The arab economies in a changing world

He was one of the authors on the team that prepared East Asian Miracle: Economic Growth and Public Policy World Bank Policy Research Report, 1993.. 11 Conclusion 299Tables Table 2.1 GDP

The Arab Economies

in a Changing World

Marcus Noland, senior fellow, has been

asso-ciated with the Institute since 1985 He was a

senior economist in the Council of Economic

Advisers and held research or teaching

posi-tions at Yale University, Johns Hopkins

University, University of Southern California,

Tokyo University, Saitama University,

University of Ghana, the Korea Development

Institute, and the East-West Center He received

fellowships sponsored by the Japan Society

for the Promotion of Science, the Council on

Foreign Relations, the Council for the

International Exchange of Scholars, and the

Pohang Iron and Steel Corporation He won

the 2000–2001 Ohira Masayoshi Award for his

book Avoiding the Apocalypse: The Future of the

Two Koreas (2000) He is the author of Korea after

Kim Jong-il (2004) and Pacific Basin Developing

Countries: Prospects for the Future (1990);

coau-thor of Famine in North Korea: Markets, Aid,

and Reform with Stephan Haggard (Columbia

University Press, 2007), Industrial Policy in an

Era of Globalization: Lessons from Asia with

Howard Pack (2003), No More Bashing: Building

a New Japan-United States Economic Relationship

with C Fred Bergsten and Takatoshi Ito (2001),

Global Economic Effects of the Asian Currency

Devaluations (1998), Reconcilable Differences?

United States-Japan Economic Conflict with

C Fred Bergsten (1993), and Japan in the World

Economy with Bela Balassa (1988); coeditor of

Pacific Dynamism and the International Economic

System (1993); and editor of Economic Integration

of the Korean Peninsula (1998)

Howard Pack,visiting fellow, is professor

of business and public policy and professor

of economics at the Wharton School, University

of Pennsylvania He taught at Yale University

and Swarthmore College He was a fellow at the

Harry S Truman Institute for Peace Research,

the Hebrew University, Jerusalem He is the

author of Structural Change and Economic Policy

in Israel (Yale University Press, 1971) and

Productivity, Technology, and Industrial

Development (Oxford University Press, 1987)

and coauthor of Industrial Policy in an Era of

Globalization: Lessons from Asia with Marcus

Noland (2003) He was one of the authors on

the team that prepared East Asian Miracle:

Economic Growth and Public Policy (World Bank

Policy Research Report, 1993) He has been an

adviser and consultant to many international

institutions including the World Bank, the

Asian Development Bank, the Inter-American

Development Bank, UN Conference on Trade

and Development, and the International Labour

Office He has served on the editorial boards of

a number of journals including the Journal of

Development Economics and The World Bank Economic Review

PETER G PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

1750 Massachusetts Avenue, NW Washington, DC 20036-1903 (202) 328-9000 FAX: (202) 659-3225 www.petersoninstitute.org

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Cover Photo: the Burj Al Arab Hotel, Dubai,

by Corbis

Copyright © 2007 by the Peter G Peterson Institute for International Economics All rights reserved No part of this book may be repro- duced or utilized in any form or by any means, electronic or mechanical, including photocopy- ing, recording, or by information storage or retrieval system, without permission from the Institute.

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1 Arab countries—Economic conditions.

2 Arab countries—Economic policy.

3 Arab countries—Politics and government.

4 Arab countries—History 5 Arab countries—Social conditions 6 Globalization.

I Pack, Howard II Title.

HC498.N56 2007 330.917'4927—dc22 2007004018

The views expressed in this publication are those of the authors This publication is part of the overall program of the Institute, as endorsed by its Board of Directors, but does not necessarily reflect the views of individual members of the Board or the

Employment Generation and Productivity Growth 94

Capital Flows 111

Religious Affiliation and Growth Across Countries 139

Appendix 6A Interaction of Education and Technology 184

Appendix 8A Select Regional Organizations 225Appendix 8B US Preferential Trade Arrangements

10 Authoritarianism, Uncertainty, and Prospects for Change 273

Appendix 10A Quantitative Modeling of Political Regimes 289

11 Conclusion 299

Tables

Table 2.1 GDP and population of the Middle East, 2004 22

Table 2.3 Incremental capital-output ratios 29

Table 2.5 Share of science and engineering tertiary graduates 36

Table 2.7 Cumulative percent change of constant price GDP

per capita and exports, 1995–2000 46

Table 3.1 Life expectancy at birth, 1982 and 2004 62Table 3.2 Maternal mortality, 1990, 1995, and 2000 64

Table 3.4 Gini coefficients measuring income inequality 67Table 3.5 Population below income poverty line 68Table 3.6 Subjective self-assessment of well-being, 2004 74

Table 3.8 Compound growth rate of real manufacturing-sector

Table 4.2 Contraceptive prevalence rates among

Table 4.5 Alternative scenarios for labor force absorption 97Table 4.6 Exports of manufactures, 1980 and 2004 102

Table 4.9 Inward foreign direct investment 112Table 4.10 Aid, workers’ remittances, and fuel exports 121Table 4.11 Financial-market development indicators 125Table 4.12 Cumulative portfolio investment 133

Table 5.3 Corruption 152Table 5.4 Indirect indicators of corruption typologies 154Table 6.1 Effects of policy variables and institutional quality

on growth in income per worker, 1980–2000 168Table 6.2 GDP per capita growth rates: Actual and predicted 170

Table 7.1 Religious affiliation shares, 1900 and 1990 190

Table 7.3 Pew responses by country and regional average 195Table 8.1 GATT/WTO and Bretton Woods accession status,

Table 8.2 Middle East’s total trade shares, 2004 216Table 8A.1 Participation in preferential trade arrangements 227

Table 9.4 Total entrepreneurial activity values and projections 247 Table 9.5 Macroeconomic environment: Business costs

Table 9.6 Chicago Council on Foreign Relations

“temperature data,” 1978 and 2002 267Table 9A.1 Lower-bound estimates of Arabs in Europe 271

Figures

Figure 1.1 Rate of growth of GDP per capita in constant prices,

Figure 1.3 Commodity price series for petroleum, spot 5

Figure 1.5 Average number of regime changes, 1960–2003 8Figure 2.1a Endowment triangle of human capital, land,

Figure 2.1b Endowment triangle of physical and human

Figure 2.2 Savings and investment ratios, 1960–2004 32Figure 2.3a Human capital accumulation, normally endowed

Figure 2.5c Investment ratio and GDP growth, 1990–2000 50Figure 2.6a Accounting for economic growth, 1970–80 53Figure 2.6b Accounting for economic growth, 1980–90 54Figure 2.6c Accounting for economic growth, 1990–2000 55

Figure 3.2 Difference between female and male life expectancy,

1960–2004 62Figure 3.3 Infant mortality rate, 1960–2004 63Figure 3.4a Childhood immunization, normally endowed

Figure 6.3 Sachs-Warner openness index, 1980–2000 167

Figure 6.5 Royalties and fees for technology licensing,

Figure 10.1 Likelihood of liberalizing transition, 1970–99 274

Box 9.1 Asian experience with diaspora entrepreneurs 252

The Arab countries confront a major challenge: how to successfully ploy a large cohort of young people reaching working age The stakes arehigh: Apprehensions about the availability of jobs together with disaffec-tion with the region’s undemocratic political regimes raise fundamentalquestions regarding political stability Terrorism, whether aimed at targetsforeign or domestic, raises the risk profile of the region and thus hassignificant implications for its economic performance In short, the Arabcountries risk being left behind in global competition precisely when theyneed to accelerate growth to create jobs

em-This book, The Arab Economies in a Changing World by Marcus Noland

and Howard Pack, directly addresses this range of issues It brings to bear

a strong comparative perspective on the historical performance of the Arabeconomies and, crucially, their future prospects Noland and Pack demon-strate that, while the problems facing the Arab economies can be largelycomprehended in conventional economic terms, the particular social andpolitical sensitivities of the region present policymakers with unusuallycomplex challenges in terms of devising and implementing solutions The authors directly confront the notion that Islam, the dominant reli-gion of the region, is itself an inhibitor to economic performance Theyconclude that, while the evidence does not support the notion that Islamimpedes growth, it is relevant to understanding the discomfort that some

in the region express about globalization and the constraints its ments face in formulating their external engagement policies

govern-In this regard, the book follows earlier govern-Institute studies by Robert Z

Lawrence, A US–Middle East Trade Agreement: A Circle of Opportunity? and Ahmed Galal and Lawrence, Anchoring Reform with a US-Egypt Free Trade Agreement, on how trade agreements could serve as precommitment mech-

anisms to “lock in” reforms and reduce policy uncertainty

The Arab Economies in a Changing World concludes that, if the region’s

em-ployment challenge can be successfully addressed, the Arab world couldlook forward to a “demographic dividend” as the new generation enters itsmost productive working years—a phenomenon that contributed to theoutstanding performance of East Asia over the past four decades or so Inthe context of growing prosperity, increasing political and social liberalismcould translate into a virtuous circle of enhanced cross-border economic in-tegration, economic efficiency, rising incomes, self-confidence, and satis-faction If this is the case, the region’s young demographic could turn from

a potential liability to a bonus

There is no guarantee that this positive vision will be obtained, ever An alternative outcome is a vicious circle in which impoverishment,discontent, militancy, and repression feed upon one another, deterring re-form and impeding growth The fact that neither of these scenarios can bedismissed underscores the extraordinary salience of Noland and Pack’sanalysis for today’s global geopolitical as well as economic developmentdebate

how-The Peter G Peterson Institute for International Economics is a private,nonprofit institution for the study and discussion of international eco-nomic policy Its purpose is to analyze important issues in that area and

to develop and communicate practical new approaches for dealing withthem The Institute is completely nonpartisan

The Institute is funded by a highly diversified group of philanthropicfoundations, private corporations, and interested individuals About 30percent of the Institute’s resources in our latest fiscal year were provided

by contributors outside the United States, including about 12 percent fromJapan Major support for this study was provided by the Carnegie Cor-poration, The Olayan Group, and JER Partners, reflecting its major inter-est in the Middle East and in economic relations between the United Statesand that region

The Institute’s Board of Directors bears overall responsibilities for theInstitute and gives general guidance and approval to its research program,including the identification of topics that are likely to become importantover the medium run (one to three years) and that should be addressed bythe Institute The director, working closely with the staff and outside Ad-visory Committee, is responsible for the development of particular proj-ects and makes the final decision to publish an individual study

The Institute hopes that its studies and other activities will contribute tobuilding a stronger foundation for international economic policy aroundthe world We invite readers of these publications to let us know how theythink we can best accomplish this objective

C FREDBERGSTEN

DirectorMarch 2007

ADVISORY COMMITTEE

Richard N Cooper, Chairman

Isher Judge Ahluwalia Robert E Baldwin Barry P Bosworth Menzie Chinn Susan M Collins Wendy Dobson Juergen B Donges Barry Eichengreen Kristin Forbes Jeffrey A Frankel Daniel Gros Stephan Haggard David D Hale Gordon H Hanson Takatoshi Ito John Jackson Peter B Kenen Anne O Krueger Paul R Krugman Roger M Kubarych Jessica T Mathews Rachel McCulloch Thierry de Montbrial Sylvia Ostry Tommaso Padoa-Schioppa Raghuram Rajan Dani Rodrik Kenneth S Rogoff Jeffrey D Sachs Nicholas H Stern Joseph E Stiglitz William White Alan Wm Wolff Daniel Yergin

PETER G PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

1750 Massachusetts Avenue, NW, Washington, DC 20036-1903

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C Fred Bergsten, Director

BOARD OF DIRECTORS

* Peter G Peterson, Chairman

* Reynold Levy, Chairman,

Jean Claude Trichet

Laura D’Andrea Tyson

In writing this book we have benefited tremendously from the nity to present this study or its background papers at conferences or sem-inars sponsored by the Aboitiz Foundation, Cebu, the Philippines; theAteneo de Davao, Davao, the Philippines; the East Asian Economic Asso-ciation conferences in Kuala Lumpur, Malaysia, and Hong Kong; Egypt’sInternational Economic Forum, Cairo, Egypt; the Gulf Research Center,Dubai, the United Arab Emirates; the Gulf University for Science andTechnology, Kuwait City, Kuwait; Harvard University, Cambridge, MA;the Peterson Institute for International Economics, Washington, DC; theKorea Development Institute Graduate School, Seoul, Korea; the MiddleEastern Technical University, Ankara, Turkey; and the US Agency for In-ternational Development mission in Cairo, Egypt

opportu-We also wish to acknowledge Patrick Clawson, Bernard Hoekman, rukh Iqbal, Mohsin S Khan, Jacob Funk Kirkegaard, and Mustapha Nablifor valuable comments on drafts

Far-We owe a considerable debt to Paul Karner, Ketki Sheth, and Erik Far-Weeks,who ably assisted us with the research at various stages of this project, and

to Madona Devasahayam and Marla Banov for turning our prose into anactual book

Historian Walter Rodney once argued that the remedying of ings is a collective responsibility Perhaps But in light of all of the assis-tance noted above, at the risk of being labeled bourgeois subjectivists, wewill shoulder responsibility for the remaining errors

shortcom-MARCUSNOLAND

HOWARDPACK

March 2007

Introduction

The economic performance of the Arab countries of the Middle East hasbeen middling over the past four decades It has been worse than EastAsia, better than sub-Saharan Africa—the other region most profoundlymarked by arbitrary borders and weak states—and about the same asLatin America and South Asia: in a nutshell, not the worst, not the best,falling behind the West (see figures 1.1 and 1.2 and box 1.1) While the re-gion has suffered no major crisis, it now faces a major imminent challenge,namely the demographic imperative to create jobs for the large cohort ofyoung people reaching working age The stakes are high: Rapid laborforce growth in many Arab countries has contributed to despair amongyoung men about their job prospects and consequent worries about polit-ical stability

The fact that economic performance slipped over the past quarter tury relative to a broad set of comparators heightens concern about thisfundamental challenge In part due to relatively high population growthrates, living standards in the Arab countries as a whole stagnated duringthe 1980s and 1990s, with per capita income in 2000 at roughly the samelevel as 20 years earlier The average disguises considerable intragroupvariation, however: Growth in countries such as Egypt and Tunisia hasbeen sustained if modest, while income levels in major oil exporters such

cen-as Algeria, Kuwait, and Saudi Arabia have exhibited greater volatility,largely mirroring movements in the price of oil With the real price of oilnearing record levels, these countries are currently riding high (figure 1.3and box 1.2) This heterogeneity complicates the analysis: While invest-ment bankers understandably focus on the Persian Gulf oil exporters thathave earned more than $1 trillion of petrodollars this decade, for thosemore concerned with generating employment, alleviating poverty, or at-

tenuating political violence, the more populous lower-income countriessuch as Egypt or Morocco may be of greater salience This division is nothermetic: Most of the 9/11 hijackers were Saudis, and the lower-incomecountries have plenty of business opportunities In short, the region em-bodies considerable diversity and complexity, features that this book ex-plicitly takes into account.

Internal pressure across the region stems primarily from demographicpatterns Mortality rates have fallen, life expectancy is rising, and fertilityrates have begun to decline During this transition, population growth hasbeen surging, and children and young people outnumber adults by a verylarge margin Eventually fertility will fall far enough so that populationgrowth slows, but the interim period of transition is generating a large “de-mographic bulge” cohort that is slowly working its way through the pop-ulation age profile Between 1980 and 2000, life expectancy in the region in-creased by more than eight years, and infant mortality was cut in half.Fertility rates fell dramatically—by more than two births per woman—butnot quickly enough to preclude the emergence of a sizable demographicbulge The three most populous Arab countries—Egypt, Algeria, and Mo-

Figure 1.1 Rate of growth of GDP per capita in constant prices,

OECD = Organization for Economic Cooperation and Development

Notes: Figure shows simple regional averages for compound annual growth rates Middle East includes Algeria, Bahrain (1982–2003), Egypt, Jordan (1975–2004), Kuwait (1962–2003), Lebanon (1988–2004), Libya, Morocco, Oman (1960–2003), Saudi Arabia (1968–2003), Syria, Tunisia (1961– 2004), United Arab Emirates (1973–2002), and Yemen (1990–2004).

Source: World Bank, World Development Indicators, various years; Taiwan Statistical Databook, 2004.

rocco—have median ages of 20, 20, and 21, respectively Only in the UnitedArab Emirates, a small country on the Persian Gulf, is the median age 30 or

more According to the UN Development Program’s (UNDP) Arab Human Development Report 2002, the population of the Arab region, narrowly de-

fined, is expected to increase by around 25 percent between 2000 and 2010and by almost 50 percent by 2020—or by perhaps 150 million people, a fig-ure equivalent to more than two additional Egypts Even under theUNDP’s more conservative scenario, in 2020, Bahrain, Kuwait, Qatar, andthe United Arab Emirates will be the only Arab countries with median agesprojected to exceed 30

These figures suggest that the region as a whole will experience laborforce growth of more than 3 percent for roughly the next 15 years or so.According to the Arab League, unemployment in the region could risefrom 15 million to 50 million over this period Under these circumstancesthe imperative is to create jobs

Besides the internal demographic pressures, the region faces an nal challenge as well: The successful ongoing globalization of China,India, and smaller rivals is creating an ever more competitive global eco-nomic environment in which the Middle East has to operate The globalmarketplace embodies increasingly stringent competitive pressures andless tolerance of substandard policies and practices than existed 20 oreven 10 years ago

exter-Yet it is almost impossible to imagine sustained generation of neededemployment opportunities without successful globalization and cross-border economic integration While the benefits (and losses to some) ofglobalization have become clichés, it is critical to solve myriad problems

Figure 1.2 Map of the Arab economies

Algeria

Egypt J ordan

Kuwait Moroc co

Saudi Arabia

Syria Tunisia

Unlike public-sector employment programs, expansion of labor-intensiveexport activity can absorb many new labor force entrants on a commer-cially sustainable basis Imports of new equipment and intermediate ma-terials can improve productivity, which can both lower prices of domesticgoods and enhance exports Foreign direct investment (FDI) can add todomestic savings, thus increasing the national saving rate, and provide

Box 1.1 What is the Middle East?

There is no commonly accepted definition of the Middle East (see map in figure 1.2) This book focuses on the Arab countries from Morocco in the west to Iraq in the east Due to data availability constraints we concentrate on eight countries: Algeria, Egypt, Jordan, Kuwait, Morocco, Saudi Arabia, Syria, and Tunisia, which together account for more than half of the region’s population and economic output We refer to the other economies of the region as circumstances permit

A number of countries on the periphery of this region (as we define it) are sometimes treated as part of the region, though we believe that the divergences outweigh the commonalities and are not of central interest to understanding the dynamics of the region For example, Israel, geographically part of the region, is distinct both economically and politically To the east, Iran shares certain common historical, religious, and economic characteristics of parts of the Middle East; in the classification scheme of the Bretton Woods institutions it is part of the Middle East North Africa (MENA) region, though it is not considered part of the Middle East by the United Nations system, whose individual agencies do not follow a common definition Similarly, countries on the African periphery such as Djibouti, Mauritania, Somalia, and the Sudan are members of the Arab League and in- cluded in the Arab Human Development Report (despite not being classified as part of the Middle East by its sponsor the UN Development Program [UNDP]) Like Iran, Turkey shares many links to the region but is not classified as a Middle Eastern country and is a member of only the broader pan-Islamic organizations Classifications and memberships according to the World Bank, International Monetary Fund, UNDP, UN Educational, Scientific and Cultural Organization, Arab League, Arab Bank for the Economic Development of Africa, the Islamic Develop- ment Bank, the Organization of the Islamic Conference, and the Organization of Petroleum Exporting Countries are reported in appendix table 1A.1.

Even though for reasons of data availability we often consider only a subset of all Arab countries in our analysis, occasionally for convenience they are referred

to as Arab, Middle Eastern, or MENA countries with the understanding that we are referring specifically to the more limited core set, though we believe that their experiences are broadly representative of the region in its entirety.

technological knowledge and ready-made distribution networks, therebyreducing the need for the time-consuming and expensive process of de-veloping such networks However, the greater social openness required torealize these benefits will disrupt established practices and mores

To date, the region’s performance on numerous indicators of economicopening to the rest of the world has been unimpressive, and looking for-ward there is cause for concern as to the region’s ability to successfullyglobalize and generate the necessary growth in employment For exam-ple, in 2003, the Philippines had more manufactured exports than the en-tire Middle East and North Africa (MENA) region combined Until the re-cent oil-fueled expansion of FDI, the region attracted less FDI than somesmall Scandinavian economies The Middle East risks being left behind,precisely when it needs to accelerate growth to create jobs for its growinglabor force

Deep uncertainty about the future of many of the region’s politicalregimes impedes successful globalization and sustained employmentgrowth While the region’s contemporary economic performance may not

be distinctive, on the whole, its political regimes are According to dom House, the only Arab League member government classified as ademocracy is the small Red Sea enclave of Djibouti Enduring authori-tarian regimes are instead the norm (figure 1.4) All received negativeassessments on the Polity IV Project ratings that range from 10 (mostdemocratic) to –10 (least democratic), based inter alia on the relative com-petitiveness of the head of government’s recruitment, constraints on him

Free-or her, and competitiveness of political participation The individual

Figure 1.3 Commodity price series for petroleum, spot

Source: IMF, International Financial Statistics, February 2006, June 2006.

US dollars per barrel

UK Brent prices

UK Brent prices deflated by US PPI

country scores range from –2 in the cases of Jordan and Yemen to –10, theabsolute minimum, in the cases of Qatar and Saudi Arabia Similar resultsare obtained with measures of repression such as the degree of extralegalpolitical terror (de Soysa and Nordås 2006) Moreover, this authoritarian-ism is enduring: According to the Polity IV scoring, only the industrial-ized democracies of the Organization for Economic Cooperation and De-velopment (OECD) experienced fewer regime changes on average for theperiod 1960–2000—no developing area was as unchanging as the MiddleEast (figure 1.5) In developed democracies, the absence of abrupt change

is unsurprising, but in poorer countries it often signifies a closed politicalsystem in which elections are infrequent and more closely resemblestaged acclamations than a genuine contest of power There is modest evi-dence of democratization in the Middle East data: Five countries exhibitincreases in democratization scores over the sample period, two exhibitdeclines, and the scores of the remainder are unchanged or exhibit fluctu-ations without any obvious trend This combination of authoritarianismand stability is indeed unique

This is not to say that the region’s political regimes are alike: Some such

as Morocco, Saudi Arabia, and Jordan are monarchies of varying historicalduration and liberalism; others such as Algeria, Tunisia, and Yemen areauthoritarian states with security services forming the core; and Syria,Egypt, Libya, and Iraq (under Saddam Hussein) combine both authoritar-ian and dynastic tendencies Lebanon is sui generis, a fragmented democ-racy subject to Syrian influence that has varied over time The PalestinianAuthority might similarly be described as an unconsolidated democracy

in a state of semiautonomy in relation to Israel Needless to say, the ical trajectory of post-Saddam Iraq is highly uncertain Whatever their for-mal institutional characteristics, a number of these regimes are dominated

polit-Box 1.2 The price of oil

In 2006 oil prices reached an all-time high, approaching in real terms to cans, at least, their 1980 peak (figure 1.3) Moreover, the recent increase appears

Ameri-to be a spike, not a gradual increase

Since 1973, the price of oil has been volatile, responding to various real nomic, technological, and political shocks There are a wide range of views on the future trajectory of the price ranging from nominal prices in excess of $100 per barrel, to rough stability at current levels, to reversion to a long-run equilibrium

eco-of $35 per barrel or less.

We are not oil experts and will not offer our own forecast but rather treat the price of oil as an important variable operating in the background of the analysis,

to be pulled to the forefront when it is particularly relevant.

by religious or tribal minorities Lacking popular legitimacy, they resort tocoercion to obtain compliance.

Popular dissatisfaction associated with lack of political voice appears to

be reinforced by dismal prospects for employment over the next decadesand an appreciation of the better performance that was forgone In a 2002poll of Arab attitudes conducted by the American pollster James J Zogby,

in most countries surveyed, respondents among the young and educatedwere generally more pessimistic about their economic future This pes-simism was particularly acute in countries like Saudi Arabia and Kuwait,which witnessed large declines in per capita income in previous years(Zogby 2002) While this discontent may have been mitigated by benefitsfrom the recent increase in the price of oil and associated trickle down, thelong-term structural concerns remain And in countries such as Syria andYemen, revenues from oil sales, which have enabled the continuance ofsubstandard economic practices and associated political regimes, are ex-pected to be exhausted within a decade (World Bank 2006a)

This situation is enormously important, most directly for the region’sresidents who endure repressive governance or the many who emigrate.Yet it goes without saying that both internally and externally there areother, noneconomic stakes as well It is often argued that authoritarian gov-ernments typically have difficulty making credible policy commitmentsbecause the lack of democratic accountability facilitates capriciousness As

Figure 1.4 Average polity score, 2003

a consequence, credibility in authoritarian regimes is, to a greater extentthan in democracies, a function of reputation, which is hard to gain andeasily lost This credibility deficit can manifest itself in a variety of ways.For example, if economic reforms are introduced, supply response may belacking if entrepreneurs are unsure if the policies will be sustained, and as

a consequence they are reluctant to make irreversible investments if theybelieve that the government could easily undo the reforms

Rather than excessive policy instability, however, the region appears to beafflicted with a stultifying policy inertia, and the political issues confrontingthe region would appear to run deeper than mere reputational effects.Across the region there is a tendency to rely on centralized regulatory in-tervention to facilitate the creation of economic rents and their channeling

to politically preferred groups By implication, cross-border economic gration, whether globally or regionally, is discouraged: Opening up wouldimply a loss of control and the concomitant ability to rig the local market tothe benefit of regime supporters All of this militates against a vibrant pri-vate sector that could promote increased productivity, employment, andgrowth This combination of political illegitimacy and policy interventionmakes it difficult for these economies to liberalize: Reform and the erosion

inte-of rents could undermine the very basis for political loyalty In the words

of one observer, “Only by altering the political logic that sustains theseregimes, moving from a base built on the discretionary distribution of pa-

Figure 1.5 Average number of regime changes, 1960–2003

tronage to one grounded in the legitimacy that comes with procedural gality and political accountability, will political elites ever be persuaded toundertake economic reform” (Bellin 2006, 137–38) Ironically, though manyspeak of a “resource curse” associated with the oil industry, the availability

le-of “natural” rents created by the energy sector may actually reduce the litical incentives to create rents through efficiency-inhibiting policy inter-ventions in other sectors such as manufacturing or publicly financed con-struction of infrastructure Sufficient payoffs to cronies are feasible with theoil rents alone

po-This lack of political dynamism in the face of underlying social changetogether with the increasingly religious orientation of the political oppo-sition paradoxically raises the possibility of abrupt transitions or regimechanges Such deep political uncertainty discourages behavior that neces-sitates irreversibility, from investment by foreigners or local residents toreturn on the part of skilled émigrés, and creates a self-reinforcing down-ward spiral: Political uncertainty impedes investment and growth, which

in turn contributes to popular discontent and intensified uncertainty.None of this is to say that undemocratic governance is an insurmount-able obstacle to development—South Korea and Taiwan in the 1960s and1970s and China in the last quarter century spring to mind as obviouscounterexamples—or that evolutionary political change is impossible, asthe South Korean and Taiwanese examples demonstrate Yet despite con-siderable external threats, in South Korea and Taiwan both governmentssought legitimacy through economic prosperity South Korean strongmanPark Chung-hee once remarked, “In human life, economics precedes pol-itics or culture” (SaKong 1993, 24) We know of no equivalent statement

by an Arab autocrat elevating economics above political or cultural or eign policy concerns Instead, in the Middle East authoritarian govern-ments have tended to encourage the externalization of discontent asso-ciated with relatively poor economic performance or to channel it intoquixotic pan-Arab projects

for-In the wake of 9/11, it may be tempting to parse the analysis that lows for insights into the relation between economic performance and ter-rorism, which, following Boaz Ganor (2002), can be defined as the inten-tional use of, or threat to use, violence against civilians or civilian targets

fol-to attain political aims Many diagnoses of the sources of terrorism haveemerged Some have emphasized discontent with the rulers of Arab coun-tries, while others locate the cause in hostility to aspects of Western cul-ture such as women’s rights The list of causes is as varied as the intellec-tual background of the writers Among the favorite explanations is thatpoverty and economic stagnation have provided a fertile recruitingground for terrorists, a view that presupposes that the economic and so-cial performance of these countries has been worse than that of other com-parably situated nations—an assumption that finds little support in theevidence reported in the succeeding chapters Yet whatever its origins,

terrorism has significant implications for economic performance in the gion It raises the risk premium in the calculus of both internal and exter-nal investors, reducing and distorting both physical and portfolio invest-ment as well as contributing to capital flight.

re-Such concerns have contributed to a revival of the neo-Weberian bution of economic prosperity to religious tradition, though in this newrendition, instead of Calvinism acting as a catalyst, Islam is recast as aninhibitor This notion has some surface plausibility: Muslims around theworld are, on the whole, poorer than non-Muslims, and Islam is associ-ated with distinct institutions and practices that could serve as the causallinks between theological belief and economic performance Some havealso argued that the all-encompassing nature of Islamic belief may alsocontribute to political cultures that give rise to unresponsive authoritariangovernments, which ultimately impede economic development We ex-plicitly address these ideas and conclude that while the evidence does notsupport the notion that Islam is a drag on growth, it is relevant to under-standing the discomfort that some in the region express about globaliza-tion and the constraints governments in the region face in formulatingtheir external engagement policies, which we argue are critical to the re-gion’s economic prospects

attri-That said, the role of Islam or other cultural factors should not be stated Obstacles to change governments face throughout the region maynot be unique, and comprehending the difficulties of implementing re-form may not require an analysis of spiritual evolution in the last millen-nium Consider the region’s largest nation in terms of population, Egypt.Over the past quarter century, it has experienced sustained growth, notparticularly low relative to comparable countries outside the region butinsufficient to absorb its rapidly increasing labor force Acceleration ofgrowth may require policy changes that could pose serious short-term po-litical challenges with no guarantee of success Incumbent politicians andthe many workers who benefit from the current system may not supportsuch changes any more than American textile workers support further re-duction in barriers to cheap imports In some respects the mix of collec-tive action problems and entrenched interest group politics that currentlyimpedes Egyptian economic reform resembles that in present-day Ar-gentina or in India two decades ago, though the rigidity of the politicalsystem and popularity of groups such as the Muslim Brotherhood createthe possibility of abrupt political transitions and raise the political stakes

over-of economic reform The latter two cases are relevant to the Middle East

in that their divergent paths dramatically underline that outcomes are notpreordained and that policy can have a significant impact—for good or ill

In sum, the region faces a demographic imperative, a globalization lenge, and a deep uncertainty surrounding its politics Responses to theseforces are to varying degrees conditional on the price of oil determined inglobal markets Contrary to rhetoric that claims the Arab countries of inter-

chal-est are sui generis, closer scrutiny employing standard modes of economicanalysis suggests they share important commonalities with appropriatelyidentified comparators from outside the region Nothing immediately sug-gests that the Arab economies of the Middle East have a particularly oner-ous heritage that is inimical to successful development In this light, thereform experiences of other countries are germane, from those of some rel-atively successful Asian countries to examples from Latin America, EasternEurope, and other regions with more varied experiences.

Addressing the Challenge

The Arab economies are squeezed by the demographically preordainedimperative to create jobs on the one hand and the increasingly competi-tive nature of the global economy on the other For the region’s more suc-cessful countries, the “crisis” is partly comparative—how will they fit into

a rapidly evolving world economy in which some of the channels of velopment such as manufacturing exports pursued by recent success sto-ries in Asia will be hard to replicate given the high competence built

de-up by low-cost rivals such as China and India, as well as their now moreadvanced predecessors And as attention increasingly turns to services,countries such as India and the Philippines are already establishing them-selves as formidable centers for offshoring back-office activities and otherbusiness services

To successfully meet this looming challenge, three intertwined tions arise:

ques-䡲 Can the underlying problems be diagnosed and the relevant policylevers identified?

䡲 Will reform be blocked by elite and popular resistance?

䡲 Will the requisite supply response to the policy change be ing, i.e., will the economy actually respond to policy change?

forthcom-The first task is, to borrow a medical metaphor, to form a proper sis In order to accelerate growth, the most important constraints imping-ing on the economy must be identified Weak links to the global economy,low levels of FDI, lack of technology transfer, industrial incompetence, highlevels of government investment and ownership, and high costs of doingbusiness are among the difficulties that have been extensively documented,for example, by a series of World Bank volumes (2003a, 2003b, 2004c) All

diagno-of these affect the critical issue diagno-of the incentives facing individuals and thefarms and firms they manage

Chapters 2 and 3 present evidence from 1960 to the present on both nomic and social indicators within a framework that allows comparison

eco-with other countries at comparable stages of development Concentrating

on this period allows us to focus on some of the structural features of the Arab economies, including the rise and then fall of oil prices in the1970s and 1980s, which is obviously relevant to the present situation,where the permanence of the rise in oil prices is unknown The compara-tive perspective is useful for a variety of reasons: It enables us to bench-mark the performance of the Arab economies historically and allows us tosituate their current position within the global economy today, and the ex-periences of other regions may also provide insights into the dynamics ofreform The reform experiences of relatively successful comparators fromoutside the region document the opportunities forgone but more impor-tantly point to the potential future gains if opportunities are seized

In chapter 4 we examine the evidence on the magnitude of the lenge and address two issues that are central to our diagnosis of the fu-ture problems of the Arab countries: (1) the challenge presented by theneed to absorb the looming bulge in the labor force and the absence ofglobalization as measured by FDI, financial-market development, inter-national trade, and other indicators and (2) the adverse effect of global-ization’s absence on the efficiency of the economy and on the ability to ab-sorb labor and simultaneously to increase per capita income

chal-This diagnosis is followed by an analysis in chapters 5 and 6 of the gion’s institutions and policies, including consideration of the impact ofthe region’s Islamic legacy on institutional development In this context

re-we demonstrate that macroeconomic policy deficiencies that have beenfrequently cited in the past have been addressed in recent years and notethe positive progress in other dimensions such as the quality of the legalsystem Yet the rates of income and employment growth remain far fromthose needed to solve the looming unemployment problem and providehigher living standards, suggesting that still other reforms are needed orthat some kind of shortcoming is inhibiting the economy’s response tothese stimuli We find that much of what appears to be problematic in theArab economies revolves around more difficult issues of institutional ef-fectiveness and technological competence, which require public policyinterventions of nontrivial complexity We also find that there is consider-able intraregional variation, particularly with respect to progress on insti-tutional reform This is important insofar as it suggests that at least across

a variety of relevant characteristics, outcomes are not determined by deepcultural or religious factors—if it takes 27 days to enforce a contract inTunisia, it is not obvious why it should take 410 in Egypt

The analysis of institutions and policies is extended in chapters 7 and

8 from the domestic to the international sphere and how local attitudestoward globalization condition the commitment to and intensity of eco-nomic reform in this dimension This is a particularly acute set of issuesbecause one of the basic challenges for the region is that it is regarded as arisky business environment for a variety of reasons already touched upon

The conventional indicators of the unfinished efforts at policy reform areuseful in indicating the directions in which the countries probably need tomove to improve their chances for more rapid growth of income and em-ployment Many of these reflect inadequate integration into both formalinternational trade institutions such as the World Trade Organization(WTO) and informal private-sector supply networks Even in the lattercase, there is a policy dimension insofar as the extent of private-sectorcross-border integration may be encouraged or impeded by a host of localpolicies, beyond those directly concerning trade and investment.

In this context, we consider how commitments through the WTO or lateral agreements might act as a credible precommitment mechanism to

bi-“lock in” reforms and at least reduce policy uncertainty if not other risksand leverage domestic support for complementary policy changes neces-sary to realize more fully the potential benefits of greater international ori-entation to address the imperative to create jobs detailed in chapter 4.Economists are social scientists, not physicians, however, and even ifthey diagnose the “illness” and suggest the correct set of remedies or pol-icy interventions, they encounter an additional—political economy—hur-dle of actually getting the policies implemented Opposition to reform byentrenched special interests or risk aversion by policymakers facing un-certainty with respect to putative benefits and cognizant of political costsmay pose a greater obstacle to long-run success than correctly designingpolicy interventions—that is, political resistance may constitute the mostbinding constraint The contemporary Middle East poses particularly dif-ficult challenges in this respect, given the profound uncertainty surround-ing the future trajectory of a number of the region’s political regimes andthe possibility of abrupt transitions

These political economy constraints are considered in chapters 9 and

10, with emphasis on the roles of uncertainty and risk in both the nomic and political spheres: If policies and practices are reformed, will asupply response be forthcoming? If the needed policies are put in place,will local or foreign entrepreneurs or in some cases state-owned enter-prises respond to a changed incentive structure, and do they have thetechnical capacity to do so?

eco-Conclusion

If the region’s employment challenge can be successfully addressed, theMiddle East could look forward to a complementary period of “demo-graphic dividend” as this generation enters its most productive workingyears—a phenomenon that contributed to the outstanding performance

of East Asia over the past four decades or so With fertility now droppingrapidly, the region may well be through the process of demographic tran-sition, and as the size of the cohorts entering adulthood begins to shrink,

there will be a concomitant diminution in the problems that all societiesface socializing young adult males This process of absorbing a rapidlygrowing labor force, while prolonged, is self-terminating In the context ofgrowing prosperity, increasing political and social liberalism could trans-late into a virtuous circle of enhanced cross-border economic integration,economic efficiency, rising incomes, self-confidence, and satisfaction Ifthis is the case, the region’s young demographic could turn from a poten-tial liability to a bonus

Yet demography is not destiny, and there is no guarantee that thishappy outcome will be achieved: An alternative is a vicious circle inwhich political uncertainty impedes investment and growth, fueling po-litical discontent and a reluctance to reform In the Middle Eastern con-text, authoritarianism enables countries to neglect economic issues in thequest for their own stability and simultaneously may help generate radi-calism that engenders still more repression, all of which discourages eco-nomic activity This dynamic is complicated by the possibility that high oilprices, if sustained, may permit the continuation of such repression (and

a reluctance to undertake reforms that would benefit the nonoil sectors)while having significant short-term economic benefits These are notpurely theoretical ruminations: For more than a quarter century, Vene-zuela, a country comparable in certain respects to the oil producers of theMiddle East, has managed to combine the favorable demographic of a de-clining dependency ratio with falling per capita income (until the recentspike in oil prices) and rising political instability Russia suffers frommuch of the same syndrome

Clearly no answer can be given to whether optimism is warranted orthe disabling dynamic will prevail We can contribute to a more sophisti-cated understanding of the workings of these economies and the mea-sures that might be undertaken, primarily by Arab governments but bythe international community as well; note their potential benefits andcosts; and suggest the deeper trepidation that they might exacerbate.Solely emphasizing the fears would consign a whole region to languish inserious economic turmoil, as the labor force growth is not a forecast butthe movement into the labor force of those already born Our concludingobservations along these lines are summarized in chapter 11

Table 1A.1 Classifications and memberships

Arab Bank for Organization

Table 1A.1 Classifications and memberships (continued)

Arab Bank for Organization

MENA = Middle East and North Africa

UNDP = UN Development Program

UNESCO = UN Educational, Scientific and Cultural Organization

OPEC = Organization of Petroleum Exporting Countries

Note: The Arab Human Development Report (UNDP) definition of MENA is identical to the Arab League definition reported here.

econ-a stecon-arting point for forming expectecon-ations econ-about its future However, econ-as vestment advisers endlessly caution, past performance is no guarantee offuture results For most countries, not only the Middle East, performanceover decades varies significantly—good in one, bad in the next (Easterly

in-et al 1993) Only a handful of countries in Asia have been able to realizesustained growth decade after decade The Middle East has not, but it isnot unusual in this respect

Second, economic performance may be related to a widespread sense ofdisaffection of significant parts of the population, which is often remarkedupon in Arab as well as Western sources (UNDP 2002, 2003) Dissatisfac-tion with current performance, if channeled constructively, might yieldpolitical pressure for reform, or it can be externalized unproductively(Lust-Okar 2004) In this regard, one can view economic performance intwo relevant ways The first is in an absolute sense: Has the economy de-livered increasing levels of material prosperity and if so at what rate? Thesecond is in a relative sense internationally: Have incomes risen more orless quickly than those of other countries to which Middle Eastern citizensand policymakers might compare themselves?

This chapter focuses on economic development in some of the majorcountries of the Middle East Given the current intense focus on the Arabeconomies and assertions that terrorism has its source in poverty and alack of improvement in social well-being (Lugar 2004), we first consider

the economic performance of the Arab nations in terms of their income inpurchasing power units relative to that of the advanced industrial coun-tries of the Organization for Economic Cooperation and Development(OECD) and then analyze the change in absolute living standards overtime within the Arab countries themselves The main findings are that (1) as a group, the Arab countries grew fairly rapidly in the 1960s and1970s but, like almost all developing nations, were not able to close therelative gap with the OECD economies; (2) their performance was muchweaker in the 1980–2000 period than in the preceding two decades; and (3) despite the increased gap relative to rich countries, in a number of Arabcountries for which data are available, the absolute standard of livingimproved, measured in local constant prices Local residents could affordmore calories and clothing, just not as many more as citizens of the OECDcountries However, in some of the highly oil-dependent economies, a de-cline in real income may have negated, in local perception, improved edu-cation and health The recent spectacular increase in oil prices has changedsome of these results not only for producers of oil but also for surroundingeconomies with which they have considerable interactions, particularly inemploying expatriates But the persistence of high prices is not assured,and we focus on the longer record from 1960 to the present.

The chapter begins by providing a number of descriptive measures in acomparative international framework We consider the evolution of a fewArab economies relative to the advanced industrial economies of theOECD These comparisons are carried out using internationally compara-ble measures that adjust for differences in purchasing power across na-tions Even one of the best performing economies, Egypt, has not closedthe gap between itself and the OECD nations over the last quarter century,while Saudi Arabia declined dramatically until the upsurge in oil prices

in 2004, the sustainability of which is unknown However, by anothermeasure, namely the growth of per capita income within a country atlocal constant prices, the performance of Egypt and several (but not all) ofthe Arab countries is not very different from many other developingcountries In our view, this measure is likely to be more informative abouthow individuals perceive their own progress, though international com-parisons are of interest in other dimensions

We then analyze some of the proximate determinants of differences ingrowth over time and consider them in an international context Contrary

to what is usually claimed by those who focus solely on the Middle East,the achievements of the non–oil dominated Arab economies are not sys-tematically worse than countries in other regions except for the East Asiancountries For nations such as Kuwait and Saudi Arabia, however, theirnear collapse since the peaking of oil prices in the 1980s has been notable(as is their more recent rise) While this failure has had ramifications forother countries, such as Jordan, ranging from reduced repatriation of earn-ings of expatriates to smaller export purchases, these effects have not pre-

cluded continued growth in the nations that are not resource rich Nowwith oil prices rising, these indirect impacts have been partly reversed.

Identifying the Comparators

We focus on Egypt, Jordan, Saudi Arabia, Kuwait, Tunisia, Morocco, ria, and Syria, which account for more than half the population and GDP ofthe Middle East and reflect the many factors that determine economic per-formance in the region (table 2.1) Data availability even for this group isuneven but is better than that for other Arab countries Even though, forreasons of data availability, we will often consider only a subset of all Arabcountries in our analysis, occasionally for convenience they will be referred

Alge-to as Arab, Middle Eastern, or Middle East and North Africa (MENA) tries with the understanding that sometimes we are analyzing the morelimited set

coun-Obviously even this small group is disparate both economically and torically Unlike the others, Egypt has a millennia-long national history, astrong sense of Egyptian national identity, a substantial cosmopolitan her-itage predating colonialism, and was home to non-Arab minorities, in-cluding Copts, Greeks, and Jews who figured prominently among the en-trepreneurial class.1French colonization of Algeria, Morocco, and Tunisialeft a number of legacies including a greater identification with Europethan is true of some of the other countries Algeria, Kuwait, and SaudiArabia are resource rich, the others less so The economic systems rangefrom Soviet-style state intervention in Algeria to the freer economy of Jor-dan In contrast, countries such as Kuwait, Jordan, Saudi Arabia, and Syriawere the creation of the post–World War I victors who disposed of the ter-ritories of the Ottoman Empire Thus, the countries considered are not amonolithic entity—they are all Arab but different in significant dimen-sions from each other Nevertheless, their economic destinies are closelylinked through population and financial flows Compared with other re-gional groupings, they exhibit much greater similarities than differences,for example, in their being much less part of emerging trends in many as-pects of international economic transactions

his-We take account of many of the major economic differences as wesearch for comparable countries It is difficult and arguably not helpful tosearch for correspondence in all dimensions such as colonial history.There is a great divergence across countries throughout the world yetmany similarities in economic performance and the policies that nationswith varying legacies have followed To cite one example, almost all coun-tries pursued a policy of import-substituting industrialization, neglect of

1 See, for example, the Alexandria quartet of novels of Lawrence Durrell or the memoir of Alhadeff (1998)

agriculture, and intensive attempts by government to foster industrial velopment Most efforts failed or resulted in slow growth, but a handful

de-of Asian countries hit upon an improved version de-of these formulas thatemphasized the role of exports while not abandoning the protection of thehome market for a long period Nevertheless, compared with other re-gions of the world, there are strong similarities among the Arab countries

we consider, particularly their much lower integration into the world

Table 2.1 GDP and population of the Middle East, 2004

GDP Population Country (billions of current US dollars) (millions)

n.a = not available

Note: GDP data for Iraq, Qatar, and Palestinian Authority territories are from 2003.

Source: World Bank, World Development Indicators, May 2006.

economy in a number of critical dimensions including a paucity of primary product exports, low inflows of both portfolio and foreign directinvestment, and tiny technology transactions Moreover, they all will face,

non-to varying degrees, a much more rapid growth in their labor force thanany nation outside of sub-Saharan Africa

For most of these countries, data from the 1950s and 1960s are sketchy,but Robin Barlow’s (1982) attempt to construct consistent time series forthe period 1950–72 suggests that, if anything, the countries of the MiddleEast exhibited slightly more rapid growth than comparable developingcountries over this period This would be consistent with the fairly rapidexpansion of education evidenced by rising rates of school attendance andliteracy Data availability problems are less severe for the 1960s Thoughconsistent data are typically in local prices, it is now well understood thatmeasures in Egyptian pounds or Saudi dinars converted to dollars at theofficial exchange rate may be misleading because of both exchange ratemisalignment and the systematically lower costs in poor countries of inter-nationally nontraded goods like haircuts and housing Purchasing powerparity (PPP)–adjusted national income data constructed using interna-tional price comparisons permit more informative comparisons of livingstandards across countries

The question of what is the relevant set of countries to compare with theArab countries can be answered in multiple ways In one sense one wants

to compare them with the best contemporaneous performers because it dicates the maximum that one might have expected from them or alterna-tively the upper bound of the opportunities forgone In this regard SouthKorea and Taiwan are the exemplars Admittedly from an Arab perspec-tive, the comparison with South Korea and Taiwan may not seem an en-tirely fair one Fifty years ago the Asians may have been “deceptively poor”:Contemporary income was low because of small physical capital stocks(due to war devastation in the case of South Korea and a lack of investment

in-on the island of Taiwan prior to the decampment of the Kuomintang frommainland China), but in the mid-1950s the ratio of human capital to incomewas among the highest in the world (Noland and Pack 2003, table 2.1).These were countries with considerable social capacity but lacking physicalcapital, which was rapidly accumulated, some of it financed by US aid inthe context of the Cold War.2Nevertheless, in establishing the upper limits

of opportunities forgone, these countries set the standard

Another set of comparators would be large developing countries far as the familiarity with these countries engendered by political or eco-

inso-2 It is worth debunking one frequently made assertion that the major source of South rean and Taiwanese growth was foreign aid, particularly from the United States Such aid can

Ko-be viewed as akin to remittances by expatriate workers, foreign aid, and rents from natural resource revenue As shown in chapter 4, some Arab countries received very large amounts

in these dimensions, dwarfing the Asian aid inflows of the earlier period Even aid alone, cluding debt forgiveness, was larger in some Arab countries than in South Korea or Taiwan.