EXCLUSIVE TO THE MIDDLE EAST ONLINE . . . Challenges ahead for MENA economies in transition

A special report prepared exclusively for THE MIDDLE EAST ONLINE  by international economic analyst Moin Siddiqi

Unlike the rich GCC oil producers
The countries in transition do not have the hydrocarbon wealth of the rich GCC oil producers to fall back on

Now into the fifth year of The Arab Spring, the Middle East and North Africa (MENA) region, especially the Arab countries in transition (ACTs) are still gripped by fundamental weaknesses in their respective economies – reflected in higher unemployment, poor living conditions, and unequal access to opportunities, which serves to increase socio-economic imbalances and incite frustration and growing dissatisfaction in the region.

The Arab Countries in transition (ACTs) refers to countries that have undergone regime change (Egypt, Libya, Tunisia, and Yemen) and those that have engaged in transformation under existing regimes (Jordan, Morocco), which have progressed along  transitional paths.

Managing transition and implementing reform agendas has proved extremely difficult in these countries and core structural deficiencies in economic frameworks and institutions have yet to be addressed. There is relative isolation from the global economy and fragmentation as a region due to high barriers to trade and monopolistic markets. The MENA region holds a negligible 1% of global market share in nonfuel exports – compared to 10% and 4%, respectively, in East Asia and South America according to the International Monetary Fund (IMF). Not surprisingly, such isolation amidst increased globalisation has meant slower modernisation, limited transfer of technology, and, ultimately, eroded competitiveness and productivity of regional companies. Hence, the region’s exports remain far below their potential because of low trade integration with the rest of the world.

The legacy of ‘State Development Models’ of the 1960s and 1970s is still dominant in various forms within the ACTs. Large/inefficient public enterprises and bloated civil services stifled the growth of private businesses. More important, the authorities fail to provide adequate public services despite their sizeable budgets. According to the United Nations Development Programme’s index of “multi-dimensional poverty,” well over a third of the people in these countries lacked access to healthcare, education, and other basic services such as sanitation, clean water, and electricity – lagging most other regions. In contrast, 26% of people in developing Asia and about 8% in South America lacked these basic services.

Burdensome business regulation (i.e. red tape) has hindered private sector led growth and encouraged corruption; state-owned enterprises and public banks – enjoying near-monopolistic powers in their sectors – have tended to operate inefficiently, leading to fiscal slippages and capital misallocation; and a lack of a level playing field between public and private enterprises, has limited competition and innovation. Moreover, access to bank finances is among the lowest in the world, constraining private investment. For example, less than 4% of the region’s population was able to obtain a loan from a financial institution in 2010. This was less than half of global average and comparable only to low-income sub-Saharan African countries.

Problems including corruption have dogged development
Red tape, weak institutional capacity and rampant corruption are retarding growth and development

Poor allocation of scarce public money coupled with inadequate social protection for vulnerable groups in society. As in most of MENA countries, generalised price subsidies constitute a kind of social contract between the authority and the people. These subsidies, however, do not always benefit the needy; for example, in Egypt in 2008 the poorest 4% of the population received only 3% of gasoline subsidies. In many other countries, the share of public resources devoted to subsidies was among the highest in the world, which prevented more productive uses, such as investment in education and healthcare – thus left the poor vulnerable.

Governance in the ACTs was exceptionally weak and worsened after the Arab Spring, especially in conflict-ridden Libya and Yemen. Combined with weak institutional capacity and rampant corruption, in turn, stifled competition and discouraged job creation in the private sector. This deprives millions of young people of better lives and prosperity. Consequently, unemployment in these countries remained among the highest in the world. It hits the young hardest – ranging from 20% in Morocco to 37% in Tunisia. Strict labour regulations provide disincentives to private sector hiring, while the public sector remains the employer of first and last resort—a role that has distorted the labour market and educational system over the decades.

Morocco_Textiles
Local industry needs to be encouraged to develop further

Well before the 2011 upheavals, disconnection between ‘official’ reported macroeconomic data and a sense of well-being at ‘grass roots’ level was evident. There was a consensus that benefits of growth were mostly captured by the well-connected, whilst the majority felt marginalised. According to Gallup, a 34% hike in GDP per capita in Egypt between 2005 and 2010 coincided with a steep drop in the number of people who said they were “thriving,” from almost one-third of the population to 12%.
In the latest (Gallup-Healthways 2014 poll), the ACTs (except Morocco) had the lowest percentage of respondents characterizing themselves as thriving in “purpose” – a measure of people’s motivation to achieve their goals – thus a clear indication of constrained economic opportunity. The percentage of respondents prospering in several dimensions of well-being was similarly low. Significantly, most respondents in Egypt, Jordan, and Tunisia said they were not thriving in any dimension of well-being. Overall, real income growth of ACTs has lagged behind other emerging market and developing countries.

TME July 2015 Tables - Sheet1-4 FINAL
How have the ACTs performed during the past few years? Generally unstable regional environment (spreading conflicts in Iraq, Libya, Syria and Yemen), coupled with large-scale dislocations and social tensions, has hindered output growth, curtailed trade/investment (including foreign direct investment) and heightened vulnerability. However, Egypt, Jordan, Morocco and Tunisia have maintained macro stability and avoided outright recession.

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trade integration serves as a catalyst for business

This was, however, achieved at the costs of depleting forex reserve buffers and accumulating public debt via widening budget deficits across the ACTs. Thanks to renewed political order and vast bilateral aid (principally from Saudi Arabia, the United Arab Emirates and Kuwait), Egypt has gradually rebuilt its external reserve buffers and embarked upon a medium-term reconstruction programme. But civil strife in Libya and Yemen has derailed progress and set both  countries back many years.
The ACTs have made modest progress with structural reforms. Energy subsidies were reduced in Egypt, Jordan and Morocco, thus facilitating spending on better-targeted social protection and on growth-enhancing public investment. Governments have also taken steps to improve aspects of the business climate, such as competition, bankruptcy, and investment regulations; strengthening tax policies and administration; and implementing financial sector reform. These steps are encouraging, but radical overhauls of policy frameworks and institutions are needed to alleviate the  ‘deep-seated’ obstacles facing these states.
The outlook remains uncertain and subject to downside risks – in the context of Eurozone debt crisis, and waning investor confidence. This downturn has worsened job prospects and led to deteriorating living standards, and may have reduced the medium-term output potential in some countries – notably Libya and Yemen. Demographic pressures suggest that, under current IMF projections for GDP growth through 2018 of around 4.2% in the oil-importing ACTs, unemployment will continue rising. While fiscal deficits and public debt will further increase and international reserve buffers should fall, thus severely limiting the fiscal space for expansionary policies in future years. In this scenario, the ACTs could be trapped in a vicious circle of economic stagnation and persistent social discontent – at worst civil strife.

Subsidies, although jealously guarded, do not always benefit the most need in society
Subsidies do not always benefit the most need in society

As one observer put it: “Putting economic realities squarely at odds with the aspirations of the population for an economic transformation that would provide quick returns in the form of job creation and income generation.” At worst-case scenario, there is a risk of increased discontent, which could further complicate the political transitions, impairing governments’ ability to implement the policies to tick-start long overdue recovery.

Escaping the pre-2011 legacy is critical for future stability. The IMF advises: “Each country must develop its own vision and path to reform. The task will be even more difficult than before the Arab Spring. Governments have limited financial resources, and the external environment is overshadowed by conflicts in the region and little appetite for private investment. Overcoming past resistance to reform calls for political will and determination, and strong support from the international community.”
The ACTs need a medium-term vision to set right policies. Goals differ among countries, reflecting their national needs, but they all share common objectives to ensure a more level playing field, to allows for greater integration into the global value chains (GVCs), and to foster an enabling environment in which a dynamic private sector can drive growth and create badly needed jobs for a growing population, while governments provide reliable basic infrastructure and regulations. Well-designed infrastructure projects create jobs and lay the foundation for robust potential growth.

A bold developmental agenda is a prerequisite for private sector activity and nurturing a vibrant, competitive, innovation-driven, and inclusive economy. To achieve such ambitious goals, however, demands gradual shifting away from state-dominated to private investment and from protected/rent-seeking enterprises to export-led growth and value creation.

Deepening trade integration offers significant benefits. Besides hefty gains from external trade and export-orientated foreign direct investments (FDIs), trade integration serves as catalyst for business reforms in other areas to help firms compete in global markets. It also opens access to advanced economy markets, but requires reducing further the ACTs’ high tariffs and non-tariff trade barriers, whilst focusing on the increasingly important areas of trade facilitation and export promotion.

morocco-high-tech-industries
public spending should be reoriented towards growth-enhancing investment

Labyrinthine bureaucracy across the ACTs needs streamlining, with a view to making the civil service more efficient and improving the administrative capacity of departments to execute reforms, which is limited in some of them. Besides political and constitutional reforms, it is vital to improve transparency/ accountability of major state institutions to prevent misuse of power (i.e. the scope for discretion), whilst improving business regulation (i.e. cutting excess red tapes) and reducing informality and graft in public services.
An efficient financial sector is critical for investment and growth in the region. Limited bank competition, a concentration of lending to larger, established companies, a generally obsolete financial infrastructure, and underdeveloped capital markets suggest that significant benefits can occur from financial reforms and improved access to finance, thereby bolstering economic activity. Reforms should focus on boosting competition among banks and upgrading their financial infrastructure, deepening capital markets and developing their investor base, and making available alternative financing instruments, Islamic finance, and microfinance for small and medium-sized enterprises (SMEs), the engine of job creation and poverty reduction in the developing world.

218B4E07-B2B0-000B-C07D3D20947BD22B
Each country must develop its own vision and path to reform

Labour market and education reforms can provide incentives for hiring and participation in the formal economy. Countries should review labour regulations – aimed at reducing distortions that, in turn, discourage hiring and skills-building. Nurturing a skilled labour force demands greater emphasis on science and technology, particularly ICT in higher education, coupled with a strong focus on vocational training schemes.
With little scope for heavy deficit financing in the ACTs, public spending should be reoriented towards growth-enhancing investment that stimulates private sector activity, while protecting the poor through well-targeted social welfare in the form of cash transfers. Revenue measures should focus on broadening the tax base and improving the efficiency of tax collection. Together, these policies can free scarce resources for priority expenditure in capital projects, health, and education, whilst enhancing equality.

The IMF notes: “Countries need to create efficient social safety nets (SSNs) to protect the vulnerable in cost-effective ways. In transitioning from costly generalised subsidies to targeted forms of social protection, countries should increase their spending on existing safety net programmes and improve their coverage; prioritise interventions such as conditional cash transfers that strengthen human capital; invest in SSN infrastructure such as unified registries for beneficiaries; and increase the use of modern targeting techniques.”

 

wholesale importers must change
The MENA region holds a negligible 1% of global market share in non-fuel exports

The Arab Spring has created an opportunity for economic transformation – where new stakeholders could become the agent of change for better, while powers of old vested groups hindering meaningful reforms will be weakened. However, decades of structural and some man-made problems cannot be solved within a generation. It would probably take a considerable time to create well-functioning democracies with dynamic and inclusive economies that ensure fair/equal access to opportunity for all segments of society.

With concerns about debt sustainability rising and fiscal/forex buffers eroding, the ACTs need to pursue sound policies within credible medium-term frameworks that safeguard against exogenous shocks. These will help revive the confidence of both donors and investors to provide necessary funding to countries in transition over the coming years.

The international community can assist the ACTs’ policy efforts through various channels: firstly, concessional financing (i.e. soft loans/grants) from bilateral and multilateral partners to support budget shortfalls, and, where necessary, ease the pace of adjustment; secondly, opening access for exports to advanced economies’ markets; and thirdly, supporting capacity-building efforts by providing technical assistance and training in many areas of economic policy. The IMF has committed about US$10bn in financial arrangements with Jordan, Morocco, Tunisia, and Yemen.

TME July 2015 Tables - Sheet1-6 FINAL

 

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