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Forum: Arab States Look to Institutional change to Boost Growth and Jobs

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2007
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The Middle East and North Africa (MENA) region is facing a very rapid prospective increase in its labor force over the next decade and a half, dismal prospects for a large number of young unemployed workers unless the growth of output and jobs can be increased substantially, and the need for institutional reforms to boost growth. These issues were the focus of a high-level seminar entitled “Institutions and Economic Growth in the Arab Countries,” organized by the IMF Institute, along with the Arab Monetary Fund, and held in Abu Dhabi, United Arab Emirates, on December 19–20, 2006 (see box). The event attracted high-level government participation—more than a dozen ministers, governors, and their deputies—and scholars and representatives from international institutions and the private sector.

Although economic growth in the MENA region has picked up over the past few years—supported in part by record-high oil prices—the longer-term growth record has been weak. Between 1980 and 2005, annual real per capita GDP growth in the region averaged only 0.5 percent, well below the average annual growth rate of 4 percent in East Asia, and was negative for oil-producing countries. Given the region’s relatively strong labor force growth, such growth rates were not sufficient to prevent a sustained rise in unemployment. A number of papers presented at the seminar argued that the constraints on longer-term growth in the region have been largely institutional. The discussion that followed focused on identifying the mechanisms that could spur a positive and sustained institutional change so that higher growth rates of output and employment could be achieved.

Jobs wanted

High on the to-do list of Arab policymakers is a solution to a demographic time bomb. The region’s labor force, which is young and growing rapidly (see table), is forecast to reach 185 million in 2020, about 80 percent higher than in 2000. With current unemployment rates already very high, second only to those in sub-Saharan Africa, the region needs to create close to 100 million new jobs by 2020 to absorb the currently unemployed and the new labor force entrants. This is equivalent to creating as many jobs in the next 15 years as have been created over the past five decades; to achieve that goal would probably require sustained real GDP growth of about 6–7 percent a year, about double the average of the late 1990s.

A pressing problemWith the largest labor force growth in the developing world since 1980, the MENA region needs faster GDP growth to create more jobs.
1970-801980-901990-20002000-10
(annual percent change)
Middle East and North Africa3.13.43.63.4
East Asia2.42.51.20.8
Latin America and the Caribbean3.33.12.52.0
South Asia2.31.92.42.0
Sub-Saharan Africa2.52.72.52.2
Source: Tarik Yousef, 2004, “Development, Growth and Policy Reform in the Middle East and North Africa since 1950,” Journal of Economic Perspectives, Vol. 18 (Summer), pp. 91-116.
Source: Tarik Yousef, 2004, “Development, Growth and Policy Reform in the Middle East and North Africa since 1950,” Journal of Economic Perspectives, Vol. 18 (Summer), pp. 91-116.

To make a dent in the pressing unemployment problem, the region must integrate with global markets so that it can achieve higher growth. Expansion of exports in labor-intensive activities could accommodate many new labor market entrants in the region; import liberalization would allow for cheaper access to the capital goods needed for growth; and foreign direct investment (FDI) could potentially be a vehicle for technology transfer, improving productivity and growth.

But, as a number of presentations made clear, the region is having difficulty integrating. Contrasts with other countries are stark. Finland, with a population of about 5 million, has more non-oil exports than the entire MENA region, with a population of more than 300 million people. The non-oil exports of Hungary and the Czech Republic (each with populations of about 10 million people) are each also greater than those of the region. Although FDI inflows to the region have recently increased, they still account for less than 2 percent of global inflows. The combined net inflows of FDI into three East Asian countries (Malaysia, the Philippines, and Thailand) are about four times larger than those into MENA (excluding the Gulf countries). Similarly, net FDI inflows into Bolivia, Brazil, Chile, and Mexico are together also much larger, more than twenty times the inflows into the whole MENA region (excluding the Gulf countries).

Leave it to the markets?

A second problem discussed in the seminar was the region’s governance gap, with several papers arguing that governance is weaker in MENA countries than in other countries with similar income levels. The gap, deeply rooted in the postwar emergence of a preference for the role of the state to that of the market in managing the economy, manifests itself, to a large extent, in institutions that do not facilitate private enterprise. The governance gap covers a wide set of institutional quality indicators, including bureaucratic performance, rule of law, political participation, and accountability. However, there appears to be wide intraregional variation in the indicators, suggesting that some countries could potentially realize substantial gains by achieving the best practice of their regional comparators. For example, Egypt or Syria could gain considerably by meeting the Tunisian standard. Neither country needs to turn into Iceland, which ranks highest in the world for institutional quality. What came out most clearly in the seminar is that leaving everything to the market is not an option: markets cannot work on an uneven playing field with large government institutions; they need a secure and predictable government framework. Therefore, clarity of property rights, contract enforcement, and the like are absolutely essential for growth.

Lackluster growth

The third problem analyzed in the seminar was the MENA region’s weak growth performance over the past two decades, which was empirically shown to be rooted in poor institutional quality (the governance gap) and large governments. Poor institutional quality has impeded growth through its detrimental effect on capital accumulation and productivity, and a large public sector has hampered growth by crowding out the private sector—for example, by competing for scarce resources and establishing wages above the equilibrium in the private sector. The policy implications are clear-cut: MENA countries can raise growth by containing the scope of government and improving institutional quality.

Although a more vibrant and dynamic private sector would clearly alleviate the region’s employment problem, institutional weaknesses, excessive regulations and red tape, cumbersome business procedures, and a high cost of doing business in general all hinder private sector development and the creation of firms. For example, the minimum capital required to start a business is higher than in any other region and is about five times the world average. Similarly, enforcing a contract requires, on average, 426 days, which is about 50 percent higher than the East Asian average and 60 percent above the industrial country level. Also, it takes 80 percent longer to import a standardized cargo of goods than it does in East Asia and 190 percent longer than in industrial countries. Participants argued that impediments exist across the spectrum of business endeavors and are complicated by weak enforcement of property rights.

Exploring institutional reform

The seminar program explored the institutional challenges facing the MENA region; the impact of governance and institutional quality on economic growth in the region and the channels through which they affect growth; the institutional challenges and reforms needed at the micro level; strategies to improve institutions and reduce the obstacles to more rapid economic progress; and the political economy of reforms and how sustainable institutional reform can be achieved.

The views and ideas presented in this article are those of seminar participants.

For a list of participants and the texts of the papers, please see http://www.imf.org/external/np/seminars/eng/2006/arabco/index.htm

A strong reform agenda

What emerged from the seminar was the sense that institutional reforms designed to reduce the cost of doing business in the region need to be accelerated and intensified. Such reforms, by enhancing efficiency, would improve productivity and growth. And, by creating an environment conducive to encouraging entrepreneurship, the reforms would elicit higher rates of both domestic investment and FDI, which should enhance the region’s integration with the world economy. These reforms could take the region in the direction of increased growth rates and better absorption of the rapidly growing labor force.

Although entrenched institutions are difficult to change, seminar participants saw that change was urgently needed, and they identified trade liberalization, openness and broader access to information, and external “anchoring” (such as free trade agreements) as levers that could spur institutional change. Opening up trade forces domestic businesses to compete and to lobby for good business conditions; it also induces businesses to look for beneficial complementary partnerships with foreign companies. External trade arrangements would help in this regard. Access to information and more open economic discourse would help establish a culture of accountability. Together, these factors—by ensuring a more open, competitive, and, eventually, robust private sector—would strengthen the domestic constituency for better institutions. As many participants pointed out, however, political will and strong and competent leadership are essential to success.

Yasser Abdih and Ralph Chami

IMF Institute

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