Governments in the countries of the MENA region have traditionally played a dominant role in their economies, especially in terms of the resources that they command, their contribution to output, and their impact on economic incentives. While government involvement has been important in many respects, such as in developing infrastructure and providing public services, expenditure has not always been directed toward efficient and productive uses, and has often been out of line with the revenues available. As a result, until recently, the MENA region has been characterized by large fiscal imbalances.

Governments in the countries of the MENA region have traditionally played a dominant role in their economies, especially in terms of the resources that they command, their contribution to output, and their impact on economic incentives. While government involvement has been important in many respects, such as in developing infrastructure and providing public services, expenditure has not always been directed toward efficient and productive uses, and has often been out of line with the revenues available. As a result, until recently, the MENA region has been characterized by large fiscal imbalances.

In recent years, policymakers have recognized the consequences of fiscal imbalances: low savings, inflationary pressures, a buildup of domestic and external debt, and an unstable macroeconomic environment that is not conducive to private investment. They understand the implications of these adverse developments for the achievement of their principal policy objectives—higher and sustainable economic growth, employment creation, and an improvement in the standard of living of the population. There is also an increasing awareness of the need to address the vulnerable nature and inflexibility of the structure of their budgets, particularly in the context of adverse exogenous developments. In the past few years, MENA countries—both non-oil and oil exporters—have begun to implement important fiscal reform measures, leading to tangible progress in reducing the fiscal imbalances and improving the structure of expenditure and revenues.

Fiscal Structure of the MENA Countries

Despite different natural resource endowments and sociopolitical structures among countries in the region, government has played a dominant role in the economies of both oil exporting and non-oil countries. The ratio of government expenditure to GDP in the MENA region has been high by international standards—predominantly because of large outlays on current expenditures, including unproductive expenditures and sizable wage bills. The magnitude of government expenditures has necessitated raising revenues that are also large by international standards. Oil exporting countries have relied heavily on receipts of oil revenues, which have been volatile, while non-oil countries have derived their revenue mainly from import duties and nontax revenues. The tax systems of both groups have been characterized by a multiplicity of tax brackets and relatively weak administration.

Expenditure Patterns

As shown in Chart 1, government spending by MENA countries has tended to be high, particularly by international standards (at 39 percent of GDP during 1980-95, expenditure and net lending in the MENA region was significantly higher than in any other country grouping).1 Large government expenditures are characteristic of both oil and non-oil economies, but there are structural differences in spending patterns between these two groups that are useful to examine.

Chart 1
Chart 1

Developing Countries and the MENA Region: Total Expenditures and Net Lending

(In percent of GDP)

Source: International Monetary Fund, World Economic Outlook.

The oil exporters. To better understand government spending in oil producing countries, two principal features of the role of government in these countries need to be considered.

  • Governments in the oil producing countries are responsible for converting oil wealth into human and physical capital, as well as into foreign assets, with the objective of maintaining a desired level of aggregate income and consumption in the period after petroleum reserves have been exhausted.

  • Because they receive the proceeds from the exports of petroleum—a national resource—governments have assumed an important distributive role. Thus, a large portion of oil revenues is channeled to the population through the provision of employment by governments, direct or indirect subsidies and transfers, public development projects, and other diverse mechanisms.

Given the distributive role of government in these countries, current expenditures have been high, accounting for roughly 80 percent of total expenditures in the five-year period 1991—95.2 An important component of spending represents transfers to the population in the form of explicit budgetary subsidies (which have generally been small) and implicit subsidies (which have been quite large) effected through many channels, including subsidized loans, the provision of a number of goods and services below cost, agricultural subsidies, and other generous entitlements and transfers.

Explicit and implicit subsidies have been an important component of expenditures among oil exporters

Another example of the governments’ welfare policies is that traditionally wage and salary bills have been relatively high in the oil producing countries, ranging between 9 percent of GDP (Algeria) to about 18 percent of GDP (Bahrain and Saudi Arabia). An implicit policy in many of these countries is that the government acts as an employer of first resort, thereby providing work for a large proportion of the labor force. Moreover, in many of these countries—particularly in the GCC countries—public sector employees receive substantially higher wages and benefits than private sector employees (Shaban and others, 1994).

Outlays on education and defense in the MENA region have been high by international standards. However, as noted in the previous chapter, the efficiency of investment in education has tended to be low, and outlays on education have not contributed to productivity in a substantial way.

The non-oil exporting economies. The inward-oriented development strategy adopted by many MENA countries in the 1960s and the 1970s and high defense expenditures partly account for the large share of government expenditure in this group of countries—some 43 percent of GDP in 1980—95. Under this strategy, aimed at promoting domestic production through import-substitution policies, government expenditure was directed to virtually all sectors of the economy. It took the form of direct outlays as well as net lending to enterprises owned and/or controlled by the government, and the latter also had budgetary implications.

Capital expenditures and net lending therefore made up a large part of the budget in all non-oil exporting countries—ranging from one eighth of the overall budget in Israel to one third in the Syrian Arab Republic—a different pattern from that observed in the oil economies, where capital spending was relatively lower in terms of GDP. Lebanon is a special case, since the high share of its government spending in total investment during the period resulted from the reconstruction that followed a long civil war (Eken and others, 1995). Traditionally, the Lebanese government had a much less active role in the economy than other governments in the region.

Governments in the non-oil countries have also been involved in income redistribution and the provision of social services, with budgetary implications through subsidies and transfers. Such expenditures were particularly high in Israel and Tunisia. Data on the functional breakdown of expenditures, while incomplete, indicate that the non-oil MENA governments have tended to spend more on education than on health, often as much as three times or more.

As in the oil producing countries, governments in the non-oil countries have also been the largest employer in the economy. At two extremes, the wage bill accounts for one third of total government expenditures in Morocco, and one sixth in Jordan.

Structure of Revenues

Revenues in terms of GDP have been high in MENA (averaging 32 percent of GDP during 1980—95) relative to other regions of the world (Chart 2). They have also been relatively more volatile, largely because of the dominant role of oil revenues at the regional level.

Chart 2
Chart 2

Developing Countries and the MENA Region: Total Revenues and Grants

(In percent of GDP)

Source: International Monetary Fund, World Economic Outlook.

Volatile oil earnings are the most important revenue source

The oil exporters. Earnings from oil (defined to cover revenues from the entire oil and gas sector) contributed on average more than 60 percent of the budgetary revenue of the nine oil producing countries of MENA during 1991—95, and more than 67 percent of revenues for the GCC. The volatility of oil revenues has also affected non-oil revenues, as economic activity of the non-oil sector is closely linked to receipts (and expenditure) of oil revenues by governments. Because of the volatility of oil prices and, therefore, of government revenues, public finances of the petroleum exporting countries are highly vulnerable to exogenous terms of trade shocks, which pose a problem for policymakers. They must distinguish between temporary and permanent shocks to oil revenues and, on that basis, decide whether and how—through formal or informal mechanisms—to adjust expenditures. In a number of the GCC countries, despite the absence of a formal fiscal stabilization facility, some of these functions are performed by government offices established for investing a portion of oil revenues. For example, in Kuwait these functions are performed by the General Reserve Fund and Reserve Fund for Future Generations (managed by the Kuwait Investment Authority), in Oman by the State General Reserve Fund, and in Qatar by the Qatar Investment Office.

The following generalizations can be made with regard to the non-oil revenues of the oil exporting countries:

  • Tax revenue is small; there is a relatively high reliance on nontax revenue.

  • During 1991—95, direct taxes generally provided less revenue than indirect taxes; furthermore, revenues from personal and corporate income taxes have become increasingly smaller since 1981.

  • Reliance on trade taxation is also very limited.3

  • With the exception of Algeria, there is almost no recourse to a broad-based tax such as a value-added tax (VAT). Instead, most countries levy specific fees and charges on some goods and services.

  • Several GCC countries have invested a portion of their oil export earnings into portfolios of financial assets abroad, and the revenue from these assets makes up a part of their budgetary earnings.

  • The growth of tax revenues in response to GDP growth has been declining.

Non-oil exporters have relied heavily on indirect taxes

Non-oil exporting countries. In these economies, the bulk of government revenues (defined to exclude foreign grants) are collected through indirect taxes. These taxes accounted for 40 percent to 60 percent of all government revenues during 1991—95. (Egypt, with indirect taxes representing only one fourth of total revenues, was an exception.) Trade-related taxes have been an important element of indirect taxes. At the beginning of the 1980s, revenues from tariffs levied on imports were the single most important source of indirect taxes in many countries. Subsequently, some countries have introduced a general sales tax (GST) or a VAT. The trade tax systems have also been reformed so that the tax burden on imports has been reduced somewhat.4

Revenues related to taxes on exports or excises on the production of exportable goods are also a relatively large source of revenue in some countries.

Income taxes generally provide a small share of revenues. In Jordan, for example, they generated only 10 percent of total revenues during 1991—95. Only in Israel did direct taxes contribute more than 30 percent of total revenues during the same period. In countries with a large public sector, the distinction between direct taxes and indirect taxes is sometimes blurred since profit transfers from public entities, which have been a source of large revenues, are often counted as nontax revenues. In Egypt, for example, the government-owned oil company and the Suez Canal Authority transferred amounts in the order of 5 percent of GDP to the central government. Similarly, in Jordan, the operating surplus from post and telephone services has been an important source of nontax revenue. Nontax revenues have been large in some countries, providing between 10 percent and 50 percent of total revenues on average during 1991—95.

Revenue systems in many non-oil countries are characterized by certain weaknesses. In several of these countries, the share of both direct and indirect tax revenues in GDP has been stagnating or decreasing since the early 1980s, the many reform efforts notwithstanding. Furthermore, effective tax and tariff rates are quite low in general despite high statutory rates, reflecting problems in tax administration and enforcement as well as numerous exemptions.

Revenue systems have structural weaknesses

For both oil exporting and non-oil countries, it is important to consider the implications of the revenue structure for growth. Prospects for increased productivity and a higher level of economic growth are determined in part by the incentives facing economic agents in their productive activities. Personal and corporate income taxes, the taxation of raw material and intermediate inputs—which in the MENA countries are in large part imported—and export taxes can represent important disincentives for producers. As discussed, many countries in the region are dependent on trade taxes, and in some countries import tariffs remain relatively restrictive. Although the taxation of income is limited across most of the region (particularly for nationals of the GCC countries), the multiplicities of tax brackets and complex tax systems are not transparent and are characterized by severe administrative problems—all of which have a bearing on the attractiveness of the domestic environment for investment and production. In some countries, progressive corporate income tax rates and wide bands could act to discourage the expansion or the formation of large business firms.

Fiscal Imbalances and Adjustment in the MENA Countries, 1980–95

The fiscal imbalances in the MENA region were on average larger than in other developing country groupings during 1980—95, but have demonstrated an improving trend since the mid-1980s (Chart 3).

Chart 3
Chart 3

Developing Countries and the MENA Region: Central Government Fiscal Balance

(In percent of GDP)

Source: International Monetary Fund, World Economic Outlook.

Fiscal imbalances. In the first half of the 1980s, the central government fiscal balance deteriorated rapidly for several reasons. These included the continued high spending associated with the dominant role played by MENA governments, high interest payments (in the non-oil countries), and lower revenues as a result of declining oil and other commodity prices, such as phosphates and potash. Thereafter, fiscal imbalances began to decline, as a number of countries began to implement fiscal adjustment measures. In more recent years, countries already implementing fiscal restraint have intensified their efforts (including under IMF-supported arrangements) and other countries, including many of the oil exporters, have initiated fiscal reform.

The oil exporters. Fiscal imbalances were on average lower in this group than in non-oil exporting countries during 1980—95, with fiscal deficits averaging 5 percent of GDP. However, the fiscal position of the oil exporting countries registered large fluctuations during this period, reflecting international oil price developments combined with limited reliance on tax revenues, as well as slower adjustment of spending patterns in response to lower oil revenues. To finance their fiscal imbalances, these countries used their gross foreign assets and to a lesser extent resorted to debt financing primarily from domestic sources.

The non-oil exporters. Fiscal deficits in this group averaged 12 percent of GDP, three times the level registered in the developing countries as a whole and twice the level in the African countries. The large fiscal imbalances reflect the dominant role of the government in these countries and the complex tax systems—with high marginal tax rates, widespread tax exemptions, and weak administrations—that rely heavily on customs revenues rather than on broad-based domestic consumption or value-added taxes. However, the fiscal imbalances in non-oil countries have been on a declining trend since the mid-1980s, as a number of countries took measures to contain spending, broaden the tax base, and improve tax administration and collection. Nevertheless, the large and long-standing fiscal imbalances have had adverse consequences for the broader macroeconomic situation (Box 1).

Fiscal adjustment started in the mid-1980s

The Legacy of Large Fiscal Imbalances in the Non-Oil MENA Economies

While progress is now being made to address fiscal imbalances in the non-oil producing MENA countries, the legacy of large central government deficits has important implications for the overall economic environment and the starting point from which governments are undertaking fiscal reform.

Fiscal deficits in this group of countries have a number of common characteristics:

  • They have been an important element underlying the low savings rate.

  • In many cases, they have been the main factor contributing to inflationary pressures.

  • They have resulted in a buildup of domestic and external debt and, in many cases, have led to uncertainties about future macroeconomic policies.

  • They have tended to crowd out productive private sector investment through higher interest rates and limited availability of financing (which has been absorbed by the government).

Fiscal Adjustment

Since the mid-1980s, non-oil countries as a group have made important headway in addressing fiscal imbalances: their fiscal deficit has been reduced from almost 20 percent of GDP in the early 1980s to 4 percent of GDP in 1995. However, progress has not been uniform across all countries, and some countries have yet to confront fully the problem of unsustainable fiscal imbalances.

Israel, Mauritania, Morocco, the Syrian Arab Republic, and Tunisia were early adjusters, while Egypt and Jordan were able to delay substantial adjustment until the end of the 1980s by borrowing both from international capital markets and bilateral sources.5 In Lebanon and the Republic of Yemen, civil unrest prevented any deliberate fiscal adjustment efforts until the first part of the 1990s. In some countries, fiscal adjustment was part of a more general stabilization and reform program supported by use of IMF resources. In the oil exporting countries, despite the decline in the external terms of trade and in oil revenues in the early 1980s, determined fiscal adjustment was delayed until the early 1990s, following the regional crisis of 1990–91 and in recognition of the need to address such problems to prevent a deterioration in living standards and ensure a more stable domestic environment. In the past few years, adjustment in these countries was relatively strong, and the budget deficit for the group declined from 8 percent in 1993 to below 3 percent of GDP in 1995.

Important progress has been made in addressing fiscal imbalances

The pattern of fiscal adjustment in the MENA countries—both oil and non-oil exporters—in 1980—95 had many similarities, as summarized below:

  • Capital expenditures often bore the brunt of expenditure adjustment in the initial stages of fiscal adjustment.

In the initial stage of fiscal adjustment, governments typically have resorted to expenditure reductions since these can be implemented either immediately or with only short delays. Moreover, capital expenditures have often been reduced earlier and to a larger extent, since current expenditures (for example, interest payments or wages and salaries) are subject to rigidities as well as political sensitivities. The cuts in capital expenditures were particularly large in the countries that had high capital expenditure-to-GDP ratios at the beginning of the 1980s (Algeria, Bahrain, Egypt, Libya, Mauritania, and Saudi Arabia). Because of reductions in net lending to public sector entities and to the private sector and rationalization in public sector investment projects, the share of capital expenditures to GDP has been falling steadily to lower levels over the last fifteen years in most MENA countries. However, in the Islamic Republic of Iran, Lebanon, the Syrian Arab Republic, and the United Arab Emirates the share of government capital outlays in GDP has rebounded and has been rising over the last three to five years.

  • Reductions in current expenditures also contributed significantly to lower budget deficits.

Current expenditures have also been adjusted downward, although generally with a lag. The contribution from cuts in current expenditures to the reduction in fiscal deficits has been large in Egypt, Israel, Libya, Mauritania, and Sudan. The cuts in current expenditures were mainly in defense outlays (Israel and Egypt) and the streamlining of subsidy systems and lowering of transfers (Egypt, Israel, Morocco, and Saudi Arabia). It is difficult to assess the degree to which expenditures supporting economic growth has been cut. Available data suggest that in most cases such expenditures have been reduced in the adjustment process: the ratios of education and/or health expenditures to GDP often fell during 1986—95. Only a few countries (for example, Egypt and Morocco) undergoing fiscal adjustment have been able to preserve socially productive expenditures at levels prevailing in the mid-1980s. Most MENA countries have found it difficult to contain the wage bill, and outlays on this category of spending have in fact risen in Jordan, Kuwait, Tunisia, and Oman.

  • The contribution of expenditure cuts and revenue increases to fiscal adjustment has been asymmetrical.

Revenue increases (excluding oil revenues) have not contributed as much as expenditure restraint to the improvement in the overall budgetary balance of the MENA countries. In fact, total revenues as a percent of GDP stayed more or less constant during 1986—95: in the non-oil exporting countries, owing to the slow implementation of structural reforms, particularly in the areas of tax administration and structure, and in the oil exporting countries, owing to the lack of substantial measures, particularly to broaden the revenue base. In those non-oil countries implementing fiscal reform, measures were aimed at simplifying and harmonizing the tax structure and removing severe distortions. The income tax system was simplified and marginal tax rates were reduced in Egypt, Israel, Jordan, Morocco, and Tunisia. The ratios of both direct and indirect taxes to GDP increased only in Jordan and Morocco and the ratio of direct taxes to GDP in Tunisia.

Challenges for the Future and Policy Implications

The MENA region has made important progress in recent years in achieving a stable macroeconomic environment. However, the broad policy response has been insufficient to realize the region’s considerable potential. Domestic savings remain low, representing a constraint to higher investment, and the fiscal positions of MENA countries continue to be highly exposed to changes in the external environment.

Further reforms are needed to support growth

Looking forward, economic challenges for the MENA countries are unlikely to ease. In addition to an uncertain external environment, the integration arrangements with the European Union that several countries are pursuing envisage a reduction in import tariffs. Moreover, the potential for transfers from oil exporting MENA countries to the rest of the region has diminished sharply. In such an environment, the MENA countries will need to address their fiscal challenges rapidly in order to minimize downside risks, benefit from the globalization and integration, and achieve high sustainable rates of growth necessary to create employment opportunities for a rapidly growing labor force.

Fiscal reforms need to be designed carefully on a case-by-case basis, taking into account the specific circumstances, conditions, and priorities in each country. Recent research on the determinants of economic growth and the experiences of many countries suggest the following general guidelines for fiscal reform:

The stance of fiscal policy should be improved to make it sustainable and credible so as to enhance macroeconomic stability, increase savings, and promote capital accumulation (Fischer, 1993). In some MENA countries, despite the adjustment efforts made in recent years, the financing of sizable budget deficits continues to crowd out productive private sector investment and create uncertainties about future macroeconomic policies in the face of large accumulation of public sector debts. In some oil exporting economies, the return to fiscal surpluses is essential to prepare better for the period after the exhaustion of their petroleum resources.

Public expenditures should aim to raise the rate of economic growth by supporting the accumulation of both physical and human capital. Typically, this involves spending on basic services such as education, health, and infrastructure that complement efforts by the private sector, but which would be in short supply without government intervention due to their public good characteristic or market imperfections (Barro and Sala-i-Martin, 1992). Cuts in expenditure should be designed to protect outlays that support the accumulation of privately supplied factors of production and the vulnerable population groups. The quality of public expenditure could be enhanced in a number of ways:

  • Increasing outlays on human resource development that would enhance productivity and better targeting outlays on basic services.

  • Limiting investment to infrastructure capital stock that increases the productivity in the private sector and/or to correct for an externality or market failure.

  • Reducing unproductive expenditures significantly, including defense spending, and rationalizing and better targeting subsidies that contribute to political stability.

  • Reforming the civil service aimed at both reducing the wage bill and improving the efficiency of government operations.

Fiscal reforms must be tailored to individual country needs

Revenues should be mobilized in a manner that minimizes the distortional effects of taxes on the returns to factors of production and on international trade and does not render public finances vulnerable to exogenous shocks. Reform efforts need to focus on the following:

  • Lowering the dependency on oil revenues in oil exporting countries by changing the structure of revenues.

  • Reducing the dependency on international trade taxes in non-oil countries by introducing broad-based domestic consumption taxes.

  • Improving the elasticity of the tax system through reduced reliance on nontax revenues, such as fees and charges, and elimination of exemptions.

  • Reducing high marginal income tax rates so as to encourage investment by the private sector.

  • Establishing a single corporate tax rate, which would be consistent with the top marginal personal income tax rate.

  • Strengthening tax administration with efficient enforcement and collection procedures.

The above agenda of reforms indicates that maximizing the contribution of government policies to growth requires attention to the composition of expenditure as much as to its level, and to the structure of the tax system as much as to its yield. These reforms at times could imply trade-offs between immediate deficit reduction and deficit reduction in the future. It is therefore important to view budget constraints in a multiperiod framework and to implement a fiscal strategy that is of high quality, transparent, and sustainable, as well as growth oriented in nature.

Fiscal policy should be sustainable, transparent, and growth oriented

Related Reading

  • Barro, Robert J., and Xavier Sala-i-Martin, “Public Finance in Models of Economic Growth,” Review of Economic Studies, Vol. 59 (October 1992), pp. 64561.

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  • de Callatay, Etienne, and Ahsan Mansur, “Public Debt Dynamics and Fiscal Policy,” in Jordan: Strategy for Adjustment and Growth, ed. by Edouard Maciejewski and Ahsan Mansur, IMF Occasional Paper 136 (Washington: International Monetary Fund, May 1996).

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  • Eken, Sena, Paul Cashin, S. Nuri Erbas, Jose Martelino, and Adnan Mazarei, Economic Dislocation and Recovery in Lebanon, IMF Occasional Paper 120 (Washington: International Monetary Fund, February 1995).

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  • Fischer, Stanley, “The Role of Macroeconomic Factors in Growth,” Journal of Monetary Economics, Vol. 32 (December 1993), pp. 485512.

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  • Milesi-Ferreti, Gian Maria, and Nouriel Roubini, “Taxation and Endogenous Growth in Open Economies,” IMF Working Paper 94/77 (Washington: International Monetary Fund, July 1994).

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  • Nsouli, Saleh M., Sena Eken, Paul Duran, Gerwin Bell, and Zühtü Yücelik, The Path to Convertibility and Growth: The Tunisian Experience, IMF Occasional Paper 109 (Washington: International Monetary Fund, December 1993).

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  • Nsouli, Saleh M., Sena Eken, Klaus Enders, Van Can Thai, Jörg Decressin, and Filippo Cartiglia, Resilience and Growth Through Sustained Adjustment: The Moroccan Experience, IMF Occasional Paper 117 (Washington: International Monetary Fund, January 1995).

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  • Shaban, Radwan A., Ragui Assaad, and Sulayman Al-Qudsi, “Employment Experience in the Middle East,” Economic Research Forum Working Paper No. 9401 (Cairo: Economic Research Forum, 1994).

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In many instances, public enterprises are outside the government budget. The dominant role of the government in the MENA economies becomes more pronounced if the activities of the public enterprises and other extrabudgetary operations are taken into account fully.


To avoid distortion, this average excludes Kuwait where, during 1991—92, current expenditures amounted to 93 percent of GDP because of outlays on rebuilding and rehabilitation.


Algeria has the highest revenues from trade taxes (5 percent of GDP in 1994). In most other oil producers, trade taxes ranged between 1 percent and 2 percent of GDP in 1994.


Morocco (1986), Tunisia (1988), and Mauritania (1995) introduced a VAT; Egypt (1991) introduced a domestic sales tax; and Jordan (1994) converted a consumption tax to a GST. In Israel, a VAT has been in place since the 1980s.

Reform and Growth in the Middle East and North Africa