Chapter

1 Reform and Growth

Author(s):
International Monetary Fund
Published Date:
November 1996
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Author(s)
Mohamed A. El-Erian and Susan Fennell 

Unprecedented opportunities have opened up for the countries of the Middle East and North Africa (MENA) region to transform their economies through accelerated economic growth. The opportunities are many and varied: prospects for continued rapid expansion of international trade; increasing globalization of world financial markets; closer economic links to the European Union; and an improved, although still very fragile, regional environment. The potential benefits to the region are enormous, but for the benefits to become reality the MENA countries themselves must ensure the necessary conditions.

The MENA region is vast and diverse (Box 1). A number of countries in the region have already initiated wide-ranging macroeconomic adjustment and structural reform policies and are reaping early rewards from their efforts. For these countries, the main challenge ahead is to accelerate the momentum of reform and to continue to build on the progress they have achieved. For countries that are lagging, it is important to grasp the opportunities and to embark on a steady course of appropriate policy reforms so as not to become marginalized in the world economy. By moving aggressively on the economic policy front, the region as a whole can not only overcome the legacy of slow growth and rising unemployment but also establish firmly its goal of improving the welfare of its population.

This study does not attempt to address the entire range of macroeconomic and structural policy issues facing MENA countries. Rather, it focuses on four areas that are fundamental to growth-enhancing structural improvements. These are (1) improving the region’s investment performance; (2) fiscal reform; (3) financial sector reform; and (4) trade liberalization. It expands on the analysis contained in two studies published earlier in 1996 by the staff of the IMF’s Middle Eastern Department: Growth and Stability in the Middle East and North Africa, which analyzed the key features of the macroeconomy of the region, and Policy Challenges in the Gulf Cooperation Council Countries, which discussed in detail the situation of the six oil producing countries that together form the Cooperation Council for the Arab States of the Gulf (GCC) (see Box 1).

Recent Economic Developments

Growth in the MENA countries between 1980 and 1995 was disappointing. The rate of growth averaged 3 percent a year, which led to a decline in MENA’s real per capita GDP by an average of ½ of 1 percent a year. In the same period, real per capita income rose by 2.7 percent annually in developing countries as a group and by 1.7 percent annually in industrial countries. Within MENA, per capita income in the oil exporting countries declined by 1.9 percent, largely as a result of the sharp drop in oil prices from their peak in 1980. Although per capita income rose somewhat in the other MENA countries, the improvement was insufficient to make significant headway in addressing their problems of unemployment and underemployment.

Box 1MENA at a Glance

Coverage. The MENA region is defined to encompass the economies of the Arab League (Algeria, Bahrain, Djibouti, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab Republic, Tunisia, the United Arab Emirates, and the Republic of Yemen), as well as the Islamic Republic of Iran and Israel.1 The region possesses abundant natural resources and, on average, enjoys a reasonable standard of living. However, individual countries exhibit a broad diversity of characteristics. They vary substantially in natural resources, economic and geographical size, population, and standards of living.

Size. The MENA region covers an area of more than 15 million square kilometers and contains more than 300 million people, roughly 6 percent of the world’s population. The population of individual countries varies considerably-the smallest among them have a population of about half a million (Bahrain, Djibouti, and Qatar) and the largest have populations of some 60 million (Egypt and the Islamic Republic of Iran). The nominal GDP of the region amounted to some US$660 billion in 1995, roughly 2 percent of world GDP and about 11 percent of developing countries’ GDP.

Population growth. Many MENA countries are experiencing rapid population growth and have a high proportion of young dependents among their population. The average increase in population in recent years has been about 3 percent, although a group of countries (Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates) have registered a higher rate of growth of 3.5 percent. Bahrain, Egypt, Lebanon, Morocco, and Tunisia have recorded relatively low rates of population growth (of about 2 percent) compared with the average for developing countries as a group.

Per capita income. The region includes some of the poorest countries in the world, with per capita incomes around US$200 (Somalia and Sudan), as well as countries among the high-income group, with per capita incomes ranging between US$14,000 and US$18,000 (Israel, Kuwait, Qatar, and the United Arab Emirates).

Regional subgroupings. Many subgroupings have been used in the literature. The most common include

  • Oil economies. Ten MENA countries are classified as oil exporting countries. They are Algeria, Bahrain, the Islamic Republic of Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. Although other countries (such as Egypt, the Syrian Arab Republic, Tunisia, and the Republic of Yemen) also export oil, the role of this sector in their economies is relatively limited.
  • Cooperation Council for the Arab States of the Gulf (GCC). Member countries of the GCC are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
  • The Arab Maghreb Union. The members are Algeria, Libya, Mauritania, Morocco, and Tunisia.
  • Mashreq. This group consists of Egypt, Israel, Jordan, Lebanon, the Syrian Arab Republic, and West Bank and Gaza Strip.
1In view of the limited availability of data for Iraq, the aggregate figures presented in this publication generally do not include information on this country.

Unfavorable external factors contributed to the disappointing growth performance. Macroeconomic conditions were adversely affected by weak economic activity in industrial countries in the early part of both the 1980s and 1990s, the sharp decline in oil prices in the mid-1980s and the subsequent weak oil market conditions, and armed conflicts and civil strife in some countries.

The domestic policy response was not strong enough to offset these unfavorable exogenous factors and to place MENA economies on a high-growth path. During 1980–95, domestic savings fell from the oil-price-induced high levels of the early 1980s and were accompanied by lower investment. As a result, both savings and investment levels during this period were below the average for developing countries as a whole.

The policy effort must be strengthened

Most MENA countries avoided the high and variable inflation rates experienced by developing countries in Latin America and, to a lesser extent, some economies in Asia. Inflation amounted to about 16 percent a year during 1980—95, some 20 percentage points below the average for developing countries. The region’s external current account imbalance (relative to GDP) was also lower than the average for developing countries as a whole. However, as the MENA region’s external terms of trade were very much influenced by developments in the oil markets, the external current account position of the region deteriorated markedly after 1980 combined with wide fluctuations. While these trends were more pronounced among the oil exporting countries, their current account positions have improved steadily since 1991 mainly because of their fiscal adjustment efforts.

MENA countries differed widely in financing their external current accounts. Most oil exporting countries relied heavily on accumulated large foreign assets. Other countries resorted primarily to medium- and long-term borrowing from official sources. Private portfolio capital and foreign direct investment inflows to the region remained low. As a result, the external debt of the region grew from 22 percent of GDP in 1980 to 38 percent in 1993 before declining to 34 percent in 1995, as the external position improved and official bilateral and commercial bank creditors agreed on debt-reduction packages with some countries.

Preliminary estimates indicate that economic and financial conditions in the MENA economies will improve in 1996. Three aspects of this expected improvement are worth noting:

  • Growth. Economic growth in the region as a whole has picked up to a projected 4 percent in 1996, compared with an average of 2 percent a year in 1993—95. As a result, the region is poised to register a positive per capita growth rate for the first time since 1992. The pickup in growth is evident in both oil exporting and non-oil countries.
  • Inflation. The higher growth rate has been accompanied by a reduction in inflation. The increase in consumer prices in 1996 is projected to amount to 12 percent, the lowest level so far in this decade; in fact, inflation rates in some countries are similar to those prevailing in industrial countries.
  • Balance of payments. External financial balances are projected to improve in 1996. The region’s current account deficit is expected to fall, together with an improvement in the overall balance of payments position, partly because of increased private capital inflows.

The magnitude of the economic and financial improvement and the reasons for it of course will vary from country to country. Nevertheless, two enabling factors are evident:

  • Policies. Several countries in the region have accelerated their adjustment and reform efforts. This is illustrated by the improvement in their fiscal balances: the central government balance is expected to decline to 2 ½ percent of GDP in 1996, less than half of the level in 1994; fiscal adjustment has been evident in both oil exporting and non-oil countries. Furthermore, countries have stepped up structural reforms, particularly in the areas of privatization, deregulation, and trade liberalization.
  • Favorable external environment. External developments have also contributed to the improved economic and financial situation. First, international oil prices have risen sharply in the first nine months of 1996. This has benefited the oil economies and, particularly because of higher remittances, will have a positive impact on other economies that have a large number of nationals working in the oil countries. At the same time, however, the higher international prices of cereals have had an adverse effect on the region’s import prices. Second, after recurrent droughts, weather conditions have improved in North African countries.

Looking ahead, the region cannot and should not depend on favorable external factors to sustain a high growth rate and further improve financial balances. Domestic policies will have to take the lead. This means consolidating the gains from the financial stabilization and deepening and widening the structural reforms. The stakes are high, because the region needs to make further and early progress in reducing unemployment, in providing jobs for the increasing number of nationals entering the labor force and, more generally, in improving living standards, especially in the poorest countries.1

Structural reforms hold the key

Summaries of Policy Issues

Against this background, the chapters that follow analyze four key policy issues facing most, if not all, MENA economies.2Chapter 2 considers the investment and growth performance of the MENA region. It concludes that improving the region’s investment performance is critical if policymakers are to succeed in increasing the region’s economic growth rate. This would require changing the nature of investment in MENA as a whole, which has been too low, too heavily tilted toward the public sector, too highly dependent on external influences, and less productive than in many other regions. It also means attracting higher inflows of foreign direct and portfolio investments which, until recently, have been relatively limited. After discussing the relationship between investment and economic growth, the chapter analyzes the investment responsiveness in various countries in the region. MENA countries’ investment performance has been positively linked to the strength of macroeconomic policies, the extent of regulatory and structural reforms, the level and efficiency of spending on basic social services, and institutional developments. The need to improve the level, composition, and efficiency of the region’s investment in human and physical resources is noted, and the policy priorities that would strengthen the basis for rapid and sustained economic growth are outlined.

Higher and more efficient investment is needed

Some of these policy priorities are considered further in the other three chapters. Chapter 3 deals with fiscal reform—a key determinant of countries’ ability to maintain the stable macroeconomic environment required for sustained higher growth and employment creation. The chapter outlines the fiscal structure of the MENA countries, including the pattern of fiscal adjustment in recent years. It next reviews the implications for the economies of the region of the dominant role played by the public sector and efforts made in recent years to improve the quantitative and structural aspects of public sector involvement. Finally, it discusses the main elements of the fiscal reform policy agenda aimed at further reducing fiscal deficits and enhancing the effectiveness of government intervention.

The improvement in public savings must continue

Financial reforms will enhance private savings and resource allocation

With lower fiscal deficits, a larger amount of noninflationary resources will be available to finance productive activities in the private sector. Accordingly, Chapter 4 considers the role of the financial sector in mobilizing savings and allocating them to the most productive uses. It assesses the reform of the financial system in MENA and highlights the outstanding issues that need to be addressed. Noting the gradual shift away from public-sector-driven development strategies that emphasized government ownership of financial intermediaries and control of resource allocation and prices, the chapter reviews the implementation of reforms seeking to improve the financial intermediation process. It argues that the remaining reform agenda, which can only be detailed on a country-specific basis, needs to increase reliance on competition and market forces, deepen markets and broaden instruments, and strengthen prudential regulation and supervision.

Trade regimes require further liberalization

Chapter 5 addresses concerns that MENA, with the exception of the GCC economies, has lagged in trade liberalization. This delay has had a negative impact on production efficiency and consumer welfare and will become more costly given the process of globalization and integration of the world economy. It could also affect adversely the region’s ability to attract foreign investment and retain domestic savings. Indeed, the region has yet to take sufficient advantage of the remarkable growth in international trade and risks missing out on the added opportunities presented by the current multilateral trade liberalization arrangements—the Uruguay Round and the European Union’s Mediterranean Basin Initiative. Against this background, the chapter describes the basic trade characteristics of the region and reviews the past and ongoing trade reform efforts of MENA countries. It also highlights the key steps that MENA countries will need to take to benefit from these trade-enhancing initiatives.

Chapters 25 are closely interlinked in that they each address a structural issue that affects the ability of the MENA region to grow and meet the legitimate aspirations of its people. Interestingly, and not surprisingly, they each point to a broadly common and consistent set of policy priorities despite starting from different perspectives. Indeed, this provides yet another illustration of the scope for promoting a virtuous economic cycle in the MENA countries, with policy measures reinforcing each other in the context of higher economic growth. It is hoped that this publication will assist policymakers in formulating and implementing the reforms needed for MENA to exploit more fully its considerable economic potential.

There is clearly scope for a virtuous cycle of reform and growth

1While these policy priorities are relevant for all MENA countries, the extent of the challenge varies among them. Indeed, growth and employment concerns are relatively less pressing in Israel, which has registered steady growth in recent years and has absorbed into the labor force the large inflows of immigrants, and has succeeded in attaining low unemployment—close to full employment—levels.
2The chapters are based on more detailed, technical analysis presented in background papers, forthcoming in the IMF’s series of Working Papers.

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