Don’t give up on an Egyptian democracy

August 19, 2013, 3:06 PM UTC

FORTUNE — Increasingly, the unfolding Egyptian tragedy is seen in Washington circles as confirmation that the U.S. has lost influence in a critical part of the world, and particularly vis-à-vis a military that receives lots of American support. While correct — given Egypt’s current realities, no foreign entity has any meaningful influence these days — this observation should serve as the beginning of the analysis rather than its conclusion. And the insights extend well beyond the sad circumstances of the Arab world’s most populous country.

The U.S. is on a long list of advanced and developing countries expressing dismay, concern, and frustration with what is happening in Egypt: dismay at the enormous and growing civilian casualties; concern that recent developments are taking the country even further away from economic, financial, political, and social stability; and frustration with the inability to help, including in promoting national reconciliation.

The U.S. has reason to feel even more exasperated.

Following President Anwar Sadat’s historic pivot away from the Soviet Union in the mid-1970s, America has been Egypt’s closest ally. It provides over $1 billion of aid per year, together with training for the Egyptian military. The two countries partner in fighting terrorism. Most Egyptians admire Americans’ entrepreneurship, freedom of expression, and rule of law. And, since the January 2011 popular uprising that started in Tahrir Square, President Barack Obama has struck an impressive political balancing notwithstanding Egypt’s extreme political fluidity and rapidly shifting domestic alliances.

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It is understandable that, with such initial conditions, many feel that the U.S. should be playing a more effective role in countering the deadly violence in Egypt. Indeed, the U.S. may be the only effective external voice of reason during an increasingly dangerous phase in Egypt’s proud history.

Yet neither the President’s wise speech on Thursday nor the threat of aid cutoff seems to have an impact. To make things worse, and as acknowledged by President Obama, the U.S. finds itself in the midst of conspiracy theories originating from all sides, including from both supporters of former President Mohamed Morsi and his opponents.

No wonder so many are inclined to characterize the situation as highlighting America’s lack of political clout. But in pursuing this narrative, it is important to remember four points — especially as they also speak to forward-looking responses.

First, what is happening in Egypt is the dark side of a phenomenon that could actually be in the country’s (and the region’s) longer-term interest — that of a material grass-root political awakening after a prolonged period of repression and culture of fear.

The January 2011 popular uprising enabled and empowered average Egyptians in a manner that many thought unlikely if not unthinkable. In effect, most citizens went from the equivalent of oppressed landless-peasants in a nation run to benefit a small privileged elite, to having a voice and an influence on the country’s destiny.

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They took to the street in January 2011 to remove a Mubarak regime that had ruled with an iron fist for 30 years. They returned last year when the first set of transitional military rulers dragged their feet in handing off to democratically elected politicians. And they were back a few weeks ago to counter a president who was failing to deliver and, more importantly, was seeking to overreach on legal and other matters.

Second, Egypt’s domestic institutions are in no position to respond to this new grass-root reality. Historically co-opted by special interest, they are structurally flawed and lack credibility. As such, they cannot channel the explosion of grass-root energy into productive ends. Indeed, quite the opposite. Their weaknesses fuel polarization and mistrust.

Third, the lack of credible political leaders accentuates the challenges. The “leaderless” character of the 2011 revolution has gone from an admirable sign of popular integrity to undermining the much-needed revolutionary pivot: from dismantling a repressive past to building a prosperous future.

Fourth, the absence of institutional and political anchors does more than undermine national reconciliation. It also serves to worsen an already-worrisome economic and financial situation.

Every aspect of Egypt’s already-fragile economy is suffering — from growth and inflation, to the budget and the balance of payments — thus placing even greater pressure on a country with widespread poverty, high income inequality, and underutilized human talent.

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There is little that any foreign entity can do today to alter these sad realities. Domestic shortfalls need first to be addressed internally, with national political reconciliation constituting a precondition. Attempts to insert an external anchor, no matter how well-intentioned, would likely be more than ineffective; they could also serve to divide a mistrusting Egyptian society even more.

But this does not mean that Egypt’s allies should step away from this really messy situation. Instead, they should maintain optionality in the short term while revamping their overall approach for the longer term.

The U.S. is doing the right thing in preserving contact with Egyptian counterparts. It is important to stress repeatedly, particularly through quiet diplomacy, the importance of maximum restraint when it comes to the use of force, inclusive political participation, and an early return to democratic rule. In doing so, the U.S. provides an important external perspective, supplemented by insights on the experiences of other countries.

It is also important to continue revamping the channels through which the U.S. will interact with Egypt over the longer-term. Financial aid, while meaningful, no longer plays its traditional “carrot and stick” role. Its magnitude pales in comparison to what Egypt can and has mobilized from Gulf countries; and dominance by military uses limits the societal impact.

Looking forward, Egyptian society needs more empowered entrepreneurship, modern and durable institutions, and enhanced technological leapfrogging that would materially impact national productivity. The U.S. can support Egyptian citizens on each of these. And all would help in eventually placing the economy on a sustainable path of higher and more inclusive growth, proper job creation, and greater social justice.

Remember, there is nothing more consequential than a citizenry that feels ownership and an ability to influence its destiny.

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Egypt is currently experiencing the downside of this phenomenon due to weak institutions and inadequate leadership; and the situation is being exploited by a disruptive few pursuing interests that undermine national well-being. But we should not lose sight of the potential upside. Indeed, it is already apparent in the surge since January 2011 in civic engagement, be it in health and education or in support for small entrepreneurs.

With Egypt sadly facing a dangerous situation in the weeks ahead, and with outsiders unable to help, it is tempting to give up on the country’s journey to democracy. We shouldn’t.

The eventual emergence of proper institutions and better leadership will play a critical role in channeling individual empowerment into productive democratic ends. Egypt’s friends need to get ready to support this process with a revamped approach and broad partnerships.

Mohamed A. El-Erian is the CEO and co-chief investment officer of PIMCO.