15 0 4: - Oc;t. 19qs FD Lri~r~ V - - r - r E , > , _ _1 _ -~r F lr Choosing Prosperity in the Middle East and North Africa (IA~~~~~~~~~~~~~~~~~~~ }< = < - . .... - l~, ,,, > __ ,>,I f' 1S^X;...E. . ~~~( F11 7@ t i ) s *~ I Claiming the Future Choosing Prosperity in the Middle East and North Africa The World Bank Washington, D.C. © 1995 The International Bank for Reconstruction and Development / THE WORLD BANK All rights reserved Manufactured in the United States of America First printing October 1995 This report is a study by the World Bank's staff, and the judgments made herein do not necessarily reflect the views of the Board of Executive Directors or of the governments they represent. Contents Foreword Preface Executive Summary 1 CHAPTER 1 Disengagement from the Changing Global Economy 15 Missing out on globalization 16 Domestic policies are ill-suited to new global realities 19 CHAPTER 2 Yesterday's Achievements, Today's Predicament 33 Achievements of the statist era were considerable 33 Past successes were the outcome of easier times, not statist policies 34 Why change has been slow 42 CHAPMER 3 The Promise of Prosperity 45 Some aspects of the international environment are favorable 45 Many of the conditions in MENA are favorable 50 Jordan, Morocco, and Tunisia are beginning to reap the rewvards of reform 54 CHAPTER 4 From Politics to Economics 61 Now is the time for action 61 Choosing to be prosperous 63 Politics in the service of economics 77 Bibliography 83 Statistical Appendix 89 Illl This report was prepared by a team led by Nemat Shafik and is based on background papers prepared by Bob Anderson, Jon Avins, Sue Berryman, Milan Brahmbhatt, Uri Dadush, Fred Golladay, Bernard Hoekman, Jalal Jalali, Bjorn Larsen, Albert Martinez, John Page, E. Mick Riordan, Shane Streifel, Kazue Takagaki, Willem van Eeghen, John Waterbury, and Lawvrence Wolff. The team was assisted by Jesmin Rahman and Soumaya Tohamy. Many others in and outside the Bank, especially in the Middle East and North Africa region, provided valuable contributions and comments (see the preface and bibliography). Bruce Ross-Larson served as the principal editor, working with Kim Bieler, Mark Bock, and Paul Holtz from American Writing Corporation. Jan- Marie Hopkins and Azeb Yideru provided administrative and production support. The report was initiated by Caio Koch-Weser and was carried out under the general direction of John Page. iv Foreword The countries of the Middle East and North Africa (MENA) region face unprecedented challenges. The pace of change in the global economy has never been faster, prompting the need for new economic strategies to participate successfully in it. Meanwhile, the end of the cold war, the aftermath of the Gulf conflict, the evolving Middle East peace process, and the rise of fundamentalism call into question traditional political assumptions and structures. Navigating these turbulent waters requires a coherent and purposeful vision of the wvay ahead among the region s leaders, business people, and citizens. This study is intended to contribute to such a vision. It is the prod- uct of considerable work at the World Bank on long-term issues in the Middle East and North Africa. Its findings-sometimes troubling, often surprising-are ultimatelv hopeful. The troubling and surprising aspects lie in the region's poor economic performance during the past decade, despite its former favorable record and considerable underlying eco- nomic advantages. The explanation lies in the region's policies and in the dramatic recent changes in the international economic environment, including lower oil prices, greater competition, and increasingly mobile capital. But the study also offers cause for hope. Many MENA countries have clearly demonstrated that they can dramatically reduce poverty, educate unlprecedentedly large numbers of their citizens, and accumulate substantial capital assets. The region's economic future lies in making productive use of these resources-human, financial, and physical-to take advantage of the opportunities that globalization brings. Ultimately, the well-being of all MENA's people will depend on real- izing a development paradigm of growth that is rapid, wvidely shared throughout societies, and environmentally sustainable. This study focus- es on the "rapid" and "shared" components of the paradigm. Issues of environmental sustainability are addressed in other Bank studies- Miftddle East and North Africa Envtironmetlal Strategy: Towvard Sustai'nable Development and A Strategy for Maniaging WVater in the Middle East and North Afi/Ya-which complement this one. While the decisions that will shape the future of the region lie in the hands of MENA governments and peoples, we hope that this work wvill contribute to the formulation of economic policy in the region. And we at the World Bank stand ready to work \vith our partners in the region in facing the challenges ahead and realizing the vision of a more prosperous future. Caio Koch-WX'eser Vice President Middle East and North Africa Region U tCLAIMIN(G THE FUTURE Preface This report is the product of a collaborative effort both in the WoX7rld Bank and with scholars and policymakers from the Middle East and North Africa region. Throughout the process we have consulted a wide variety of individuals knowledgeable about the region. None of our col- laborators, however, is responsible for the findings of this report, which are the views of World Bank staff. To get feedback on the report's emerging messages, the Bank cosponsored a workshop with the Economic Research Forum for the Arab Countries, Iran, and Turkey in Tunis in June 1995. Papers were also commissioned from scholars in the region about local perspectives on long-term strategic issues and presented at the Tunis workshop. A group of distinguished thinkers in the region participated in reviewing the final draft report and served as advisers before publication. Valuable contri- butions were made by these regional "friends" (Dr. jassim Al-Mannai, Director General and Chairman of the Board of the Arab Monetary Fund; Dr. Abdullah El-Kuwaiz, Associate Secretary General for Economic Affairs of the Gulf Cooperation Council; Professor Said El- Naggar, Cairo University; Dr. Ziad Fariz, Chairman of the Jordan Trade Association; Dr. Attila Karaosmanoglu, former Deputy Prime Minister of Turkey and World Bank Managing Director; Mr. Ismail Khelil, former Minister and Ambassador for Tunisia; Dr. Ghassan Salame, Professor at the Institute of Political Studies in Paris; and Dr. Yusif Savigh. Economic Consultant). The report draws on much of the ongoing economic and sectoral work prepared on the MENA region by Bank staff. Further details and supporting analysis for the results in this report can be found in the back- ground papers prepared for this study. In addition, a series of seminars based on the background papers were held in the Bank, and comments from participants were very helpful in shaping the messages in the report. In particular, valuable contributions were made by the seminar discus- sants: Ishac Diwan, William Easterly, Mohamed El-Erian, Ahmed Galal, \ii Elizabeth King, Barbara Nunberg, Lant Pritchett, Julian Schweitzer, David Tarr, Dominique van der Walle, and Michael Walton. In addition to the MENA regional staff, a group of senior "friends" throughout the World Bank advised on the content of the report at the final stages: Masood Ahmed, Abdallah Bouhabib, Magdi Iskander, Emmanuel Jimenez, Jagannathan Murli, Daniel Ritchie, Joanne Salop, Anil Sood, Lyn Squire, Inder Sud, William Tyler, and John Underwood. v iii (-CLAIMING THIE FUTURE Executive Summary A vision for a prosperous Middle East FIGURE I and North Africa Major economic and social improvements are possible Mashreq Life e-pectLny -ear s By 2010 the countries of the Middle East and North Africa have EQ the potential to double incomes, increase life expectancv by close on to ten years, and cut illiteracy and infant mortality by almost half GDP pe, 7/ Goros (figure 1). They could also become full partners in the global c4 5 t n - mero t do 1,,s~ ~ ~ 4 00 'O's0 ~~~percenty economvy usin-g integration with Europe and within the region as ! - a stepping stone to intemational competitiveness. Peace, macro- t economic stability, and an attractive investment environment 80 could attract billions of dollars of capital from nationals and for- L teesci fpercent) eign investors. The faster economic growth would reduce pover- Maghreb Life experL 'eaels. ty and bling dowmn unemployment, restoring hope to millions. 80 From vision to reality GED,P pe, ros dclaer s lOO *rQ 11 / 8Q percent) Making this vision a reality is within the grasp of today's poli- *4 cyrnakers. Perhaps the greatest feature of today's global econ- / omv is that no country is destined to be poor because of a bad au L ten cr, ipe cert. endowment of natural resources, an isolated location, or a con- > ~~~~ ~ ~~~~Gull Lfe e,pectan, reyean,> centration on certami products. Production, finance, and trade Cooperation - Council have changed to make human talent more important than nat- *4 ural endowment, agility more crucial than location, and quali- *fDP pe, 1/-10s tv and innovation more important than mass production. The ''Up / eel a mneent - drI ar Sr r C E perrent implication is that countries can choose, through their policies, - to be rich-or to be poor. 4 For too long, countries in the Middle East and North , , Africa (MENA) region have squandered their potential. The Lrterc/ (percent) MENA region is vast-spanning from Morocco in the west to - qC -'Q1- 0 Iran in the north and east and as far south as Yemen. And Ncite GfDe -pita fo 20 0I- been prietedeesicthe 2. 3-00 D omth rate frc r, the D.se ..3e sceensrici while the region is very heterogeneous, some common themes 'eoc,re Drwrn and Scuare 992: Ward Beae -staff t mnates characterize many countries' development experience. Political energ,y has sometimes focused on regional conflicts and rivalries rather than on economic development. Oil wealth often went for activities with low social returns. Major investments in education and health often helped the privileged rather than the disadvantaged. And natural resources were mined to fuel this process. That era is waning. Peace, with all its vicissitudes, is bound to reduce the political risks in the region and make space for more determined efforts at economic reform over the long run. The domestic voices for Realizing the vision change are growing more numerous. The region's governments are under will mean that greater pressure to be accountable to their citizens and transparent in their actions. To attract private investment, all countries wvill have strong incen- recionomies lofo tives to offer access through association agreements to the vast European region will look market as well as to the numerous regional markets. But realizing the quite different vision wvil mean that the economies of the region will have to look quite from today different from the wav they do todav. Yesterday's achievements, today's predicament MENA countries were "high performers" During 1960-85 the MENA region outperformed all other regions except East Asia in income growth and the equality of income distribution (figure 2). FIGUR' 2 Past growth was rapid ... but not sustained Growth of GDP per capita (percent) * 1960-85 U 1986-94 . East Ass Eg.:r t Tireis- S 3r 1 a DC Ms srrsrseal E rir- | UrrEa. t Asa ndLdes Cl-h a, Hong Krn rdunresa. RepLi rof Korea, Malayse , the Ph I ppi^e. ngB-pore ind Thairnd. Lat r, Amerie irs: udes Aree t ra Po 3, IBBr,lr Chi e CO -sbia, EcCIador ParagLla;,Pelr Uerriey arad versezere. GDP orrroth rates are crlrlated &as S3assce 's.ssl-ld Ban4k cata. 2 CLUJMJNG THE FUTURE The social payoffs have been enormous. Infant mortality more than halved, and life expectancy rose by more than ten years. Primary school enrollment shot up from 61% in 1965 to 98% in 1991. And adult litera- cy inmproved from 34% in 1970 to 53% in 1990, with particular progress made in the oil-exporting countries. The region's governments were also effective at reducing poverty (fig- ures 3 and 4). By 1990 only 5.6% of the population in MENA lived on3 less than $1 a day-the global benchmark for absolute poverty-compared withl 14.7% in East Asia and 28.8% in Latin America. And whatever the wealth. poverty was lower in MENA countries than elsewhere. 'Tlhese achievements were the result of rapid growth in the 1970s and early 1980s and generous transfers to large parts of the population. c GPRE 3 Poverty in MENA has been low ... Past achievements were the outcome of easier circumstances Poor (percentage of total population) I i The era of statism coincided xvith a far more accommodating 2 international context for MENA countries. Oil prices were CC high. The world economy was buoyant. Industrialization was still in the easy stages. And the world was a less competitive place. Times have since changed, and many of the policies 4 and institutions that seemed to serve MENA countries well 2 have become the stumbling blocks to the future. A gena ,pt liap a Fursa The economic crisis of the past ten years is the product * U of tw,o fundamental factors-collapsing oil prices and deteri- Q8sF Pun a,nh'bias ape - rpi orating productivitv. Since 1986 real per capita incomes have :Or& Ce vrn Este? fallen bv 2% a vear-the largest decline in anv developing WJEJ - , ^ . O , ., r omp~~~~~~~ared with the rest of the world region. For oil exporters, the fall in output per capita of 4TX, a c p year between 1980 and 1991 closely paralleled oil prices. Poor(percentageoftotal population, Even the non-oil exporters in the region (such as Jordan, 3 Morocco, and Tunisia) grew by less than 1% because oil rev- enues had strong "ripple effects" through regional labor and _ capital markets. Investment in MENA countries also c _m i declined in the 1980s, but output declined eveni more, implv- ing that productivity was falling, too (figure 5). ' 1tlE7 .A E.-st Aa Lat.'' Sub .A,rrer Ca . l aha i.ld-n Past investments are the nub of today 's reform predicament * I Ni.l' Po-,, Adie3 &etependlfc S- ,t T.1-, adi,2' it The huge investments in state-oxw-ed en terpises and human I, a r po.er a iv N ici .d nr-v skills unsuited to today's marketplace are the nub of thie r',,r Ceir,tt DiandRc,P~i ile : rQ,,i FE-'&ua- EXEUCUtITE SUMMARY adjustment problem facing most MENA economies. Overall productivity, though accelerating rapidly in other parts of the world, has been declining steadily by about 0.2% a year (figure 6). High investment rates yielded lower than expected returns under policies that thwarted competition. Competitive pressures from the world economy-along with domes- tic pressures for new and better job opportunities-are the most likely forces to trigger change. Until recently, oil and other revenues (such as aid and remittances) enabled many countries to postpone reforms. It is no accident that the countries most integrated with the world economy- Jordan, Morocco, and Tunisia-lacked substantial natural resources on which to rely. The postponement of reform has meant that interest groups profit- ing from the old regime are deeply entrenched. Firms that have bene- fited from protection and cheap credit and a middle class accustomed to subsidized commodities and services are reluctant to see their privi- leges eroded. And governments often have been slow to respond with FIGURE5 better policies, effective services, and more transparent Output fell more than investment- procedures. so productivity fell Investment (percentage of GDP) GDP growth (percent) Choosing to prosper :42 Investment 283 6 How can governments overcome the troublesome nexus of 20 4 state-owned enterprises, resistance to trade liberalization I 0GDPgroMS and privatization, and the labor elite in the public sector? 8) 2 What direction should reforms take to ensure a prosperous 4 > future for the region? In addition to maintaining macroeco- C1 0 970-74 975-79 98Q-84 985-.9 nomic stability, four measures are essential: promoting non- Sou-ce. Page 1995. oil exports, making the private sector more efficient, pro- FIGURE ducing more skilled and flexible workers, and reducing MENA is losing competitiveness poverty through faster growth (box 1). Average change in total factor productivity (percent), 1960-90 2.0 Promoting non-oil exports .5 .0 MENAs non-oil exports (with 260 million people) are less than Finland's (with 5 million people). Meeting future 05 s - - _import requirements (such as food) means that exports will 0 have to grow, and non-oil merchandise exports offer the Easr Asia OECD Latin America MENA -0 5s biggest opportunity for the future if there is progress in So;,, -. WorId Bank 1993 trade liberalization and competition policies. Manufacturing 4 (LUIMING TIHE FUTURE BOX Getting from here to there: A reformer's checklist For now ... ... and tomorrow Credible and consistent trade liberalization mtust leadi the cway * Use international signaling mechanisms, such as the * Move toward free trade or u_Liform tariffs not in excess of World Trade Organization and the association agreements 5"O bv 2010. with the E U, to lock in reforms and gain credibility * Support non-oil exports through assistance in financing and market penetration. Create a high return, nimble znvestment environment * Abolish burdensome licensing requirements, excessive * Reduce the costs of doing business by upgrading infra- customs fees, and protracted conflict resolution. structure services with private sector financing. * Encourage competition in the financial sector to reduce financing costs for producers and develop securities markets, payment and trading systems, and regulatory capacity. AMake privatization a priority * Centralize the management of the program under a high- * Use simple, transparent rules for enterprise sales and for level privatization "champion." regulating private investment in infrastructure. * Decentralize the implementation of privatization transac- * Rexvard managers for successfully implementing privati- tions by using consultants and managers who are paid fees zation. based on the price at w4hich they sell the firm. * Sell privatization to the public through information campaigns. Get on the international financial mnap * Provide clear, simple, and credible rules for foreign * Put information in the international arena by publishing investors. economic data, issuing international paper, and obtaining internationallv recognized credit ratings. Integrate eduication anaI tke economy * Increase student flexibilitv by focusing on basic skills and * Raise access targets bv level and increase quality through reducing early specialization. various feedback mechanisms to test the educational system's * Make vocational training demand-driven through joint performance witlh national and international standards. public-private management, governance, and financing. * Liberalize labor markets to increase the productivity of educational investments. Use natural resources sustainablv * Eliminate remaining subsidies to natural resources Impose environmental taxes to ensure that polluters pay (energy and water) and environmental services (municipal water and sanitation). Relv on grout!h and targeted inter;lentionsr to reduce pov ertY * Aim for rapid grow th and keep real wages in check. * Rely on self-targeted interventions where possible, such as * Reassess regulations that discourage job creation for the differeintial qualities of goods or public works programs. poor (such as minimum wages and restrictions on firing and . Provide cash transfers for the chronic poor, but monitor temporary contracts). closely to ensure maximum benefits to the truly needy. EXECUTIVE SUMMARIY F GURE7 exports, usually a major source of productivity gains, have Manufacturing exports are not growing grown slowly (figure 7). And the openness of MENA Manufacturing exports per capita (U.S dollars) economies lags behind their competitors (figure 8). For 3500" E3. A,i., some countries in the region-such as Jordan, Morocco, and Tunisia-the required growth in exports is attainable 2 OD0 / given their recent performance. But for many oil-dependent 1.500 J - ENA economies, the improvement in non-oil exports needed to 1,000 - - maintain living standards is massive-and difficult without 500M-D __ fundamental changes in policy. 0 What should governments do to promote non-oil exports? Successful exporters in East Asia used four key A, C Bank dat i. elements-access for exporters to imports at world prices, export financing, assistance in market penetration, and pol- FIGURE 8 icV flexibilitv in response to changing circumstances (World The average tariff burden on trade is high Bank 1993). What sectors are likely to fuel the growth in Collected tax/value of imports, 1993 exports? The main export growth so far has been in chemi- 20I cals, clothing, machinery, textiles, and other manufactures, 16 such as carpets, gold, silver, and jewelry (figure 9). Building I* competitive advantage on this existing export capacity is the most promising approach in the immediate future. O | Making the private sector more efficient -$ )'_A-f-''c 'All countries compete for the attention of the private capi- S I- IMNF QQ4b and n94c. tal so critical for growth. But with its increased mobility, pri- vate capital has become fickle. It follows high rates of return FIGURE and leaves when the environment sours. MENA countries have been Clothing and chemicals unable to keep national capital home (capital from the region held have been MENA's largest exports, 1992-93 abroad is about $350 billion), and thev generally have been unsuccessful at attracting foreign investors (figure 10). About half the capital held Cd- Oth r 2 2 abroad is from the GCC, for whom investing abroad is economically Tedt e. 8'-.'3 _ optimal given their need to diversify. Why has investment lagged? The business environment is plagued by burdensome regulations. Privatization has been slov. Infrastructure qual- ;-tl,e29 lcm,c,s ~ ity is inadequate and financial markets remain underdeveloped. For example, Egyptian entrepreneurs spend about 30% of their time resolv- N_te Exc udes *sr-. ing problems with regulatory compliance. Even in Morocco, where the aocrcc Piod ahn aln r "tV-ls o595. investment regime has been substantially liberalized, as many as 20 doc- uments and six months are needed to register a business. The percentage 6 (LAIMING THE FUTURE of unsuccessful telephone calls is 34% in Tunisia, 46% in Yemen, 50% in FIGURE I0 Lebanon, 57% in Morocco, and 60% in Jordan. Intermediation mar- Foreign investment is low, 1993 gins-the difference between banks' lending and deposit rates-aver- ddl riE,a1 aged about 9% for non-Gulf Cooperation Council (GCC) MENA coun- E.si - rLt tries in 1991-93, compared with about 3-4% in Asia and the OECD. 'z8jt"Ia therjue,r Profitable for banks-unappealing for businesses. a Dismantling burdensome regulations while simultaneously building a WSWAW- system that addresses the needs of a more global economy is essential in -F most MENA countries. First, privatization needs to be a priority. Countries with large and inefficient public sectors (such as Algeria and SoLJC& Siba 995 Egypt) will have to focus simultaneouslv on selling off state-owned enter- prises and trying to attract private investment in infrastructure. Countries with less burdensome public enterprise sectors (such as Jordan, Lebanon, Morocco, Tunisia, and many Gulf countries) will be able to focus on attracting investment in infrastructure and other services that are crucial to long-term competitiveness. Second, the MENA region needs to get on the international financial map by clarifying regulations and putting information into the international arena to attract investors. Given the investment requirements into the next century, governments will need to bring in the private sector as serious partners. Producing more skilled and flexible workers To create the human capital for international competition, labor markets will have to be liberalized (to ensure investments in human capital have high payoffs) and access to education will have to increase. MENA coun- tries have to set a goal of nine years of basic education for all children. By 2010 minimum enrollment rates should be 100% for primary school in all countries, 70% for secondary school, and 25% for higher education. Increasing enrollments, demographic pressures, and the need to improve quality wi\l put severe financing pressure on the education sector. The annual cost of achieving this expansion (adjusted for population growth, higher teacher salaries, and modest quality improvements) would be about $17.5 billion in Egypt, Iran, Jordan, Morocco, and Tunisia in 2010, three times their spending in 1990. Such an increase in spending can only be achieved if the region's economies are growing rapidly. Vocational training programs, now often "warehouses" for unem- ployed youth, xvif have to become flexible systems that respond to the changing skill requirements of labor markets. In Egypt 61% of secondary EXECUTIVE SUMUMAY 7 students attend vocational and technical schools, despite their higher costs, often to divert the numbers seeking admission to higher education. The result: the vocational training system supplies five to seven times the number of technical workers needed in the economy. In Morocco a pay- roHL tax on employers goes solely to publicly provided vocational training, often divorced from the needs of the private market. In most MENA countries training programs need to be linked to employers through joint private and public financing, management, and goal-setting-as is start- ing to happen in Iran, Jordan, Tunisia, and Yemen. 'With reform, abject Public financing should go for universal literacy, numeracy, and poverty could be coherent social and cultural values through high participation rates in pri- marv, lower secondary, and eventuallv upper secondary education. dramatically reduced Economic growth's higher incomes will enable private financing of high- er levels of education. This is already happening in Lebanon (where pri- vate higher education predominates), Iran (where half the university enrollments are in one private university), and Jordan (where 20% of higher education enrollments are in the private sector). Reducing poverty through faster growth Higher growth is essential for reducing poverty and for providing sus- tainable social spending and safety nets. Moving from zero growth to 1% annual growth in the MENA region would reduce the number of poor in the region by 8 million over the next decade. Without the higher growth that reform can bring, the number of poor (those living on less than $1 a day) would rise to about 15 million by 2010 (figure 11). Because many people in the MENA region are close to the poverty line, faster econom- ic growvth can greatly reduce their vulnerabilitv. With reform, abject poverty could be dramatically reduced, although at higher incomes the definition of poverty would have to change. Additional GDP growth has less impact-a percentage point increase in the average rate of growth from 5% to 6% would reduce the number of poor people by only 1.5 million over the next decade. Policies have to become much more specific, targeted to address the needs of the chronic poor. The amounts needed to eliminate poverty are small, but some leakages are inevitable, and targeting can be costly, both politically and administratively. Tunisia's subsidy program, which includes some tar- geting, still costs three times as much as would be needed to give all the poor the equivalent of the povertv line income each vear. Egypt's social 8 CL.MMING TIHE FUTURE assistance program provides very small payments (about 5% of the pover- ty line) to 2.7 million beneficiaries, but administrative costs consume 12% of total costs. Jordan, Morocco, and Tunisia are beginning to reap the rewards of reform A few countries have made important strides in their reform efforts- with Jordan, Morocco, and Tunisia as notable examples. They began their adjustment programs in the 1980s with macroeconomic stabiliza- tion, deficit reduction, trade liberalization, and structural reforms in Incomes, exports, pricing, regulation, and financial market development. All three insti- and jobs are tuted reforms gradually. But unlike manv of their neighbors, they have been fairly consistent in the direction of reform, building up credibility growing faster over time. None of the three was an oil exporter, and, except for phos- among reformers phates in Jordan and Morocco, they could not draw on rents to finance the public sector. Remittances were important to all three, but because of profitable opportunities for the private sector at home, capital flight was very low. The new policies are starting to pay off (table 1). All three coun- tries-Jordan, Morocco, and Tunisia-have higher growth in incomes, exports, and jobs than do other countries in the region. Jordan and Tunisia are exceptional performers on virtually every indicator of human development-life expectancy, enrollment rates, and infant mortality. FIGURE I Reform will bring down poverty Projected poor (millions) 1 6 I £ 8 4 With reform 2 1 994 1 996 99& 2d00 2002 2004 2006 2008 20 0 Note: Poor is defired as anerage spend ng of less than $ a d3a at 1985 pJIchasing pow:er parity The-ro_ th elast rly of poverty used here is -4.48 Wth,out r efomn GDP per capta grovvs at - 469.; tor MENA Ws'ith reforri., GDP per capta grows at 2.5%. icludes Ager-ia, Egypt Iran Jor dan. Lebanon', Morocco, Syria. L.risia anc, Yenie- SowCse vari Feghen 1995. EIXECLUTIVE SUMNMARY 9 Many low-wage jobs, crucial to reducing poverty, were created in export- oriented industries in Morocco and Tunisia. And unlike other countries in the region, where labor market policies have encouraged investors to substitute capital for labor (figure 12), both Morocco and Tunisia have given investors incentives to create jobs and have kept capital-labor ratios low. And both have cut poverty in half (table 2). The payoff to What would the payoff to reforms be for other countries in the reforms is region? Considerable. An ambitious reform scenario of 3.5% per capita considerable growth to 1999 and 5.0% thereafter would result in a doubling of per capita incomes by 2010. Even under a more probable scenario of 2.5% FABLE i Jordan, Morocco, and Tunisia have had better economic results (percent, unless otherwise indicated) Per capita Non o I Average Population GDP growth exports annual infla- Mean years spending less rate, growth rate, tion rate,a FDI inflows/ of schooling, than $1 a day, Country 1990-94 1980-93 1984-94 GDP, 1993 1987 1990 Jordan 0.39 4.3 5.33 -0.65 5 12.601t Morocco 0.70 3.8 5.73 2.00 2 2.49 Tunisia 2.10 10.5 6.00 1.63 5 2.89 Algeria -2.33 4.5 18.00 0.03 4 1.16 Egypt -0.72 0.5 14.80 1.20 5 5.60 Iran -1.04 -1.0 20.50 -0.05 4 8.94 d. Usirg GDP deflator. b This estimate wvas done at the tine of the Gulf war. H gher grovwth r-aites since then have p, obabYI leduced povertY n Iordan. uo e-e: World Bank data: vare Eeghen 995 FIGURE 12 Morocco and Tunisia have created more jobs with lower capital-labor ratios Capital-labor ratio (1970=100) 400 350 250- _ ra _ 200 01 o _p~~ 300~~~~~~~~~~~~~~~~0 2 50'T 6 00 50 00 I °70 1 972 1974 976 978 1 980 1 982 984 1 986 1988 1 990 Sit.,ce World Barik staff estimates based on data from Nehru ard Dharesrwalr 993. 10 (.LAIMIN(; THE FUTURE TABLE 2 Morocco and Tunisia have reduced poverty substantially Morocco Tunisia 1984/85 1 991 1 985 1 990 Head-count index 6.06 1.64 4.63 2.89 Poverty-gap index' 1.62 0.23 0 89 0.64 Squared poverty gap indexb 0.82 0.06 0.31 0.28 Note Poverty iS detned as average spend ng of ess than $ a day at 1985 p-rchas ng power panty a Tfhe shortfall Ir expenditure fromr the povelty mne of the average poor person, e.pr essed as a per-centage ot the povers, line b A ,easure o he dstrbut on of income o those be ow the pover-t I ne. Sowice. World Bank 995e. Chen Datt. dnd Ravall cn 1993 per capita growth, incomes would be 50% higher by 2010. Instead of having rising unemployment and domestic tension, reforming economies will grow fast enough to absorb their expanding labor forces while expe- riencing a gradual rise in real wages. With reform, all countries can real- ize positive growth rates in per capita incomes. Without reform, all coun- tries that have not alreadv initiated reforms experience falling per capita incomes. Now is the time for action Pressures for reform are mounting In today's fast-paced world economv, the gradualist strategies of the past Potential winners may mean no growth (given the mobility of capital) if policies lack cred- from reform ibility. And half-hearted or stop-go approaches to reform are a sure way outnumber the to lose credibility. While the region's population is groxing at 2.7% a year, losers the labor force is growing at 3.3%. Jobs for 47 million new entrants to the labor force will have to be found by 2010. The number of unemployed, now about 9 million, will rise to 15 million by 2010 at today's high rates. Attracting investors to create jobs will require credible public institutions with a clear long-term reform strategy Just as the number of "losers" from the lack of reform is growing, so is the cost of inaction. In many MENA countries those interested in new job creation (the unemploved and those entering the labor force) now outnumber those interested in the preservation of old jobs (those employed in the state sector). Even under conservative assumptions about overstaffing in the public sector, the potential winners always out- number the potential losers by at least three times. In Egypt the poor number 3.2 million and the unemployed number 1.7 million, compared with about 1 million with protected jobs in public enterprises. EXEUCUTIE SUMMARY Experience elsewhere shows that structural reforms involve some job destruction, but that it is more than offset by the new jobs created through efficient investment and faster growth. Reform costs Economic reform has costs in the short run. A substantial share of exist- ing capital-both human and physical-must be retrained, converted, or simply retired to allow for the accumulation of more appropriate types of capital. These costs translate into higher unemployment and lower con- sumption (to allow for greater investment) during the transition, conser- vatively estimated to be about five years. Without additional external support, estimates of these adjustment costs in MENA countries are a 1-2% loss in per capita consumption and a 3% rise in unemplovment rel- The absolute costs ative to the no-reform scenario. Where population growth rates are high of implementing (as in Algeria, Jordan, Syria, and Yemen) or economies are dominated by reforms are fairly inefficient public enterprises (Algeria and Egypt), the development of a small dvnamic private sector will require more sacrifices in consumption (to enable greater investment) and will take longer than for the more advanced reformers. But the absolute costs of implementing some of the reforms outlined in this report are fairly small. Providing a package of basic health care interventions would cost less than 0.5% of the region's GDP Paving every poor person enough to bring them to the poverty line is less than 1% of GDP in most countries. And eliminating the gender gap in educa- tion would cost less than 1% of the region's GDP. Economic growth is central to making such higher spending on the social sectors politically viable. For example, with no growth, maintaining per student expendi- tures on education in Jordan would require doubling the education bud- get's share of total spending over the decade-unlikely. But with faster growth, higher social expenditures can easily be accommodated. Partners can share the burden The costs of reform can be shared-with the private sector and with donors-and there is no shortage of financing to cushion the costs of adjustment in the MENA region. The approximately $350 billion in assets held abroad is just one source of potential financing for the massive investments in new industries, new infrastructure, and new commercial 12 CLLXMING THE FUTURE and social services outlined in this report. The $158 billion in private cap- ital flows to developing countries in 1993 is another potential source of financing. Donor funds are also sizable-the European Union's Mediterranean Initiative alone could increase official resource flows to the region by more than half. NWith such additional external support, the costs of reform in terms of lower consumption and higher unemployment can With external be significantly reduced. support, the costs The key is for international support to reinforce rather than replace of reform can be the reform process. Private financing will not materialize unless the con- ditions are right-and that means serious progress on structural reforms to create a competitive business environment. And donors are willing to finance the political costs of reform-such as severance payments or tar- geted transfers-to ease the short-run difficulties for reform-minded governments. The central issue for governments is to have a credible long-term strategy and to sequence and set priorities in the interim to realize the vision of a prosperous future. EXECUTJV SUNINLARY 1 3 CHAPTER I Disengagement from the Changing Global Economy The economies of the Middle East and North Africa (MENA) have been unable to deliver improved living standards to their populations over the MENA's policies are past decade.' Comparing the performance of MENA countries with oth- ill-suited to the ers indicates that they are lagging behind in exports, private investment, labor productivity, and in managing their natural resources sustainablv. global economy The reason: policies are ill-suited to a world economy that is fundamen- taHly different from that in the past. Despite fairly high rates of investment in both human and physical capital, groxvth rates were abysmal in the 1980s as productivity stagnat- ed. Real per capita GDP fell by 2% a year over the past decade-the largest such decline in any developing region (figure 1.1). Meanwhile, many countries in Asia witnessed the best economic performance in recent memory. The downturn was particularly severe among MENA's oil-exporting countries (their GDP per capita fell by 4% a year between 1980-91), but even the non-oil exporters in the region grew by less than 1% a year (Riordan and others 1995). The earlv 1990s have seen some improvement in growth performance, especiallv in Bahrain, Oman, Saudi Arabia, Syria, and Tunisia, but in most countries there were mini- mal or negative gains in per capita incomes. For the non-oil countries in MENA (such as Jordan, FIGURE l I Lebanon, Morocco, and Tunisia), oil has strong "ripple Annual income growth has been the effects." Links bet-ween regional labor and capital markets world's worst, 1980-91 amplify the impact of oil markets. Worker remittances have Percent been the most important [ink-with a 10% increase in oil 6 prices associated with a 6% rise in remittance income for 4 MENA countries. For Egypt, Jordan, and Yemen, remit- 3 *Latin Al d-e DP y tances amounted to $90 per capita, 40% of exports, and 10% _and the- ArI of GDP in 1993. In the Maghreb, where workers tend to E S -Cat -an Africa MENA East South Euirope migrate to Europe, the link to oil markets is weaker, but the Xl Asia Asa nd importance of remittances for foreign exchange revenues is Asa stiHl significant. Aid from the oil economies to others in the ScOt,ce Rordanandothers 995 FGURE 2 region has been another important link-closely following OPEC aid has fallen with oil prices developments in oil markets. Official grants from the oil Grants (billions of U.S. dollars) Oil price index (I1987= 1.0) exporters to their MENA neighbors peaked at about $3 bil- 4 ° <3l price 2. c lion a year during 1979-81 (with the exception of a peak in 1990 during the Gulf war), but with faHling oil prices grants " have averaged only about $500 million a year more recently 25 l 2 / 4 1 > (figure 1.2). In 1993, 80% of OPEC official grants went to l5s Z , l V V oe the Mashreq. wvith only 10% to the Maghreb.2 .0~~~~~~~~~~~~~~~~~~0 o5 1 | l l | s 1ll nMissing out on globalization 1970 .973 976 1979 982 1 985 19t8 199I cd data,. Rordal arc othe,s 1 Perhaps most striking is that MENA countries have not used integration with the world economy as an engine of growth. They are less integrated today than 30 years ago, with trade as a share of output having declined, in contrast to all other regions except Sub- Saharan Africa (figure 1.3). The Gulf Cooperation Council (GCC) coun- tries are perhaps the most integrated, with a high ratio of trade to GDP and intraregional trade equivalent to about 7% of total trade. Yet despite decades of emphasis on diversification and industrialization policies in the region, primary exports, especially fuel, remain the most important link to the global economy. Oil constitutes 80% of total exports for the region-and for some countries petroleum products are virtually the only source of foreign exchange (table 1.1). That MENA countries trade so FIGUPE .3 MENA's trade integration has actually declined (Exports + imports)/GDP 14 1.2 0, East As1a 0 Sb~ Sr r= _ ~ic o4~~~~~~~~~~~~~~~~a n A,e,c ari n th,eCar be,on_ ME.2A SOLIth A..ia r0.2 970 1972 1q7' 976 1978 198C 1932' 1934 939 19Q8 99D 1992 ire. MMENA does rot incu de Jo,dan, Lebay,r. OCran. Qatar. a rid i`'enn. Sowee. RiPrrJan and oahers 995. 1 6 CLAMING THE FUtURE FABLE . I Oil continues to dominate many MENA economies (percent) Trade in fuels as a share of GDPa Share of total exports Oil exporter 1970 1974 1984 1993i' 1993 Gu f Cooperation Council 50 85 35 35 95 Bahrain 140 105 72 67 90 Kuwait 62 80 47 40 80 Oman 78 70 47 30 95 Saudi Arabia 46 90 37 33 99 United Arab Emirates 40 78 3 40 95 Other exporters 10 30 10 10 85 Algeria 15 30 22 20 85 Egypt 5 2 6 7 45 Iran 20 47 7 15 90 Iraq 3 2 9 2 35 Syria 6 8 7 14 42 Total 25 60 20 30 90 MENA exports (billions of US$) 10 90 100 110 80 aM Mne al fte sr IllC Lid ng psioole,rn) and p,rdm ctt nat ia Eas. ml Id rtal, a gas lIqAld) b E-t mate ort!,, e P-ordLin anid othe': °9a little with each other (intraregional trade is only 7-8% of total trade) is a reflection more that they trade very little at all, not that there are no regional trading opportunities.3 Export prospects are bleak and more volatile than in any other region More worrisome is that the region's real export earnings per capita are highly volatile and on a gradual decline. Oil prices are projected to remain flat, with grow,th in MENA's real oil export earnings increasing by only 2-3% a year through 2010 (figure 1.4). The prospects for oil markets are subject to large uncertainties. Some are FGL-UPE I on the demand side. because of potential energy conserva- Oil prices will probably be flat tion. Others are on the supply side-wvith the eventual US dollars return of Iraq to the market, uncertainty about output from 6D the former Soviet Union, and possible technological 50A advances. Over the long run, the floor for oil prices is about 40 $5 a barrel (equal to the long-run competitive costs of pro- 3 duction) and the ceiling is about $25 a barrel (the price of the closest alternative energy source). But even at $25 a bar- rel, the region's real export revenues per capita would be less than half those achieved during the boom years of '9C5 197C 98e 19ic 2O O D z a 1975-85. c-rm oc,d-ac andothner: I-S D)TSENGA(GENIENT FROMt THE CHAN(IN( GLC)BAL LCC)NO)MY 17 Transfers and income flows to the region (remittances, aid, and income from assets abroad) also are expected to remain flat. Remittances are expected to stabilize as European demand for immigrant labor con- tinues to decline. The Gulf countries will try to encourage greater labor force participation of nationals while meeting a portion of imported labor requirements through lower-wage Asian workers. Interest and dividend earnings also are likely to decline, especially for the GCC countries, as foreign assets have been depleted, especially during the Gulf war. Aid flows to the region are expected to remain stable in real terms as increased assistance from the European Union offsets declining support from the United States and the GCC. Tourism revenues are a bright spot-the entire MENA region's rev- enues were less than Mexico's and about equal to Thailand's in the 1990s-implying substantial potential for growth given the region's geog- raphy and wealth of destinations. But the size of the sector is too small to offset other adverse trends, and regional stability will be a key factor since tourists are unlikely to visit destinations with high perceived risks. While export prospects are bleak, needed imports (such as food) will absorb up to half the export revenues in the Mashreq. The recent surge in international food prices will increase the region's food import bil by $4-5 billion a year (figure 1.5). In the medium term, as the Uruguay Round reduces the breadth and depth of the industrial countries' intervention in agricultural markets, world food prices are expected to rise. But the agri- cultural liberalization under the Uruguay Round is limited, and the net effect will be relatively small-a 1-4% increase in prices over six years. In the longer term, with continuing gains in worldwvide crop FIGURE 15 yields, the international prices of staples such as cereals are The food deficit is growing expected to declne in real terms. Net food exports (billions of U S. dollars) 0 Financing the region's deficits will get harder -2 -4 The MENA region was once the only capital exporter among s-\ all developing regions, but its resource deficit (on goods and -A2 \ non-factor service trade) became the largest of all developing -I\ regions in the 1990s. This was driven largely by rising exter- -16 \ / nal deficits in the Gulf countries (particularly Iran, Iraq, and 18 Saudi Arabia) as a result of falling oil prices and uneven -20 1961 965 1969 1973 1977 981 1985 1989 macroeconomic adjustment to this new reality. Resource Source. Rordan and others 1995 deficits in the Maghreb and the Mashreq have shrunk 18 CLAIMING IHE FtUTUIRE because of policy adjustments to reduce imbalances and as external financing from both private and official sources has been harder to attract. Relative to its GDP, the region's financing requirements are the largest for any developing region. The situation is particularly extreme in the Mashreq countries, where the financing requirements as a share of GDP are three times those in Africa or South Asia. Moreover, interest payments on foreign debt relative to GDP are now as high as in Sub- Saharan Africa in the early 1990s or as in Latin America in the 1980s. Debt to GDP ratios averaged 62% in the Maghreb between 1990-93 and 114% in the Mashreq-comparable to the Sub-Saharan ratio of 70% of The region has GDP in the same period. In the GCC countries declining overseas assets not featured in have meant a halving in net interest income-from more than 10% of the upsurge of GDP in 1985-89 to less than 5% in 1990-93. Moreover, the region has not featured in the upsurge of private cap- private capital ital flows to developing countries-attracting less than 1% of the total to developing (El-Erian and Kumar 1995). In 1990-93 MENA countries attracted less countries than $1 billion in private capital (comprising private debt, foreign direct investment, and portfolio equity). In countries like Egypt, Jordan, and Lebanon, much of the flow ended up in government reserves (which often needed bolstering) rather than in new investment. Explanations for poor performance include political tensions, slow progress on structural reforms, and lower oil prices. Foreign direct investment showed more variation-with flows into Morocco increasing from $122 million a year in 1985-89 to 8407 million a year in 1990-93 while those in Tunisia more than doubled to about $200 million a year in 1990-93.4 In contrast, stagnation in the reform process and mounting political tensions resulted in a sharp drop in for- eign direct investment in Egypt-from $1.1 billion a year in 1985-89 to less than $500 million a year in 1990-93 (Wiorld Bank 1994c). Domestic policies are ill-suited to new global realities Unlike the past, when the accumulation of capital was the key to efficient mass production, today's market demands more flexible production that takes advantage of the plummeting costs of international communications and transport. Competitive advantage no longer solely means producing a uniform product efficiently in one location. It means being able to orga- nize and coordinate production of goods and services among multiple suppliers to respond quickly to the demands of various niche markets. DISENGA(GEMENT FR(NI) IHE (CRANGING GLOBAL ECONONY 19 Globalization also sharpens the differences in performance among different policv regimes. As Mexico's recent experience shows, increas- ing integration in the world market brings important benefits, but it also requires stricter discipline in economic management, since policy errors are punished swiftly. For most countries in the MENA region, the policv regime has lagged behind one that would enable producers to take advantage of globalization's opportunities. Ease of communications is the main driver of globalization Communications are ever cheaper and easier, and competition forces companies to seek the lowest cost location for production. The cost of an international phone call fell bv a factor of six between 1930 and 1950 and Technological by a factor of ten since. The average number of international air-passen- innovations imply ger miles traveled per person increased by 15 times in the past 20 years. "the end of Innovations of the past ten vears appear to spell yet another revolution, "the end of geography." The advent of the fax machine and of computer geography" networks such as the Internet put offices in Paris and WXashington next door. In Western Europe betveen 1987 and 1992, the number of fax machines per person increased from 1:1,000 to 120:1,000, but most developing countries in 1992 were still at 1:1,000. The implication of the "end of geography" for many companies, small and large, can be summarized in two words: specialize and global- ize. Narrow the business focus, and aim for the world market. Increasingly, there is international specialization of functions within com- panies-software development in India, airline tickets cleared in the Caribbean, and car design in Italy. Ease of communications allows trade to extend to a wide array of ser- vice activities, often not properly reported. Even with underreporting, the share of services in world trade rose from 17% in 1980 to 22% in 1993, and it looks set to accelerate due to the growvth of long-distance services. Swissair recently decided to move parts of its back office from Zurich to India-taking advantage of the fact that the salary of a bank clerk in Bombay is a fortieth of that in Zurich. The World Bank estimates that long- distance services of this kind could double commercial service exports by developing countries in the long run from the current level of $180 billion (World Bank 1995b). For many developing countries, becoming part of these highly complex netvorks at a stage other than the production of pri- mary commodities or simple components represents a new challenge. 20 (CLIUMIN( THL FUTURE Just as producers of goods and services have to become more respon- sive to changes in consumers' tastes and demands, the skills demanded of workers must change dramatically. Flexible production requires flatter organizational hierarchies, decentralized responsibility, and workers with broader job skills, more initiative, and better problem-solving skills. The impact of such changes is fewer low-skill jobs, restructuring some less- skilled jobs to require higher-level skills, and changing what workers need to know. Ensuring that the educational systems in MENA countries pro- duce workers with the needed skills will require redefining the social con- tract governing both access to and the quality of schooling. Trade liberalization is lagging An open trade regime is the channel for transmitting the benefits of inte- Distortions gration and the signals for needed reforms. But MENA countries are that thwart currently if-prepared to take advantage of the potential benefits that the competitiveness Uruguay Round could bring (box 1. 1). To take advantage of new market opportunities (which most MENA countries had access to before), eednted domestic distortions that thwart competitiveness need to be eliminated. eliminated These distortions reside both in policies (such as tariffs and quotas) and institutions (bureaucratic hassles, lack of internationaHly accepted stan- dards, and costly transport and communications services). MENA countries' average tariffs were fairly typical of other develop- ing countries in the 1980s. While quantitative restrictions have been reduced, average collected tariffs in MENA (with the exception of the GCC economies, which are quite open) are now higher than those in most Latin American and East Asian economies (table 1.2). Imports too are often subject to additional taxes. In Jordan these additional taxes included a 5% import license fee, a 4% tax earmarked for universities, a 2% tax for municipalities, a consolidated fee of 6%. a customs fee of 0.2%, and a surcharge of 3-5°,o. Morocco imposes an import lev-y of 12.5-15.0%. Tunisia imposes surcharges on a range of products. And Egypt maintains service fees of 3-6%. The cumulative effect of such trade distortions is higher prices for consumers and less competition for domestic producers. The bureaucratization of trade also has increased costs and reduced competitiveness (box 1.2). DISENGAGEMENT FRONI THE CHLANGING( GLOBAL ECONOMY 21 BOX I Benefiting from the Uruguay Round begins at home The Uruguay RouLId achieved substantial liberalization in ; Many preferential arrangements that benefited Middle many areas. Industrial country tariffs on manufictured Eastern exporters (such as distortions from the Multi-Fibre goods wvill be lowered by 40'X0% (from approximately 4"% to Agreement) are being phased out under the Round. So, the 9.4°/O), although the cuts are loxver than average for products region's exporters will face greater competition. of major importance to developing countries (such as tex- WVithout changes in policies, the overall impact of the tiles, clothing, footwear, and some machinery). Tariffs on UruLuay Round on MENA countries xvill be negative. Des- natural resource-based products (such as metals, minerals. pite the modest export gains, the net effect is adverse as and fish) svdll be cut by 38%. Althouglh agricultural trade was preferences are eroded and food import prices rise. Esti- not substantially liberalized, tariff equivalents were agreed mates reveal that social wvelfare in the region will fall by to. facilitating future liberalization. about $2.6 billion a year (0.45%o of 1992 GDI) with the WVhat are the implications for MENA exports? Estimates implementation of the Round. from a recent study indicate that they should increase by These wvelfare loss estimates are based on the current $800-$900 million. This is equivalent to an annual expansion policv stance in MENA countries. But the dynamic effects of less than 1'.. WY hy is the impact so small? cotIld be far more beneficial if MENA countries unilater- * Average tariffs facing Midcdle Eastern expolters before the ally liberalized their trade policies so that domestic firms Uriguay Round already were generally low-0.4",% into the would become more competitive and take advantage of Europeani Union, 3%`, into Japan. and 1.1% into the United the enhanced market access opportunities that the States. In part this is because oil, the region's major export, is Uruguay Round can offer. Achieving these dynamic gains Lgenerafly imported dotv' free or faces ver, low tariff barriers. will depend mainly on the policy decisions in MENA * MENA countries did not offer to liberalize their markets counltries. by very much under the Round and therefore their exports will not become more competitive. Source. Yeats 1995; Diwan, h'ang, and W'ang 1995. TABLE .2 Trade taxes shelter domestic producers from competition, 1993 (percent) Snare of import Average collected tariff duties in total Share of "other" taxes in Country (revenue/imports) government revenue total import tax revenue ndia 29.9 23.6 0.8 Yemen 19.1 20.2 3 Pakistan 19.0 10.0 0 Tunisia 18.7 28.3 46 Jordan 17.8 35.9 40 Morocco 17.5 17.7 52 Syria 16.4 10.0 25 Egypt 14.9 10.0 8 Chile 9.7 9.9 Indonesia 4.9 5.2 Mexico (1990) 4.8 5.1 Korea, Rep. of 4.4 4.8 Bahrain 4.0 9.2 Oman 3.0 3.2 Turkey 2.5 4.4 78 Israel 1.2 1 .0 . va able Hauce Hoe. ,rnar, I 995 CLAIMING ITHE FUTURE BOX I 2 Costs of trading in Egypt Egypt provides a good example of how complex trade regulations and poor trading lacil- ities reduce competitiveness. A plethora of government entities regulate trade-the Customs Authority, Ministry of Health, Ministry' of Supplv, General Organization for Veterinary Services. General Organization for Quarantine, Atomic Energy Association, Industrial Control Authority, and General Organization for Export and Import Control-wvith the objective of protecting consumers from low-qualitv goods. But because Egypt does not recognize interniational certification bodies, the General Organization for E,xport and Import Control must inspect a sample of every consign- ment of goods that is on a list of products subject to quality control. Some 1,550 tariff lines, or 25.% of the tariff schedule, are stiblect to quality control. The process is time- consuming for importers, who face additional uncertainty about when products will be Savings rates are cleared. Firms also have no incentive to employ the services of certification entities and below where increase their awareness of the qualitv standards needed in international trade Poor infrastructure also raises trading costs. The costs per ton of handling a contain- they should be er in the port of Alexandria is tvo to three times that in other Mediterraneall ports. Insurance premiums charged for trade coverage are higher than those confronting Egypt's competitors on world markets. Unlike the tariffs on intermediate inputs, the extra costs associated with customs clearance, quality control, customs valuation, and the monopoly service providers in the ports cannot be recovered through a dutv drawback scheme. Thev constitute, therefore, a major disadvantage for firms producing for export-andL a major disincenitive for foreign firms that might invest in export-oriented activities. Source: Hoekman 1995. Government revenues come from rents, not production Most countries in the MENA region are relatively advanced in macro- economic stabilization and, except those at war, have managed to avoid the bouts of high inflation observed in several countries in Latin America, Africa, and Eastern Europe. But in the long run, there will have to be a fundamental reorientation in MENA countries' fiscal stances as revenues from oil and aid decline. This is true not onlv for major oil exporters, but also for Egypt, Jordan, and Yemen, which benefit from oil revenues indirectly. Savings rates remain below where they should be, especially given the rates of natural resource depletion. MENA countries' gross savings rates are about 10 percentage points of GDP lower than in Indonesia, Malaysia, or Thailand. Adjusting for the depletion in natural resources, the estimated net savings rate has been negative for manv countries in the MENA region. In contrast, several natural resource extractors in East Asia have dramatically improved their net savings performance (figure 1.6). DISENGAGEMENT FROM THE CHANGING GLoBAL. ECONOMY 25 FIGURE 1.6 The situation is particularly severe in Algeria, Egypt, Oman, Savings rates are well below optimal levels and Syria, which are expected to deplete their reserves of oil Net natronal savings rate and gas in 15-40 years. The major oil and gas exporters in is / the Gulf have more time to adjust their savings rates to loEA :t,/ ensure that they will be able to maintain consumption levels. A major feature of the required fiscal adjustment will be greater reliance on taxation to finance the government. At present, governments rely excessively on rents and indirect taxes. Heavv reliance on customs duties will have to dimin- -5 \ //\l\l ish if progress on trade liberalization is to be achieved (see table 1.2). Future reliance on income and consumption taxes are likely to coincide with increased pressure for 972 Q975 1978 96.1 '984 1987 993 1993 greater accountability and more efficient use of public Note Net naona v saAings ate is deVr,ed as (gfoss nat:orial sdrigs resources. a ate - depreciation c cap)tal stock - deple ior cI -csrenewable resosuice')GNP EastAsa nrieludes Chia. Indonesia, ard Malaysa MENA inC Lides Ag e-ia. Erypt. ,an, Sn-ia, and Tnisia. osa,e Lirsen 2995. The investment regime is not seductive All countries are now competing for the attention of private capital, which is critical for growth. But, with increased mobiity, private capital has become fickle. It goes where the environment is conducive to mak- ing high rates of return and leaves wvhen the environment turns sour. Policies friendly to the private sector are the way to get the attention of private investors. Capitalists in the MENA region continue to "vote with their feet" by holding assets abroad where returns are safer. Estimates of the stock of capital abroad from the region are about $350 billion, more than any other region in the world as a share of GDP5 The GCC accounts for about half the total capital flight, although investing these assets abroad is economically optimal for major oil exporters who need to diversify their investments. In the rest of the region, countries with the least hos- pitable environment for investors, as measured by capital flight, are Egypt, Iran, Iraq, and Syria. In contrast, capital flight is not much of an issue in the Maghreb, particularly in Morocco and Tunisia. What policies bring in private capital? Political and macroeconomic stability are an essential precondition, but so are government policies that affect the private sector's rates of return. In fact, the productivity of investment in MENA countries has deteriorated substantially, as evi- denced by the low level of output obtained from every 1% increase in investment (figure 1.7). Most MENA countries get about half the output 24 CLAMxING TI lE FUTUiRE per unit of investment that East Asian countries do, despite FAiUiE 7 the more rapid growTth of the labor force in MENA. investment is low In a world of intense competition for capital, underdevel- oped financial svstems, burdensome tax rules, and regulatory 17' v hassles are a sure way to deter investors (box 1.3). In Morocco, despite recent liberalization, as manv as 20 docu- ments are needed to register a business, and it typicaUly takes T-, six months to complete the formal steps for commercial estab- rac,, Moitau lishment. Resolving a commercial case takes 2.0-2.5 years in war", La ' Ae,r de Ia ' I rhbv'ed, 1 Egypt, Jordan, and Lebanon-compared writh 1.2 years in Mcdlt E,1,t r I-, = Canada. A World Bank study estimates that up to 30% of the s d = average entrepreneur's time in Egypt is spent resolving prob- = lems with regulatory compliance (Saba 1995). In Jordan legis- 0 3' I 2 03 34 lation intended to encourage private investment adds three Percnage point growh n real GDP attained wt each addional months to a year to processing an application. In Lebanon percentage pont of GDP used formvestment, 1983-93 clearing customs can require as many as 18 signatures, and the Stane ic WorId Bane stdff a\oulhtior,- lack of clear regulations in such areas as health and safety cre- ates substantial uncertainty for business. The litmus test of government commitment is often privatization. Is the government willing to withdraw from certain areas and allow the pri- BOX 3 Investor ranking of constraints What do investors look for in the business environment when deciding where to put their capital? Surveys of investors have identified a number of constraints to investment in MENA countries. Despite the common practice of rolling over short-term loans as a means of financing some fixed assets, the lack of long-term finance greatly increases the risk associated with fixed investment. Moreover, the costs of borrowing tend to be high and are compound- ed by the costs of complying with regulations. Foreign investors tend to be more con- cerned with political stability, the rule of law, and policy predictability. MENA countries need to address constraints to investment Constr aint Ranik F nance (cost and aval abil ty) Taxation ( evel and adminiistration)r Inadequate skills 3 Poor nftrastructure 3 Comp ex regulations 4 Legal system 4 Source. Anderson and Martinez 1995. DISENGAGEMENT FROM THIE CHANGING GLOBAL ECONOMY 25 FGURF 1.8 vate sector to take the leading role? On this measure, The share of public enterprises in economic activity is high ... MENA countries lag substantially behind other regions. The (percent) share of public enterprises in economic activity is higher in MENA countries than in other middle-income countries Algera _~ (figure 1.8). There have been very few privatization transac- Egypt tions (figure 1.9). And revenues from divestiture have been small (figure 1. 10). morcco GDP The size of the public sector in most MENA countries is Tunisoa D ,y}<, (;onagr;culural activi' bigger than is good for growth. International evidence indi- Gross rivustmeri income cates that where the public sector's share of total investment counltries :": Cr0 10 20 30 10 50 6C) 70 exceeds 40%, both the productivity of investment and over- Average, 1986-91 all growth tend to deteriorate markedly (World Bank 1991). Scsa:e: Wc-d B1nk 9°Sa. In the MENA region many countries' public sectors exceed FIGURE .9 40% of total investment, with such exceptions as Lebanon ... the privatization transactions, few ... and selected Gulf countries. In Jordan a study of industrial Argentina companies showed that those with less than 15% govern- Tu,keO ment ownership had higher productivity, faster sales growth, Snkista= and greater profitability than those with more than 15% Pr lip;iner government ownership (Kanaan 1995). Poor performance of public enterprises imposes large direct fiscal burdens MoFocot (about 2% of GDP in Morocco and Yemen). It also results Omypt Oman in the accumulation of bad debts by the banking system. 0 0 20 30 40 5d 60 70 80 9o 00 And it crowds out private firms that could have been pro- Privatization transactions, 1988-93 ductive and contributing tax revenue. In Algeria, despite state- oned enterp.,-seo massive investment in the past (about 50% of GDP), public Anderson and Martinez 1995. enterprise losses reached $5 billion in 1990. There is also FIGURE I 0 evidence that state-owned enterprises create less than half . .. and privatization revenue, small the number of jobs per doHlar invested as private firms-in Latin Ame, ica part because public enterprises are often in more capital- a sd the Caribbean Eu-ope and intensive sectors (Anderson and Martinez 1995). Central Asia Financial systems in the region are relatively large. East Asia and thePacfic Financial depth in MENA, as measured by the ratio of M2 So,th Asia to GDP, is higher than in Latin America, South Asia, and, Sub-Sanaran Africa until recentlv, East Asia. But their lack of competitiveness Midd e East and Nolh Afl-ca has raised costs for the private sector. C 13 20 30 40 SC 60 State-owned banks dominate financial svstems. In Egypt Privatization revenue (billions of U.S. dollars), 1988-93 four public sector commercial banks control 70% of the sys- Note. fid:eEast and NEorl AIrca coes not rclude Basran. tem's assets. In Tunisia the state has majoritv shares in five Kuviait, Qatar Sau.di Araba and Unitee Arsb Enwrates. t I Sour-:Ande son and Martl ncz 1995. of the six largest commercial banks. And in Algeria the 26 CLAIMING THIE FU1TURE financial system essentially consists of five state banks, traditionally spe- cializing in a particular sector. Such state-dominated svstems have meant above-average financing costs for the private sector. Intermediation margins (the difference between lending and deposit rates) for non-GCC MENA countries aver- aged about 9% in 1991-93, compared with about 4% in OECD coun- tries and South Asia and about 3% in the high-performing East Asian economies. The differences across countries are significant. In Algeria the relatively h.igh spreads of 8.5% to 13% for short-term loans are due to the lack of competition. Morocco, with significant private ownership and foreign participation, has relatively low spreads (4%). Securities mar- kets in most MENA countries (except Israel, Jordan, and, to a lesser extent, Egypt) are underdeveloped. The importance of infrastructure to any integration strategy also The poor quality requires a major improvement in the quality of serxices. Quantity is less of services increases of a problem. Most countries in MENA supply infrastructure services to production costs households in quantities analogous to countries with similar inconmes. Jordan again is the major exception, providing a level of infrastructure services to households in excess of most other countries with similar competitiveness income levels (World Bank 1994d). The GCC countries too have made massive investments in infrastructure and the quality of services is high by international standards. But the poor quality of services in manv countries hits production costs and competitiveness. For example, waiting time to obtain a tele- phone connection in 1992 was 4.4 years in Tunisia, 5.8 years in Jordan, 6.1 vears in Egypt, and 10.0 years in Algeria. The share of unsuccessful calls was 34% in Tunisia, 46% in Yemen, 50% in Lebanon, 57% in Morocco, and 60% in Jordan. Less than half the paved roads in most of the region are considered to be in good condition (compared with 85% in most high-income countries). Labor is losing competitiveness More than half a billion workers in developing countries will enter the labor force over the next 15 years, most at wages well below the MENA average. Nearly all will have attended primary school and acquired basic numeracy and literacy skills. More than 150 million of the new workers will have completed secondarv school. And the growing numbers of workers qualified to perform basic manufacturing tasks in such countries DISENGAGEMENT FROM TIlE CHANGING GLOBAL ECONONIY 27 as China and Indonesia will make the markets for mass-produced goods intensely competitive. To maintain living standards, MENA countries will have to improve labor productivity and increase female participation in the labor force. Productivity in MENA countries has fallen dramatically (figure 1. 11). The creation of new jobs has stagnated, and unemployment rates are the highest in the world (figure 1.12). Labor has borne the brunt of the adjustment-with real wages falling more than in any other region. The average worker in MENA today is earning no more in real terms than in the early 1970s. Only Sub-Saharan Africa has such a poor track record. This deterioration in wages occurred even as massive investments in human capital continued. MENA countries devote a greater share of their national income to education than any other region. But these investments in human capital appear to have generated poor FIGURE I I returns, as evidenced by low completion rates, high unem- MENA is losing competitiveness ployment among graduates, and low labor productivity Average change in total factor productivity (percent), 1960-90 Extensive distortions create incentives for the wrong kinds 2.0 _ of education and training services, reduce the social returns to investments in human capital, and lower the external ben- 1.0 efits associated with the accumulation of skills. Quality also os5 _ -has deteriorated, especially where student numbers have increased rapidly under publicly dominated systems. East As.s. OECD Lat e, An-e.rca 'IENA -0.5 Poverty, especially of opportunities, has worsened f5) A A'lorld Bank 15953 FIGURE I 12 The failure to generate growth has increased the number of Unemployment rates are the highest poor people in the region. Based on household surveys, the in the world number of people surviving on less than $1 a day reached 11 (percent) million-an increase of 700,000 between 1985 and 1990 (table 1.3). Which groups were most affected? The poor are I 0 largely rural, especially farmers with little or no land, and 5 * | have large households and little education. The poor in 5 .I * h I. I urban areas tend to be unskilled or self-employed. Even o * * * * * * * countries that have fairlv good social indicators and exten- EC,stAsa Easter, Latin Mddle OECD Sotuth Sub ,rd the Europe Anrncca East Asia Sahlaran sIve social assistance programs, such as Iran and Jordan, wit- Paefic and and hie and Africa Cential Car-ib No-th nessed a sharp increase in poverty as growth stalled and pop- Asj3 Lear, Af,_i ulation increased rapidly. Nvote: Unerrip oyment arte, for most cour_ittis repeesent the astost ece,Testimates av, labe Oetvveen 1990 and 995. MENA does Despite the recent deterioration in povertv associated not ni de GCC couetries. 5ouic- Flirter 199 -. with slow groxvth, the region has been moderatelv successful 28 (C:LIMIN(G Tril FUTURE TABLE 3 The number of poor has increased with rising populations, 1985, 1990, and 1994 1985 1990 1994a Percentage of Percentage of Percentage of Country Thousands population Thousands population Thousands population Algeria 400 1.83 290 1.16 439 1 60 Egypt 3,465 7 45 2,936 5.60 3,438 6.05 Iran 3,005 6.48 4,987 8 94 4,394 6.94 Jordan 110 4.16 413 12 60 589 13 83 Morocco 1,569 7 11 625 2.49 432 1.58 Tunisia 336 4.63 233 2 89 148 1.60 Total 8,885 6.06 9,484 5.59 9,440 5.01 MENA region" 10,291 .. 10,995 . 11,028 NoL a,., able iYi1 PEic r cefired as tr ware speldingi f les. t.ran $ I a c-d a, I 95 purcc cl ng powp , parit,. ai Pie ni rlai- eat mite based on C -DP 6roVrth atec b The si1 cul -tlesa above p 1 et rotes tic Lebar ,i . Lav and Ye ren L's no the l cionr a 1eel a.e Dovelr ,ilt Sr,w e .a Eeliern 1ct at reducing the poverty of incomes. But opportunities-in access to effective education and health care-remain severelv inadequate for many. Consider Morocco. It translated growth (helped by bountiful rain- fall) into one of the sharpest reductions in income poverty in the world by 1991. Yet primarv school enrollment ratios fell from 79% in 1985 to 66% in 1990-the lowest in the region and rivaled only by Sub-Saharan Africa. The majority of Moroccan women (62%) are illiterate. All this is problematic for the skills development central to competitiveness. Natural resources are being mined unsustainably Most MENA countries have relied excessively on mining TABLE I natural resources as a development strategy, but many are Economies are dependent on natural resources, 1992 also beginning to face serious resource constraints. More (percent) than half the MENA countries derive about half their GDP Country Share of GDP Share of exports from natural resource-based sectors-defined as oil and gas, mining, and agriculture (table 1.4). But reserves of Algeria 52 92 nonrenewable resources are falling rapidly in Algeria, Kmwant 52 - Oman ~~52 95 Egypt, Oman, and Syria. And such renewable resources as SaLud Arabia 52 99 United Arab Emirates 49 96 Water are being tapped unsustainably, wvith use rates that Iran 37 96 exceed 100% of renewable supplies in Bahrain, Gaza, Emetn 365 65 Israel, Jordan, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Tunisia 32 27 Morocco 29 45 United Arab Emirates, and Yemen (table 1.5). Meanwhile, Jordan 20 50 lost productivity from land degradation is estimated to cost N>ct acic able $11.5 billion a year (World Bank 1995c). rc 'AriaBank °-4d DISENG(A(GEMENI FROM THE C(HANGINCG GLOBAIL EC(NOIMY 29 Water quantity and quality are problems Increasing urbanization, industrialization, and vehicle use also mean that air and water pollution levels have Water High water Low water quality quantity' quantityb become a serious threat to health and to tourism. Lack of High Algeaia, Egypt. Gaza, o-dan access to safe drinking water and safe sanitation translates Iran. Iraq, Lebanon, into about 10 million lost vears of productive life each vear MForocco, Syria, oTur,isia in MENA countries. Almost 60 million people breathe dan- Low Bantam,l sr-ae1, gerously polluted air from highly polluting industries, ineffi- Kuwvait, Libya, cient vehicles, leaded gasoline, and high-sulfur fuels. The Oman, Qatar- Saudi A-abia, combined cost of such unsustainable resource use is esti- UEniated Aeamen mated at $12-14 billion a year, roughly 30% of the region's a. Use ess thnI 00of @ renewabe supplies. GDP (World Bank 1995c). Moreover, air pollution takes a b. Use rmore tha I 00% of renewable sIpp es. severe toll on the region's antiquities, as does coastal pollu- Sowir-e WNo, Id Bank: I 995c. tion on tourist beaches. Given the disengagement from the world economv and the ill-suited domestic policies, the need for reform seems obvious. So, what prevents reform? Whv has the old economic structure failed to generate growth, jobs, and improved living standards over the past decade? And how insurmountable are the constraints to reform? Chapter 2 looks at these more complex issues of political economy to reconcile economic effi- ciency with political viability. Notes 1. MENA is defined to include Algeria, Bahrain, Egypt. Iran, Iraq, Israel, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Syria, Tunisia, United Arab Emirates, West Bank and Gaza, and Yemen. The oil- exporting countries are included in regional aggregates (depending on data availability) unless other-wise stated. Data for Lebanon, Libya, Qatar, and the West Bank and Gaza are scarce but are included wvherever possible. 2. Maghreb includes Algeria. Libva, Morocco, and Tunisia: the Gulf Cooperation Council (GCC,) includes Bahrain, Kuwait. Oman. Qatar, Saudi Arabia, and United Arab Emirates; and Mlashreq includes Egypt, Jordan, Lebanon, Syria, and Yemen. 3. Although intraregional trade activity may appear low, the region only absorbs 3-4% of global exports. As such, MENA countries have a higher than average propensitv to trade with one another, given their low propensity to trade at all (Yeats 1995). 4. Preliminary estimates for 1994 indicate that foreign direct investment in Morocco may exceed $700 million. 5. Capital flight from MENA is about $85 billion based on the World Bank's residual method, where capital flight is defined as (external borrowing + foreign direct investment) - (current account deficit + increase in resenres). 30 (CLAIMING TIll FUTURE However, compounding of hypothetical earnings at LIBOR results in an esti- mate of $600 billion. To the extent that such earnings are repatriated through recorded flows, estimates of the base for such calculations wvould be commen- surably lower. On balance, for MENA as well as other developing regions, the "true" levels of capital flight lie somewhere in between, hence the $350 billion estimate reported here. DISENGAGENIENT IFROM THE C(HANGING GLOBAL ECONOMY 31 CHAPTER 2 Yesterday's Achievements, Today's Predicament History matters. Proximity to Europe meant that countries in the Middle East and North Africa had one of the most g p Growth of GDP per capita. 1960-85 (percent) intense encounters with colonialism in the world. The lega- 5 cy of that period of exploitation has permanently colored attitudes toward economic policy, political legitimacy, and the appropriate role of the state. Colonial states tended to be politically authoritarian and discriminatory, but econom- icallv laissez-faire. Such policies were intended to integrate I '> '" the economies of the region into world trade, but on No, EastA ucluces G.la HagKarp. Irilonesa. Republ.oC unequal terms and with minimal benefits to local people. Koreo.Aaa,sa, eate Pt-, pp res. SngApoi e and Th.0,i LdTill P4nei ica,ndcudes h&gentid Pol,v a Braz Chi e. C ioirilooa Eruadol . In response to that experience, almost all the states in Peru, Paraguay Uruguay andVoeriezuel, the region (except Lebanon) adopted statist developmenit 'uice 'WordBankdta strategies in the post-colonial period. The state was to play and equitable a modernizing role, taking control of investment and pro- Growth of GDP per capita (percent). 1965-89 duction, providing mass access to education and social ser- 8 vices, and redressing the huge inequalities that had emerged ' H. sa .r.,B,t. in society. The instruments of such policy were nationaliza- tion, protection for domestic industries, large public invest- ment programs, and extensive systems of subsidies for basic M, -1t, goods and services. E.1. , - i C,- Th.tm, C 11 , I,.z Achievements of the statist era were considerable U no~~~~Irnoro'n>fl~~~~ , a,trf 20 S%, Mnn During 1960-85 the MENA region outperformed all other ,h I -S Ka ,a regions of the world except East Asia, not only in income Cne 5.n1o growth per capita, but also in the equality of income distri- D bution. Growth rates in MENA were among the highest for countries at their level of per capita income (figure 2.1). Income inequality was low for countries growing so rapidly 023 (figure 2.2). Improvements in social indicators were dra- Incomeinequality matic. A MNiddle Eastern child born in 1990 could expect to Nece inco,ri,e nequaity s leasui ed so te iat-oJ the ncorne Alssies l the icoect o i. nd tli n poorest 209S.:, Of the ent re popus,tfin. live 13 years longer than his or her parents. Infant mortality Sri(1'- Psge 1'35 3 3 FIGURE 2 3 more than halved over 25 vears-from 151 deaths per 1,000 Poverty in MENA has been low ... live births in 1965 to 61 per 1,000 in 1991. Primarv school Poor (percentage of total population) enrollment improved markedly, from 61% in 1965 to 98% in 1991. And literacy among adults improved from 34% in oi |1970 to 53% in 1990, with particular progress in the oil- 8 exporting countries. b L - | | Middle East and North African governments were also 4 effective at reducing poverty (figure 2.3). By 1990 only 5.6% of the population in MENA lived on less than $1 a day, com- A5eria Enpt Irar Jordan Morn= TLOs,a pared with 14.7% in East Asia and 28.8% in Latin America * 1955 * 1990 (figure 2.4). For anv given per capita income, poverty was N]re Por,I ; defned a, ;.erages perdcof ers tian a daya lower in MENA countries than elsewhere (figure 2.5). And Q85 pu rChaS r, poverel paoit''. s i - t 30r(e ' dll aegher 1995. the share of income that goes to the richest 20% of the pop- ulation relative to the poorest 20% of the population tends FIGURE 2 4 to be lower in MENA countries than in many countries in ... compared with the rest of the world East Asia and Latin America. These achievements were the Poor (percentage of total population) result of rapid growth in the 1970s and early 1980s and the introduction of generous transfers to large portions of the 50 s _ population (table 2.1). Making MENAs achievements particularly remarkable 30 - - is the prevalence of armed conflict in the region. No region 2x - _ _ has been characterized by so manv persistent conflicts- IC the Arab-Israeli conflict, the Iran-Iraq war, the Gulf war, MENA EastAsa Lat n South SLib the conflict in former Spanish Sahara, the civil wars in Amelr -a As, Salha ai-, Afrca Algeria, Lebanon, and Yemen-to name a few. The losses in human life and in physical capital from these conflicts re Poor i defred as wVerape soerid v o' es; tran S da Ja, dt 1935 p9wc-asrnr po,e par ry MENA nor der Agera Enyp, "all can only have hurt economic welfare and slowed progress joId,n1 MC.I'DCC:O rl1d TylsC 1 I/ ce Che,l Dat t.and Ravall 1593 van Fechen I 95 in development. Past successes were the outcome of easier times, not statist policies The era of statism coincided with a far more accommodating interna- tional context for MENA countries. Oil prices were high, the world economy was buoyant, industrialization was still in the '"easy" stages, and the world was a less competitive place. Times have changed, and many of the policies and institutions that seemed to serve MENA countries well in the past have become stumbling blocks to the future. 34 (.LAIJMING THE FLUTURE FIGURE 2 5 Given income levels, the number of poor is below average, 1990 Percentage of population below the poverty line 80 - - Pred cted oerceniage ot poor 60 St, Lank.d 80 ~~~~~~ t * * ~~~~~~~Brazil -20 25 50 75 10 25 5I 75 230 Average monthly income (purchasing power parity dollars) 24cfe Sample inctudas alt taw- and nm,ddle- conm c::u!rnes for PINt .h oata l, e ava lab e Soe,,ce tihen, Datt anl Rxa tior, I93. Past success was driven by oil and investment The oil boom was an unprecedented time. During 1973-85 one of the largest transfers of income in world history occurred from oil importers to oil exporters-so large as to contribute to one of the most prolonged recessions in the industrial countries. At its peak, the effect of the wind- fall on oil producers was equivalent to a 50% increase in their national incomes. (figure 2.6). The spillovers for the rest of the region (through aid flows, remittances of migrant workers, and FlGURE 'o exports) were substantial and equivalent to a 35-40% The oil windfall was massive increase in GDP for the NIiddle East and North Africa as a Export revenues as a share of nominal GDP (percent), 1973-93 whole. 50 l , The windfall enabled a massive buildup of public invest- 40 ment, in excess of the already high levels prevailing since the 1960s (figure 2.7). The state invested heavily in both human and physical capital. Because of the windfall and government o3 policies, firms adopted capital-intensive technologies, despite the need to create jobs for a growing population. State-owned enterprises were effective at generating growth C73 t9'77 M1 985 989 993 in an era of mass production and relatively little competition, while large oil and other rents meant that non-oil exports cI-nteiiactua 0) estiaei s include Agr, a. Eg,pt, an Iraq, Yernen ln-d the GCC C coflni es and international competitiveness wvere not a priority The M,-IRao.n-d ases tc,5 YESTERDAYS ACHIEVEMENTS. T( DAY'S PREDI( AME NT 35 TABLE '-.I Social safety nets are large and leaky Measure Number of people affected Impact Budgetary cost Leakage Algeria Family a iowance& 6 million Little because of its small size 1.25% of GDP Large. No link between family ncome and eligibi ty School allowance A famil es w th Small because it onlv goes to 0.2% of GDP Large. No link between family income children aged 6-21 famil es contribut ng to and eligibility socia security Health care Available to social insurance Large 2.6% of GDP Large. No link between income contributors and noncontr b- and el gihility utors without distinction Consumer subs d esa Avai able to a 1. Cover basic Large. 2 0% of GDP Houiseholds in the top incomile decile receive foodstuffs, some energy more than twice the subsidy of those in products and public services the lowest dec le, and top five deciles of households rece ve 60% of food subsidy expenditures Public works and PuJblic works provide compen- Cover 7% of the popu ation Less than 0.5% Large. Somne peop e receive multiple cash transfers sation to those able to work of GDP in benefits and cash tranisfers provide 1994 financial support to those unable to work Unemployment Was introduced in July 1 994 to Targeted to the retrenched Not ava lab e Not available insurance facil tate industrial restructuring workers Egypt Food subsidies 87% of the populationi Large, a though some of the 4.8% of GDP Large because most of the popu at on poorest segments are not benefits reached because providing the necessary documlientation is cost y for them Social assistance 2.7 m Ilion beneficiaries Smal -the payment is only 5% 0. 1 5% of GDP None of the absolute poverty line Casual workers 771,000 Total number of benefic aries 0. 1 6% of GDP None scheme represents only 30% of the total poor Electricity subsidy Available to all Regressive (ranges from 86.4% 1.71t% of GDP Large because the ent re population of cost for the lowest to 19.72%i beniefits for the highest consumption groups) Water subsidy All users, but price discrimi- Large 4.9% of GDP Large because higher-income peop e bene- nation is applied n favor of f t by more than their share in the low-so ume users. population Education subsidy Lntire popu ation, to Poorest do not benief t 4.9% of GDP Large because higher- ncome people bene- varying degrees proportiona y fit by more than their share n the population Jordan Education Ent re popuJatiort Poor beniefit proportionately less 5 4% of GDP Large. Benefits are regressive Health care 5 5 million v sits Military personnel are main Llsers 3.7% of GDP Moderate. Those with low incomes pay lower fees Cash transfers to the 22,400 households The program relies on inclividual 0 25% ,of GDP L rmiited because extensive documentat on is unemployed poor assessment and self-select on of requ red and mon toring activities ensure the chronically prior that al beneficiaries deserve the transfer 36 CLAIMING tIHE FIUITURE TABE 2 1I (iCON7iNUED) Measure Number of people affected Impact Budgetary cost Leakage Jordan, continued Fooc coupons All households Self-selection 0 48% of GDP Large Of every Jordanian dinar, only one third accrues to the bottom 20% of the populatiort Morocco Health care Available to all Moclerate There are vast 3 5%!. of Large [he richest 20% of the populaton regional imbalances in total public appropriates 40c10 of pubi c spending in heath expendirrres expenditure health, while toe bottom 40% receive less than 20% Certificates for Aimed, in principle, at g.virig Local aulthorities have insuffi- Not available Large health care free access to basic services cient information to target to the poor eftectively Activitres of Not available Targets needy populatons 0 7% of totai Not ava iable narional inutual a d through nutrition assistance central govern preschool eduIcation, ment budget vocational train ng, and aid expenditures Food support and 2 5 mnillion Poor ch Idren are less likel to 0 5% of GDP Large nutrition programs 875,000 children are bereft since they are m1ore getting food at school I kely to res de in rural areas and not lo attend school Puoilc works Was Initiated in 1961 and Psblic workers undertaken are Not available None. Although there are no progranl employs on average 50,000 irn the areas of agrcultIral established targeting persons annua.ly development, basic onfrastruc- nnechan!s-s, the pub!ic vvorks ture and social eouiomerit program appears to reach the Workers are remunerated at poor the minimum wage and In somte cases partly in food WorAcen's programs 56,000 poor and The programs consist ot vocaton- Not avariable Not acaJlable Illiterate women al training and techn cal and financial assistance to women's workshops and cooperatives Tunisia General Until 1990 subsidies on food, Food sUbsid,es are regressive 2% of GDP Self-targeting mechanisms reduced the compensation an mal food, and fertilizers as a percentage of income leakage, but further steps should be fund were ava lable to all taken to sharpen the effectiveness of the reform DOrect transfers Targeted through inidicators and Services 300,000 preschoolers, 0 43% of GDP Large. fligibility lists are rarely updated, and include food aid in school 5,000 handicapped peoole, In 1994 eligibility criteria are very general Some cafeterias and food rations for 4,700 elderly poor, and people receive multiple benefits preschoolers, financial aid to tO 1,000 needy families the handilcapped and the elderly poor, cash transfers to poor families who need Income support Health care Basic health care services are Provides essentially uniform 5 2% of GDP Large. More than half the population available to almost the entire subsidies to tne enitire enjoys free or heavily subsidized population, regardiess of population health care income Public works Aimed to provide eriTployment The largest and the most About 0 1 2Gh None. Has been effective in targeting the program for the poor in urban and effective programs for of GDP in poor through self-targeting mechan sms rural areas unskilled workers 1994 a Recent reformns to Agenuas plogurni oG anem dy loetsaines a-d consul, e s ,bsdiet nave resited - --provcme-ts -vu,vverer estm nates of te -enpact c these reforrms are not yet ava lable terse van Eeghen 9955 YESTERDAY'S A(CHIEVEMENTS. f()DAY S PREDICAMWENT 37 FIGURE 2.7 fact that many governments were not "picking winners" but Public investment far outpaced private I ki favorites" did not seem to matter where indigenous investment picng Public investment as a share of GDP (percent) private sectors were small and did not constitute a major 25 engine of growth. Most MENA countries could afford relatively generous .C s tsocial expenditures during this period. Enrollments increased 1 / rapidly and expenditures per pupil as a share of national It-5 , * ; income rose to some of the highest levels in the world (figure _th. 'd ', * 2.8). There tended to be a spectrum of educational traditions 5 ,glh p',l1i_,lll11RR:llleton es 1l:rin the MENA region-the more exclusive or elitist tradition 9 typical of Morocco (with low coverage and higher repetition °69 973 9) 7 .7 198 985 939 rates associated with higher quality standards) and the more Private investment as a share of GDP (percent) inclusive or populist tradition typical of Egypt (with high 25 Hgh cti,,.- e access but poor quality). Excess demand for skilled labor in th20,,, Ap-~ an expansionary public sector obscured the fact that many 20 graduates lacked skills relevant to the private market (box 1 \J 2.1). Extensive safety nets, substantial consumer subsidies, IQ Z ^ ** - _ and free health care and education were introduced with lit- R - w ' tie targeting (see table 2.1). MENA lC Hoclre But what matters today is productivity, flexibility, and speed 969 a73 1977 198 985 ana Ntce MENA ncludesAgeria, EFypt ran, liaq Joordan Mclocco The economic crisis affecting the region since 1986 was the Syra and Tuisia.o sll :e uITIani 1993 product of two fundamental factors-the collapse in world oil prices and the decline of productivity. For the oil exporters, the fall in output closely paralleled developments in oil prices (figure 2.9). Investment in MENA countries declined in the 1980s, but the fall in output was more extreme than the collapse of investment- implying that not only did the quantity of investment fall, but so did its productivity (figure 2.10). Economic policies have been slow to adjust to these changed circumstances. The importance of productivity improvements for sustaining growth can be illustrated by contrasting MENA countries xvith those of East Asia (figure 2.1 1). NWhat would have happened to growth if MENA countries (whose per capita incomes differed from East Asia's bv only $80 in 1960) had achieved the same rates of investment and educational attainment as the East Asian "superstars" during 1960-91? Raising the average rate of investment in MENA to East Asian levels-increasing it by 7.6% on aver- age for the period-would have increased 1991 per capita income from 38 CLAIMING THE FITIRE. FIGURE 2.8 Education spending is high, even accounting for young populations Ku ,a t Saud, Arabia Sr. Lanka M-0orocc Japan Malatsia , ngapore Egypt ,aq Qatar Los,a B Ca Israel Iran Bal rain Ka, ea Alger a Venezue a Thai and El Sa ador 1r dan Ho5g KOle Ch I! Er. aacr id-ae s a Untn A4rab Ei-rates Pei D I10 20 31 40 50 to .3 30 Spending per student/GDP per capita Sou:ce Worle d Bank staaf est mates based on United Nations Educat oral. Scrent hc mc(d Crti i,al Oioanizat on ard Vir, c Bank data. $3,342 to $3,863. Adding East Asia's levels of human capital to the higher investment levels results in a further increase to $5,179. Yet East Asian incomes grew over the same period from $1,603 per capita to $8,000. More than half the difference in growth rates (55%) cannot be explained by East Asia's superior performance in accumulating human and physical capital. Instead, it was due to differences in the productivity of using capital. The fierce competition in world markets at the close of the 20th cen- tury requires producers to be fast, to have low costs, and to innovate continuously, as have the successful economies in FIGlURE 2 9 Oil and output go together for oll East Asia. In the past it often took up to a year between the exporters placing of an order for wearing apparel and the arrival of Oil price index (1970= l 0) GDP index (1970= 1.0) the goods at the retailer. Today, it might take days-as suc- 30 .8 cessful companies have learned to be very responsive to 25 DP .4 shifts in consumer demand. Intense price competition has 20 I2 forced firms worldwide to reduce middle management jobs i.i7 by shifting supervision and management functions to work- 0 J to ers with improved qualifications. Competition also drives 04 up quality and consistency standards because customers 0 can easily find alternative suppliers whose products have 0970 1974 978 1982 986 1990 lower defect rates and lower maintenance requirements. Sn,rce R ordar anc others 995 YESTERDAY'S A(' IlEVENIENTS, 'ITO)AY'S PREDICANiEN f 39 BOX 2 Educational quality for a changing world jorclan has one of the best-educated labor forces in the solving" in mathematics and 'integrates" in science. These MENA region, but recent measures of quality indicate latter skills are central to the changing requirements of weaknesses in precisely those skills needed for international work in internatioliallv competitive econonies where competitiv'eness. Jordan is the onlv country in the MENA workers are expected to solve nonroutine problems, adapt region to have participated in international comparative to change by learning, and make decisions based onl an assessments of student achievement. The results show that understanding of the broader context of their companies' of all the countries assessed, Jordanian students scored the priorities. lowest in ter ms of average correct answers on both math and To address these issues, Jordan is developing a system to science achievement tests. Jordan is in good company-its assess and evaluate its educational programs. Under the aus- results are just below those of much wealthier countries, pices of the National Center for Education Researclh and such as Spain and the United States. Development, its monitorinig and policy researclh capacity Most interesting are Jordan's results for ditferent cogni- will enable ongoinig evaluation of whether the educational tive processes. Students performed better on 'conceptual system is teaching the skills essential for the future. understaniding" for mathematics and 'knows" for science (referring to grasp of facts and concepts) than on "problem Source: Golladayv Bcrvman, and Avins 1995. International assessment of educational progress of students, age 13, 1990-91 For mathematics For science (organJ o dan u l ted Slt.es __ Ireland Spa 1n Ur ted Sltes shcZYe -ldasi Ir-e,.cid _ Scot arc Scotia- _____________________ Fr-ance ___________________ Is- e strae Erni a-Romagind, ita,, El,-, ia_Ro__ia- na, It3y Fr-anca _____________________ s oveni a HuriSaryo S.o-e- un on StDa-ea Jnicn HLar gacy switeeS and _ S-- tiar and Ta-an. Ch rt_ Ta -n-an, Ch na kr3ea, Rep. _F Frea, Pep. -' Aveil-cge _ A ol dg 30 40 50 39 0 :X .D 4Q 50 eO . C C a Average percent correct, by cognitive process Average percent correct. by cognitive process io alt. teol-r ob it- t a-pcp y en-ial sl lIs to a crcquc Sitatior Kncc.'- kr-r,-,o edgf bas it. attd :c-cepts. Pi cedralkw n e an 'b tytOpp fact ndo cr epts tc olne outire *Use. ab lito tor,ib n facts th i uae o a spec t c popr ., -oblems d ioid n, t,i 't,,ndg, d p c-dL1-S. i ntegrates dbi it to d ds. roncl1atio -s fro-m a-a ab e data * Co pcpta unde-t,,rnd kec ge kn crt _t a,d cclcepts. oali,- Egdcat orial Test n" an i199I 40) CLMIMING THE FUJTURE Successful firms must monitor the preferences of customers FIGURE 2 UC) closely, constantlv looking for ways of reducing costs and Output fell more than investment- so productivity fell improving goods and services. Investment (percentage of GDP) GDP growth (percent) 36 .3 Past successes sowed the seeds of today's reform predicament esc 6 But the achievements of the past also sowved the seeds of - 4 today's economic predicament. The huge investments in I state-owned enterprise assets-and in human skills no longer relevant to the market place-are the nub of the c l 9 adjustment problem facing most MIENA economies. As in 97 the post-centrallv planned economies of Eastern Europe, o g the productivity of capital has deteriorated steadily under statist strategies in Algeria, Egypt, and Jordan (figure 2.12). FIGURE 2.1 Despite relatively high investment rates, returns to invest- Low productivity accounts for differences Despite relatively high ~~between MENA and East Asia ment declined under policies that thwarted competition. GDP per capita (U.S. dollars) Inflexibility of enterprises and workers. Trade liberaliza- tion, public sector retrenchment, and privatization imply Aooveere( 8,000 considerable losses for a small but powerful minority of the labor force in the short run. This is especially the case for d ,1 3,163 skilled labor in the Mashreq, where secondarv school gradu- 3.3 4 2 ates constitute 80% of the labor force in the state-owned A enterprises and only 20% of that in the private sector. c91 Similarly, in the Maghreb a two-tier labor market has emerged with high levels of pay, benefits, and job securitv f-or P~ 9 a small number of educated workers alongside temporary contracts and minimal protection for the vast majority of FIGURE 2' workers. Exposing such protected workers and firms to Marginal productivity of capital international competition is politically complex. Govern- lorcan ments in some MENA countries are already feeling the 3 5 ypt effects as labor unrest has increased. In Egypt there were 8 4 strikes in 1990, 63 in 1993 (Ibrahim 1994). 03 Weak incenti'ves to be productiVe. The old social con- c2 tract-linking years spent in school to guaranteed high-wage jobs-needs to be renegotiated. Governments are already 94 58 19c3 968 Iq73 978 1983 988 unable to fulfill their part of the bargain. The vast majority Nose Macr',al p,odctv,t'cfaptal-w,pha- Y/Ki, here capital's of the unemploved in the region are first-time job seekers. 'are alpha s estimnated iro,i constant returns to sce Cobb Doug-as production fuInctcn vvt11, t1,ee subperiods (1958c 72 In Algeria, Egypt, Jo , and Syria educated young work- 1973 86, aid l7-90i. Aphla - 2.6o (Agge-a), G603 (Egyptl. ers account for 60-80% of the unemployed. Graduates in 2 ,ce V,W,ocl Bank stalf eslinates NehoLi anc Dhxeish,war 9a3 YESTERDAY'S ACHIET:EIENTS, TODAY'S PREDICAMENT 41 Egypt now have to wait seven to eight years for their public sector jobs, resulting in a deteriorating quality of civil servants since the most talent- ed workers find alternative employment before their turn comes. In Kuwait undemanding government employment has become the mecha- nism for transferring oil wealth to citizens, deterring the vast majoritv of Kuwaitis from taking on productive private sector jobs. Expensilve subsidies anzd triansfers. Fiscal retrenchment in an era of diminishing rents will also involve asking producers and consumers to pay for services that they have always received for free. The situation is perhaps most extreme in some of the Gulf countries, where even token user fees for electricity, education, or health care have met with strong protest. The subsidies involved were often massive-estimates for Saudi Oil and strategic Arabia in 1985 showed a total subsidy bill equivalent to about 18% of rents have enabled GDP (Askari 1990). In Kuwait operating subsidies for electricity and many countries to water alone amounted to 8% of GDP in 1992. In Bahrain electricity sub- sidies amounted to 6.5% of GDP and water subsidies were 8% of GDP ,postpone reform in 1992. The 1995 budget in Saudi Arabia reveals a considerable effort to move toward more realistic pricing. Gasoline prices were doubled. Electricity and water prices were raised for commercial users, although they remain below the real costs of provision. And telephone charges were increased. Why change has been slow WX7hy have countries in other parts of the world been able to overcome the political obstacles to reform while most states in the MENA region still struggle witlh change? El many cases it is because countries in other regions started to adjust earlier because the shocks hit them sooner. For example, the debt crisis in Latin America was the catalvst for a major rethinking of development strategy and the emergence of the "Latin American consensus" on market-oriented reform. Moreover, the avail- ability of oil and strategic rents enabled manv countries in MENA to postpone reform. It is no accident that the countries farthest along in integrating with the world economy-Jordan, Morocco, and Tunisia- lacked substantial natural resource rents. Postponing reforms has meant that interest groups that profit from the old regime are deeply entrenched. Firms that have benefited from protection and cheap credit-and a middle class accustomed to subsi- dized commodities and such benefits as education and well-paying public 42 CLAIMING THE FUTURE sector jobs-are reluctant to see their privileges erode. And many gov- ernments have been slow to respond with better policies, improved ser- vice delivery, and more transparent procedures. Competitive pressures from the world economy combined with Reforms have been domestic pressures for new and better job opportunities are the most successful where likely forces for triggering change in MENA countries. In many of them, leaders have there are the additional domestic challenges of fundamentalism and dis- affected poor and middle classes. Incumbent regimes are sometimes marshaledpoical poorly placed to initiate change because that would assume blame for support technical past failures and undercut important support coalitions. But in other expertise, and parts of the world, reforms have been possible where leaders have suc- external financing cessfullv marshalled domestic political support, technical expertise, and external financing to provide the basis for effective reforms. What is the region's economic potential, and what direction vould these reforms have to take? These are the subjects of chapter 3. YESTERDAY'S ACHIEVEMENTS, TODAY'S PREDICAMENT 43 CHAPTER 3 The Promise of Prosperity Despite the bleak prognosis in previous chapters, there are many rays of The global hope. The world economy is tough, but it handsomely rewards those economy that can compete. The peace process and Europe's Mediterranean presents vast Initiative offer new possibilities for the MENA region. And some coun- .r . tries-such as Jordan, Morocco, and Tunisia-are taking advantage Of opportunfties their potential and reaping considerable rewards. Some aspects of the international environment are favorable The global economic environment, invigorated by buoyant world trade that promises to grow by more than 6% a year over the next ten years. is better than it has been since the 1960s. The speed of integration-the growth of world trade minus the growth rate of output-has risen steadi- ly as trade liberalization has progressed and countries have benefited from greater globalization. The economic recovery in the industrial countries combined with the continuing decline in inflation will mean favorable markets for MENA exports. The tightening of world capital markets has resulted in higher long- term interest rates, and private capital flows to developing countries have decelerated somewhat. Nevertheless, net private capital flows to developing countries are expected to grow on the order of 7-10% a vear over the next decade as savers in industrial countries seek higher returns. If policies remain supportive, growth in developing countries could approach 5% a year over the next decade. For countries positioned to take advantage of the opportunities that globalization brings, the exter- nal environment in the future will be very favorable. But for the ill- equipped, the trends will be adverse as growing competitiveness results in some countries being "left behind." 45 Globalization brings opportunities Taking advantage of globalization begins at home. The best example is the array of new trading opportunities offered by the Uruguay Round. There are two key issues for MENA governments: adopting a trade pol- icy regime that fosters integration into the world economy and establish- ing a set of institutions that make this trade policy stance credible. The World Trade Organization (WTO) can help on both fronts. First, mem- bers of the WTO must fulfill obligations that ensure that trade policies Taking advantage of are largely nondiscriminatory, avoid the use of most quantitative restric- globalization begins tions on goods or the prohibition of market access by service providers, at home restrict the use of export subsidies, eliminate some trade-related invest- ment measures (such as local content requirements or export perfor- mance rules), encourage reliance on international product standards, protect intellectual property, and ensure that rules and enforcement pro- cedures are transparent. Second, the WTO provides a legal mecha- nism-bindings-for countries to signal the seriousness of their commit- ments (box 3.1 ). And lastly, improved dispute settlement procedures pro- vide a mechanism for resolving conflicts. The European Union's Mediterranean Initiative is a strategic opportunity Guided by the fear that poor economic development in MENA coun- tries would cause instability on Europe's southern flank, the European Union (EU) has proposed to negotiate a free trade area with the coun- tries of the Mediterranean. The basic objective is to incorporate the Mediterranean countries into the European Economic Area through a series of agreements, with the ultimate goal of creating a free trade zone in the region by 2010. These objectives are to be achieved gradually, and the European Union has committed to assist in financing the adjust- ment costs associated with free trade. The budget for such assistance amounts to about ECU 9.4 billion ($12 billion) for 1995-99. divided evenly between funds from the European Union and loans from the European Investment Bank. About half the funds are earmarked to pre- pare for free trade (private sector development, trading infrastructure) while the remainder will be devoted to poverty alleviation, rural devel- opment, and the environment. By the end of the century the Mediterranean Initiative could increase official resource flows to the region by more than half. 46 CLAIMING TI IE IIUTIJRE BOX 3 Committing to stay put or to move forward? Liberalization and the World Trade Organization Credibility is the key to reform. especiallv in countries restricted from opening branches that will cause "harmful" that take a gradual approach. A major advantage under competition to existing companiies. the W\'TO is the requirement that a schedule of bound What are the costs of such half-hearted liberalization? tariffs be presented for all industrial proclucts. This The lack of bindings or "policy anclhors" means that investors enables governments to commit themselves to maximum continue to face an uncertain environment as governments tariff rates that can be applied in the future. But evidence send mixed signals about their commitment to trade liberal- from a number of MENA countries indicates that bind- ization. The lack of liberalization in service markets means ings have been used to "lock in" the status quo, not to that MENA producers will he disadvantaged in a context signal further progress on trade liberalization (box table where access to efficient global nervorks in communication, 3.1). transportation, and other services is necessary for interna- Similarly, MENA's WTO members did little to open tional competitiveness. There is thus a real opportunity for their services markets despitc the potential benefits in fos- using WX'TO bindings (as vell as EU association agreements) tering more efficient domestic services and in enhancing to signal selious policy commitments to the private sector. the competitiveness of both goods and services in export markets. Commitments were made bv Algeria, Bahrain, 3jX TABLEB Egypt, Kuwait. Morocco, and Tunisia wvhile commit- Bound and applied tariff rates ments are expected from Jordan, Qatar, Saudi Arabia. (percent) Sudan, and LUnited Arab Emirates. But the only substantial commitmenits have been in hotel and restaurant services. Industry Agricu tire Othersvise, no liberalization occurred, and little uise wvas Post-Uruguay Round bound made of the option to bind policies under the General average tanrff rates (unwveighted) Agreement for Trade in Services (GATS). Even Egypt, the Arab country with the fewvest restric- Egypt 31 61 0. ~~~~~~~~~~Tunisia 27 41 tions on market access and national treatment in the service __ _ _ __ _ _27 4 sector, essentially did not liberalize under the GATS. The Current app/led average share of foreign personnel in foreign-owned enterprises is tariff rates (unweighted) restricted. A maximum of 495,. of shares is set for foreign Egypt 23 ~~~~~~~~52 capital in such industries as constructioni and related engi- Tgypt 33 40 neerinig services, totirism projects in the Sinai regior, alld insurance. Foreign banks and insuLalnce companies alre Souice Hoekrnan 1995 The Mediterranean Linitiative is strategically important for both the European Union and the MENA countries. In the European Union, the southern countries of France, Italy, Spain, and Portugal are seeking to counterbalance the eastward expansion of the EU led by Germany. just as U.S. firms have used NAFTA to subcontract lower-cost Mexican pro- ducers, and Germany has used association agreements with Central European countries for outsourcing to gain competitiveness, the south- ern European nations seek to build similar mutually beneficial relationls with their Mediterranean neighbors. For MENA countries the Mediterranean Initiative implies a major shift in the development paradigm-and a commitment to realign poli- cies, institutions, and companies in the direction of Europe. It is the 'T'HE PROMISE OF PROSPERITY 47 same strategic choice that such countries as the Czech Republic. Greece, Poland, and Portugal have made. Joining the EU block gives MENA countries preferences relative to Asia and levels the playing field relative to Eastern Europe and Turkey. Moreover, deeper links with the European Union imply financial support for adjustment costs, greater credibility of policy commitments, and the possibility of attracting greater investment as part of a larger market. Wages in most MENA countries are a fraction of those in most European countries, implying substantial potential for competitiveness. Consider the Central and Eastern The export payoff European countries, which have penetrated the European market (from a verv low base) and are reaping the benefits (table 3.1). from harmonization-- can be surprisNot much can be expected from the European Union in market can be surprisingly access for sensitive products (like some agricultural goods), although large such improved access could provide immediate benefits to many MENA exporters. Nevertheless, improved market access is not the main benefit of the EU agreement over the long run. The key is that the agreements provide MENA countries the opportunity to "lock in" policy commit- menits and begin to harmonize domestic laws and standards with inter- national norms-making it easier for domestic producers to penetrate foreign markets. The "export payoff" of such harmonization can be sur- prisingly large (box 3.2). Using the next decade (as the Multi-Fibre Agreement is phased out) to improve productivity and move to higher value-added activities in the European market is a way to ensure that MENA countries get to participate in the prosperity brought by the growth in world trade. Moreover, because the EU agreements will create strong incentives for Mediterranean economies to open up to each other, greater intra- TA3LE 3. Eastern European economies have exploited outsourcing from the EU (net exports as a share of total exports to EU) Central and Eastern Europe MENA Export 1989 1993 1989 1993 Leather 38.9 34.5 8.0 8.5 Garments 60.8 74.5 15.6 11.1 Machinery 8.1 14.4 5.4 2.6 Transport 12.3 4.7 4.5 2.3 Instruments 6.4 11.9 6.5 2.5 Furniture 26.5 13.9 1.2 1.5 Tota 10.4 17.9 1.6 1.7 Nwte Net enports nc Code- al adIstmin-int ftO Cl.iOt.1 fl2n. M E NA dcone m-t Akire Ban ali- , aiI, Oman, Qatar and 'terneni. -c,]C. HDekrman '95 48 (CLAtMIN(G TFIE FUTURE BOX . 2 The benefits of free trade agreements? Not necessarily what you would expect Recent studies of the impact of free trade agreements harmonization and improved trading infrastructure. with the European Union on the economies of Morocco Furthcr export gains can he attributed to the real and Tunisia produced some surprising results (Rutherford. exchange rate depreciations that are induced bY trade Rustrom, and Tarr 1993 and 1995). Despite the fact that liberalization. Mlorocco and Tunisia already have preferential access to Although the estimates of welfare gains appear small- European markets (without having to reciprocate bv giv- 1.5%X/ of GDP in Morocco and 4.7'Y% of GDP in Tunisia- ing European producers access to their own markets), the these gains persist everv vear. To give a sense of the magni- welfare gains from a free trade agreement are large. The tudes, if Morocco per capita income without the free trade reason is that the bulk of the welfare gains stem not from agreement were $1,400 in 2004, it would be $1,600 with the reduction of tariff and nontariff barriers but from the the agreement, reflecting the compounding of wvelfare gains gains in competitiveness that result from the harmoniza- over the years. More dramatically in Tunisia. per capita tion of standards and the reduction in trading costs from inconmes would increase by about 60`L)-to $2,800 in improved infrastructure financed by the EU. In Tunisia, 2004-as a result of the free trade agreement. for example, three-quarters of the welfare gains in the Perhaps the most striking finding is that the benefits short run and more than half in the long run come from increase even more when free trade agreements are com- bined with unilateral trade liber- alization. If Tunisia were to BOX FGURL 3 undertake full trade liberalization Free trade agreements and unilateral trade liberalization with the rest of the world, the produce significant benefits welfare gains would increase to Real GDP per capita (U.S dollars) 5.3%5r, of GDP in the long run. In 3,000 Ovl -3,0 Morocco the combination of an 2g'',U 5% agreement and liberalization -ate;ce -2,i, of tariffs with the rest of thc 2.500 wo \vorld increases welfare by 2.5%, of GDP The cumulative impact is reflected in per capita incomes 2.000 rising to almost $1,800 in , *unsa , 1 M300 Itvorocco and $3,000 in 'Tunisia _, - - ' '>,m,-, (box figure 3. 1). These welfare 1, 500,. oo gains are achieved with verv low additional adjustment costs for oo ,00 - -M=',,ocCo <1'1e, labor and capital becatise less trade is diverted to higher-cost 991 1 096 .998 200 2002 250G stippliers in the EU when liberal- "V\orlca Bnk stafie5 rn 5 ased nR o,eKo,d Rusito-, uscTar 1r093a arc ization is comprehensive. regional trade among MENA countries is a likelv by-product of the process.1 The peace process will reduce perceptions of risk in the long run Much of the talk of "peace dividends" is exaggerated. MENA's military spending as a share of GDP is the highest in the world, but it is fueled by more than the Arab-Israeli conflict-conflicts in the Gulf region have been an important source of higher military expenditures in recent years THE PROMISE OF PROSPERITY 49 (table 3.2). It is thus unlikely that there will be sharp reductions in arms spending, even in the medium term, although over the long run the grad- ual decline in military expenditures is likely to continue. Substantial rewards for peace in the form of aid, like that for Egypt after the Camp David accords, are also unlikely to materialize in an era of donor fatigue. The biggest potential dividend from peace is a reduction in per- ceived risk for the region. Private investors' subjective assessments tend to rank MENA countries as risky because of the persistence of conflict and civil strife, rather than because of commercial risks. For some coun- Peace will reduce tries, being in a region perceived as being in a "risky neighborhood" has the region's adverse effects on country risk. These risks translate into lower invest- therceived risksment and higher interest rates for international borrowing. Political risks perceived risks also affect expectations about the stability of policy and the revenue from such key growth sectors as tourism. Many of the conditions in MENA are favorable Many of the basic elements of competitiveness are there Most countries in MENA are advanced in stabilizing their economies and are at various stages of implementing structural reforms. Unlike many Latin American countries prone to high inflation, MENA coun- tries have been characterized by macroeconomic stability in recent years (table 3.3). Much of the windfall of the past xvas invested in infra- TABgL 3 2 MENA countries excel at spending on the military, 1992 Millions of US dol ars Per capita Share of Country (1985 prices) (US dollars) GNP (percent) Kuwait 10,185 5,000 62.4 Oman 1,498 943 17.5 United Arab Emirates 4,249 2,418 14.6 Saudi Arabia 14,535 1,371 11.8 Jordan 586 133 11.2 srael 3,984 783 11.1 Yemen 682 59 9.3 Egypt 3,427 60 6.0 Lebanon 18 7 5.0 Morocco 692 27 4.0 Tunisia 355 42 3.3 Algeria 1,592 59 2.7 Al developing countries 119,350 31 3.5 'ace K.v.wa t'- level orf mi tart, spendirng v_s enceptiona hih in th,e ake of the Gulf /i a j 499D. Frm the m- d 980s to I c99 Ku-ait s ra it :la spenid vp as a share O' 52P rangeG front 5 pe -ent tso percent. Ssta'ce Iriteinat onal rst l ie for Stratearn Stud es 9°3. 50 CLGAMING THE FUTURE structure-so MENA households have adequate access to TABLE 3 3 Macroeconomies are stable in relative telephones, electricity, paved roads, and safe water, although terms quality is still an issue. Risks of contract repudiation or (percent) Average annual expropriation are limited in MENA, though measures of the Avnerage depreciation or annual rf ation,a clevalUation, quality of bureaucracy indicate problems in some countries. Region 1988-93 1988-94 Nevertheless, the region as a whole ranks higher than Latin Maghreb 10 13 America, South Asia, and Sub-Saharan Africa in several Mashreq 16 84 GCC 3 0 institutional investor ratings. Sometimes this reflects the MENA 10 34 existence of well-established mechanisms (such as commer- LAC 319 255 South Asia 1 2 8 cial agents or legal advisors) to steer investors clear of what East Asia 7 2 would otherwise be a difficult business environment. a. Cc,j,ted f,anr the onsure,r price nc * * * a X r . j~~~~~~~owP- Vvoi^,ld B.rl. d,,ta Some of the legacy of past policies has also been posi- tive-with a large human resource base in most countries. MENA countries have invested heavily in human capital-public spend- ing on education is higher than that in any region in the world. Large portions of GDP have been devoted to education in countries like Saudi Arabia (10.6%Yo), Jordan (6.5%). Egypt (5.5%), Tunisia (5.4%), and KLuwait (5.1%). Those investments are beginning to pay off, with the mean years of schooling in many MENA countries approaching that in other countries at similar incomes (figure 3.1). But as with infrastructure services, the varying quality of education has emerged as a key issue for future competitiveness. Manv countries have a strong entrepreneurial tradition that has been channeled into unproductive rent-seeking and trading activities as a result of the structure of economic incentives. This could be redi- rected. And nascent clusters of competitiveness exist in some areas (box 3.3). Financing is available for those committed to reform The flip side to the substantial capital flight from the region is that large foreign savings held abroad could finance new investment if the domes- tic conditions for investors improve. Investors in several countries have already brought money home. In Egypt private capital inflows amount- ed to $31.5 billion betveen 1987 and 1993 (including remittances) after a successful stabilization program vwas initiated in 1987 (IMF 1994a). In Lebanon private capital amounting to about $16 billion flowed in between 1989 and 1994 after the civil war ended. But in both cases pri- vate capital flows are largely financing needed reserve accumulation and T HE PROMISE OF PROSPERITY 51 FIG:1URE 3.1 Average education levels are approaching those of comparators Co-ta _i S flaipore y^h le Peu - Bczlwd S, i La,ka Malays a Ecuado- Thai andD E S:al, ido, jol dar- Tundons a Frazil Iraq aged a Iran D 3 1 5 m . Mean years of educarion | F,r oiarf Sez-^r-,ac.y Tar, arc 3CI/;. Mel, iEVri;ci, a i' L~C>eP I3r International capital short-term government debt at high interest rates to finance sizable and official finan g deficits. Only a small portion has gone to direct investment-$4.3 billion and offcial fiancing in Egypt and $2.0 billion in Lebanon-evidence that the investment cli- are available mate is not vet sufficientlv attractive for private capital to make major, long-term commitments. In addition to financing from nationals' savings abroad. interna- tional capital is available to finance new investment and adjustment costs, but only to serious reformers. Private capital flows to developing countries amounted to a staggering $158 billion in 1993. But it was concentrated in a handful of countries in East Asia and Latin America that had made substantial and sustained progress on reform-55% of the aggregate flow went to China (23%), Argentina (14%0), Mexico (.10%), and Brazil (8%). Official financing is also possible, particularly from the European Union, but that too will increasingly be tied to eco- nomic performance. 52 C(LUINtN(G.THE FUTURE BOX 3 3 Building on existing clusters of firms to gain competitiveness In many parts of the world groups of firms Italian shoe cluster or "clusters" have been an important source of competitiveness. Northern Italy,',s- - -- I- Southern Germanyv and Catalonia in Spain a 'itt shres - 5h nior F. LsI,r)w: have industrial districts in which small firms K specialize in different stages of the ptroduc- F F ' - - -- tion process, both competing and cooper- _e1,e! .'-c L C . s es 5ei e.ll f, r'Ah .sle ating in markets. Althouglh many of these 1 - - - - -- clusters produce goods such as shoes and L - - r | textiles (usually associated with low wages), Leae :,,lzr>g r flLeather shoes - rl, h Ino T -.M. , tr, p they manage to generate hligh value added _ _ _ l | and hiigh wvages by concentiating on high U | quality. The success of these industrial dis- r r c[rite -sci tricts has becn based oni stmazll scale and hLatlh I3 -lba-,- - - -,, -, flexible production, continuous innovation, - vertical (supplier to purchaser) and hodi- r I 1 1 zontal (rivalroLs) relationshiips, and mutual Ia in Vo Was hztnc; - t l trust and strong interfirm relations often . - I - - led by a local authority or professional asso- l - - - ciation. Similar clusters have emerged inr l i s 5 boei Lot - - Speca re,e:r some developing countries: the footwear clusters of Sinos Valley in Brazil, Trujillo in r _ I Peru, and Agra in India: the textiles clusters in Deagu in Korea and Ludhiana and Ate s J Mode - Wwowe :g Tirupper in India: and the diamond polish- - ing cluster of Surat in India. In Mlorocco a geographically concentrated leather and textile industry in Fez and Casablanca has a tradition of high-quality handicraft production and a bazaar culture of Moroccan shoe cluster business relationships based on mutual trust. But it has not h F r -- yet emerged as a competitive cluster because of a lack of | %P » eis, e-J r t (th | technological innovation, institutional infrastructurc, and I_ v - L cooperative solutions. The most striking difference I t r between Morocco's embryonic leather and shoe cluster Hao>rdb-. _ 1j Kr ,I and that of the world-famous Italian leather and shoe - - - industry is the absence in the Moroccan industry of the - -- r- - L - more sophisticated functions-such as design, dies, and 7B- c, Leater shoes c.,11,-- specialized equipment-necessary to innovate and pro- L - L I duce higher value-added exports. To develop this potential -V in Morocco, a tripartite comnmittee (private sector, govern- I' ment, and the World Bank) has been established with sup- port from the European Union to identify the missing components of export-oriented clusters and to find private Fasr,:te,,'i sector solutions to improving the export potential of these t l firms. Sotrce: Pyke, Becattini, and Sengenberger 1990; Nadvi and Schmitz 1994; and Ettori 1995. THE PROMISE OF PROSPERI T' 53 Jordan, Morocco, and Tunisia are beginning to reap the rewards of reform The diversitv of economic strategies in MENA countries is probably greater todav than at any time in their recent history. While almost all the region's countries adopted statist strategies in the 1960s and 1970s, a few have adopted a different strategy-Jordan, Morocco, and Tunisia are notable examples. Lebanon is the major exception: throughout its histo- rv it has had a private sector-dominated economy, held back by political Jordan, Morocco, instability. HIow have these early reformers in the MENA region fared? and Tunisia have Jordan, Morocco, and Tunisia all instituted reforms graduallv. But unlike many of their neighbors, they have been fairlv consistent in the been consistent, direction of reform, building credibility over time. None of the three was building credibility a major oil exporter and, with the exception of phosphates inJordan and over time Morocco, none could draw on sizable rents to finance the public sector. Remittances from workers abroad were important to all three, but because there were profitable opportunities for the private sector at home, capital flight was low by regional standards. All three began their adjustment programs in the 1980s with macroeconomic stabilization, deficit reduction, trade liberalization, and structural reforms in pricing, regulation, and financial market development. The payoffs to these policies are obvious (table 3.4). All three coun- tries-Jordan, Morocco, and Tunisia-have experienced faster growth in incomes, exports, and jobs than have other countries in the region. And foreign investors have shown confidence in the business environment. Education levels in Jordan and Tunisia are relativelv high (Morocco still lags), and poverty is at fairly low levels. Jordan and Tunisia, unlike Morocco, relied heavily on human resource development as the basis of their strategies, evidenced by the data on mean years of schooling. On virtuallv every indicator of human resources-life expectancy, enrollment rates, infant mortality-Jordan and Tunisia are exceptional performers, by both regional and interna- tional standards. Even when controlling for per capita income, thev have above-average social indicators (figures 3.2-3.4). Adjustment costs are significant, but often lower than expected HIowIO severe have the adjustment costs been for these countries? Unemployment rates have been high in the 1990s-13% in Jordan, 12% 54 CLMMNIIING THE FU'TFUE in Morocco, and 16% in Tunisia-but no higher than those in other countries in the region.2 Real wages have been flat in all three, but Economic strategies employment has grown substantially. In Morocco and Tunisia many low- in MENA countries wage jobs were created in export-oriented industries that were crucial for reducing poverty. Capital-labor ratios have remained low in Morocco and Tunisia as labor markets have given investors incentives to create jobs, unlike the situation in other countries in the region, where labor market regulations have encouraged investors to substitute for labor (fig- ure 3.5). TABLE '4 Jordan, Morocco, and Tunisia have had better economic results (percent, unless otherwise indicated) Per capita Non-oil Average FDI Population GDP growth exports annua inf a- inflows/ Mean years spending less rate, growvth rate, tion rate)a GDP, of schooling, than $1 a day, Country 1990-94 1980-93 1984-94 1993 1987 1990 Jordan 0 39 4.3 5.33 -0 65 5 1 2.601 Morocco 0.70 3.8 5 73 2.00 2 2 49 Tun sia 2.10 10.5 6.00 1.63 5 2.89 Algeria -2.33 4.5 18.00 0.03 4 1.16 Egypt -0.72 0 5 14 80 1.20 5 5.60 Iran -1.04 -1.0 20.50 -0.05 4 8.94 i. Using GDP detlator b Tl s estimte i3-. dcne 3t he tri-e o the Gu t w^a HI gear g cites lre ither hase pr obsb educec pover 'iil loldan So,- i odd BK6 dit. v- Eeg'en 1995. F GUPE B. Jordan and Tunisia do better on life expectancy Life expectancy (at birth) 70 :ltd -h * * e. 41 45r 2 .000 4,00e0 8000 5V00cm Per capita GNP based on purchasing power parity dollars ores L ie represe -ts egressicn ect mate for a, I ct atd im dde e- oriae coint es. shsi'-e Sitk eS, 4 THE PROMISE OF PROSPERITY 55 Who gains and who loses from further integration into the world economy? In general, sectors that are tradable gain, while those that are nontradable lose, but the effects are quite country-specific (table 3.5). In Tunisia the textiles sector is a major gainer, doubling over the long run. In Morocco textiles suffer (but only in relative terms) compared with FIGUPE 3 - Tunisia's primary enrollment exceeds the average for its income Primary enrollment (total) 20 I OC 4 ,C Nt:LIO(e rep,set- *ge~o etate, al,l lu-adndeino-on,e '~~~~I,Durce *Sl~iaf 4 14C~ 62, 90 O_000LG 4,060 6 DOO - DOO 2,00D Per capita GNP based on purchasing power parity dollars Nocte. L ine represents egress n est iaita or all oa'- dna 11 dd e ir,come cauntr es S.Lr(e SIia k I99 , IGI NTPE 3.4 Tunisian and lordanian infants are less likely to die Infant mortality per 1000 live births 60 140. 100' 80 eO~~~~~~~~~~~~~I 40' 2 000 40O00 6,000} 8 200 I020 2,000 ZO) Per capita GNP based on purchasing power parity dollars roeLle lepresenzts r-epess car estonatse ior al c.v- ard micdle-r come ccuntries Soa,rc. S'aSk 1994 56 (CLALIMINC THE FUITURE phosphates, which are the biggest beneficiary. In the short run, 2.1% of TABLE 3 5 Impact of free trade the labor force will have to change jobs in Tunisia, but in the long run as agreements on employ- many as 8.8% will change jobs. These adjustment costs are significant, ment in Morocco and Tunisia but unlike the cumulative welfare gains from trade liberalization (see box (percent change in labor use) 3.2), the adjustment costs are one-off. Sector Morocco And what have been the dislocations caused by privatization? The Textiles -3.7 few instances of privatization in the MENA region have had negligible Cereals 59.4 91 ~~~~~~Meat and dairv -52.0 effects on unemployment-often because the firms chosen for early sale Phosphates 68.5 Eiectnica. eqiiprrent -6.1 were better ones not plagued by overstaffing, as in Morocco. In Tunisia, Leather and shoes 10.9 too, the effect on employvment has been fairly small. Only 4% of the Tradnseport 2 .2 6,483 workers in the privatized state-owned enterprises were laid off, Sector Tunisia 46% were transferred to the new purchaser of the privatized enterprise, 16% departed voluntarily with severance packages, 29% retired, and 5% Temxicals 26 0 were transferred to other areas (Saghir 1993). Agr culture -6.5 Private services -8 1 Electrcal industries -5.5 Reform often has been good for the poor Manufactures -6.9 Reform often has been good for the poor ~~Trade 6.8 Transport -5.9 The success of Morocco and Tunisia in reducing both the percentage and 3c'RLPthe loid, Rustrom dce Tarr 1 993 the number of poor reveals the gains from good policies. In both coun- _ h25 tries poverty was cut nearly in half-exceptional performance by inter- national standards. In Morocco reductions in the povertv rate were par- ticularly sharp-decreasing from 22% in 1985 to 11% in 1991 in rural FIGURE 3 5 Morocco and Tunisia have created more jobs with lower capital-labor ratios Capital-labor ratio (1970= 100) 40C 35C 400~~~~~~~~~~~~~~~~~~~0 50 97Q 9. -Q 1 07 6 q~ 9. 1 9Ed 1 9t32 a84 95t 1 933 99D SrceWoa-ld Bank staffestmates based on data firrn-, Nehi-u alid Dhllesh,r al 19'-3 'I HE PROMIS1E O)F PRO)SPERI' areas and from 9% to 3% in urban areas (table 3.6). Some of this reduc- tion in poverty can be attributed to the fact that 1990 was a vear with good rainfall, hence the especially sharp reduction in rural poverty. The creation of many low-wage jobs and the rise in female participation rates in the labor force made important contributions to the incomes of poor households in both countries. More recently? a series of droughts may have worsened Morocco's poverty performance, particularly in rural areas. The outcome in Jordan is more complex since the adjustment peri- Adjustment costs od was accompanied by a major external shock-the Gulf war-which are manageable caused a massive drop in output as well as an influx of unemployed labor. Both had severely negative consequences for the poor. The per- centage of poor in the Jordanian population increased from 2% in 1987 to almost 16% in 1992. This deterioration occurred despite Jordan's impressive achievements in the social sectors-school enrollments and health indicators in Jordan are among the highest in the region. Nearlv all the increase in poverty in Jordan wxas due to the 8.8% contraction of GDP between 1986 and 1991. But output growvth of 16% in 1992 and 6% in 1993, combined witlh falling unemployment, is likely to have improved conditions for Jordan's poor. Poverty reduction in MENA tends to be responsive to growvth, and when combined with effective social policies, as in Tunisia, the effect on human welfare is dramatic. In addition to having one of the lowest rates of income poverty in the world, Tunisia has provided its citizens with social services that have generated some of the best social indicators in the region. The average Tunisian citizen lives longer, has fewer children die, and is more likelv to have basic education and be literate than any country in MENA at an equivalent per capita income. A large part of these achievements stem from a long-standing commitment to female education and the provision of services and opportunities to women. TABLr `. Morocco and Tunisia have reduced poverty substantially Morocco Tunisia 1984/85 1991 1985 1 990 Head-couoit index 6.06 1.64 4.63 2.89 Poverty-gap indexa 1.62 0.23 0.89 0.64 Squared poverty gap indext 0.82 0.06 0.31 0.28 Uorv. Poverty is defined as a.erage spend na of eas thar $ a da-v at 985 purchasing powee part-s a The -horfa I in enperditaire itrnm the pcve ty ine) c the aver ae poor, per son, exp essec as a pevcenta_e la the pcve tY ine b. A rrecs.re et the distr- b[t'Jr or inCo ra re ot those be ovv tae pov. e i- I e. Jlitre var Eeghen 1995 Chen, Dan. -nd Pave. or 993. 58 CLAIMING THIE FUTURE Better resource management can have high payoffs Protecting the environment has been an important avenue for achieving efficiency and productivity gains. For example, energy intensity in Morocco and ITnisia is about half the MENA average, implying less energy-related pollution per unit of output. A major reason for the high- er energy efficiency in these tVO COuLntries is higher energy prices that reflect economic costs. Gasoline prices in 1992 were about $0.83 a liter in Morocco and $0.58 a liter in Tunisia-compared with $0.25 in Lebanon, $0.14 in Saudi Arabia, and less than $0.05 in Iran. 3 Fuel con- Jordan Morocco sumption per vehicle in Morocco and Tunisia is less than half the average and Tunisia still have in the non-Gulf MENA countries and less than a third of that in Iran. im Prices of industrial fuel oils are also substantially higher in Morocco and portant reforms Tunisia than in most MENA countries, providing incentives to conserve ahead, but are energv in the industrial sector. moving in the Jordan, Morocco, and Tunisia still have important reform agendas right direction ahead. All three countries need to improve productivitv to meet greater competition from Europe as they enter association agreements. Morocco needs to achieve much more on its social agenda, especially education of girls in rural areas. Jordan and Tunisia must learn to better manage envi- ronmental fragilitv. But all three countries are moving in the right direc- tion and provide examples of the way forward for the rest of the region. Notes 1. If the European Union only negotiates bilateral free trade agreemelnts witvh countries of the Mediterranean, a '"hub and spoke" pattern will emerge, providing strong incentives for investors to locate in the '"hub" in order to have access to the markets in the "spokes." To avoid such a diversion of investment, countries in the Mediterranean will have strong incentives to open up to each other (Hoekman 1995). 2. Unemployment data for Morocco are from 1991 and for Jordan and Tunisia are from 1993. In Jordan unemployment fell from a high of 19% in the immediate aftermath of the Gulf war in 1991 to 13% in 1993 as returnees from the Gulf were gradually absorbed into the labor force. 3. Gasoline prices in Saudi Arabia were raised to $0.16 a liter in 1995, which is close to the world wholesale price. THE PROMISE OF PROSPERITY 59 CHAPTER 4 From Politics to Economics "The strelngth of a country. i's no longer measured by its military ;ingbt, size of population, geographical situation, or miciteri'il resources. The strength of a counitrv1 is neasured b the wvealth of its scholars and its scienitists, b, its i1niZo- vati've capabilities and ability to discovet; achikeve, and apply. Naguib Mahfouz, 1994 Now is the time for action Most countries in MENA have relied on gradualist strategies-some- times sacrificing growth for lower adjustment costs. But in the new, fast- paced world economy, gradual reform may mean no growth (given the Reforms must be mobilitv of capital) if countries lack credible policies. And half-hearted or credible and stop-go approaches to reform are a sure wav to lose credibility Attracting investors usually requires up-front commitments, and promises about the consistent future direction of economic policy are adequate only if thev are made bv credible public institutions with a clear long-term reform strategy. Catching up in the future will become more difficult because trade and investment linkages are increasingly self-reinforcing. Emerging as com- petitors are some of the world's lowest-income countries-India and China-whose real wages are a third to half the average in MENA coun- tries. Onlv a few countries in MENA (like Egypt and Yemen) have low wages that can compete at these levels. Competing will be more difficult because serious demographic pres- sures will coincide witlh an increasing scarcitv of public resources. During 1970-93 MENA's population growth rate was the highest in the world- and at current trends the region's population will reach 400 million before 2010. The age structure is very young, with half the population under the age of 15 (World Bank 1994a). Greater demand for education and social services from a young population will result in severe financ- ing pressures. Reducing educational quality or access is not an option for relieving the pressures since enhanced skills are the kev to higher 6 1 incomes in the future. The impetus for reforms that create good jobs and improve welfare can onlv increase (box 4. 1). The "pressure points" in box 4.1 spotlight the losers from the lack of reform and growth-and their numbers are growing. The costs of inac- tion are growing witlh them. In many countries in the MENA region, those interested in new job creation (the unemploved and those enter- ing the labor force) now outnumber those interested in the preservation of old jobs (those employed in the state sector). In several MENA coun- tries the number of potential winners from structural reform are far Potential winners greater than those who stand to lose in the public enterprise sector. Even from reform far under conservative assumptions about surplus workers in the public sec- tor as a whole (including the civil service), the winners alwavs outnum- outnumber the ber the losers by at least three times. In Egypt, for example, the poor potential losers number 3.2 million and the unemployed another 1.7 million, xvhile those BOX 4 Pressures for reform are mounting Most MENA couLitries are at a critical julicture where simultaneous pressures are emerging: * WVhile the region's population is growing at 2.7',,% the labor force is growving at a much faster 3.3%`, Jobs for 47 million new entrants into the labor force will have to he found by 2010. * The number of unemployed in the region stands at 9 million. By 2010 thev will num- ber 15 millioni if the current high rates of unemployment persist. * Rising productivity in agriculture is likelV to free up even more labor from rural areas to join the ranks of the uLnemployed or the urban informal sector. * Real \vagTes remain stagnant at 1970 levels. * Current projections for GDP growth indicate that the number of poor (those living on less thani $1 a day) will rise to about 15 million by 2010 if reforms are not intro- duced. Unemployment usually exceeds 10% (percent) 23 S AI,mera Hn1t,-oce T.ris,, dr t ,er Egypt A'oVerts s r ra Beraeet I 'an Nw,tc Some scurces report '-diet onet'ploynt rt et based urt cHfeceot deiniteons ol untorpcot-erlt U emple'aIcriorrt -ri.rrers al-e fO a9 except ir Turis a ( 903), Vest Banik and Gaza t 993-5 arid Ye't...e&t ( 91) ' A' :e. aIo Baeik data. 62 CLAV%IING THE FUTURE with protected jobs in the state-owned enterprises number only about 1 million. Obviously not all the "potential \vinners" would be winners-the chronic poor are always difficult to reach, and some of the unemployed lack marketable skills. And not all "potential losers" wifl lose since some employees in the public sector will keep their jobs or find good alterna- tive jobs in the private sector. Experience elsewhere indicates that struc- tural reforms necessarily involve some job destruction, but that it would be more than made up for in new jobs created as a result of more effi- cient investment and higher growth. Choosing to be prosperous Perhaps the greatest change in today's world is that no countrv is des- No country is tined to be poor because of a bad endowment of natural resources, an destined to be poor isolated location, or a concentration on certain products. Production, finance, and trade have changed such that human talent is more impor- tant than natural endowment, agility more than location, and quality and innovation more than mass production. The implication is that countries can choose, through their policies, wvhether to be rich or poor (box 4.2). BOX -42 Portugal and the European Union: A model for MENA? Portugal's per capita income in 1970 was $790-well below Portuguese manufacturing and sersices. both of xwhich grewk the MENA average and onli slightlv exceeding that of the rapidly The economic response xvas significant during poorest states, Egypt and Yemen, today: Throughout the 1986-90 output grew by 4.4.', investment increased by 1970s Portugal's policies closely paralleled the statism in the 43i°,, and unemployment fell to 6.4/%. MENA region-a leftist coalition government naitionalized The negative effects on Portugal's trade balance were private holding companies. expropriated land, and restricted offset bK rxvo benefits-transfers from the EU and foreign foreign direct investment. Persistent balance of paymients direct investment. Transfers from the ELJ amounting to crises forced the government to turu to the International almost 4%X, of Portugal's GDP helped to cushioni the ad just- Monetary Funid in 1977 and 1983. But the economv contin- ment to a more competitive environment. Everv fourth escu- ued to flounder with current accoulit deficits of 14% of do spent by the Portuguese state in 1988 came from the EU GDP, unemployment at 12'.%, real wages falling by 17" in cohesion policy coffers such as the European Social Fund, 1983-85, and stagnant private investment. European Investment Bank, European Regional Develop- After eight years of negotiations, Portugal acceded to the ment Fund, and the short- and medium-term funds for bal- European Union in 1986, and a serious elfort at structural ance of payments stipport. More important, foreign invest- reform was launched in 1987. Economic policy focused on ment boomed. increasing threefold in1 the second half of the fiscal consolidation and tax reform, privatization, easing reg- 1980s as Portugal's business climate improved. The ulations against dismissal, and promoting growtli. Portuguese experience contrasts sharply with Greece's, What was the impact of joining the ElI? The trade bal- where there has been little structural adjustment, stagnant ance worseined as barriers were removed and imports from foreig n direct investment, and continuing heavy dependence the EU flooded in. Trade diversion wvas smaUl (less than 1' on transfers from the European Unioin. of total trade) and concentrated in the agricultural sector. The benefits of trade creation were concentrated in Source: Axt 1992. FRONI POLITICS TO ECON()NIICS 63 For too long the MENA region has squandered its potential. Political energy was spent on regional conflicts and rivalries rather than on eco- For too long the nomic development. Oil wealth was sometimes misspent on activities MENA region has with low social returns but high payoffs for a few. Large investments in squandered its human capital were underused because of misguided labor market dis- potential tortions intended to help the disadvantaged-who eventually became the privileged. And the region's endowment of natural resources wvas mined to fuel this process. That era is waning. The peace process. with all its vicissitudes, is bound to reduce the political risks in the region and make space for more deter- mined efforts at economic reform in the long run. The domestic voices for change are growing more numerous. To attract private investment, all countries xvill have strong incentives to liberalize trade and offer access to the vast EU market through association agreements and to the numerous regional markets by forging cross-regional association agreements. An ambitious vision What could the region look like for the next generation? Achievable social and economic goals for the MENA region are shown in table 4.1. The social goals imply longer and healthier lives and a better-educated popula- tion. These inmprovements, desirable in their own right, also contribute to higher levels of output and reduced population grovth. The targets are fea- sible because they are consistent with improvements achieved in the past. Egypt, for example, already has managed to reduce its infant mortality from 145 per 1,000 live births to 66 in a 25-year petiod. Tunisia did even better, with a reduction from 145 to 41 between 1965 and 1990. Similarly, the gains in life expectancy are not unusual-in both Jordan and Tunisia people can expect to live 67 years. The educational goals also have prece- dents-Tunisia reduced the illiteracy from 80% in 1965 to 35% in 1990 TABLE 4 I Major economic and social improvements are possible Infant mortality L fe expectancy at birth Illiteracy (percentage Gross secondary school (per 1,000 live b rths) (years) of tota population) enrollment (percent) Region 1990 2010 1990 2010 1990 2010 1990 2010 Mashreq 70 32 60 71 48 25 76 85 Maghreb 64 36 64 72 45 20 48 70 GCC 23 10 71 75 29 15 68 80 S'0-ce. Diman and Squ r-e 1992 orld Bank dact. 64 CLMNIIN(G THE ItUTUJRF and Algeria increased secondary school enroHlment from 6%(, to 61% between 1965 and 1990. Economic projections indicate that, despite having to accommodate 120 million more inhabitants by 2010, per capita incomes in the region could double in the long run. This ambitious target assumes that per capita growth rises from 3.5%/ in the 1990s (as reforms are undertaken) to about 5.0% in the later years. A more probable "base case" scenario is per capita growth of about 2.5% (which translates into a still sizable 5% growth in GDP), resulting in a 50% gain in per capita incomes by 2010. These levels of economic performance are achievable-almost even, country in the region experienced per capita growth rates of 3-4% or more between 1965 and 1980 and many East Asian economies have sus- tained even higher rates of growth. But achieving such growth rates now will mean that the economies of the region will have to look quite differ- ent from today Promoting non-oil exports FPGURE i I Today, MENA's non-oil exports (with 260 million people) MENA's GDP and per capita income are less than Finland's (with 5 million people). Meeting growth future import requirements (such as food) means that Percent exports will have to grow, and non-oil merchandise exports are the biggest opportunity for the future if there is sufficient progress on trade liberalization and competi- - tion policies. How fast must non-oil exports grow to achieve the 2.5% base-case target growth rate for per capita incomes (figure -2 DDF CDP eCPa 4.1)? Riordan and others (1995) show that: Ao.wce Rorcoan and uthers 1995 For one group of countries, "required" growth in exports for the 1995-2010 period is either below the performance FIGURE 42 achieved over the past decade (Tunisia) or should be readily Readily achievable non-oil export growth Percent attainable in a favorable external environment (Jordan, 2 Morocco). Althouglh the targeted growth in per capita GDP lo * *9 S Se lies above the historic average for these countries, it is likely 8 that actual outturns will well exceed annual gains of 2.5% 6 (figure 4.2). It is no accident that this group includes the 4 early reformers-Jordan, Morocco, and Tunisia. 2 * For a second group of countries, including those of the , trne( Mol-orr, (or Mashreq, as well as Bahrain and United Arab Emirates S.LIce R%O,da an:i c,thers 995 FROM P'OLITICS TO ECONOMIC S (5 FIGURE 4 3 targeted exports will require a doubling of historic growth, Policy-supported non-oil export growth but are within reach if significant efforts are made to Percent Percent improve competitiveness and to diversify the product and 30 I1980 q3 ael 25 * I°20 2 required) market mix (figure 4.3). 20 ;sDlotl-adegl-o>rh U > * The third group comprises those economies in which 5 _ * * fuels account for more than 90% of exports. Although the o * l * -- * growth in petrochemical exports has been favorable for s these countries in recent years, the group will require a ten- t! :zur Olr Ranrain Ulrir[ecArab fold improvemelnt in performance (figure 4.4). Export nte1 [e growth will have to rise from 5% a vear to more than 50% Dou!,ce: Riondan and othe,s I '493 for incomes to outpace rapid population growth. Relying on FIGURE 4.4 non-oil exports to maintain living standards in the future is Paradigm change non-oil export growth not an option for these countries. The problem is clearly Percent more acute for those countries with large population densi- I 2C a 130 U * 195 q[ 0 me ties and import requirements, including Algeria. Iran, and 03 80 nOon trade hrl.eIr Iraq. As targets for non-oil exports are unlikely to be 60 achieved over the next decade, this group of countries will 40 need to find alternative means of generating foreign *0 exchange, such as commercial services, higher savings, and au Ar_ li earning higher returns on foreign asset holdings. This will S-td A, ab a 1 1131 Cr-a g- Source PRordan and othrers 1995 require a shift in the prevailing development paradigm and social contract. In the early stages building competitive advantage on the basis of this existing export capacity is more promising than starting from scratch in new areas. Revealed comparative advantage indices are an indication of where opportunities for expanded trade exist (table 4.2). For MENA countries the opportunities are in refined fuels, chemicals, foods and feeds, and manufactures. The most rapid growth in non-oil exports has been in chemicals, machinery and manufactures (particular- ly clothing and textiles, but also carpets and jewelry; figure 4.5). The countries that have achieved the greatest gains in non-oil exports have been Bahrain, Jordan, Oman, Qatar, Saudi Arabia, Syria, Tunisia, and United Arab Emirates. In textiles the biggest export gains have been in Tunisia, Morocco, Egypt, and Svria. Much of the growth in Tunisia has been based on out- sourcing of European multinationals, which import textiles for final assembly and ship clothing for sale in Europe. So, while Tunisian exports of clothing rose from $0.3 billion in the early 1980s to $1.1 billion in the early 1990s, net exports of textiles and clothing increased fivefold, from 66 CLM\ING THE E UTI URE TABLI 4 2 Competitiveness already exists in many sectors (revealed comparative advantage indices for processed products classified by major SITC groups, 1992) Beverages Animal and Manufactures Machinery Other Foods and Crude Refined vegetab e by and manu- Exporter and feeds lobacco minierals fuels oils Chemicals material' transport factures Bahrain 0.01 0.02 0.08 18.43 0.07 0.54 1.21 0.17 0.53 Cyprus 2.41 7.22 0.26 1.70 1.25 0.68 0.65 0 30 2.68 Egypt 1.07 0.10 000 9.06 000 062 1.75 034 0.87 Iran 6.62 0.02 0.08 110.40 0.00 0.11 2.58 0.09 0.15 Israe 2.62 0.11 0.25 0.44 0.01 1.32 2.10 0.49 0.88 Jordan 0 15 0.39 0 00 0.00 0 00 4.95 0.85 0 37 0.47 Lebanon 2.90 3.73 0.02 0.08 0.03 0.32 1.38 0.30 2.54 Libya 0.01 0.00 0 01 26.94 0.00 1.34 0.25 0.06 0.01 Oman 0 25 0.00 0.00 13.59 0.00 0.18 0.37 0 64 1.29 Qatar 0.01 0.00 0 05 15.89 0.20 3.02 0.25 0.07 0.63 Saudi Arabia 015 0.00 0.16 19.59 001 2.26 0.23 0.23 0.17 Syria 2.32 0.01 0.03 22.10 0.00 0.06 0.45 0 06 1.17 Turkey 5.10 0.10 038 0.70 0.24 031 1.44 0.24 2.57 United Arab Emirates 0.57 3.28 0 38 10.27 0.12 0 57 1.01 0.39 1.20 iRe P.eccled compuratt c avaentage s deSlned 3, s pIrOdLICt'S II1.rIe 11. a CC'LIItrI S ecpcr1s 1a - P Clpr DII Cre t its sh.,e n waled tl ide When she -de, has 3 value Lireitoe thei I The cuntr har i A ',ie,eaied cDmpar atve adar age" n th,Ct p-, ict C MariLLicUr F's sased un ravv miter ipi-,ti '1iw- 'tcatrs