Economic Research Forum (ERF)

Arab economic integration: trade and growth policy after the crises

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Greater economic and financial integration of the Arab countries is widely agreed to be essential both to promote growth and to shelter the region more effectively from the negative impact of future global crises. This column outlines key policy measures.

In a nutshell

Arab countries should continue to integrate regionally to shield their economies more effectively from international financial shocks and shocks to oil prices and world demand.

Due to growing competition from world markets, it is imperative for the Arab region not only to abide by already ratified preferential trade agreements, but also to reform and modernise existing trade policies.

To succeed in their recent trade integration efforts and their new outward-oriented trade policies, Arab countries need to encourage foreign direct investment, which allows for transfer of technology and knowledge, as well as increases in productivity.

After the recent debt and financial crises and the worldwide recession (see Neaime, 2012, 2015a, 2015b, 2016), it became of paramount importance for the Arab region to enhance the region’s economic and financial integration. It is well known that economic and financial crises tend to spread along the lines of trade linkages (see Neaime, 2012, 2015a, 2015b, 2016).

The extensive openness of the Arab region’s trade relationships with the rest of the world has rendered the transmission of shocks to the region a matter of great concern. Arab policy-makers should take the opportunity to increase economic growth and dampen the effects of world economic crises through further integration of the Arab economies (Michelis and Neaime, 2004, Mora et al, 2013).

Since the early 1980s, Arab countries have been aiming for increased regional and international economic integration. A significant portion of economic integration is the expansion of inter- and intra-regional trade, thereby achieving higher GDP growth rates, and allowing a higher degree of inter-Arab specialisation and improved allocation and distribution of resources.

Although Arab countries face numerous stumbling blocks to increasing regional trade, there is now a consensus among policy-makers that Arab economic integration is crucial to shelter the Arab economies more effectively from the negative impacts of further debt and financial crises and meet the challenges of globalisation from a regional perspective. This would also constitute a good strategy to boost growth and economic development (see Neaime, 2000, 2005, Mansoorian and Neaime, 2003).

Furthermore, world trends towards globalisation and regional trade conglomerates require that Arab countries take the necessary steps to address the challenges from an increasingly integrated world economy, as well as seizing the opportunities that globalisation and regional integration present (see Neaime, 2004a, 2004b, 2008, 2010). But many challenges remain for Arab countries to maximise the economic benefits from globalisation and deeper regional integration, given the current deterioration in the world macroeconomy and growth prospects.

With respect to trade integration, the Arab region has lagged behind the rest of the world. This is despite the fact that there is strong empirical evidence that trade liberalisation enhances economic growth and increases long-term employment opportunities, particularly when combined with investment liberalisation policies. Further liberalising of Arab trade through export promotion strategies, tariffs reductions and the adoption of regional and international trade preferential agreements is crucial. It also constitutes an important instrument for stimulating growth.

Advocates of trade liberalisation and economic openness posit that openness spurs economic growth, especially in developing countries, whereby the exploitation of technology and capital available in the world markets pushes a given economy to new production frontiers. Yet despite the potential benefits emanating from trade liberalisation and economic openness, some countries have remained trapped in a low economic growth environment despite lowering their barriers to trade and investment since the early 1980s.

Latin America and Africa are examples of places where growth rates have stagnated at where they have been in the 1970s despite embracing globalisation at various levels. Yet countries like China, India and others in East and South Asia have reaped the benefits of globalisation through a sequential and gradual process of trade liberalisation (Rodrik, 2001).

The empirical evidence on the relationship between trade and economic growth is still mixed given that proxies used for openness are either poor measures of trade barriers or are highly correlated with other sources of weak economic performance (Rodriguez and Rodrik, 2000). But there is a consensus among economists that for successful trade liberalisation requires a judicious blend of imported practices with domestic institutional innovations that do not forgo a domestic growth strategy.

Since the early 1980s, most Arab countries have embarked on a trade regime that supports free trade, and that is more outward-oriented. But this has increased the exposure of the region to international economic and financial shocks. Of the 13 Arab countries studied here, eight are now members of the World Trade Organization (WTO), and three enjoy observer status (including Iraq). In addition, all of the 13 countries are members of the Greater Arab Free Trade Agreement (GAFTA), while only six are members of the Gulf Cooperation Council (GCC).

Some Arab countries are also part of the European Union’s (EU) partnership agreements, the global system of trade preferences, the generalised system of preferences, and the Organisation of the Petroleum Exporting Countries (OPEC). Some too have established various free zones and qualified industrial zones, in addition to signing numerous bilateral trade agreements.

Arab countries still need to devote efforts to achieving the desired levels of growth and development, and reducing the region’s economic vulnerability to external shocks (including oil prices, international financial markets and world demand) by enhancing further regional trade and financial integration.

The inadequacy of public services, which drives up business costs, in addition to the need to rehabilitate infrastructure (particularly telecommunications, power generation, water and transport), in several Arab countries remains an obstacle to further development of both the services and industrial sectors, and continues to constitute important impediments to promoting and intensifying intra-regional trade.

In addition, the current trade policies of Arab countries appear to be still inhibiting the competitiveness of domestic firms, thereby reducing proper implementation of existing regional trade arrangements, and hindering economic growth and development through trade creation. All the newly ratified preferential trade agreements and the structural reform programmes and privatisation schemes introduced since the early 2000s are still unable to remove impediments to both national and regional trade liberalisation efforts.

Such impediments include high nominal tariffs, which are still prevalent in many Arab countries; the maintenance of high rates of protection for domestic producers in a number of sectors; many industrial product imports are still subject to licensing requirements; and the processes of exports and imports are accompanied by costly and burdensome administrative procedures.

As a percentage of total trade, intra-Arab total trade and total exports have remained low, indicating that all the newly ratified trade agreements are still unable to intensify Arab trade, and stimulate further trade integration in the region. This highlights the need for intensification of efforts by Arab countries to overcome the stumbling blocks obstructing the liberalisation of intra-Arab trade, and to enhance further regional trade integration to protect Arab countries more effectively from the negative spillover effects of the recent debt and financial crises (Gaysset et al, 2019, Neaime and Gaysset, 2017, 2018; Neaime et al, 2018).

Rodrik (2000) addresses the question of what institutions matter when it comes to enhancing trade integration and globalisation in the region. He identifies two critical areas that are still missing in the Arab region: first, property rights or, strictly speaking, control over property rather than legal rights per se; and second, regulatory institutions to correct externalities emanating from further trade liberalisation, information failures and market power, such as anti-trust bodies, banking supervision and, more controversially, coordination of major investment decisions.

The United Arab Emirates (UAE) imposes the lowest tariffs on its imports, followed by Saudi Arabia, Qatar, Bahrain, Lebanon, Egypt, Jordan and Oman. Moreover, Oman has the highest market access for its exports, followed by Saudi Arabia, Qatar, the UAE, Bahrain, Egypt, Lebanon and Jordan.

In terms of the most conducive business environment among Arab countries, Saudi Arabia ranks first, followed by Kuwait, Oman, the UAE, Jordan, Lebanon, Yemen and Egypt. In terms of the efficiency of customs and other border procedures, the UAE has the best logistics, followed by Bahrain, Saudi Arabia, Kuwait, Qatar, Oman, Jordan, Egypt, Lebanon, Yemen and Syria.

Despite the various trade agreements that the region has already ratified, Arab countries are still unable to attract the level of investment that is conducive to growth and development. Further Arab trade liberalisation should pave the way for more specialisation within the region, and should enhance growth and development.

Arab countries should be able to specialise further in the production of goods where they enjoy a comparative advantage, that is, where they have lower opportunity costs. If applied properly, these trade agreements should also enhance trade creation within the region with the further reduction of trade barriers.

Policy recommendations

(1) Arab countries should continue to integrate regionally to shield their economies more effectively from international financial shocks and shocks to oil prices and world demand. They should continue to encourage import-substitution and export promotion policies. The further establishment of free zones within the Arab region will further attract investment through special tax exemptions and customs. Aside from increasing investment, free zones will also help in increasing employment and GDP growth.

(2) Due to growing competition from world markets, it is imperative for the Arab region not only to abide by already ratified preferential trade agreements, but also to reform and modernise existing trade policies. Further improvement of the communications and information technology sectors will play a vital role in enhancing markets and trade in the Arab region. Although this sector has continued to grow in recent years, more efforts need to be devoted towards improving it and integrating it with international markets.

(3) To succeed in their recent trade integration efforts and their new outward-oriented trade policies, Arab countries need to encourage foreign direct investment, which aside from increasing savings and employment opportunities, allows for transfer of technology and knowledge, as well as increases in productivity.

(4) Arab governments need to improve the domestic investment environment by facilitating trade management procedures, reducing all the bureaucracy complications, and becoming more transparent. Privatisation still remains as an important venue to increase investment opportunities in the region.

(5) Arab countries need to devote additional efforts to promoting investment in the region. At the country level, investment promotion policies should focus on three main elements: first, enacting and updating investment promotion laws; second, establishing national committees to oversee investment projects and facilitate administrative procedures relating to these projects; and third, establishing more free trade areas.

(6) The recent removal of several barriers to trade and human capital appear to have benefited the Arab region to some extent. Arab countries need to integrate their labour markets further. Large intra-regional labour movements will constitute the main vehicle for the region’s economic integration, triggering substantial financial flows in the form of workers’ remittances.

(7) Arab countries should further reduce trade barriers such as tariffs, quotas and non-tariff barriers.

(8) Arab countries should enhance efficiencies in production by exploiting comparative advantages in domestic markets in order to achieve increased production due to better exploitation of economies of scale made possible by expanded markets.

Further reading

Gaysset, Isabelle, Thomas Lagoarde-Segot and Simon Neaime (2019) ‘Twin Deficits and Fiscal Spillovers in the EMU’s Periphery: A Keynesian Perspective’, Economic Modelling 76, 101-116.

Mansoorian, Arman, and Simon Neaime (2003), ‘Durable Goods, Habits, Time Preference, and Exchange Rates’, North American Journal of Economics and Finance 14(1): 115-30.

Michelis, Leo, and Simon Neaime (2004) ‘Income Convergence in the Asia-Pacific Region’, Journal of Economic Integration 19(3): 470-98.

Mora, Nada, Simon Neaime and Sebouh Aintablian (2013) ‘Foreign Currency Borrowing by Small Firms in Emerging Markets: When Domestic Banks Intermediate Dollars’, Journal of Banking and Finance 37(3): 1093-1107.

Neaime, Simon (2000) The Macroeconomics of Exchange Rate Policies, Tariff Protection and the Current Account: A Dynamic Framework, AFP Press.

Neaime, Simon (2004a) ‘Sustainability of Budget Deficits and Public Debt in Lebanon: A Stationarity and Cointegration Analysis’, Review of Middle East Economics and Finance 2(1): 43-61.

Neaime, Simon (2004b) ‘South-South Trade, Monetary and Financial Integration and the Euro-Mediterranean Partnership: An Empirical Investigation’, Femise Research Network.

Neaime, Simon (2005), Portfolio Diversification and Financial Integration of MENA Stock Markets. In Money and Finance in the Middle East: Missed Opportunities or Future Prospects? Vol. 6, pp. 3-20.

Neaime, Simon (2008) ‘Twin Deficits in Lebanon: A Time Series Analysis’, Lecture and Working Paper Series No. 2, Institute of Financial Economics, American University of Beirut.

Neaime, Simon (2010) ‘Sustainability of MENA Public Debt and the Macroeconomic Implications of the US Financial Crisis’, Middle East Development Journal 2: 177-201.

Neaime, Simon (2012) ‘The Global Financial Crisis, Financial Linkages and Correlations in Returns and Volatilities in Emerging MENA Stock Markets’, Emerging Markets Review 13(2): 268-82.

Neaime, Simon (2015a) ‘Sustainability of Budget Deficits and Public Debts in Selected European Union Countries’, Journal of Economic Asymmetries 12: 1-21.

Neaime, Simon (2015b) ‘Twin Deficits and the Sustainability of Public Debt and Exchange Rate Policies in Lebanon’, Research in International Business and Finance 33: 127-43.

Neaime, Simon (2016) ‘Financial Crises and Contagion Vulnerability of MENA Stock Markets’, Emerging Markets Review 27: 14-35.

Neaime, Simon, and Isabelle Gaysset (2017) ‘Sustainability of Macroeconomic Policies in Selected MENA Countries: Post Financial and Debt Crises’, Research in International Business and Finance 40: 129-40.

Neaime Simon, and Isabelle Gaysset (2018) ‘Financial Inclusion and Stability in MENA: Evidence from Poverty and Inequality’, Finance Research Letters 24: 230-37.

Neaime, Simon, Isabelle Gaysset and Nasser Badra (2018) ‘The Eurozone Debt Crisis: A Structural VAR Approach’, Research in International Business and Finance 43: 22-33.

Rodriguez, Francisco, and Dani Rodrik (2000) ‘Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence’, NBER Macroeconomics Annual 15: 261-325.

Rodrik, Dani (2000) ‘Institutions for High Quality Growth: What They Are and How to Acquire Them’, NBER Working Paper No. 7540.

Rodrik, Dani (2001) ‘Trading in Illusions’, Foreign Policy 123 (March-April): 55-62.

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