 Ishac Diwan and Ibrahim Jamali There is no question that in the medium-to-long term, Lebanon’s economic growth will be highly dependent on raising competitiveness. This involves at least four mighty dossiers: improving the security situation, restarting the financial sector, reducing public debt, and resolving the electricity shortage. However, in the current context, these are ambitious and difficult goals that require several years to achieve, at best. This raises the question of whether some economic progress can be achieved in the interim, and if so, how. The reasons why national production fell by perhaps as much as half are not well understood. Some firms went bankrupt, many others operate below potential, and unemployment and under-employment are rampant. In other recessions around the world, outside situations of destructive wars, GDP declines of more than 10-20% are rare. The production collapse is particularly noteworthy given that the country’s assets – people, buildings, infrastructure - are broadly the same, although some decay took place in the form of brain drain, firm closures, and the destruction due to the port explosion, and recently by Israel. So why such a huge drop? Most attention has focused on the supply-side issues listed above, plus other factors that discourage production by making it less profitable, such as a lack of a direct route to GCC markets, the scarcity of skilled labor, and, more generally, a very poor investment climate. But while these factors are certainly at work, this is not the only part of the story. A more direct reason for the production drop relates to the collapse of aggregate demand. Demand collapsed early in the crisis, as households got impoverished by the LBP maxi-devaluation, hyper-inflation, mass unemployment, loss of LBP-denominated assets (like pensions), and the lack of access to their bank account. There was also a decline in tourism and a collapse in FDI. The last published National Accounts in 2021 give indications about where demand fell most. By these estimates, total spending collapsed by 65% between 2018 and 2022 (when accounted in market exchange rates). The decline was much larger for government spending (by an extraordinary -90%), followed by investment (an astonishing -85%), and then private consumption (around -50%). By now, public sector spending and wages remain extremely depressed, even though they have started to recover. Recent estimates from the Ministry of Finance suggest that the public wage bill, which stood at around 11-12% GDP pre-crisis, declined to 3.5% GDP during 2022-23, and is now recovering slowly (it is estimated to reach 7.4% GDP in the 2026 budget). There are some indications that private formal wages are recovering faster, especially among skilled workers. This suggests that it is mainly a rise in the wages of public sector jobs and low-skill jobs that can fuel transition growth -- both are also desirable to improve public sector efficiency, reduce petty corruption, and reduce rampant inequality. Data on international trade – one of the few areas that still produces data – confirm that both demand and supply constraints are at work. By 2021, imports of goods and services fell by nearly 50%. This is a clear indication of a large fall in aggregate demand. But second, exports of goods and services also dropped by 50%, despite a large real devaluation. This indicates a loss of competitiveness on account of factors of production other than non-tradables (such as low-skilled work or real estate) becoming more expensive, especially energy and capital. Over time, imports recovered, but this does not indicate that aggregate demand recovered. Indeed, the composition of imports changed, with intermediate inputs shrinking and cheap consumption goods rising. This suggests that domestic production has become more crowded out by foreign imports, as domestic firms have not yet managed to regain competitiveness. Exports also partially recovered, as some firms managed to develop coping mechanisms that allowed them to continue benefiting from their comparative advantages. Therefore, there seems to be three ways to achieve some economic progress in the short to medium term, before Lebanon can become competitive enough to grow using an export-led strategy: 1. The first is to attract external support to invest in infrastructure repair, and transitory support for the state to support public wage recovery. This will create jobs, and through multiplier effects, and through a rise in aggregate demand. 2. The second type of progress that can be achieved before ambitious reforms are implemented would be through more modest second-best reforms that can help improve the business climate and reduce production costs. For example, there can be new providers of credit before a systemic restructuring of the banking sector takes place. Similarly, Lebanon could import cheap energy before it rebuilds its large power plants. 3. The third type of policy that can generate a recovery in the short term is to focus on pushing up aggregate demand, so as to use up more of the existing production capacity, with minimal additional investment. The rest of the piece focuses on this third type of policies, boosting aggregate demand, in a way to generate a supply response, and thus generate some growth, more jobs, and somewhat higher wages – i.e., some catch-up of the economy, until Lebanon becomes more competitive. This is for sure easier said than done. The difficulty with expansionist policies is that fiscal and monetary policies, which are usually used to expand domestic demand, cannot be used, since both the state and the Central Bank have no financial headroom available to increase spending. Moreover, it is hard to implement policies with a very diminished state capacity, and this is made even harder by the paucity of economic data. Finally, there are high risks of generating inflation and destabilizing the LBP if such policies are not structured properly. The mechanism that allows the economy to gain from a rise in aggregate demand is closely related to the presence of unused excess capacity in firms. In the tradable sectors, foreign products are presumably more competitive given the high domestic cost of production, and it will be hard for domestic firms to compete (in the absence of some temporary trade protection). But in the non-tradable sectors, excess capacity can be reduced in the short term if demand can be boosted. At the firm level, interviews of enterprises recently conducted by my students suggest that unused capacity in non-tradable sectors is high, averaging around 50%. At a macro level, unemployment has not been measured recently, nor do we know the extent of idle machinery and unused real estate, but everyday observations suggest large excess capacity. If this is correct, then policies could try in a first phase to invigorate aggregate demand, with the goal of using up more existing production capacity, while at the same time initiating the more difficult measures to reduce production costs, which would allow in a second phase to improve competitiveness and drive export-led growth. How much is feasible before the impact of structural reforms kicks in? The main limit of this sort of growth comes from the risk of higher demand going largely to imports, putting pressure on the exchange rate and generating inflation. This risk is exacerbated if there is no domestic supply response. Firms cannot operate near full capacity without some complementary investment, but investment cannot start to rise in the absence of some minimal level of credit, which has not happened yet because no new financing vehicles have emerged. Another limit is related to insecurity. If money were dropped from helicopters, households would prefer to save a large part, even if they are cash-constrained, if the risks of insecurity remain high. While one would be hard pressed to come up with precise estimates, it is quite possible that catch up growth operating by increasing capacity utilization of the non-tradable sectors (the state, health, education, trade, tourism) can generate a cumulative growth of perhaps 15 to 20% in GDP over the next 2 or 3 years before capacity and competitiveness become the binding constraints to growth. How can demand be boosted in the short term? There seems to be three instruments available: external support, tax policy, and trade policies.
In parallel, some supply support will be needed to ease the use of excess capacity, directed to firms where excess capacity can be readily mobilized. One possibility is to offer tax rebates for investments, to incentivize firms’ self-financing before credit restarts. There is also a need to create a financing facility that can provide some new credit to help rehabilitate decayed productive capacity, before the banking sector comes back to life. Another needed complementary input to allow for a fuller use of underused factors is skilled labor, much of which has migrated, but which can be attracted back if the security situation improves sufficiently. Multiplier effects can be very large here given that the corporate sector balance sheets are spotty clean now, the result of the elimination of corporate debts during the banking crisis. In sum, a good understanding of the causes behind the recession, and the factors constraining a recovery, are necessary to shape short-term policy priorities. These are also important as an input into the discussions of the 2026 budget and to the ongoing negotiations with the IMF. Lebanon needs to negotiate an IMF program; it would be important to support the right policies. The recent IMF projections are based on assumption of improvement on the supply side, more specifically, on: “reconstruction, tourism, pent-up demand, tourism, and structural reforms.” The assumed presence of pent-up demand suggests a conceptual frame of constrained supply with excess demand, the opposite of what was argued above - a situation of constrained demand with unused production capacity. All this suggests that it is time to start thinking more seriously about how to build up a recovery. This goes beyond negotiating a macro-economic framework and needs to involve a constructive narrative that can be credible and that can mobilize firms, entrepreneurs, financiers, and workers. Using the wrong framework has a high opportunity cost, since in the absence of economic progress, there is a risk of a vicious circle developing. Conversely, improved economic outcomes will ease the implementation of politically difficult reforms. Thus, great care is needed to develop a narrative about how to achieve progress in the short and medium terms that is adjusted to local circumstances. References Banque du Liban. Quarterly Bulletin, September 2025. Diwan Ishac, and Henry Chaoul. Lebanon at risk. ERF working paper, 2023. International Monetary Fund: Lebanon: Technical Assistance Report on Putting Tax Policy Back on Track, 2023. Infopro. Relaunch 2025. An alternative Roadmap for economic revival. Leaders Club, 2025. Ministry of Finance, Budget Plans for 2026, Government of Lebanon, September 2025 World Bank Economic Monitor: Turning the Tide? 2025. About the Authors Ishac Diwan is an IFI University Fellow and Professor of Practice of Economics at AUB. Ibrahim Jamali is an IFI University Fellow and Associate Professor of Finance at AUB. This blog is published by the Issam Fares Institute for Public Policy & International Affairs (IFI) at the American University of Beirut, made possible (in part) by a grant from Carnegie Corporation of New York, and is available on the following website: http://www.aub.edu.lb/ifi.
The views expressed in this document are solely those of the author, and do not necessarily reflect the views of the Issam Fares Institute for Public Policy & International Affairs or that of Carnegie Corporation of New York. Comments are closed.
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