5th issue

A Long Hard Road

Middle East Transitions:

A Long Hard Road

A Summary by Shahid Yusuf

Growth Dialogue

George Washington University

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Throughout the Middle East governments are under pressure to satisfy some of the urgent demands of the populace in the near term and credibly commit to policies that are likely to lead to steady and inclusive development. This paper briefly examines and assesses the factors responsible for the recent and ongoing upheavals and discusses the key remedial policy measures being proposed, which are of (varying) relevance to six transitioning Arab economies (Egypt, Jordan, Libya, Morocco, Tunisia and Yemen – henceforth referred to as ACT).

Growth as a necessary condition for development

Weak economic growth was not the only cause of turmoil and regime change in MENA; low-to-moderate rates of growth over two decades in the face of rapidly increasing labour forces dashed the expectations of a generation that is aware of progress elsewhere, and expects more.

Between 1990 and 2000, MENA economies averaged a GDP growth rate of 3.8% per annum; between 2000 and 2010 they averaged 4.7% per annum, well below the low- and middle-income country average of 6.4% and the 9.4% achieved by East Asian countries. Higher growth will not be a panacea for the ACTs, but if growth does not quicken in the near-term and remain strong well into the future, the core issues – employment for the expanding army of the young and disaffected, poverty, social services, fiscal imbalances, quality of life, and longer-term prospects for the young – cannot be adequately addressed. Faster growth is a necessary but not a sufficient condition for a return to stability and the achieving of inclusive development that in time may begin to heal the corrosive sectarian and tribal divisions that have emerged in several countries.

Sources of growth

The sources of growth can be approached from three different angles: supply-side; sectoral; and demand induced. Higher growth requires working on all three registers. Supply side measures that raise the rate of investment in productive assets promise the quickest returns, while the quality of education and skills, plus the accumulation of R&D capital and innovation capabilities provide a stimulus after a gestation lag of perhaps a decade or more. The sectoral sources of growth are acquiring greater importance because of technological change. Until fairly recently, growth was synonymous with industrialisation: in virtually all of the upper-middle- and high-income economies, manufacturing was the leading sector and a major employer. However, over the past two decades, a shrinking contribution of manufacturing to GDP is paralleled with higher capital and reduced labour utilisation coefficients, the result of labour-displacing technological change and the lower relative cost of capital in a number of the industrialising countries and worldwide. If manufacturing is surrendering its lead role, then, by default, services become the principal driver of growth, productivity gains, employment and exports. Achieving these will be a considerable challenge.

Complementing the above is the demand-side of growth derived from consumption, investment, and net exports. For more than a decade, transitioning countries, such as Egypt, Jordan, Morocco, and Yemen, have relied on domestic consumption to propel growth. But for small and mid-sized economies seeking to accelerate growth with the help of productivity gains and innovation, this is not a viable strategy. A diversifying bundle of exports that benefit from economies of scale and learning and induce innovation will need to contribute possibly up to a third of annual growth. Diversification is vital also for resource dependent-countries, such as Libya and Yemen, that are cushioned by oil exports but need to develop a base of tradable goods and services to create employment, to initially supplement energy exports, and to eventually supplant the latter as mineral resources are depleted. A large and thriving tradable sector is at the heart of every successful growth story. Both exports and imports are key: imports no less than exports serve to raise productivity by transferring technology, putting competitive pressure on domestic firms, and providing exporters with the inputs they need produce and to participate in global value chains.

A reform menu

Confronted by an impatient population, governments old and new do not have the luxury of time. They need to take concrete policy steps producing quick results in the current less-than-propitious global environment, and to follow through with additional measures based on new economic strategies (crystallised from the many reports that have been produced to date) that build upon these early initiatives so as to sustain the tempo of development over the longer run.

In many countries, a start has been made to address macroeconomic imbalances, an important precondition for growth-enhancing policies. A recent World Bank report stated that “employment miracles” require a combination of macro stabilisation, flexible business and trade regulations, improved governance, and the time it takes to enforce contracts and start a business. Progress in these spheres would take the edge off the uncertainties that beset the ACTs and that are dampening private investment and inducing capital flight. Macroeconomic policies will need to be juxtaposed with skillful management of political differences, a degree of tolerance for the articulation of dissent, willingness to compromise, and proactive efforts by governments to forge a consensus with major stakeholders on developmental objectives.

Growth should narrow rather than enlarge fiscal and external imbalances, which means that it should ideally be led by tradable sectors and begin contributing to foreign exchange earnings. Absorbing more youth into the public sector and/or raising the salaries of public employees—as Egypt, Tunisia and Morocco have done—can temporarily placate the restive workforce; however, such actions involve long term fiscal costs as they cannot easily be undone, they negatively impact productivity, and they further distort the expectations of young graduates for whom a ‘tenured’ public sector job with benefits is life’s driving ambition— and they affect wage costs in other sectors as well.

Macroeconomic policies must be complemented by short term measures impinging upon tourism, trade promotion, small and medium enterprise development, and infrastructure. And by a credible longer-term strategy targeting improvements in the business environment; state enterprise reform and private sector development; 21st-century industrial policies; entrepreneurship; and an upgrading of education and training. Some of these are briefly noted below and discussed at greater length in the paper.

For countries that derive large earnings from the labour-intensive tourism sector, Egypt, Jordan, Morocco, Tunisia, and to a lesser extent Yemen, this is a sector deserving urgent attention because it can initiate a revival and help persuade foreigners that ACTs are on the mend.

From among the menu of feasible export-promoting policies, all of which were implemented by the East Asian tiger economies with varying degrees of success, the following remain of relevance for ACTs, albeit for the ones with merchandise exports to sell:

Exchange rate policies that address exchange rate misalignment and lost competitiveness, thereby supporting exporters;

Export subsidies, insurance, and guarantees (to the extent permissible under existing trade agreements);

Reduction of trade barriers and trade facilitation procedures, and WTO/EPA-related capacity building; and

Soft infrastructure: i.e. assistance with overseas market intelligence, standards, metrology, etc.

Assuming that investment will remain the principal driver of growth for the foreseeable future for the ACTs, raising the level of investment in manufacturing and tradable services would be good for productivity, innovation, trade and, of course, employment. In order to achieve results, each of the countries will need to adopt a multi-pronged approach suitably tailored to their individual circumstances.

International experience, and in particular the experience of East Asian economies, suggests that investment responds to steps that improve the business environment however, these must be matched by equally vigorous actions along three other axes: state owned enterprise reform and private sector development; market compatible industrial policies; and entrepreneurship. The lesson from China and some of its neighbours is that growth and employment generation really took off when a combination of institutional reforms and industrial policies enabled the private sector to gain traction. A curbing, corporatising, and/or downsizing of the public sector not only releases human and financial resources; it also lowers entry barriers into industries dominated by state-owned enterprises (SOEs). In addition, it raises the level of competition, including competitive pressure on SOEs. ACTs face a dual challenge: they need to scale back the role of public enterprises, and they also need to curb the market power of the quasi-public entities owned or controlled by regime insiders and friendly business allies.

The industrial policy (IP) variants now coming into vogue embrace support for competitive subsectors; these subsectors are being buoyed by a widening of comparative advantage (aided by foreign direct investment as in Tunisia and Jordan) and are demonstrating their prowess via expanding domestic market shares and/or exports. This approach to IP includes measures to strengthen the research infrastructure and to build a “triple-helical” innovation system, with special attention to research universities and advanced training in the sciences. They incorporate some vestiges of the traditional industrial polices, in that they maintain that ‘competitive winners’ and firms testing the edges of new technologies can receive doses of supportive credit from public venture–type institutions, even as they establish a foothold in international markets or work through the gestational phase of new technologies.

Arguably the most widely touted solution to the unemployment problem is reform of the education and vocational training systems that will raise quality and reduce the skill mismatches in labour markets. This is a solution being proposed for all other countries, including advanced ones. Labour market institutions in the ACTs, as well as education and training systems, need overhauling; however, as noted above, this is a project that will span a decade or more and will require parallel changes in institutions and attitudes. There are no quick wins here; but delay in embarking on reform would be costly and perpetuate the current problems.

Arab countries in transition face strong headwinds, which increase the necessity of introducing tough often politically unpalatable reforms. Implementing some of the measures proposed in the paper will be hard going but when faced with adversity, nations are capable of making difficult choices (as Ireland has done), and some countries in the MENA region may yet surprise us by rapidly transitioning to a higher growth rate.

Even as their immediate problems are partially resolved, the ACT will need to come to grips with others of a less tractable nature such as: climate change and associated desertification; water shortages; rising relative prices of minerals and grain (Egypt is the world’s largest importer of wheat); and because of technological change, a continued shrinking of the relative share of manufacturing (in GDP and employment) putting the burden on services to create good jobs, innovation, and increased productivity.

Shahid Yusuf is currently Chief Economist of The Growth Dialogue at the George Washington University School of Business in Washington DC. He holds a Ph.D. in Economics from Harvard University, and a BA in Economics from Cambridge University. Dr. Yusuf has written extensively on development issues, with a special focus on East Asia and has also published widely in various academic journals. 

He has authored or edited 27 books on industrial and urban development, innovation systems and tertiary education which have been translated into a number of different languages.

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