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IMF Economic Forum: How can the Middle East return to a high growth path?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
October 2003
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Although there are significant differences among the region’s 24 economies, Abed said, all countries face common challenges. A number depend on oil exports to sustain development and finance budgets. Others have a legacy of centralized planning and state control. The region’s economic performance has been mediocre over the past 20 years, he noted, but not all is bleak in the region. Faced, in the late 1980s, with very slow growth and some decline in per capita incomes, governments began to pursue reforms. As a result, the MENA economies moved forward in the mid- to late 1990s, but recently the reform momentum has waned.

Lagging structural reforms

Although it has implemented a number of important reforms, most notably on the macroeconomic front, the region’s structural reforms, Nabli noted, have not gone deep enough. Why? First, as oil resources declined as a result of the 1980s oil price shock, the MENA economies continued to operate under soft budget constraints. This access to “easy money” allowed governments to continue to fund welfare systems but left little to finance the reforms that could create more domestic wealth.

According to Nabli, the second reason can be attributed to governance issues. Many reforms undertaken in the late 1980s and early 1990s, such as reducing tariffs, were done in a top-down, administrative fashion that made them fairly easy to implement. That explains the clear progress on macroeconomic-related structural reforms. However, more substantive efforts to reform the financial sector and create sound institutions made only limited progress. These reforms, which typically touch the interests of many groups, were hampered by inadequate systems of governance, transparency, and accountability.

What does the future hold? Nabli warned that the MENA region might be in the middle of a new crisis. Tighter budget constraints, he explained, have eroded the resources available to sustain the old welfare systems. And the dramatic increase in the labor force has created high unemployment rates—about 15 percent for the region. These pressures are becoming untenable, he stressed, and need to be contained.

Private sector’s role

The MENA region, according to Findakly, can be characterized as having three main dependencies. It relies on the public sector; raw materials, particularly energy oil and products; and lower-skilled activities. This last dependency, he said, explains the lack of wealth and job growth, and the real challenge is not only to employ the region’s existing workforce but also to create jobs for the fast-growing workforce.

While it may not be fair to compare the MENA economies to the United States, Findakly said, a lot can be learned from the restructuring that has taken place in the United States over the past 25 years. About 52 percent of U.S. GDP is now produced by small businesses that employ 50 people or fewer.

And over 50 percent of the U.S. labor force works for those small businesses. The MENA region’s private sector, with its large amount of capital, should pick up the slack and redeploy part of its capital to support the growth of small businesses. This would allow the labor force to be absorbed while governments pursue other reforms.

Ready for financial globalization?

The MENA region, Bisat said, is remarkably isolated from the global capital markets. Since the mid-1990s, about $1.5 trillion in capital has flowed into developing countries, but less than 5 percent has gone to the MENA region. To find out why, Bisat talked to a number of bankers, who mentioned four main factors: a low level of economic growth; absence of a “trigger,” such as privatization; lack of institutional transparency; and security concerns.

Is this isolation bad for the region? Until recently, most mainstream economists would have answered yes, but Bisat is not so sure anymore. He now feels it should come with the following warning: globalization may be hazardous to your health unless you are well prepared. Bisat cited a paper by the IMF’s Kenneth Rogoff and Eswar Prasad that found that if a country is not well prepared, it could be hurt by globalization.

In Bisat’s view, the macroeconomic side is not yet ready for intensive capital flows, and the domestic financial sector is also ill prepared for massive inflows. The traditional recipe of domestic financial reforms—interest rate liberalization, removal of debt lending, privatization of domestic banks—is no longer sufficient to prepare the banking sector. The region will need to implement a more ambitious “second generation” of reforms in the financial sector before embarking on more intensive capital account liberalization.

Is the political will there?

While it is not difficult to come up with prescriptions as to what needs to be done in the region, the real question is how to get existing governments to adopt reform measures and change and evolve. According to Telhami, this is more of a political question than an economic one.

Are there incentives that make governments change? One external incentive is the fear of collapse.

China, for example, accelerated reforms after the collapse of the Soviet Union. But in the MENA region, Telhami noted, the war in Iraq has not had the same effect because of the destruction it has entailed. At least in the short run, the war has created reservations about change. In the past, pressures from the international community, particularly the United States, have had an impact on the region, but these effects have not been long-lasting. For the moment, he said, there is no external dynamic to make governments move in the direction of reforms.

What about domestic pressures? In general, the comforts afforded by the welfare state have dampened demands for greater political participation. To the extent that this has continued, the population has been satisfied. But per capita incomes in the region have declined, generating some dislocation and rising political pressures on governments to change. In the past, governments have undertaken cosmetic changes because they viewed domestic pressures as short-term problems. The real question is whether governments will respond by implementing reforms. That, said Telhami, is hard to predict.

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