Economic Research Forum (ERF)

Formidable challenges facing the Middle East require a sea change in economic policies

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Weakening global growth, endemic conflicts and increased tensions within the Middle East and North Africa (MENA) – as well as emerging challenges such as climate change and rapid demographic shifts – are likely to have an adverse impact on the region’s economic, social and political stability in the coming years. This column outlines the policy responses that are needed to avert disaster.

In a nutshell

Continuing conflict, lack of serious political and economic reform, and increased inequality dampen MENA’s potential for sustainable economic growth and poverty reduction.

Resource dependence and lack of progress in diversifying economies and integrating them into the global economy have retarded private investment, competition and productivity growth; in combination with rapid population growth, these factors have resulted in some of the world’s highest youth unemployment rates.

Only a sea change in economic policies can prevent disaster: measures are needed to bolster job-creating private investment and productivity growth, and to reduce inequality of opportunity, waste and inefficiency; to increase regional cooperation, underpinned by peace-building efforts and reconstruction of the region’s civil war-torn countries; and to provide all citizens with access to the growing digital economy.

Growth of real income in the MENA region is projected to remain weak in 2019, at about 1%. Given projected population growth of 1.6%, this slow rate means that per capita income will fall.

Economic activity in the region’s oil exporters has slowed substantially as a result of low oil prices (about 40% below their average level in 2011-14); cuts in oil production (to support prices); and US economic sanctions on Iran, which cut back its oil exports by about two million barrels a day, causing a deep recession combined with high inflation.

Economic growth is improving modestly in some oil importers in the region, thanks to low oil prices and some policy reforms. Some of these countries are likely to continue to benefit from an improved business climate and a rebound in tourism activity. Based on these assumptions, the World Bank projects that real GDP growth in the region will accelerate to about 3.5% in 2020. But regional and geopolitical tensions, backtracking on reforms and intensification of global trade tensions could lower growth.

Egypt, Iraq and the Gulf Cooperation Council (GCC) countries are expected to continue to grow significantly faster than the average for the region. Continuing civil war in Libya and Syria, a devastating military conflict in Yemen, political upheaval in Algeria and tightening of the US sanctions on Iran are expected to cause economic contraction and put strong budgetary and balance of payments pressures on these countries.

Growth is uneven; poverty and inequality rising

Average GDP per capita in the region in 2018 (about $20,000 at purchasing power parity) was substantially above the world average ($17,000). But the region has witnessed a rise in poverty, as a result of weak and uneven growth, over the last three decades. According to a recent World Bank report, in 1990 about 6% of MENA’s population lived in extreme poverty ($1.90 a day). That share had fallen only marginally – to 5% – by 2015.

The lack of meaningful progress in reducing extreme poverty looks even worse using the $5.50 a day poverty line (appropriate for middle-income countries). Between 1990 and 2015, the region reduced the proportion of people living on less than the $5.50 line from 58.8% to 42.5%. But 158 million people were living below this poverty line in 2015, up from 135 million in 1990.

MENA is the only region in the global economy that hardly experienced any growth in its economy-wide productivity (total factor productivity) between 1985 and 2014. This indicates serious structural problems and massive economic inefficiencies.

Moreover, according to another recent estimate, MENA ‘appears to be the most unequal region in the world’, with the top 10% earning 64% of all income. This is a larger share than in Western Europe (37%), the United States (47%) or Brazil (55%).

The impact of prolonged civil wars and other armed conflicts has been devastating for the people of the region. In 2018, conflict and violence continued to drive internal displacement in MENA, with more than 2.1 million new displacements bringing the total figure to almost 11 million people living in internal displacement, more than a quarter of the global total. By the end of 2018, refugees from the region’s conflicts numbered more than 7.3 million (90% from Syria), around 38% of the global total.

Massive global shifts are affecting the region

Over the last two decades, the rest of the world has been going through massive changes. Some are having discernible impact on the region’s future. The most important change has been the shift in global economic power from North America and Europe towards Asia, whose share of global output (in purchasing power parity) rose from 20% in the late 1990s to 37% in 2018.

A second important shift is the reversal in globalisation and the recent rise in protectionism. This latter trend, initiated by the trade conflict between the United States and China, will have significant adverse impacts on trade and financial flows in the region and lead to further economic slowdown if not reversed soon.

A third shift is the emergence of new, disruptive technologies and a digital economy. These trends tend to be ‘labour-saving’ and highly ‘skill-biased’, requiring workers with a strong educational background and good cognitive skills.

The new technologies promise to spur economic growth over the longer term, but they have already led to massive shifts in labour markets and new vulnerabilities, such as cyber-attacks. They require major policy initiatives and investments to increase affordable access to broadband internet for all citizens in order to maximise the benefits and mitigate the risks.

A fourth major transformation with a potentially huge impact on the region is climate change. Recent climate model simulations predict increased temperatures for the region combined with severe droughts towards the end of the century. These trends will have a substantial adverse impact on the region’s meagre water supplies and small agriculture sector: the region is already the largest food-importing region in the world, spending almost $100 billion a year on imported food.

As climate change begins to have significant negative effects on the world population’s wellbeing, the likelihood of an accelerated shift from fossil fuels to renewable energy and taxation of carbon will rise, leading to a substantial decline in the real price of oil over the next two decades. This would have devastating economic and financial impacts on the oil exporters in the region unless they succeed in diversifying their economies away from high dependence on the production and export of fossil fuels.

Despite its massive natural resource wealth and geostrategic location (connecting Asia, Africa and Europe), MENA has been unable to sustain adequate economic growth to absorb its rapidly growing labour force. The region’s unemployment rate is among the highest in the world, at 8.5-9% outside the GCC. (Within the GCC, unemployment is less than 0.5%.)

Particularly worrying is the high rate of youth unemployment in the region, which exceeded 20% in 2018 – more than four times the rate for adults. The unemployment rate among women (about 15%) is more than two and a half times that of men. Migrant workers account for a large share of the workforce (41% in the region’s Arab states), making MENA the region with the world’s largest share of migrant workers.

Unless countries in the region substantially accelerate economic growth, create massive numbers of jobs and invest heavily in human capital and the needed high-quality skills, the region’s social and political situation is likely to get worse, particularly in the non-GCC countries.

According to the latest population projections by the United Nations, the region’s population (including Iran but not central Asia) is estimated to increase from 583 million in 2019 to 683 million by 2030. About 60% of this increase – the fifth major shift confronting the region – will be in Algeria, Egypt, Iran, Iraq, Saudi Arabia, Turkey and Tunisia, where youth unemployment and underemployment are already very high.

The sixth shift confronting the region is changes in the global economy. Over the last few months, the International Monetary Fund, the OECD and the World Bank have all warned that trade and policy uncertainties could lead to lower growth in developing countries, as world economic growth slows.

Business and consumer confidence have faltered, with manufacturing production contracting. In response, financial conditions have eased, as central banks have moved towards more accommodative monetary stances and fiscal policy has provided stimulus in a handful of countries.

Increased economic uncertainty relates mostly to trade tensions, including tariff increases, between the United States and China. But trade-related uncertainty also hovers over relations between the United States and other key trading partners, including Canada, the European Union, Japan and Mexico.

Trade tensions are taking a toll, reducing global growth by an estimated 0.5-0.8 percentage points in 2019 alone. As a result, global growth is projected to slow to about 3% a year in 2019 and 2020, well below the average of nearly 4% a year over the last two decades. Policy mistakes or unforeseen adverse shocks could trigger a further slowdown.

The leaders of the G20 countries met in June in Osaka, Japan, to discuss global economic issues and attempt to resolve conflicts. The communiqué failed to address adequately the heightened business and consumer uncertainties in advanced economies and a number of middle-income countries, such as Argentina and Turkey, which have been affected by high debt levels combined with increased volatility in global markets.

The fact that voters in many democratic countries are rejecting parties that espouse traditional policies of open trade and economic integration may bode ill for the future of free trade.

As of early August 2019, the global economy remained dependent on persistent policy support. Ten years after the financial crisis, with inflation subdued, central bank balance sheets remain at unprecedented high levels, short- and long-term interest rates are historically low, and government and private sector debt levels are much higher than they were in 2007, just before the Great Recession.

Despite unprecedented policy support, the global economic recovery outside the United States has not been sufficiently vigorous or lasting to translate into higher wages and improved standards of living in most countries.

MENA countries need to accelerate sustainable and inclusive growth

Weak oil prices and exports have forced oil exporters to attempt to reduce the role of the state in the economy and their dependence on oil by diversifying their economies and exports. They have tried to reduce public investment and politically sensitive subsidies, and to encourage private financing, particularly for infrastructure projects.

Many governments in the region are under pressure to increase their savings and improve the quality of their investments while they manage their external debt and increase investments to make progress towards achieving the Sustainable Development Goals (SDGs).

But the weakening global economy over the next 18-24 months is likely to constrain the ability of governments to preserve their austerity drives. Fear of provoking social unrest is likely to temper efforts to contain spending and reduce subsidies.

World Bank economists project MENA growth of 1.5-3.5% a year over the next three years. This level of growth will be insufficient to make a dent in the region’s high unemployment rates. To accelerate the pace of growth, the World Bank advocates an all-out effort to create an advanced digital economy and to adopt other major structural reforms.

IMF economists also suggest structural reforms and expanding the use of technology to help to increase tax compliance and improve the effectiveness and governance of fiscal institutions. Maximising these benefits requires that countries increase their institutional capacity, facilitate access to digital services, and address privacy and cyber-security concerns.

The World Bank (and, more recently, a high-level panel of United Nations experts on digital cooperation) argue that the digital economy, combined with complementary structural reforms, can help developing countries to achieve these goals.

Key outcomes would include increasing the efficiency of government and the transparency of public services (e-governance); improving the business environment for small and medium-sized enterprises (including reducing corruption, which is endemic in the region, and enhancing financial inclusion); and opening up service sectors (such as accounting, banking, insurance, transport and health services), which have become the largest part of the economy in many emerging and developing economies.

MENA needs to launch an all-out effort to create a digital economy

An all-out effort to create an advanced digital economy requires fundamental reforms and massive investments to enhance digital connectivity and ensure the adequacy of supporting infrastructure, such as sustainable and affordable energy, and access to high-speed internet.

Despite decades of experience with information and communication technologies, many countries in the region have serious deficiencies in terms of infrastructure, access, usage and skills. As late as mid-2018, mobile broadband connections (3G and above) accounted for only about 65% of total connections in the region.

Competition policies should be revamped and kept strong to ensure that markets continue to provide a level playing field for firms, to facilitate entry by new firms, and to encourage innovation. The digital economy is raising new challenges that competition policies will need to address, including market concentration, as technology giants evolve into natural monopolies, reducing or eliminating competition in many countries.

With knowledge-related assets becoming an increasingly important driver of economic expansion, the innovation ecosystem should be improved to foster broader diffusion of advances in the knowledge and related algorithms embodied in new technologies. Patent regimes should be reformed to achieve a better balance between incumbent interests and the promotion of wider economic impacts.

Emerging economies and developing countries (as well as the high-income countries, including those in the MENA region) need to boost public investment in research and development (R&D), and make a priority of public-private investment ventures in infrastructure that support digitisation. They need to attract foreign direct investment as well as domestic private investment, including by the sovereign wealth funds of the GCC countries.

Most importantly, investment in skills must be substantially increased, with stronger programmes for worker ‘up-skilling’ and ‘re-skilling’ that respond to shifts in the demand for skills. These efforts will require innovations in the content, delivery and financing of the needed training and retraining, including new models of public-private partnerships.

Persistent inequalities in access to education and training opportunities must also be addressed. Labour market policies and social protection systems must be adapted to the realities of a changing world of work. These reforms must be reinforced by an overhaul of social contracts, which have fallen apart since the Arab Spring nearly a decade ago.

Achieving peace and efficient security could help to finance digitalisation and the SDGs

Over the last 60 years, the MENA region has been the epicentre of crises with global economic and financial repercussions. It has been chronically war-prone, the site of some of the world’s most protracted armed conflicts.

With less than 7% of the world’s population, the region’s arms imports over the last decade, which have more than doubled, accounted for about 34% of the world’s arms imports between 2008 and 2017. (Arms sales by the United States to the region accounted for 49% of its global sales over the same period.)

Before it is too late, the region must make an all-out effort to demilitarise, through diplomacy and regional security pacts for a common, efficient defence of the region against external aggregation, opening the way for meaningful regional economic cooperation.

Doing so would save the region billions of dollars a year, which could help to finance the needed investments, particularly in human capital and the digital economy, for accelerating economic growth, increasing non-fuel trade in goods and services within the region and globally, and making good progress towards achieving the SDGs across the region.

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