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Per Jacobsson Lecture: Arab countries need to set clear priorities to create momentum for reforms

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
October 2003
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The Arab region—extending from Dubai on the Arabian Gulf to Nouakchott in Mauritania on the Atlantic—is extremely large and diverse, geographically, resource-wise, and in terms of development, Al-Hamad said. The region, with a total population of 295 million, is the poorest in the world in water and agricultural resources but one of the richest in hydrocarbon reserves. Average annual per capita GDP is $2,445, placing the region in the group of middle-income countries.

From 1960 to 1985, the development performance of the Arab region surpassed all regions except Asia in income growth and outperformed them all in income distribution, owing largely to the windfall earnings from oil, whose benefits spilled over to the entire Arab region.

But the momentum was not maintained. Over the past 15 years, investment and productivity rates declined, economic growth barely kept pace with the increasing population, and per capita growth rates dropped to less than 1 percent a year. What caused the serious reversal in the performance of the Arab region, and what dynamic forces could produce change and improve its overall performance? Al-Hamad stressed that setting clear priorities was key to jump-starting the reform process.

Performance and challenges

According to Al-Hamad, the economic ailments of some countries were caused by flawed leadership and inept policies, made possible by the huge oil revenues that accrued directly to the state. But for most countries in the region, he said, a common mix of factors caused the dramatic downturn in their economies.

Sharp decline in oil revenues. The average nominal price of crude oil decreased from $27 a barrel in 1985 to $12 by 1998, causing a dramatic decline in incomes, investment, and job creation in the Arab region. This slump was the main cause of the decline of economic growth during 1986-2002. However, the performance of some non-oil-exporting countries, such as Egypt, Syria, and Tunisia, compared with that of other developing countries, was more encouraging over the period. Their economies today are more diversified than those of the main oil-exporting countries in the region.

Collapse of the centrally planned economic systems. Because of the absence of a clear vision and in view of the pressures created by a growing population with rising social demands, Al-Hamad argued that many of these countries failed to adopt appropriate policies for growth and institutional reform. Their strategies continued to rely on physical capital accumulation while neglecting the need for human and institutional development.

Inappropriate macroeconomic policies. Inflexible and overvalued exchange rates, high interest rates, and reliance on indirect taxes led to serious distortions. Overvalued exchange rates discouraged production of both exports and import substitutes. The related policy of high real interest rates discouraged investment and promoted accumulation in short-term bank deposits and other nonproductive assets.

Lack of urgency in implementing badly needed reforms. With an overall decline of their economies in the second half of the 1980s, Arab countries faced a number of hard choices, Al-Hamad said. Some agreed to follow the prescriptions, originally designed for Latin America (the so-called Washington Consensus), albeit reluctantly. Others, especially oil-rich countries, did not feel any urgency to restructure their economies, and their growth rates now lag behind those in Asia and Latin America and even some Arab countries.

Protectionist policies. The reluctance of a number of Arab countries to change their trade policies away from excessive protection and in favor of export-orientation hampered their growth. But the small group of countries (including Jordan, Morocco, and Tunisia) that followed the outward-orientation route made important strides.

Political and social instability, poor-quality services, and weak governance, according to Al-Hamad, contributed to the Arab countries’ failure to attract significant amounts of foreign investment. The United Nations Conference on Trade and Development’s World Investment Report 2002 points out that the share of foreign investment flowing to these countries is negligible: its total in 22 countries does not even match that of Singapore. Foreign direct investment brings not only capital but, more important, technology, management skills, and access to international markets. It is critical for effective participation in the international production networks, which the countries of the region badly need.

High population growth rates. At an average rate of 2.5 percent a year, population growth is hindering progress in most Arab countries. The demographic challenge is not only about numbers; even more critical is the lack of required skills. The failure to reform the educational systems and adjust to the needs of the marketplace is a real obstacle to modernization. Growth is hampered, and unemployment and poverty are rising, including in the oil-rich countries of Kuwait and Saudi Arabia.

Water shortages represent a challenge for all Arab countries. The sources of all the rivers flowing through Arab lands are controlled by other nations, Al-Hamad said, and violent conflicts over water must be avoided. All countries should do their utmost to arbitrate disputes and ensure that water resources are shared fairly. More important, he added, all countries must follow policies for better water management.

Some bright spots

Some Arab countries have succeeded in correcting distortions that have plagued the region’s economy. Productivity has increased, efficiency has been enhanced, growth has accelerated, and foreign trade performance has improved, particularly in Egypt, Jordan, Morocco, and Tunisia. However, sustainable progress has not been achieved in most other countries.

There are a number of bright spots in social areas as well, Al-Hamad noted. Women’s rights have improved in most Arab countries, and the level of school admission has grown by more than 150 percent—a rate not matched by any other region in the world. The expansion of education to include both genders and all segments of society has strengthened the desire for societal change in all Arab countries.

Reforms and priorities

How should we view the future of the Arab region? Unfortunately, Al-Hamad pointed out, its prospects seem gloomy in the short run. The dependence on oil is not likely to change soon; financial difficulties will probably endure; public investments will continue to decline; and the private sector will remain inefficient, overprotected, and too weak to provide a credible alternative.

But a number of the prerequisites for long-term growth are in place. These are in education, infrastructure, and social development. While the pace of recovery will not be the same in all countries of the region, the crucial factor is the quality and sustainability of the reform process in a difficult global environment. It is therefore imperative, Al-Hamad argued, to determine the right priorities and create the momentum for reforms. In his view, the most critical of these are in four areas:

Good governance. A key to economic development is economic and legal institutions. Improving governance is of great urgency in the Arab world. No country can be integrated into the world economy if it lacks the rule of law, an independent judiciary system, and transparent accounting and reporting.

Poor governance, Al-Hamad said, is generally considered the greatest obstacle to improving efficiency, competitiveness, and growth. Arab businesses should evolve and adopt new management styles compatible with global business practices. And government involvement in the economy should be restricted to three major roles: ensuring the supply of high-quality public services, maintaining a national legal framework that enforces laws and contracts fairly and efficiently, and managing the macroeconomy to preserve economic stability and social harmony. But bureaucracies in many Arab countries are resisting such a conversion of roles.

Freedom and democracy are lacking in the Arab world, hindering sustainable development. Genuine political participation is weak, with many restrictions on liberties, and accountability is generally lacking. No progress can be achieved, Al-Hamad observed, if citizens are unable to think freely and act independently.

Reform of financial systems. An efficient financial system, Al-Hamad noted, is an essential component of more competitive markets. Development of strict standards and best practices for Arab banking is crucial if these countries are to succeed in mobilizing savings and liquidity in financial markets. A well-regulated securities market providing sound information and protection to all investors must be developed. All these steps hinge on serious and fair privatization policies. These are only the minimum prerequisites for the creation of a viable financial system.

Education and appropriate technologies. The Arab region needs to improve the quality and quantity of education. The current workforce has four years of schooling, on average, which is not conducive to productivity. Development strategies must take into account that competitiveness is no longer based on cheap labor and abundant natural resources but on knowledge, innovation, and productivity.

What does the future hold?

The Arab region’s ability to achieve sustained growth over the long run appears to be impeded by the fear that reforms might spark social and political upheaval and destroy the power base of vested interests, Al-Hamad said. The Arab world is being shaken to its very foundations by the rise of poverty and unemployment, a condition that could drive people to despair and nurture extremism and violence.

However, Al-Hamad was convinced that the Arabs were capable of rising to these challenges. They have always been open to the world—from Babylonia to Egypt, from Carthage to Andalusia, from Damascus to Baghdad—and have always been among the leaders of civilizations. They were the first to farm, build cities, and adopt each of the three monotheist religions of the world. Such a heritage should never be forgotten or squandered, but now Arab countries urgently need to implement reforms and rejuvenate institutions, not only in the economic sphere but throughout the social system.

Photo credits: Denio Zara, Padraic Hughes, and Michael Spilotro for the IMF, pages 297–301, 303–305, and 310–312; Andy Mueller for Reuters, page 309; Sweta Chaman Saxena, page 312.

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