Global Changes And What They Mean
For The Development Strategies
Of The Middle East And North Africa

These are revolutionary times in the global economy. The embrace of a market-based development strategy by many developing and former centrally planned economies, the opening of international and regional markets, great advances in the ease with which goods, capital and ideas flow around the world, and the end of the cold war, are bringing in new opportunities to billions of people. But are these favorable developments from the point of view of the Middle East and North Africa region? Some element of an answer may be found in the following four important dimensions: the globalization of markets and the emergence of the World Trade Organization (WTO); the increased mobility of private capital with its attendant risks; the European-Mediterranean (Euro-Med) Initiative which is now gathering steam in the region; and the ongoing sub-regional trade agreements that are being considered with increased seriousness. Each of these dimensions has important effects for the economy of the MENA region. And each calls for equally important changes in development philosophy and strategy.

The Globalization of Trade. For the Middle East and North Africa region, future developments on the trade front will be important determinants of success or failure. For unlike in the 1970s and early 1980s, labor migration and official aid will not be the future engine of growth; instead, increased exports will be needed to finance development. In this regard, external developments are however mixed: In the short term, the recently completed Uruguay Round (UR) agreements are likely to lead to some losses for the region; in the longer term, they will open external markets more widely, making an export-driven policy more realistic. In any case, for the new environment to have a favorable effect, the opportunities it offers must be seized and fully exploited with the help of supportive domestic policies.

The limited short-term direct losses implied by the UR have been well documented in recent studies. These show that the Round would increase social welfare in North America, the European Union (EU) and East Asia, but reduce it slightly in Eastern Europe and the former Soviet Union, and in the MENA region. To illustrate the magnitude of this effect in the MENA region, the losses are estimated at about US$2.5 billion per year, or only one-half of a percentage point of its GDP. This unfavorable outcome is due to three factors. First, subsidies on agriculture will be reduced in industrial countries, leading to higher food prices, an import item in the region. Since imports account for 12 percent of the region’s food consumption, the 27 percent projected increase in agricultural import prices induced by the UR will therefore have a sizable adverse effect.

Second, the international quota system under the Multi-Fiber Arrangement (MFA) will be dismantled over time, intensifying competition in wearing apparel — an important export item for the region — and reducing their export prices by about 7 percent. Finally, the expansion of production and trade is expected to induce increased specialization and higher demand for capital- and skill-intensive manufactured goods, thus driving up the world prices for a class of products that constitute about 35 percent of MENA’s imports.

The negative effects of the UR will take place whether or not the MENA countries join the WTO. The best way to minimize these losses is to adjust quickly to the new realities by shifting away from the production of goods whose prices are falling, and towards those whose prices are rising. Over time, the key is to be able to take advantage of an increasingly educated workforce by moving away from labor-intensive industries and up the technology ladder.

Is such a strategy open to the MENA region? The globalization of trade promises to open up new markets, but also to bring in more competition. In this context, the international field has been changing fast in the past two decades. A first group of rich countries — mainly OECD — has continued to upgrade its productive sectors and is increasingly specializing in high value-added products. Production of the more labor-intensive goods has already been shifting to lower-income countries.

A second group of countries in East Asia specializes in the production of medium-skills goods. These newly industrialized economies (NICs) were the first to use cheap exports as an engine of growth; by now, they have managed to upgrade their skills with massive investments and good education policies, and are producing sophisticated industrial products that can ensure good earnings for their workforce. These NICs have been joined over time by a few reformers such as Chile and Turkey. The post-centrally planned economies of Eastern Europe are now trying to join this group. Success, however, will be determined by the extent to which these countries are able to attract capital and reconvert their extensive human and physical resources into assets that can produce the goods demanded by the global market-place.

A third group is made up of low-income countries. These countries have large pools of surplus labor and have geared themselves up to produce exports based on unskilled labor and cheap wages. Their ascent has been staggering. Already, China has half the non-OECD workers with jobs in multinational corporations. In 1992, Foreign Direct Investment (FDI) in China was nearly a quarter of the total in all developing countries, while the combined share of Indonesia, Malaysia, Singapore and Thailand was 27 percent. In contrast, the Middle East share was only 1.5 percent. Increasingly, unskilled workers will crowd the market in its low-end, putting downward pressures on wages the world over.

Ideally, the Arab world would want to stay ahead of this third group of countries, expand its exports of semi-skilled goods, and keep upgrading over time to catch up with the second group. Most countries in the region have the necessary manpower and infrastructure to attract capital, but they are not yet fully exposed to international prices, and they have not committed themselves to sizable tariff reductions. While domestic policy reforms have started everywhere and are well advanced in some countries, overall, the region is still behind the successful second group of middle-income countries. The goal, therefore, is to move ahead fast by deepening reforms, improving productivity, speeding privatization, and taking full advantage of existing human assets.

Capital on the Move. The region’s traditional sources of finance have declined and are now not sufficient to support the kind of investments needed to fully utilize its potential. Between 1992 and 1995, official capital inflows shrunk by half. In spite of an expected rise in EU assistance, the supply of official credits will continue to become tighter over time, with shrinking aid budgets in the OECD and Gulf countries, and increased competition by poorer countries as well as, recently, by the reformist countries in the former Soviet Union and Eastern Europe. While, as an exception, the international community has pledged relatively large sums of funding for the West Bank and Gaza, it is the extent of future private capital inflows to all countries that will make the difference between success and failure. Private capital is needed to allow the weak sectors to retool and restructure in response to a more open regime. In contrast, limited capital flows would reduce the chances of a soft landing and increase the risks of falling deeper into a low productivity trap.

External assistance to the region has been large in the past. During the last two decades, net inflows of capital, mainly from public sources, averaged 15 percent of gross national product a year in the Mashreq and Israel, an international record. As such, these flows had a large effect on the evolution of these economies, especially the expansion of the public sector. They also resulted in an accumulation of private savings abroad, as the large external inflows to the public sector were accompanied by large outflows of private capital seeking better combinations of risk/return abroad. These past savings now largely sit safely outside the region of which the total stock is estimated at as much as 100 percent of gross domestic product for the region as a whole — more than in any other region of the world.

The two legacies of the past, high stocks of external public debts and of private assets placed abroad, constitute both an obstacle to as well as an opportunity for a market-driven growth path.

Private capital and investments are unlikely to be strong in countries that are not creditworthy. While most countries in the region fell into a high-debt trap in the past, some progress has been achieved recently. Egypt, Jordan and Morocco have improved their creditworthiness following some debt reduction. Debt reduction, however, remains key in Syria and Yemen before a private-sector led growth strategy can be seriously contemplated. In these countries (and in Lebanon), judicious debt management will be crucial to eliciting private sector participation.

Most governments, from Damascus to Rabat, are now trying, with some initial success, to attract private capital inflows with a liberal investment regime, high interest rates and stable exchange rates. But these capital inflows have to a large extent remained invested in financial instruments and real estate. The exceptions are Morocco and Tunisia, where FDI flows have risen sharply and remain concentrated in low-capital, labor-intensive manufacturing.

In the future, the mobility of capital will continue to rise. However, capital mobility is a two-edged sword: success breeds success because it attracts more capital, but failure results in greater capital outflows. The latter also aggravates the problems which arise from bad policies, especially for labor, which has to bear a disproportionate share of the resulting adjustment costs. The discipline imposed by the mobility of savings — on macro-policy, governance and institutions — is more omnipresent than any International Monetary Fund (IMF) program has ever been. The crisis in Mexico and, more recently, in East Asia are reminders of how hard the fall can be when the macro-fundamentals deteriorate in the presence of mobile financial capital.

To avert potential financial crises and avoid over-leveraging weak banking systems, several countries in the region (Egypt, Jordan, Lebanon) have largely sterilized the considerable capital inflows that took place after the Gulf war and the initiation of the peace process. But while safer in the short term, such policies cannot be pursued indefinitely because of the fiscal costs involved. To be able to attract capital into long-term domestic investments, both sound macro- and micro-fundamentals — including the state of the domestic financial system — are prerequisites. Countries where fiscal policy is conservative, productivity is rising, markets are reasonably competitive, and social stability is well entrenched will gain. But capital outflows will further reduce investment and growth in countries that do not manage to develop a virtuous cumulative circle of stable social relations.

The European-Mediterranean Initiative. This Initiative — which is a multifaceted attempt at deeper regional integration between the two shores of the Mediterranean — has moved fast. Already Tunisia and Morocco have signed free trade agreements (FTA) with the EU, Israel has deepened its existing FTA, and Turkey recently joined the European customs union. In addition, Egypt, Jordan, Lebanon, Syria and the West Bank and Gaza are in the process of negotiating their own Euro-Med agreements. In this connection, two themes are of particular concern.

The first theme relates to the nature of the gains that can be expected to arise from the Euro-Med initiative. While most MENA countries did not get, or are not expecting to get, new trade preferences in Europe, the commitments they have to make with respect to the openness of their own markets are very real. It is clear that for these agreements to have positive effects, the policies and mechanisms that can produce dynamic gains must be put into action. Four dimensions seem particularly important.

The EU will put in place a program of assistance for the MENA countries. It is important that these funds be used productively in the transition towards a more open trade regime, helping in the conversion of the import-substitution sectors, retraining displaced workers, and enhancing competitiveness.

The EU should refrain from using new protectionist devises such as exaggerated anti-dumping claims, quality standards or restrictive rules of origin.

The creditability of the reform programs in the region should be enhanced. As the region increases its exports to Europe in the early years, it will become increasingly attractive to deliver the domestic side of the agreements.

The region should at the same time reduce trade barriers with other partners and within the region. Otherwise, the losses due to trade diversion will be large.

The second theme relates to how domestic policies should adapt to the new Euro-Med environment. The important dimensions here range from fiscal to financial, industrial and regulatory issues.

The fiscal dimension is crucial and requires that new instruments be put in place in order to counteract fiscal erosion. Fiscal revenues losses are likely to be high, especially where the EU is a large trading partner. While in order to mitigate these losses the EU has pledged to increase its total aid to the region (committing to spend some ECU 10 billion in the next 5 years), it has also made clear that the rules under which this aid is allocated should be changed in the direction of favoring the countries that adjust faster to the new circumstances. Today, an important policy concern in the region’s capitals is how to draw on European financial promises. The new processes for this assistance are not yet firmly in place; indeed, the types of vehicles that can be used have not yet been tested. Concerns about industrial restructuring, the need to upgrade the efficiency of domestic firms, labor retaining and compensation to those most adversely affected by the adjustments are all now on domestic agendas. But it is still not clear how these issues can be turned into well-designed programs.

Sub-regional Developments. There is an important connection between the EU Initiative and regional cooperation. While the expectations that free trade with Europe will lead to rising FDI from Europe are high, it should be pointed out that that the reverse could well occur, since European firms dealing with individual MENA countries may prefer to locate in Europe from where they might have better access to all the markets. In order to alleviate this problem, the EU has offered a favorable treatment of rules of origin to favor intra-regional trade. But the so called hub-and-spoke problem still arises when the existing constraints, many of them man-made, continue to severely limit intra-regional trade. As such, the removal of constraints to intra-regional trade is a key component of a successful linking to Europe and, over time, to the global marketplace. The recent revival of the Arab Common Market initiative, both at the regional and at several bilateral levels, is crucial in this respect.

But is the Arab Unified Market around the corner? By international standards, the region is well integrated, not only on the labor market front, but also on the trade front. In addition, contrary to common belief, regional trade flows — 7 percent of total regional trade — are not insignificant by international standards given that the region constitutes a small part of the world economy — with only 5 percent of its trade taking place within it. The real problem is not that the share of total exports going to the region is small. Rather, it is that the total volume of exports is too small. In fact, the non-oil exports of all the Arab countries are lower than the exports of Finland, a country of 5 million people. As a result, inter-Arab trade is very small in absolute terms, much below the expectations of many who aspire to a far more integrated region, one that could obtain better deals for itself in the new world of regional blocs.

It is quite plausible that regional integration will be helped by international openness, as is happening now in Latin America and much of Asia. The strong cultural bond that unites these regions is also present in the Middle East and North Africa countries and, as they get closer to the frontier of international competition, it could increasingly help them develop their comparative advantage in a differentiated market. Amman, Bahrain, Beirut, are all clearly looking into this potential. In an increasingly global economy, achieving greater competitiveness also requires openness. For instance, in the past, importing record players allowed Oum Kalthoum to sing for all the Arabs. Similarly in the future, importing cheap computers will boost the regional software industry. But this industry will not take off as long as computers remain heavily taxed at the border.

In devising a strategy for market opening, sub-regional issues must increasingly be considered. One example is the Syria/Lebanon tandem: Syria wants to open slowly, while Lebanon wants to profit from the fact that it is already open. This could lead to a transition strategy that is beneficial to both Syria and Lebanon — a la "China/Hong Kong" — even if on a much smaller scale. But this logic can prevail only if Europe allows Lebanon to treat Syrian value-added similarly to Lebanese production — that is, to "cumulate" rules of origin. A second example is the Jordan/West Bank/Israel trio, which has its own logic. Palestinians are very open to Israel, whether willingly or not, which causes harsh competition with Jordan, whose people and capital are very close to the West Bank. Jordan’s capital could easily flow to the West Bank to profit from the Israeli market if Jordan were not open to the Israeli market.

In sum, with the globalization of world trade and faster capital mobility, the EU Initiative and closer Arab market interactions will help the governments of the region adapt faster to the new circumstances. But gains are contingent on action and implementing policies that favor flexibility and change.

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