Economic Research Forum (ERF)

Rethinking the role of the state in the Middle East and North Africa

What should be the role of the state in MENA economies? This column argues that countries in the region should try to increase their level of accountability towards their citizenry by inculcating a culture of ‘value for money’, promoting the emergence of independent, yet accountable, regulators and relying less on the state to rejuvenate their economies.

In a nutshell

While maintaining the safety and stability of the market is a priority, governments in MENA countries also need to focus on enhancing service quality, innovation and competition.

This conception of the role of the state in MENA will help governments to be more accountable towards their citizenry and become more effective – which will in turn lead to a virtuous cycle of trust building, reform and growth.

This approach will also allow countries to mobilise more resources towards achieving the Sustainable Development Goals, which require a significant shift in how countries finance their development plans.

Economists generally agree on broad principles of how and when the state should play a role in the economy. In theory, governments should intervene when the marketplace does not produce outcomes that are socially optimal or when there are natural monopolies. This is the main rationale for public sponsorship of basic research and development (private firms cannot fully recover the costs) and for regulation and monitoring of pollution (since the costs of pollution are not borne by the producer).

While generally economists agree in principle on when public intervention is warranted, they often do not agree on the specifics – including on the choice of instruments with which to intervene and the sectors that should be subject to public intervention. For example, the debate among economists over rising inequality and the need for redistribution to ensure social cohesion has proven contentious.

Individuals in various countries have different beliefs and expectations about what the role of the state should and shouldn’t be. These beliefs often depend on which economic model their country has historically adopted and where individuals stand in the income distribution.

We argue that countries in the Middle East and North Africa (MENA) should try to increase their level of accountability towards their citizenry by inculcating a culture of ‘value for money’, promoting the emergence of independent, yet accountable, regulators and relying less on the state to rejuvenate their economies.

State of play

Although most of the region’s ancestral tradition is rooted in commerce, since their independence, countries in MENA have adopted state-led development models that have resulted in economies overly reliant on the state.

As Nazih Ayubi argued in his 1995 book Overstating the Arab States, these countries have done poorly in pursuing social goals, with a notable inability to collect taxes and deliver quality services. Markets in MENA economies are plagued with entrenched incumbents, permitting few new entrants and an extensive web of state-owned enterprises – including in the extractive sector, utilities, manufacturing and telecoms.

This economic model has endured despite dramatic setbacks in the 1990s, followed by various attempts at structural reforms. The endurance is rooted in a nexus of arrangements in which the state provides public sector jobs and universal subsidies –funded by revenues from oil sector rents and public borrowing.

By sparing citizens from most economic risk, these arrangements stifle entrepreneurship and innovation. They have also undermined the delivery of public services, while stoking mistrust of government.

The persistent waves of protests rattling MENA countries signal the determination of the citizenry, especially the younger generations, to set new standards of accountability for governments in the region. Rethinking the role of the state is the order of the day.

Harnessing the private sector and technology

Countries in MENA need a new approach, one that could, for example, focus on the use of technology to provide their young people with greater economic empowerment. Indeed, the public sector has so far failed to absorb (and appears unlikely to do so in the future) the hundreds of millions of young people entering labour markets in MENA over the coming decades.

Creating a vibrant private sector that produces technological innovations is one promising way for MENA economies to achieve durable and inclusive growth. To get there, governments need to move from being ‘doers’ to becoming ‘enablers’ – paving the way for a vibrant private sector with minimal barriers to exit and entry. This will require not just the provision of public goods, including digital ones, but also an overhaul of the regulatory system to ease market entry for new businesses.

This approach is in line with what it takes to achieve the Sustainable Development Goals (SDGs), which were endorsed by all MENA countries, along with the other members of the United Nations, and which are fully aligned with the emphasis on the role of the private sector, science, technology and innovation as part of the means of achieving the SDGs.

The World Bank Group can be of help through its new programme of Maximizing Finance for Development (MFD). This innovative approach, initially focused on infrastructure finance, will, wherever possible, promote the use of private finance to support the SDGs.

Specifically, MFD promotes upstream reforms to unleash commercial financing by addressing market failures and removing other constraints. Where risks remain high, the approach calls for the use of government guarantees and other risk-sharing instruments. It is only when reforms and risk mitigation cannot foster market solutions that official development assistance, including concessional loans, should be used.

Similarly, because of mounting levels of public debt, government financing of infrastructure and other projects in developing countries, especially in MENA, should be used only as a last resort.

Fostering a culture of ‘value for money’ and taxation

Accountability is key to a well-functioning state. Developing a culture of ‘value for money’ in public administration helps to build trust with citizens. It starts with data, measurement and disclosure to build robust and transparent diagnostics. Once authorities make an informed commitment, mechanisms such as information feedback loops can allow public administrations quickly to identify quality issues and sustain improvements.

One plausible way to achieve this is to emphasise action at the local level – or localisation of development – an approach traditionally ignored in many MENA countries when they consider budget design, domestic resource mobilisation and effective targeted spending. In countries like Colombia, Indonesia and Kenya — all rapidly urbanising countries – there is strong commitment from national governments towards localising the implementation of their development plans, with the SDGs as key indicators of success.

If MENA countries can improve the capacity of their local governments to plan, finance and deliver key services, they could make great strides towards building confidence among their citizens and achieving the ambitious SDGs.

While most MENA countries spend a fair amount of resources relative to their income levels, they achieve relatively poor outcomes, especially in health and education. Because investing in human capital is the most important long-term action that a government can take, the World Bank Group’s initiative called the Human Capital Project is geared towards documenting the reasons why human capital investments often lack efficiency (certainly in MENA countries) and towards helping countries get the maximum ‘bang for the buck’.

More generally, MENA countries should consider rethinking social protection by moving away from the Bismarckian model – organised around formal occupations – towards integrating all individuals independently of whether they are in the formal sector or the large informal sector. This would allow them to achieve social goals, avoid polarisation and encourage risk-taking and initiative.

MENA countries are among the least efficient tax collectors in the world. That has been due, in large part, to the availability of abundant revenues from the energy sector as well as rentier sources, which reduce the incentive to mobilise tax revenues. But rising debt levels, persistently volatile and less dependable low oil prices, reduced tourism and reduced foreign direct investment now necessitate meaningful tax reform.

A renewed commitment to delivering quality services – that is, value for money – would increase trust between citizens and the state and could facilitate better tax revenue mobilisation. To do so, governments should focus on broadening their tax base rather than increasing tax rates. Implementing efficient tax systems with lower transaction costs can effectively improve efficiency in public spending and encourage greater voluntary compliance.

In turn, as citizens pay more taxes, they will demand better quality services. Indeed, rather than the historical case – in which revenues derived from energy sector profits went directly to government coffers without any public input – having to pay taxes should make the citizens more attentive to state performance. That is, taxpayers become the principal and the state becomes the agent. A commitment of MENA governments to increase accountability — including at the local level — will not only bridge the gap with the citizenry but also help to restore public finances.

The essential rise of the regulatory state

Protection of public and private incumbent firms – especially in critical sectors such as financial services, telecoms, water, waste management and energy – is common in MENA countries. It imposes excessive and outdated regulations that deter new businesses from entering the market or poorly regulates natural monopolies. This short-circuits competition and contestability, undermines the diffusion of ‘general-purpose technologies’ and blocks the type of adaptation and evolution that underpin a vibrant private sector. The regulatory status quo will condemn the young people in MENA countries to unemployment and disenfranchisement.

Admittedly, the effective application of competition policy takes time and requires efficient implementation of its measures. Historically, the evolving role of the state towards a regulatory role has not been easy – plagued with as many setbacks as victories – but important lessons can be drawn from this trajectory.

In the United States in the late nineteenth century, rising inequality, social tensions and oligarchy led the federal government to rise above the fray and reinvent itself as a regulator. The Sherman Antitrust Act is the foundational federal statute in the development of competition law, which was passed by Congress in 1890 and which later gave way to the Clayton Antitrust Act of 1914.

Fast-forward to today and in advanced and developing economies alike, states are faced with the rise of technology giants, such as Facebook, Amazon, Tencent or Alibaba, with business models based on matchmaking ‘turbo boosted’ by digital technology. That business model naturally lends itself to ‘ultra-concentration’.

That is not to say that it necessarily involves infringement of free entry, but it does require vigilance on the part of regulators to ensure otherwise. In fact, the old way of regulating through a compartmentalised approach, based on specific sectors, is no longer appropriate as these technology giants are becoming conglomerates that encompass ‘fintech’ (financial technology), health and other sectors.

Such ‘decompartmentalisation’ is good news because it stimulates competition and should reduce prices and increase the quality of services. Besides the challenge of economic concentration, digitalisation also creates important challenges around ‘personalised pricing’ – charging consumers a price that is a function of their willingness to pay – which can lead to abuses such as misleading consumers and even racial and gender discrimination.

Smart regulations designed around the protection, the access to and use of personal data will be of paramount importance in the digital technology era. In the developing world, leapfrogging should not just be a private sector endeavour but also a top priority for the public sector to build appropriate regulatory capacity to support sustainable development.

With these new opportunities and challenges in mind, the states in MENA should take adequate steps to tackle the age-old issue of fostering a more vibrant and barrier-free private sector. Specifically, they should move away from regulation that has a solely prudential focus to one with a dual focus that balances prudential behaviour with enhancing service quality and competition.

To do so, states in MENA should reinforce the independence of their regulatory bodies but yet ensure that these agencies are accountable. MENA countries should move away from protecting national champions and other incumbents and further put consumer welfare at the centre. The regulatory bodies should be accountable to both parliaments and consumer groups.

Rule of law and the independence of the judiciary

In rethinking the role of the state, one must not lose sight of the importance of the balance of power between the different branches of government – namely the executive, legislative and judicial branches. That balance of power favours the rule of law – that is, the restriction of arbitrary individual and institutional behaviour by subordinating it to well-defined and established laws.

More specifically, if regulation and taxation are to be efficient tools of a new state role in MENA economies, then an independent and impartial judiciary is needed to give them credibility and efficacy. That judicial system must be the ultimate equaliser – socially and economically. To achieve the fair and progressive taxation that is a crucially important element of social solidarity and fairness, there must be means of redress when there is fraud or corruption – a role that must be assumed by the judiciary.

Regulatory authorities or agencies that aim to ensure fair competition and prevent abuse of dominant position to facilitate investment and innovation, will need independent adjudicatory powers. These include the capacity for self-referral and the ability both to sanction fraudulent or illegal behaviour and to offer redress to aggrieved parties. To play their regulatory roles effectively – and to be seen as fair – such agencies must be fully independent of the executive branch.

The bottom line

While maintaining the safety and stability of the market is a priority, governments in MENA also need to focus on enhancing service quality, innovation and competition. This conception of the role of the state in MENA will help governments to be more accountable towards their citizenry and become more effective. That in turn will lead to a virtuous cycle of trust building, reform and growth.

This approach will also allow countries to mobilise more resources towards achieving the SDGs, which require a significant shift in how countries finance their development plans. In fact, the SDGs specifically include target 17.1 to ‘Strengthen domestic resource mobilization, including through international support to developing countries, to improve domestic capacity for tax and other revenue collection’.

In this rapidly evolving political, economic and technological landscape, governments in MENA must adapt to promote stability and to improve the lives of their people. The SDGs provide a universal benchmark for reaching these aspirations, while the means of implementation are fully within their financial and administrative capacity.

These reforms will certainly not be easy, but the experience of countries in other regions shows that this new approach is not only achievable, but can pay abundant dividends for this generation and many more to follow.

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