A Reform Agenda for Arab Economies

Economic challenges are central to the political transformations sweeping the Middle East and North Africa. Arab governments–some of them fragile democracies–need to tackle corruption, slow growth, inequity, and unemployment that helped arouse protest movements. Manuela V. Ferro, a World Bank expert on Arab economies, says the region faces significant difficulties in the near term, including reductions in trade, tourism, and foreign investment. Governments intent on reform, she adds, must strive for an economic recovery with “visible benefits to all citizens,” and focus on fiscal sustainability, job creation, and protecting the poor.

We’re just over a year out from the start of the Arab Spring. What are the economic prospects for the Middle East and North Africa (MENA)?

Political events in 2011–revolutions and evolutions–in several countries have created opportunities for more open societies and inclusive growth. However, there are also short-term consequences on economic performance; we saw tourism, trade, investment, and in some countries, remittances have also slowed down. Tourism, which comprises 4 and 6 percent of Egypt and Tunisia’s GDP, respectively, contracted significantly following revolutions. Yet this labor-intensive sector is a major source of foreign exchange for several countries; in Egypt tourism revenues were the second-largest source of foreign exchange earnings in FY2010. The region has witnessed foreign direct investment (FDI) declines in a number of countries.

In several countries (in particular non-oil exporters – Egypt, Jordan, Tunisia, Morocco, Syria, and Yemen), while the medium-term economic and social outlook remains promising, near-term growth prospects are weaker than a year ago. This is especially the case in countries where there is significant uncertainty about the length, nature, and direction of transition.

It is against this backdrop of economic vulnerability in several MENA countries that the eurozone crisis is hitting. So far, domestic and regional events are still dominating the economic outlook for most countries in the MENA region. Economic and social challenges in MENA are unrelated to the Eurozone crisis, but could be exacerbated by it.

What are the biggest challenges these countries face, from an economic standpoint, during these transitions? And what are some of the basic reforms that are necessary?

Governments need to ensure that economic and social policies support a strong economic recovery with visible benefits to all citizens, not just those politically connected. This means that economic governance policies that ensure a level-playing field will need to play a much greater role than they have in the past.

Many (non-oil exporting) countries in the region had an acceptable–though not stellar–economic performance during the last decade: about 3-4 percent growth per year. Creating the fifty to seventy million jobs needed to reduce unemployment will require three things:

First, ensuring economic stability and fiscal sustainability in the context of increased social pressures and rising borrowing costs.

Second, supporting job creation through a more vibrant private sector, in particular by integrating MENA countries more fully in the world economy. Until now, MENA has been one of the least integrated regions in the world. Looking forward, economic integration through greater trade and investment is an overarching development strategy that can do for the MENA region what it did before for Central and Eastern Europe, East Asia, and other emerging trading partners that are now sustainable growth paths.

Third, protect the poor through more effective, much better targeted social protection. MENA countries have long had redistributive policies through subsidies and public employment programs. MENA countries have operated extensive subsidy systems–for energy, water and food–for the past forty years, which have totaled more than $50 billion for the region as a whole. These systems are inefficient and do not provide an effective mechanism to help households cope with temporary shocks or move out of poverty.

The concerns are very different as you move from the short term, to medium term, and then to the long-term structural problems. Could you talk a bit about the various challenges along this timeline?

Policies that make sense in the short run should also make sense in the long run. There is a question of sequencing, yes, but thinking exclusively of the short run is likely to be detrimental.

For instance, the Tunisian transition government introduced a set of measures to signal a clear break from the past and set the country on a new path. This included enhancing access to information to promote transparency; opening up access to the Internet; improving public procurement procedures; streamlining the regulatory burden faced by firms; introducing new rules for good governance in the banking sector; reforming the National Employment Fund and introducing new programs to better assist the unemployed. Because these reforms helped lay the foundations of a stronger, more open Tunisia, and set the country on a faster, more inclusive, development path, (the World Bank) supported the reforms introduced by the government with a development policy Loan, alongside other development partners.

Are there success stories from other parts of the world that can serve as a model for some of these transitioning Arab countries?

Eastern Europe benefited from a popular rejection of an economic model driven by central planning, by a supportive global economic environment, and by openings towards EU membership. In many Eastern European countries, there was an organized political leadership that adopted market-friendly policies. In Latin America there were many fits and starts, as might be the case in the Middle East and North Africa.

In East Asia, Indonesia offers an interesting example, as governance and economic reforms led to a vibrant, dynamic economy. Each of these experiences offers lessons for MENA. But there is no clear-cut model that applies directly. Each transition happens in a particular context, with particular initial conditions. The path is rarely straight, and we must be prepared for potentially long transitions.

What is the best policy for these countries as they navigate the financial straits of transition?

Different countries in transition face different economic stresses, and will find their own way to address financing needs. Egypt, like other countries in the region undergoing a political transition, is managing a fast-evolving situation, now made more difficult by a global economy that is itself in a dangerous phase. Egyptian authorities have taken some steps recently to address foreign exchange needs. For instance, they auctioned dollar-denominated treasury bills, perhaps part of a strategy to diversify funding away from local sources.

Perhaps for historical reasons, there is a perception in some quarters in Egypt that external debt is at dangerously high levels. In fact, much of Egypt’s debt is domestic; the composition and small size of Egypt’s external debt makes it relatively resilient to external shocks.

Given that domestic borrowing costs are running at double digits and that public sector borrowing needs are high and could be crowding out the Egyptian private sector, the authorities have remained engaged with potential sources of external finance.

High unemployment, particularly among the youth, is a persistent problem in the region. What steps need to be taken to address this?

What we have heard from young people is that they want jobs, social justice, and dignity. In the late 1990s and early 2000s, the social contract–and the economic model that underpinned it–became increasingly strained, in particular in non-oil producing countries. Governments became gradually unable to continue employing people.

The private sector was unable to absorb labor because of the rapidly growing youth population and government policies that limited entry of new firms but protected those that were politically connected. In some countries, education was increasingly unable to provide the skills for a modern private sector, and labor productivity was low. For non-oil producers, the subsidy bill became difficult to uphold because of unprecedented high prices of fuel and food.

With relatively high rates of unemployment around 10 percent and youth unemployment at 24 percent for the MENA region, approximately forty-eight million jobs will have to be created in the coming decade. Women face even higher rates of unemployment.

Only a dynamic and growing private sector can create jobs at a rate that keeps pace with this growing and increasingly young population. The public sector can help in the short run, but short-term jobs programs cannot solve a structural unemployment challenge. Managing expectations of how fast the deficit of jobs can be addressed is critical.