SPECIAL REPORT – MENA AT THE CROSSROADS

Without reforms and significant capital inflow from both private and official sources, the MENA region risks being trapped in a vicious cycle of economic stagnation and sociopolitical strife. Some of the ways in which such a calamity might be averted are presented in this report, written exclusively for The Middle East by international economist Moin Siddiqi.

Three years into the Arab Spring the citizens of countries in transition have yet to see any tangible dividends from turbulent socio-political reforms and remain largely pessimistic about their future.

The post-revolution era could see one of two scenarios: We could see economic deterioration, if political instability hinders stabilisation let alone reform – thus condemning the region to prolonged stagnation or at best tepid growth; or we could see a new economy emerging, as newly elected but inexperienced governments gradually find a way of ending economic disruption and begin genuine democratic reforms geared at enhancing opportunities for their people. What is needed now is a clear agenda.

In fact, political risks in the Middle East and North Africa (MENA) are among the highest across emerging and developing regions. “The Arab countries in transition face a predicament. Political uncertainty makes it difficult to introduce far-reaching and comprehensive reforms. At the same time, a lack of improvement in economic conditions could reinforce socio-political frictions and deal further setbacks to transitions in many countries, further delaying a broader return of confidence and private investment,” said the International Monetary Fund (IMF) Middle East Department Director Masood Ahmed.

The divergence in performance between oil and non-oil countries is striking despite moderation of overall growth in the former due to levelling-off oil production. Among the latter, political disorder, deteriorating internal security, and rising socioeconomic tensions continuing to weigh on commercial activity. Available indicators point to continued sluggish growth of 2.8% in 2013 (excluding Syria) or 1.6% if Syria is included, well below the average growth of 5.7% over 2006-10, thus pushing more people below the poverty line.

Moreover, external and fiscal buffers of many countries are running low. Soaring public spending (mostly on subsidies) and depleting budgetary receipts amid growing instability further hiked already high fiscal deficits and public debt to an unsustainable path.

“Over the past three years, in response to growing social demands and higher food/fuel prices, governments in most oil-importing countries have expanded spending on generalised subsidies, public employment, and wages, while revenues have fallen due to the economic downturn,” the IMF noted. The weighted average fiscal deficit and government debt is expected to remain elevated at about 10% and 86%, respectively, of GDP in 2014. Gross budgetary financing needs of oil importers are estimated at $250bn for 2014.

At the same time, external activity remains subdued due to slow global recovery. Together with weak capital inflows, these have resulted in a sharp decline in official international reserves. Meanwhile, tourist arrivals (principally in Egypt,Tunisia and Jordan) are suffering from ongoing geopolitical tensions and the Eurozone’s recession. But remittances, mostly from the Gulf, are holding up. With swelling external deficits especially in Jordan and Lebanon, bilateral and multilateral financing from the Gulf Cooperation Council (GCC) countries as well as the IMF/World Bank has helped support reserve buffers.

By contrast, the six-member GCC region has remained stable with continuous expansions – driven by infrastructure investments, lax fiscal policies and low interest rates. With combined ‘twin surpluses’ – the budget and current account – estimated at 10.8% and 21.3%, respectively, of GDP for 2013 by the IMF, net foreign assets reportably reached a high of $2.2 trillion by end-2013, more than aggregate GDP, according to the Washington-based Institute of International Finance (IIF). Non-hydrocarbons growth is expected to remain robust at 5.3% this year.

The monetary cost of the “Arab Spring” to (Syria, Egypt, Tunisia, Lebanon, Jordan, and Morocco) has been colossal. From 2011-13, the IIF puts foregone economic output at 10% of cumulative gross domestic product (GDP). At end-2013, GDP was one-fifth lower than it would have been if the past output trend had been maintained. A recent UN report on Syria reckons the crisis has cost $100bn – affecting key sectors: agriculture, transportation, construction, trade and oil. The country’s physical infrastructure and capital stock have suffered huge destruction. In addition, more than 100,000 died – this civil war (by far the worst in modern Arab history) has inflicted woeful human suffering – with regional spillovers into Jordan, Lebanon, and to some extent Turkey.

The Arab world stands at an historic crossroads with daunting challenges and the outlook is highly uncertain with domestic and external risks firmly tilted on the downside. The global economy is projected to recover slowly, but growth slowdown in Brazil, Russia, India, China, and South Africa (the BRICS) or protracted stagnation in the Eurozone (the main trading partner of North African countries) could weigh on tourism, trade, remittances, and capital flows (especially sovereign financing). Most countries financing costs are already very high – reflecting large ‘risk premiums’ specifically in Egypt.

Current regional growth projections will have little, if any, impact on either job-creation or improving living standards. At best, Arab countries in transition (excluding Libya) should grow at 3% this year, well below the average of emerging and developing countries, and about the same as in 2013, according to the IMF. Numerous obstacles – poor business climates, inflexible labour and product markets, weak basic infrastructures, and, for some, underdeveloped financial systems – undermine competitiveness and productivity, which are already among the lowest in the world.

In the short term, raising growth to levels that reduces poverty and joblessness hinges on improved security and substantial external financing. Over the medium term tangible progress in structural adjustment is needed to boost and sustain growth above 5%. But without reform momentum and capital inflow from both private and official sources, the MENA region risks being trapped in a vicious cycle of economic stagnation and persistent sociopolitical strife.

To achieve sustainable development, the region should also move away from state-dominated to private investment and from protected industries and rent seeking to exportled growth and higher ‘value- added’ production and knowledge-intensive sectors.

That’s where future jobs lie. The Geneva-based UNCTAD advises the host countries to “adopt policies that help improve their local capacities, and in particular their labour skills and technological capabilities”. To embrace the kind of competitive dynamism of East Asia, the private sector must become a magnet of growth in MENA, which, in turn, requires accessing global markets, not just their home markets.

Since the 1980s, private sector investment across MENA has averaged between 13-15% of GDP, compared to 20% and 30%, respectively, in South Asia and East Asia (both of which saw investment shares accelerate from below 13% in the late 1980s). At 40% of GDP, bank credit to private businesses is well below that in other regions. Micro-business policies are not conducive for investors, which explains why most MENA countries persistently rank low in the annual World Bank Doing Business Report – with only the UAE (23rd) and Saudi Arabia (26th) among the top 30 performers in 2013 rankings. With the concrete medium-term policy agendas in many countries, investors are holding back. Concurrently, foreign direct investment (FDI) has fallen steeply. Also, volatile exchange rates and higher interest rates tend to depress business confidence.

Reforms to ensure ‘inclusive growth’ should be pursued to improve business climate and governance, whilst providing skills/incentives for youths to gain productive jobs in the formal sector. “More meaningful economic cooperation involving both the public and private sectors and instituted within a medium to long-term framework anchored in political stability and fundamental reforms could bring about vast benefits across the whole region,” advised the IIF.

Reforms, no matter how technically sound, should only be imposed with broad popular support. But it’s vital that both stabilisation measures and design of structural reforms are formulated with a view to “minimise adverse impacts on the vulnerable.” This effort, the IMF added, clearly lies with respective countries and needs the international community’s support through concessionary finance, technical assistance, and enhanced access to the developed world’s export markets.

Governments need to play a central role in facilitating robust growth via the pursuit of structural reforms that help tackle growing disparities in socio-economic conditions and provide the population with tangible benefits, whilst restoring macroeconomic sustainability. In such a challenging environment, the IMF recommends that region’s policy-makers need credible reforms, including:

Improving the business environment by tackling complex, burdensome regulations that hinder job creation and productivity. There is a need for simplifying procedures for business start-ups (for example, a one-stop shop), establishing an investment code guaranteeing investors’ rights plus a procurement code for government projects, and improving contract enforcement in judicial courts. Fighting corruption should accompany structural reforms.

Facilitating access to finance in order to nurture the growth of micro, small-to-medium sized enterprises (MSMEs) – the engine of job creation. Setting-up a nationwide credit bureau, a registry of collateral assets, and effective insolvency laws would help expand access to funding start-ups and fast-growing MSMEs in the form of seed finance. Presently, private credit mainly benefits top companies, and only 10% of firms use banks to finance investment. This is the lowest share of bank financing in the world, according to the World Bank figures.

Increasing the flexibility of the labour market. In Egypt and Iran, 650,000 and 700,000 people, respectively, enter the labour force each year. Women face stiff difficulties in securing employment, with only about a quarter holding jobs in Egypt, Jordan and Morocco. The state in most countries remains a major employer and rigid labour laws are disincentives for hiring in the private sector.

Social assistance in the form of joint public/private sector training for unskilled and unemployed, along with vocational training programmes tailored to private sector needs, would encourage job creation in the near and medium-terms. Total and youth unemployment rates – at 10 and 24% (conservative official estimates) exceed global average rates of just 6 and 13%, respectively.

Improving the education system that is unduly focused on preparing young people to work in the civil service or other white-collar jobs. Nurturing a skilled workforce to compete in global markets requires greater technical skills in engineering and science, particuarly ICT in higher education – specifically tailored for the needs of private employers. Lack of proper training and skills mismatches are principal obstacles for youths in most MENA countries.

Over time, the authorities need to achieve a more gradual and less painful fiscal consolidation, whilst rebuilding buffers to protect the economy from exogenous shocks. With limited scope for raising high budget deficits, spending on universal subsidies that benefits mainly the better-off should be reoriented towards health, education and infrastructure, which will help enhance growth potential.

However, an efficient ‘social safety net’ is needed to protect the poor in the form of cash transfers and targeted price subsidies. Jordan, Morocco and Tunisia are cutting back on subsidies. Energy subsidies are largest in most oil exporters but still exceed 5% of GDP in two-thirds of MENA countries, well above spending on education. Untargeted subsidies lead to over- investment in capital-intensive activities, limiting job creation, and under-investment in renewable energy.

Swift progress on each of these priorities can help signal commitment to reforms and improve confidence, thus reviving much-needed private sector activity.

The MENA is diverse and each country needs to chart its own road map to a “prosperous, equitable and cohesive society”. Useful insights can be gleaned from the post-Socialist era in Central Eastern Europe, where the prospect of European Union (EU) membership provided strong impetus to democratic reforms and helped orient the transformation to market-based economies.

Investment in the private sector by the European Bank for Reconstruction and Development (EBRD) and other financial institutions acted as a catalyst, leading investors into new sectors and markets. Those investments also served the EU’s wider economic and security interests. In MENA, strong external incentives and enhancements from multilateral-bilateral partners are currently missing.

Interestingly, during its golden age, which lasted 500 years, the Middle East possessed tremendous economic might, with commerce, communications and transport reaching across Europe, Africa, and Asia. Let’s see what the future holds for this volatile but resourceful region of over 400m people tomorrow.

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