheless, these reforms are what Tunisia needs to reach full employment and so the groundwork must be laid out today.

In order for these reforms to even have a chance of success, they must be accompanied by two important elements. First, the identification of the probable beneficiaries of the measures in order to gain their backing is needed.

Often the probable beneficiaries of economic reforms may not even be aware of the benefits these will bring. Second, the identification of the probable victims of the measures in order to generously compensate them is necessary. This could be done with the proceeds of privatisation.

Economic reformers have often paid a heavy price for their attempts, even when the need was great. The ruler of Tunisia Sadok Bey dismissed his Grand Vizier Hayreddin Pasha (or Khayr-aDin Pasha) for his reform efforts in 1877.

Sultan Abdulhamid II in Istanbul reacted in similar fashion with the same Hayreddin Pasha as Grand Vizier there in 1879. France also saw La Disgrace of Anne-Robert Jacques Turgot by King Louis XVI in 1776 for his reform attempts.

There might very have been better times to try to reform the policy framework in Tunisia. Right now, it is very risky. In particular, it would be difficult to try to cut the food subsidy at this point.

It might be tempting to paraphrase perhaps an apocryphal statement by a French Minister of the Third Republic that policy reform is on the government agenda and it will stay there. Tunisia though should find in itself the strength to start resolutely implementing economic reforms.