Economic Research Forum (ERF)

Domestic demand and competition: a new development paradigm for MENA

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A lack of competition in domestic and regional markets is holding back development in the Middle East and North Africa. This column argues that the region and the international community must ensure that barriers to market entry and exit are eliminated, and that independent regulatory bodies at the national and regional levels help to promote domestic demand as the main engine for sustainable and inclusive growth.

In a nutshell

For MENA countries, harnessing the power of their regional domestic demand is just what is needed to help them transform from administered to market-oriented economies.

The demographic bulge in both the Middle East and Africa is a source of pent-up demand that could help boost domestic production and trade integration within the continent, and revive regional integration among MENA countries.

To unlock domestic and regional integration, the wall of vested interests in MENA countries must be torn down – this could translate into creation of regulatory watchdogs to champion competition.

Economic development paradigms have shifted focus over past decades: from minimising imports to encouraging exports as the path to prosperity.

Individual countries in the Middle East and North Africa (MENA) region have had little success under either paradigm – the result being stagnant economies and high unemployment, especially among young people. Perhaps now is the time for MENA countries to follow a different path and focus on harnessing the power of their collective domestic demand to foster economic development.

The import-substitution strategy, which gained popularity in the middle of the last century, advocated replacing imports with domestic production to foster industrialisation. That strategy – which gave a central role to the state by emphasising state-owned enterprises, high tariffs and import licences – gradually fell out of favour during the debt crises near the end of the twentieth century.

Instead, the export-driven success of Asian economies like Korea made stimulating exports the centrepiece of development strategies. That shift was grounded in the belief that exposure to global competition and the transfer of technology from foreign direct investment would have a catalytic effect on domestic production. Export-oriented policies evolved from promoting trade in support of domestic industries to turning developing countries into platforms in the value chains of multinational corporations.

As they did nearly everywhere, import-substitution strategies came to nothing in MENA countries, although associated instruments of earlier import-substitution strategy – such as state-owned enterprises, high tariffs and subsidies – have survived. Countries in MENA have also had little success with export-led development strategies. Moreover, the viability of the exclusive export-oriented model is increasingly being questioned as global trade tensions, protectionism and the fear of a global recession intensify.

Regional domestic demand

For MENA countries, harnessing the power of their regional domestic demand is just what is needed to help them transform from administered to market-oriented economies. No doubt that will require a sea change for countries that have always preferred to ‘go it alone’ – the region is the least integrated in the world, despite the potential gains from removing barriers to the flow of goods and services within countries.

Most MENA countries are relatively small markets. But together the region has more than 400 million people, about twice as many as Western Europe. Moreover, while Europe’s population growth is virtually stagnant, the population in the MENA region is projected nearly to double by 2050.

The growing numbers of young people, who comprise the majority of the population, are shaking up the status quo as they seek political and economic change, and increased opportunities. Enthusiasm for digitalisation among both young people and leaders provides some glimmer of hope.

Quality services and improvement in the productivity of the informal sector could become a new engine for growth; and trade in services could be a regional driver of prosperity – provided that MENA countries do more in a regionally integrated manner to build the foundations for the internet and for digital payments systems.

There is also hope that countries such as Algeria, Egypt and Morocco could integrate more closely with their neighbours in sub-Saharan Africa in such sectors as banking, energy, agribusiness and telecommunications. The demographic bulge in both the Middle East and Africa is a source of pent-up demand, especially for agribusiness and other goods and services that could help boost domestic production and trade integration within the continent – including the rest of Arabia – and revive regional integration among countries in MENA.

This closer integration within MENA will complement the many initiatives in the African continent including the latest one to date – the African Continental Free Trade Area.

Boosting market contestability

Reducing tariffs, solving poor logistics and creating cross-border payment systems will undoubtedly help with regional integration. But the heart of the inability of MENA countries to integrate domestically and regionally lies in the almost impenetrable barriers to firms entering or leaving crucial markets – or, as economists put it, the lack of contestability.

The MENA economies have favoured incumbent firms – whether private sector or state-owned. The lack of contestability leads to cronyism and what amounts to rent-seeking activity – including, but hardly limited to, exclusive import licences, which reward the holders and discourage both domestic and foreign competition.

The lack of domestic market contestability reverberates at the regional level. Incumbent firms typically erect barriers to entry and exit, and lacking domestic competition, they have difficulty projecting regionally, let alone internationally.

To unlock domestic and regional integration, the wall of vested interests in MENA countries must be torn down. In practice, the teardown could translate into creation of regulatory watchdogs to champion competition.

Unleashing regional demand accompanied by arm’s length regulation that fosters competition and fights anti-competitive practices could prevent the perpetuation of oligarchies – the powerful few who often seize control of liberalisation attempts, with the unfortunate result that the idea of reform is sullied among the citizens.

The key role of transparency and data

An integral part of the contestability agenda is transparency and data availability. MENA countries trail other similar middle-income countries on government transparency and disclosure of data in critical areas that measure the evolution of poverty, the degree of competition in sectors, and assessment of domestic debt levels and contingent liabilities associated with government guarantees.

The flow of funds between public banks and other state-owned enterprises is opaque and leads to cronyism and corruption. Transparent public procurement can help to eradicate that scourge.

More generally, state-owned enterprises are not neutral players in their markets. They tend to crowd out other firms, especially medium-sized enterprises, by limiting their access to credit. This leads to a ‘missing middle’ with no viable firms operating between small informal firms and big state-owned enterprises. That carries social costs because medium-sized firms typically create more jobs than their smaller and larger counterparts.

Access to data will allow a better evaluation of policies and their continuous improvement, and, more importantly, allow a direction change in policies that can avert big mistakes with high costs, such as those that led to the debt crisis.

In addition to access to data, freedom of investigation, especially for thinktanks, is central to instilling a much-needed domestic debate on economic and social policies, which in turn would foster ownership of reforms and social cohesiveness.

Support from development partners

Development partners can help MENA countries. In a coordinated fashion they should raise the issues of contestability and of associated credible and independent local bodies to promote competition as a necessary step toward building more inclusive societies.

To ensure progress, the partners could condition assistance on pro-competitive steps and provide technical expertise in the institutional design of competent and independent national and regional regulatory bodies.

The rules of the World Trade Organization and European standards on exports have had limited impact on the structure of MENA economies because of their limited scope. The strong conditions imposed by the European Union (EU) on accession countries in Eastern Europe and Turkey prompted authorities in those nations to build a robust competition culture and attract foreign direct investment.

Europe, once the theatre of interminable wars, is now the largest integrated market in the world. The EU could serve as a source of inspiration for MENA countries. A joint call for action by MENA leaders with the support of the development community could go a long way toward creating intra-regional trade, and attracting the foreign direct investment required to create the millions of jobs and the peace and stability that the MENA region needs.

The persistence of incumbent players and the rent-seeking behaviour encouraged by the absence of contestable markets will forever deter integration. The region and the international community must ensure that barriers to market entry and exit are eliminated, and that independent regulatory bodies at the national and regional levels help to promote domestic demand as the main engine for sustainable and inclusive growth.

 

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