In the sumptuous shadow of Abdeen Palace near downtown Cairo, a bread line forms each morning in front of a small kiosk. It snakes past the open double doors of the nearby bakery where the bread is baked from cheap, government flour as neighbors wait for hours to buy it at the subsidized price of five piasters (or a little less than a penny) a loaf.

On bad days, the line reaches around to local vendor Ashraf Ali’s stall, which manages to accommodate three refrigerators, a glass display case featuring items from packaged sweets to toilet paper, and eleven flavors of potato chips at 100 piasters a bag. An affable 48-year-old, who, like his father, grew up in the neighborhood, Ali has been running his stall for four years, working six days a week, twelve hours a day, and he knows most of the locals in the daily bread line. He gives one of them a few pounds to buy his family a day’s supply of bread, which he and his wife and two sons eat with every meal.

Ali’s late father earned a decent living his entire life working a respectable government job, benefiting from policies put forth under former President Gamal Abdel Nasser that guaranteed state employment for all college graduates. But no longer can the state afford to employ a majority of working Egyptians. Ali works as a freelance auto parts dealer in his spare time just to make ends meet, and his family’s income is still well below the poverty line. As a kid, Ali ate meat several times a week; now he is lucky to have it a few times a month.

A Government Safety Net?

Subsidies have long functioned as what passes for a safety net in Egypt, helping families like Ali’s survive by providing low cost staples like bread and fuel. Subsidized goods are meant to help the poor, who comprise some 42 percent of the population by state estimates, in place of social support tools such as welfare, unemployment benefits, and food stamps that are more commonly found in developed democracies.

But as Egypt’s population has exploded, the cost of subsidies has ballooned to a third of the public expenditure. Meanwhile, only a small fraction of the money actually reaches the underprivileged classes it is supposed to help. With the government facing a widening budget deficit and a moribund economy on one hand and steadily increasing food and fuel prices on the other, Egypt simply can’t afford to foot the bill for subsidies much longer.

President Mohamed Morsi’s administration is searching frantically for ways to put the brakes on runaway subsidy costs through better management and reduced waste. It is also looking to other developing nations that have replaced subsides with sustainable, affordable social safety systems using such tools as “smart cards” and targeted cash payments to the poor. From Iran to Mexico, developing nations have demonstrated that a well-designed social safety net can equip a society’s poorest citizens to participate in “capitalism with social justice,” to borrow a phrase from the president’s election platform.

But Morsi’s biggest challenge isn’t likely to be coming up with a better system. Rather, it will be convincing Egyptians that there is something to be gained by exchanging subsidies for a system that actually helps uplift the poor. Or as Jake Kendall, a former World Bank economist, puts it, “Getting people into the system means the poor can help themselves.”

Challenges to Much-Needed Reform

Like many countries, Egypt began subsidizing basic necessities in the aftermath of World War II, and following the 1952 revolution, they were critical to President Nasser’s socialist economic model. Attempts by past leaders to reform subsidies have been met with riots. Today, the country has become the world’s second largest spender on subsidies in terms of percentage of GDP.

But even faced with an untenable situation, efforts to find a better system have been piecemeal. Piloted schemes include issuing coupons to limit the quantity of subsidized goods allotted each person, paying the poorest families to keep their kids in school, and simply distributing cash. In recent months, the Morsi administration has repeatedly announced the government’s intention to cut certain subsidies— but it has yet to follow through with significant reforms.

Each commodity the government provides at below-market rates—goods including electricity and natural gas; sugar and cooking oil—requires costly layers of bureaucracy to get to the marketplace, with plenty of opportunity for graft and waste along the way. By the time subsidized wheat reaches the market, for example, about a quarter has been lost to theft and spoilage.

And in the end, this high overhead system benefits families like Ashraf Ali’s to the tune of just a few pounds a day. Egypt’s bread distribution system costs the state 3 Egyptian pounds (LE) for every LE 1 of savings—and bread is the most efficiently distributed subsidized commodity. For every LE 1 of fuel savings, the World Bank estimates the state spends a whopping LE 40. Administrative costs are so high that simply handing out the savings to everyone in cash rather than distributing subsidized bread under the current system would cut government costs in half.

Cheap bread and fuel are widely regarded as fundamental rights in Egypt. Signs during the 2011 revolution famously called for “bread, freedom and social justice.” Egypt is the biggest importer of wheat in the world, importing 9 million metric tons annually, which must be paid for in foreign currency. Keeping food and fuel prices at set levels has hit many developing nations as populations and consumption have increased along with fuel prices.

The situation has gradually inspired countries across Latin America and Asia to replace subsidies with more efficient social safety nets that protect their most vulnerable citizens for a much more modest 2 to 4 percent of their GDPs rather than 12 percent, as in Egypt.

Policy Options for Reform

In addition to consuming vast resources, subsidies do not help the people they are supposed to. A commonly cited estimate holds that 80 percent of subsidy spending actually goes to the richest 20 percent of Egyptians (who consume much more fuel than the poor, thereby benefiting more).

Moreover, distributing a commodity of known market value at a lower rate invites corruption. A truck driver can make easy money by filling spare gas tanks with heavily subsidized Egyptian gasoline and reselling it across the porous Libya-Egypt border at four times the price.

“As long as these items are not sold at their actual prices, there will be corruption,” says Magdi Nasrallah, chairman of the Department of Petroleum and Energy Engineering at the American University in Cairo. Magdi believes there is a simple alternative that would solve the problem: “Just give them the cash.” Many economists agree. Systems such as Egypt’s for distributing benefits are often so inefficient that governments can save money by cutting out the costs of dispersing cheap food and fuel and simply giving people the money to buy them at market rates.

Apart from their daily bag of subsidized bread, Ashraf Ali’s family has a smart card that entitles them to a kilo each per month of government sugar, cooking oil, and rice at heavily discounted prices, which gets them most of the way through the month. Ali’s storefront brings in a few hundred pounds, rarely enough to cover his rent of LE 500. With his income from selling vehicular parts, the family’s monthly take is around LE 1,000 (around $165). That’s after taxes and a LE 40 payment toward his government pension, which Ashraf estimates will eventually pay out some LE 200 to LE 225 each month when he becomes too old or sick to work.

This meager sum was considered adequate when it was first established some four decades ago, when the Egyptian pound was worth more than the U.S. dollar. But the pension system has failed to keep pace with inflation. Asked how his family would live on such a sum, he shrugs, “It wouldn’t.”

Many believe the best hope for creating a new social safety net is by continuing to modernize the Nasserist system of providing pensions and subsidized food allotments currently rationed via smart cards like Ali’s. In other words, do not do away with subsidies, but overhaul their distribution to ensure they reach those they are intended for.

Ahmed Darwish, an economic consultant who until last year was Egypt’s Minister of State for Administrative Development, oversaw the initial steps of an endeavor to shift the distribution of pension benefits from a handwritten record system to smart cards known as family cards, which contain information on a microchip. Introduced in 2005, the system saved the government more than a billion pounds in decreased overhead and waste in its first year.

But the benefits, which target the poorest, are insufficient: pensions of a few hundred pounds a month for families with no way of earning an income and around LE 35 worth of subsidized food allotments for families with low incomes. Through their smart cards, some 15 million impoverished Egyptian families like Ali’s are entitled to a few heavily subsidized kilos of food staples every month under the system, while 1.2 million families also receive pensions.

Darwish is aware that this system is still a long way from providing a comprehensive support system for all Egyptians, but unlike blanket subsidies, at least the benefits of the new program are reaching its intended recipients. “You have no idea how inefficient government is,” he says.

At the administration’s urging, the Ministry of Administrative Development is overseeing an expansion of pensions to 3 million more families over the next decade and distributing family cards to a total of 17 million families by the end of this year. The ministry has also embarked on several pilot projects exploring the use of smart cards to improve the distribution of gas cylinders, bread, and gasoline.

The cards are designed to be adaptable to other functions in the future. For example, people could someday use their smart cards to withdraw the cash value of food subsidies from an ATM. If a government shop is out of rice, a cardholder could simply withdraw the cash and purchase the rice somewhere else. Or if her children do not like rice, she could buy lentils instead. Such schemes have shown great promise in countries from India to Brazil, with improved nutrition among recipients and better provision of staples at government shops as storeowners step up their efforts in the face of competition.

Changing the system is far more complicated than simply achieving greater efficiency, however. It must also tackle a deep-seated mistrust of government resulting from decades of official graft. Ashraf Ali laughs out loud at the notion that the government would ever make good on any promise to provide the poor with cash in lieu of cheap bread.

Darwish is well aware of such sentiment. If the government promised people a monthly cash allowance for a base allotment of food and fuel, he says, people would riot, claiming the state was trying to cheat them. Of course, such skepticism is not particular t o Egypt.

In order to assuage its populace when it transitioned away from subsidies, Iran actually created bank accounts for all of its citizens beforehand and deposited cash benefits into them so people could check their balances. On December 18, 2010, the day subsidies were cut, the accounts were made accessible, and according to institutions such as the International Monetary Fund and the Economist Intelligence Unit, Iran succeeded in creating one of the most successful models to date for building government trust and replacing subsidies.

Risk Adversity, Inequity, and Financial Services for the Poor

Last spring, Ashraf Ali’s doctor told him he had a severe heart condition and needed to eat better, quit smoking, and rest for two weeks. Ali cut back on cigarettes, and his wife cooked healthier dishes, but with no unemployment benefits, following the doctor’s orders to spend two weeks in bed meant he had to pull his kids out of school to cover the shop. He explained this on a recent afternoon while simultaneously keeping an eye on a live feed playing on the shop TV that gave updates on a local soccer match.

Since learning about the heart condition, Ali has stopped watching the matches live because they get him too excited. Cigarettes have proved more difficult to give up than sports, however; before the match was over he had smoked half a pack. But Ali has no money for more medicines or other further medical treatment. If he dies suddenly, he says, his sons would have to quit school to take over running the shop. “I want a dignified life for my family,” he says. But for many Egyptians like Ali, achieving this goal has become increasingly difficult.

His predicament demonstrates another major failing of blanket subsidies: They don’t provide people with a cushion when they are down on their luck, which is the very definition of a social safety net. Markus Loewe, a senior economist at German Development Institute, says this state of affairs can be particularly disastrous for members of the hard-working poor such as Ashraf Ali, who in normal times are often barely treading water.

“In today’s Egypt, if people fail in their economic activities, they fall down to zero,” he says. This makes them risk averse, inclined to keep their savings liquid, stuffed in a mattress, rather than investing in, say, training or machinery. And when they hit economic road bumps such as illness, they resort to extremes, pulling kids out of school, selling off investments—doing things that ultimately hurt their future earning potential. It is a cycle that helps keep Egyptians poor and ultimately hurts the whole economy.

Conversely, in countries in which citizens are covered in case they lose their jobs or get sick or hurt and cannot work, people are more likely to think, “Well, there will always be a minimum income level, I may invest and take the risk.” In Loewe’s view, an economic safety net is a necessary step toward the universal goal of building a more innovative, entrepreneurial, and stable Egypt.

Educating people on the importance of supporting and uplifting the poor for the good of the country as a whole may be a critical step toward implementing such a cushion. Moves to reform subsidies are likely to be fiercely opposed by middle and upper class Egyptians, who benefit from them most.

Francisco H. G. Ferreira, a lead economist with The World Bank’s Development Research Group, says that when there is an acknowledged inequality of opportunity in a society, reforms can be successfully rolled out in the name of social justice. Loewe advocates campaigning for subsidy reform by emphasizing the overall benefit to society. “People who feel the state cares for them are more likely to care for a mutual feeling of responsibility to community,” he says.

Ferreira says providing subsidies to the poor tends to be more acceptable to the wider community if benefits specifically reward the working poor or require that people strive for a better quality of life. For example, Mexico devised a poverty reduction scheme in 1997 dubbed Progresa, which replaced tortilla and electricity subsidies with payments that were conditional upon families sending their children to school and getting regular medical check-ups. The program has since been credited with spurring significant improvements in school attendance, nutrition, and health.

Other ideas are in the pipeline on how a social welfare system could support the poor while more effectively integrating them into Egypt’s economy. Pakistan has rolled out a successful model by providing all its citizens with I.D. cards linked to individual numbers and cash accounts. Those eligible for benefits receive payments directly to these accounts, which are electronically recorded on their I.D. cards.

Because the system was designed in an open manner that can also be utilized by banks and employers, the cost of doing business with the poor drops: Financial institutions and other businesses can outsource their services to “mom and pop” shops rather than build expensive brick and mortar stores in impoverished neighborhoods to target this segment; nor do they have to deal with the logistics of collecting a great number of very small payments in cash.

Conclusion

The system has the potential to create “an ecosystem of services for the poor, innovative financial systems, building pensions, and credit ranking systems as we have seen begin to emerge in Kenya,” says Jake Kendall, formerly a researcher with an arm of the World Bank dedicated to exploring ways to expand financial access for the poor.

Egyptian smart cards are currently equipped with an as-of-yet unutilized “money purse” feature that could be used in the future to distribute cash payments electronically to poor families, like in Pakistan. Such developments make the poor “an addressable market,” says Kendall.

That is important to someone like Ashraf Ali, who has no bank account but has dreams of making improvements to his business and hence his family’s standard of living. With a Shariah-compliant loan of LE 1,000, he says, he could afford to rent a bigger shop with higher customer turnover. But currently Ali has no access to loans or credit.

Last year, he wanted to expand his inventory by purchasing a cabinet to hold dried beans, grains, and spices. It took him ten months to save the LE 500 to buy it. If Ali’s identity had been linked to a verifiable source of money, however, his chances of being eligible for that loan would have improved greatly. He could possibly have accessed private pensions, insurance policies, and a host of other services that could ultimately help Ali and his family transcend poverty.

The Social Fund for Development is in the initial phases of providing I.D. cards to millions of Egyptians who currently lack any means of proving their identities—and therefore any way to access targeted government assistance. This underlines the size of the task ahead as Egypt seeks to create a system to support its most impoverished citizens.

In the meantime, Ashraf Ali and his neighbors continue to spend hours each day waiting for cheap bread— hours that might otherwise be spent doing things that could help get Egypt’s economy moving again.