Shadow Economy & Corruption : Invisible Hands: Op-ed

Tuesday 23 October 2007

Op-ed

The Inward East

by Marcus Noland, Peterson Institute
and Howard Pack, Wharton School

Op-ed in Newsweek International
October 29, 2007
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Talk of a Middle East economic renaissance is running strong, even wild. With oil running at $80 a barrel, and petro-states investing the windfall more wisely than in the past (that is, not in offshore bank accounts), pundits have begun to speak of a “transformational moment” in the region. Stock markets have been booming—Saudi Arabia’s is up 200 percent over the last five years, while Egypt’s has risen a whopping 1,700 percent—and investors from Europe and the United States have begun to take notice.

Now let’s look at the reality. The oil boom is real, but two-thirds of all Arabs live in countries without major oil exports. And outside of oil and tourism, the Arab world is in a state of long-term deglobalization, more isolated today than it was 20, 30, or 40 years ago. The region’s shares of world trade and investment have fallen by half in the past 25 years, and though it has risen more recently, that’s almost entirely due to oil. Its slice of global manufacturing exports, never high, has dropped to less than 1 percent. Technology royalty payments—which show how quickly a society adopts new inventions—have stagnated while growing rapidly elsewhere.

So talk of an Arab spring may be premature. The Middle East already has the world’s lowest employment rate, a staggering 47 percent of the adult population. To keep pace with an exploding population of young job-seekers, the region will have to create 55 million jobs in the next 13 years—or 70 million if it hopes to bring unemployment down to the global norm, according to the World Bank. Only by engaging in global trade can Arab governments hope to hit those targets and ensure their own stability.

The problem is that recent economic progress hasn’t translated into jobs. While Egypt jumped up 39 places in the World Bank ranking of the best nations in which to do business last year, it fell two places (from 106th to 108th) in the “employing workers” category, while Saudi Arabia and Syria fell even further. In Jordan, Kuwait, and the United Arab Emirates (UAE), foreigners, not locals, have secured most of the new jobs, and unemployment among nationals has actually increased over the past five years. Employment growth has also stagnated in populous countries such as Morocco and Algeria, encouraging emigration (much of it illegal) to Europe.

Manufacturing, which probably has the best potential to create jobs, is lagging. In the early 1960s, Egypt—the Arab world’s most populous country—exported manufactured goods at roughly the same per capita level as South Korea and Taiwan. Now they export more in three days than Egypt does all year. The Philippines exports 10 times as many manufactured goods as does Egypt, and last year its increase alone was more than Egypt’s total figure. Then there’s Thailand, which by itself exports more manufactured goods than the entire Arab world, despite having only about a fourth of the population. And while Saudi Arabia, the UAE, and other oil exporters have modestly increased exports by getting into petroleum refining, petrochemicals, and aluminum smelting of late, these are capital-intensive industries that do little to create jobs.

The weakness in manufacturing owes to a host of factors: poor technical skills due to decrepit university systems (no Arab school ranks among the world’s best), weak protection for intellectual property rights, and continued state dominance of industry. Together, these factors retard the creation or adoption of new technologies that could boost productivity. The Philippines alone now spends more on foreign technology than does the entire Arab world.

Worse, some of the progress is a mirage. Foreign direct investment (FDI) in Arab nations has surged nearly $30 billion in the past five years, but most of it is from Gulf states spending their oil windfalls. Thus the money hasn’t brought in new ideas or technology. Though Egypt saw FDI rise twelvefold between 2001 and 2006, to $6.1 billion, that is still over $3 billion less than Sweden, which has just one-ninth Egypt’s population.

These problems are often blamed on Arab culture—or on Islam. But neither Islam nor culture alone can explain the big differences between Arab nations. It takes three times as long to start a business in Saudi Arabia as it does in Morocco, or nearly three times as long to enforce a contract in Egypt as it does in Jordan. Some Arab countries have made progress, so why can’t others?

In fact, certain Arab governments are making impressive attempts to join the world economy. Dubai now aims to turn itself into the Singapore of the Middle East, a secure and efficient transportation hub and base for international corporations. Even Syria and Libya have climbed on the reform bus, hoping to boost growth and employment.

Of course, reforming intentions may not be enough in the Middle East. The conflicts in the Palestinian territories and Iraq and the risks of terrorism and assassinations will continue to discourage outsiders from investing in the region. (Our research shows that merely reducing the business costs associated with terrorism could boost foreign investment by 20 to 30 percent.) Repression stifles growth in places like Syria, where per capita income has grown only half a percent annually over the past four years. Yet the Arab dictatorships are brittle, and when they fall, the Islamists who might replace them could turn out to be effective reformers along the lines of the governing AK Party in Turkey.

There’s reason to think reform would be popular. A recent Zogby International poll in Egypt, Jordan, Lebanon, Morocco, Saudi Arabia, and the UAE showed strong support for governing business by Sharia, but a version of Sharia that would allow Muslim businesses to integrate into the global economy. Even Syria's Muslim Brotherhood supports what its leader has called “the gradual and calm transformation of the public-sector economy to a free-market economy.”

If the region can figure out how to reconnect to the outside world, the Arab demographic explosion could turn into an asset. A number of East Asian countries have shown how large populations of young workers can fuel an economic boom if channeled in the right directions. The problem is that the time for reform is now, and no major Arab state is moving fast enough.