Middle East and Central Asia Department
Copyright © 2016
International Monetary Fund
Joint Bank-Fund Library
Names: Mitra, Pritha, 1974- | Hosny, Amr. | Minasyan, Gohar. | Fischer, Mark. | Abajyan, Gohar. | International Monetary Fund. | International Monetary Fund. Middle East and Central Asia Department.
Title: Avoiding the new mediocre : raising long-term growth in the Middle East and Central Asia / Pritha Mitra, Amr Hosny, Gohar Minasyan, Mark Fischer, and Gohar Abajyan.
Description: Washington, DC : International Monetary Fund, 2016. | At head of title: The Middle East and Central Asia Department. | Includes bibliographical references.
Identifiers: ISBN 978-1-51357-271-0 (paper)
Subjects: LCSH: Economic development—Middle East. | Economic development—Asia, Central.
| Middle East–Economic conditions–1979- | Asia, Central–Economic conditions–1991-Classification: LCC HC412.A893 2016
The Departmental Paper Series presents research by IMF staff on issues of broad regional or cross-country interest. The views expressed in this paper are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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The authors would like to thank Masood Ahmed, Director of the Middle East and Central Asia Department, for his guidance and comments. They are also thankful for the supervision and support of Natalia Tamirisa and general guidance of Alfred Kammer and Aasim Husain.
Thanks are also due to Abdul Abiad, Benedicte Baduel, Ernesto Crivelli, Jonathan Dunn, Enrique Flores, Daniela Gressani, Giang Ho, Elena Ianchovichina, Chris Jarvis, Jung Yeon, Kim, Roberto Perrelli, Marco Pinon, and Kevin Wiseman for providing comments at various stages of drafting the paper.
We are also grateful to Neil Hickey for his editorial contributions; Cecilia Prado de Guzman, Hanan Altimimi Bane, and Esther George for assistance with formatting and document preparation; and Joe Procopio for editorial guidance and production support.
The Middle East and Central Asia region is facing unprecedented challenges. Deepening conflicts have caused a devastating loss of life and massive economic damage, forcing large portions of the population to flee abroad. Spillovers from these conflicts, including through increased security tensions, are weighing on confidence and economic activity across the region. At the same time, the new “lower for longer” oil price reality has dampened oil-exporting countries’ longer-term growth prospects and rendered their oil-centered economic growth models untenable, with spillovers to oil-importing countries through lower trade, remittances, and investment. In all these countries, even six years after the Arab Spring, fast-growing populations continue to be frustrated by the lack of inclusiveness in the economic environment, in which job opportunities are few and connections appear more important than merit in accessing the gains from economic growth. In the neighboring Caucasus and Central Asia, spillovers from the recession in Russia, in addition to low oil prices, have brought on the most severe economic difficulties since these countries gained independence 25 years ago.
Against this backdrop, hopes for better standards of living have been dampened, and sociopolitical tensions are rising. Governments have responded by pursuing multifaceted reform agendas. In many countries, political and constitutional reforms have created a foundation for large-scale structural reforms. Large and inefficient energy subsidies across the Middle East are being reduced or eliminated, helping reduce macroeconomic vulnerabilities and free resources for growth-enhancing public spending on infrastructure, education, and health, as well as targeted social assistance.
Raising the region’s economic growth potential is essential for creating jobs and improving the population’s quality of life. The IMF and other institutions have advised countries on structural reforms that can support these goals. However, in the face of heightened macroeconomic vulnerabilities, sociopolitical tensions, security challenges, and a weak global environment, further reforms are difficult to implement, requiring careful prioritization. This publication attempts to help countries identify the most critical reforms for improving their economic prospects, tailoring advice to the unique characteristics of various subgroups of countries within the Middle East and Central Asia region.
I hope that this publication will be useful for policymakers and other stakeholders across the region as countries set out their reform agendas to improve economic prospects and create jobs, as well as for the international community that supports them in tapping into their enormous economic potential.
Director, Middle East and Central Asia Department
International Monetary Fund
Raising the Middle East and Central Asia’s1 long-term growth prospects is critical for meeting the pressing need for jobs and higher living standards in the region. These goals were at the core of the Arab Spring movements in the Middle East, North Africa, Afghanistan, and Pakistan (MENAP) and are also key to confronting the sources of violent regional conflicts. However, these goals remain unfulfilled. Persistently low oil prices, necessitating prolonged and substantial fiscal consolidation, are also increasingly putting jobs and living standards at risk in the region’s oil-rich economies, where oil revenue–financed spending had fuelled growth in the non-oil sector and allowed governments to become a major source of employment. In the Caucasus and Central Asia (CCA), the slowdown in Russia, in addition to low commodity prices, is weighing on income and living standards (IMF 2014a).
Long-term growth prospects in the Middle East and Central Asia have weakened significantly over the past several years. The global financial crisis reduced long-term growth rates across the globe (Cubeddu and others 2014; IMF 2013a; IMF 2015). In the Middle East and Central Asia, low oil prices, geopolitical tensions, and regional conflicts have amplified this growth slowdown. Over the next five years, the decline in long-term growth prospects in this region is expected to exceed the emerging market and developing country (EMDC) average by 1¼ percentage points (Mitra and others 2014), raising fears of a “new mediocre,” in which the long-term growth malaise becomes the rule, not the exception, across the region.
Complementing the broad literature on estimating and raising long-term growth in advanced and large emerging market economies (for example, Cubeddu and others 2014), this paper identifies and prioritizes key policies for catalyzing long-term growth in the Middle East and Central Asia—tailoring recommendations to different subgroups within the region. The focus is on analyzing potential growth—the rate of growth underlying an economy’s long-term growth prospects—and understanding how policies affect its supply-side drivers—long-term growth in productivity, physical capital (such as machinery, buildings, and computers), and employment. Although a number of studies have split growth into its supply-side factors, this paper systematically examines and prioritizes key reform areas affecting each supply-side driver. This study also accounts for sociopolitical concerns, along with other, more typical macroeconomic drivers of growth considered in the literature. This approach is applied to the MENAP and CCA subregions and, further, to oil exporters and importers separately within each subregion. Cross-country regression analysis on a large sample of advanced economies and EMDCs helps benchmark the region to its global peers and provide insights into policy priorities that could accelerate growth in productivity, physical capital, and employment in the Middle East and Central Asia. In the oil-exporting economies, a critical part of this process will be diversification away from oil and fostering private sector–led non-oil economic growth.
Raising productivity growth and building up physical capital—especially in the private sector—are essential for unlocking the growth potential of all countries in the Middle East and Central Asia region. These two drivers could be effective because they would allow the region’s rapidly growing labor force to contribute more productively to the economy, creating more and/or better goods and services more efficiently. At present, investment and, hence, capital accumulation are depressed in many countries in the region, especially in non-GCC MENAP and the CCA, because of weak confidence, stemming from sociopolitical and geopolitical tensions, spillovers from conflicts, and strained public finances. These effects are amplified in the countries experiencing conflict (Iraq, Libya, Syria, and Yemen). In oil-exporting countries, especially those in the GCC, public capital has been growing rapidly in recent years but the pace of growth is slowing as these countries are starting to adjust to the new oil price environment. Faster private capital accumulation can partly make up for slowing public capital accumulation, while supporting economic diversification away from oil.
Three common reform areas will be most critical for boosting long-term growth by accelerating productivity and physical capital accumulation—though specific policy priorities within these reform areas vary across subregions.
Ensuring a competitive business environment boosts productivity growth. To this end, streamlining regulations, tax codes, and red tape, as well as reducing the dominance of state-owned enterprises, will be important steps for all countries in the Middle East and Central Asia. In non-GCC MENAP and the CCA, strengthening the rule of law is particularly important for raising productivity growth.
Worker talent—workers’ skills, quality of education, know-how, and professional networks—is also critical for raising productivity and the Middle East and Central Asia lags behind its global peers in this area. An important finding of this paper is that leveraging extensive and potent diaspora networks can help improve productivity in the region as its diasporas can convey knowledge and expertise, as well as help raise finances for training and education. Improving the quality of education by working with the private sector to develop a curriculum focused on the skills needed for private sector jobs can also help close the gap in worker talent. In most countries in the region, promoting worker talent is an immediate priority.
Financial market development, vital for physical capital accumulation, also falls short of global peers. This paper quantifies the benefits of easing access to finance, especially for small and medium enterprises (SMEs), and ensuring adequate protection of legal rights for raising growth potential across the region.
Closing gaps with global peers in these three critical structural reform areas could raise potential growth by 1½ percentage points in the GCC and 1 percentage point in the CCA oil exporters, while in the non-GCC MENAP oil exporters and MENAP and CCA oil importers, potential growth could double. Of course, security and political stability are a precondition for reforms in these areas to succeed, especially in countries experiencing conflict.
A variety of additional policy measures can support reforms in the above core areas. Efficient and high quality public infrastructure complements the aforementioned reforms in raising physical capital growth. In the GCC and CCA, the focus should be on raising the efficiency of public investment. In the non-GCC MENAP, more and better quality infrastructure (especially for electricity) will be paramount. Across both the Middle East and Central Asia, encouraging technology transfer through increased openness to foreign investment can spur innovation, help firms use their resources more efficiently, and facilitate the use of modern production methods—whose significance for productivity is another important finding of this paper. Greater trade openness, especially with large emerging markets, can enhance the accumulation of physical capital and employment growth. Greater labor market efficiency will also be important for employment growth, especially in the non-GCC MENAP oil exporters. Finally, gradually raising female labor force participation rates would foster innovation, productivity, and, subsequently, job creation.
Effective communication will be essential for overcoming any resistance to these reforms. In a climate of sociopolitical, security, and geopolitical tensions, as well as intensifying spillovers from regional conflicts, reform implementation is deeply challenging. A strong communication strategy relying on outreach and buy-in from vested interests will help clear the road for reforms.
The paper is structured as follows. Chapter 1 provides context, focusing on the importance of raising long-term growth for the region and assessing the region’s drivers of growth—namely growth in long-term productivity, long-term physical capital accumulation, and long-term employment. Regression analysis on a large sample of advanced, emerging, and developing economies provides insights into the most influential macroeconomic and structural areas for each of these drivers (Chapter 2). Key policies in each of these areas—tailored to the unique characteristics of each subregion in the Middle East and Central Asia—are discussed in Chapter 3. Lastly, Chapter 4 concludes with main findings and policy implications.