The region benefited immensely from the sharp increase in oil prices in the 1970s. The resulting wealth financed an explosion of investment and growth in the oil-exporting countries. This investment, in turn, helped boost worker remittances, trade, and capital flows in other countries in the region. But as oil prices and production softened, the boom faded, prompting a slowdown and, in many cases, a decline in growth rates in the 1980s.
Deteriorating economic conditions brought about pressures for reform. In the mid-to-late 1980s and early 1990s, a number of countries introduced fiscal reforms, strengthened monetary policy frameworks, liberalized trade regimes, encouraged foreign direct investment, and pursued more flexible exchange rates. As a result, fiscal deficits have narrowed since the mid-1980s to levels that are well below those of other developing countries; the size of the government has declined considerably; inflation has been low and was on the decline for most of the 1990s; and the region has weathered the financial crises that plagued other regions during the past two decades.
MENA real GDP per tvpita growth has not kept pace with growth in Other developing countries
Growth resumed in the 1990s, with faster growth rates in reforming countries such as Egypt and Tunisia. But the region as a whole did not grow as quickly as expected, and, more important, it lagged other developing countries throughout the decade (see chart, this page).
Thus, while the region has maintained macroeconomic stability, it has failed to generate the high and sustained growth rates needed to create jobs for its young and growing population. It has also been unable to reap the benefits of globalization that other developing countries have enjoyed.
To address these challenges, the region must take urgent steps to reinvigorate growth, reignite the reform process, and strengthen its links to the global community.
Although there are significant differences among the region’s 24 economies—notably between oil producers and non-oil producers and between early reformers and late reformers—all countries face, to varying degrees, several key challenges.
Increase productivity growth. The region’s population is one of the fastest growing in the world. It has nearly quadrupled since 1950 and is expected to double over the next 50 years. But jobs have not kept pace with the region’s work force: unemployment rates are high, and underemployment (inadequate job opportunities for skilled workers) is pervasive. A young, productive labor force can boost economic growth, but only if there are adequate jobs, complementary factors of production, and a business-friendly environment. The region’s performance has also been constrained by weak, often negative, productivity growth.
Continue political and institutional reforms. Despite its geopolitical significance, the region’s impact on the global economic system remains weak. Political fragmentation, recurring conflicts, and authoritarian rule have hampered the development of democratic institutions and remain major obstacles to economic reforms.
The demarcation between the public and the private sector in many countries is often unclear, encouraging conflicts of interest, rent seeking (that is, lobbying policymakers for purely private gains), and widespread corruption. Although there are exceptions, transparency in government is poor, and accountability remains problematic (see chart, this page).
Although the public continues to perceive governance as inadequate, some progress has been made. In most countries, elections for representative legislatures are becoming more open and meaningful. A growing number of countries are also strengthening their economic institutions with the assistance of international financial institutions.
Further rationalize public sectors. Fast economic and population growth in the 1970s fueled a significant expansion in the size of central governments, as measured by the ratio of central government spending to GDP. Although the size of government has declined since then, by the end of the 1990s it remained relatively high by international standards.
In the face of continued slow economic growth and high unemployment, the public sector has increasingly served as the employer of last resort, inflating public payrolls and wage bills. In addition, several countries in the region maintain extensive generalized subsidies and devote large portions of their budgets to military spending.
Confronted with persistent deficits since the early 1970s, some countries have pursued tax reforms (Lebanon and Sudan) and improved transparency and expenditure control (Pakistan and Mauritania). And some progress has been made on privatization, particularly in the region’s telecommunications sector. Nonetheless, the process of rationalizing the role of the state and adapting it to the requirements of a modern, competitive economy remains incomplete.
Strengthen education reforms. The region has made significant progress in raising the education levels of its population—in a sample of 12 countries, the average years of schooling increased from 1.3 years in 1970 to 4½ years in 2000, and access to good schools has increased dramatically as well. But the quality of education and training has not advanced correspondingly. Education systems are characterized by fragmented management structures spread across several ministries, inflated administrative bureaucracies, and a spending bias toward higher, rather than primary, education. While in some countries—such as Jordan, Lebanon, Syria, and Tunisia—male-to-female education ratios are converging, in many other countries, enrollment rates, years of schooling, and literacy rates remain distinctly lower for females. More needs to be done to close the gap between male and female access to education.
Some progress made, but govemamce remains weak
Modernize financial markets. From the 1970s through the mid-1980s, the region made significant strides in financial sector development. Some countries, such as the Gulf Cooperation Council (GCC) countries, Lebanon, and Jordan, now possess well-developed banking sectors. Overall, however, the region’s financial markets remain fragmented and are dominated by traditional banking activity. As a result, financial sectors have not played the intermediation role needed to accelerate the pace of investment and growth. While the region has been a net exporter of capital for the past 30 years, the financial sector has failed to develop the capacity to channel a significant portion of these savings into long-term productive investment. In many cases, banking systems are predominantly owned or controlled by the state, with considerable exposure to government debt, weak regulatory and enforcement capacity, inadequate management skills, and weak links to international capital markets.
Continue trade liberalization. Trade regimes vary across the region. Many countries—notably the GCC countries, Mauritania, and Yemen—are generally open to free trade, but several continue to maintain relatively high tariffs and nontariff barriers, despite recent trade liberalization efforts. Overall, the region has a higher degree of trade restrictiveness than other regions, although there has been improvement over the past six years. In terms of nontariff barriers, the countries are not that different from developing countries as a group.
Adopt appropriate exchange rate policies. About half of the countries in the region have fixed exchange rates, and another one-fourth have exchange rate regimes that are near-fixed, such as pegs or moving pegs with narrow bands. While some countries, such as those of the GCC, have benefited from using a pegged exchange rate, the choice of an exchange rate regime has not always been appropriate. Countries have tended to delay adjustment in the presence of clear real exchange rate appreciation or have hesitated to exit an inflexible arrangement when this was called for.
Inappropriate exchange rate policies and the inability to successfully address the closely related phenomenon of the “resource curse,” typically associated with countries with rich natural resources or large foreign exchange inflows, contribute to the slow growth of non-oil exports from the region. Inflexible exchange rate policies, among other factors, may also have delayed the development of monetary policy frameworks (for example, inflation targeting) that are more suitable for emerging market economies seeking to integrate more fully into the world economy. Such economies include those of Egypt, Jordan, Lebanon, Morocco, and Tunisia.
Some countries—for instance, Egypt and the Islamic Republic of Iran—have recently made progress in making their exchange rate policies more flexible. Such flexibility is important for the continuing efforts of these countries to undertake structural reforms that promote economic efficiency and stimulate trade and investment.
Boosting growth, creating jobs
What can the region do to reignite and sustain high output and employment growth, better integrate with the global economy, and better manage the booms and busts in oil prices?
Over the past 20 years, the region has made clear progress on macroeconomic reforms and has moved on structural reforms, but these have not gone far enough to address deep-rooted problems or seriously tackle the area’s governance and institutional reform issues. Accelerated and broad action is needed on these fronts, including a fundamental reassessment of the role of the state in the economy and the creation of a rules-based regulatory environment.
Greater efforts are also needed to accelerate trade liberalization, reform financial and labor markets, and improve transparency, governance, and the quality of state institutions. Economic liberalization should seek to ensure fair and open competition in which market forces could create opportunities for a more efficient allocation of resources and support private sector investment and growth.
Oil-exporting countries need to cushion the effects of booms and busts in the oil markets and, over the longer term, take into account intergenera-tional equity considerations in mapping out strategies for government spending, investment, and financing of government operations.
While all countries in the region need to maintain macroeconomic stability and pursue structural reforms, it is the reform of public and private sector institutions that, in the final analysis, will make the difference. A more determined and sustained drive by MENA countries toward a more open and democratic society, embracing fundamental structural and institutional reform, appears to be the best assurance that the region, with its rich civilization and abundant natural resources, can achieve its potential for higher growth rates and a decent and dignified life for the 500 million human beings who live in it.
Photo credits: Denio Zara, Padraic Hughes, and Michael Spilotro for the IMF, pages 1, 2, 3,17,19,21,24, 29, and 31; Ahmed Jadallah for Reuters, page 1; Government of Mali, page 3; Leila Gorchev for AFP Photo, page 4; Romeo Ranoco for Reuters, page 6; AFP, page 18; Aizar Raldes for AFP Photo, page 20; George Mulala for Reuters, page 22; IMF staff, pages 22 and 23. Illustrations: Massoud Etemadi, pages 8-9; Miel, 13-15.