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2. Economic Reform in the Arab Countries: A Review of Structural Issues

Editor(s):
Saíd El-Naggar
Published Date:
May 1993
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Despite adverse exogenous factors, Arab countries have achieved important economic gains in recent years. Nevertheless, many of them remain subject to internal and external constraints that prevent the full realization of their considerable economic potential. The welfare gains forgone are of particular relevance in the current environment, characterized, inter alia, by rapid population growth in some countries in the region, concerns about the availability of natural resources (namely, water), uncertain oil prices, and a move outside the Middle East toward regional economic blocs combined with slow progress in multilateral trade liberalization efforts.

There is growing recognition among Arab countries on the need to strengthen their economic performance in a sustainable manner. This involves the implementation of comprehensive measures to enhance the mobilization, and increase the efficient use, of productive resources. Indeed, several Arab countries have taken structural reform and adjustment measures aimed at improving the supply responsiveness of their economies and containing excessive aggregate demand pressures.

Given the considerable economic and financial diversity of the Arab world, there is no single approach to identify concisely and comprehensively the challenges facing individual countries in the region as well as their policy implications. At the same time, however, several of these countries share similar policy issues, particularly in the area of structural reform, and some of them have already taken actions to address these issues. Accordingly, by reviewing the broad economic issues and the policies taken so far, this paper specifies an overall framework that may be applied to individual countries, taking account of their specific circumstances.

The first section of the paper briefly reviews economic and financial developments in Arab countries in the 1980s, using the experience of developing countries as a whole as a basis for comparison. This review provides the background for the discussion in the following section of a “core” set of structural policy challenges facing Arab countries in the 1990s. After briefly analyzing these challenges, the paper reviews specific reform measures drawing on the experience of countries in the region. It concludes with a summary of the main findings.

Developments in the 1980s

The decade of the 1980s was a relatively disappointing one for developing countries as a group. Compared with the 1970s, it was characterized by weaker macroeconomic performance (Chart 1). Specifically, (1) real GDP growth was lower in the decade of the 1980s compared with that of the 1970s; (2) the consumer price index increased significantly faster in the 1980s; and (3) the accumulation of external debt was higher in the 1980s despite the sharp curtailment in the availability of spontaneous financing. These country averages conceal important differences among regional groupings, with relatively weak performance by African and Latin American countries, particularly relative to Asian economies. Underlying the macroeconomic developments were adverse exogenous developments (including unfavorable terms of trade) and domestic policy weaknesses (including large financial imbalances associated with overexpansionary fiscal and monetary policies).

Arab countries’ performance was mixed relative to the developing country average.2 Real GDP expanded at an average annual rate of some 2 percent in the 1980s (Chart 2). With a relatively high population growth, per capita incomes declined at an average annual rate of about 1 percent.3 Inflation performance in the Arab countries was considerably better than that for developing countries as a whole, in spite of the acceleration in the rate of inflation in the later part of the decade (Chart 3). Finally, the group’s current account position improved after 1984, despite the lower international petroleum prices.

Chart 1.Developing Countries: Selected Indicators

(Index numbers)

Source: International Monetary Fund, Data Fund.

Chart 2.Arab Countries: Growth of Real GDP1

(Annual changes in percent)

Source: International Monetary Fund, Data Fund.

1 Weighted geometric average.

As with the developing country group, macroeconomic aggregates for Arab countries as a whole conceal important differences between individual countries—countries that differ (substantially in some cases) in their natural resource base, labor endowments, and financial resources. This difference is most apparent when comparing oil and non-oil countries’ growth performance—and despite strong interrelationships among the two groups (including those resulting from remittance and aid flows, both of which have been affected by changes in oil export receipts).4 As expected, the fall in oil prices, compounded by a reduction in production and exports, affected more severely growth performance in the oil producing countries.5 Thus, while non-oil countries’ per capita income gains exceeded those of developing countries as a group, the oil producing countries recorded negative per capita growth rates in several years during the 1980s. The non-oil countries’ inflation performance was also better than that of developing countries as a whole but fell short of that of the oil producing countries. This differentiated performance was consistent with monetary developments, with non-oil countries recording larger domestic liquidity growth throughout the period (Chart 4). This primarily reflected the financing requirements of fiscal deficits in the context, inter alia, of limited reserve funding.

Chart 3.Arab Countries: Consumer Prices1

(Annual changes in percent)

Source: International Monetary Fund, Data Fund.

1 Weighted geometric average.

Major Policy Issues for the Remainder of the 1990s and Reform Experiences

Arab countries face important economic challenges and opportunities in the remainder of the 1990s. Of course, their exact nature and magnitude vary, depending on the country being considered. In addition to differences in economic and financial conditions—including the degree to which they were affected by the 1990—91 Middle East crisis—countries vary in the extent to which they have already embarked on comprehensive economic adjustment and reform programs. Thus, some countries have implemented some corrective measures but as yet do not appear to have reached the critical policy mass required to address decisively the economic and financial imbalances. In contrast, others have persevered with comprehensive adjustment and reform programs, placing them more firmly on the road to sustained medium-term economic growth and financial stability. In view of these factors—which are compounded by differences in the “reserve cushion” available to countries in the region and their vulnerability to exogenous shocks—the type of approach taken in this section will, by necessity, involve a certain degree of aggregation and generalization.

Chart 4.Arab Countries: Broad Money Aggregates1

(Annual changes in percent)

Source: International Monetary Fund, Data Fund.

1 Weighted geometric average.

There is widespread agreement that most countries in the region stand to benefit from sustained domestic policy efforts aimed at improving the efficiency of resource use. Indeed, some observers have noted that the real issue is not whether to implement adjustment and reform measures, but rather the nature of the required measures.6 This issue assumes added importance given some countries’ rapid population growth and concern about water supplies and oil prices. Moreover, the international environment facing Arab countries includes movements toward regional trading blocs outside the region (for example, in Europe, Asia, and the Americas) in the context of slow progress in multilateral trade liberalization efforts.7

This section seeks to identify, in a summary fashion, some of the major structural economic challenges facing countries in the Arab world. Their policy implications are discussed, and the experience of selected Arab countries’ in implementing appropriate reform measures is reviewed.8

Reforming Public Enterprises

One of the important features of many countries in the Arab world is the dominant role played by the public sector. Thus, over the years, the public sector has increasingly participated directly in a wide range of economic activities, many of which bore little relation to arguments of strategic importance, natural monopolies, public goods, and other market failures. In many countries, the growth of the public sector initially had its roots in considerations relating to the establishment of “essential industries” (such as steel, fertilizers, and chemicals)—industries deemed imperative for the development of the economy but considered beyond the capacity of the private sector. In several countries, these factors were accompanied by sociopolitical considerations (Algeria, Egypt, Iraq, Sudan, Syria, and the former People’s Democratic Republic of Yemen), including the wish to reduce the influence of external forces and certain segments of domestic society.9 In some countries, the importance to the government of securing control over the exploitation of a strategic natural endowment also played an important role. Thus, the private sector came to perform an increasingly residual role in a number of economic and financial sectors, with administrative allocation of resources replacing market signals. Moreover, in the 1970s, the increased dominance of the public sector in several oil countries reflected the structure of these economies, particularly the relatively limited role of the private sector in production activities in the context of large windfalls accruing to the public sector as a result of the oil price increase of 1973–74. Indeed, public finance policy was the primary determinant of domestic liquidity, aggregate demand, and non-oil GDP growth.10

Economic performance of public enterprises in Arab countries has been far from satisfactory in most cases.11 The enterprises’ earnings have tended to fall short of their current financial obligations, let alone provide for an adequate return on capital. As in other developing countries, production efficiency has been undermined by insufficient commercial orientation and management accountability—including exogenously determined investment, pricing, and employment considerations. In addition to receiving direct transfers from the budget to subsidize mounting losses, some of the public enterprises were provided with subsidized inputs and credit—placing a heavy burden on already strained budgetary and monetary policies. In some cases, the banking systems’ nonperforming claims on public enterprises have also weakened the integrity of the financial system. These problems have been compounded by rigid labor legislation in a number of countries—an issue that also has adversely affected private sector production and investment.

There is increasing recognition of the need to rationalize the public sector’s activities to those operations that it undertakes most efficiently and that are warranted by market failures. In some Arab countries, this recognition has been translated into efforts at enterprise reform incorporating the provision of greater autonomy and accountability, financial restructuring, and privatization. However, compared with other developing country regions, the scale of privatization in the Arab world has been limited. Thus, with one exception, no country in the region may be regarded as having implemented a comprehensive program of wholesale divestiture of public sector enterprises—in contrast to the experience in Asia, Central and Eastern Europe, and Latin America.

In Arab countries implementing public sector restructuring programs, the initial stages included diagnostic studies to assess the financial viability of enterprises and the rationale for public ownership and control (Mauritania, Morocco, and Tunisia).12 Decisions have also been made regarding the best institutional setup to implement the restructuring program. Thus, in some countries, the process of granting greater autonomy to enterprises has involved the use of a holding company construct (Algeria and Egypt), which, while still under public ownership, was to be free from administrative interference. The holding companies were given the authority to approve business plans, restructure, merge, liquidate, or privatize the enterprises under their control. Progress, however, has been slower than anticipated, reflecting, inter alia, constraints inherent in the construct itself—and has resulted in further policy adaptations. Other—albeit less comprehensive—approaches have also been implemented in the region. These approaches include transfers to workers’ cooperatives (Libya and Somalia); sales of some shares to the public (Oman, Qatar, and Saudi Arabia), to foreign minority partners (Qatar), and through joint ventures (GCC countries); employee buyouts (Morocco); use of management performance contracts (Algeria); and assumption by the central government of enterprise obligations to the banking system (Mauritania).13

In addition to institutional constraints (including the absence in some countries of sufficiently deep capital markets), public enterprise reform has been delayed by concerns about the absorption of surplus labor and by difficulties in addressing the large financial obligations of the enterprises—obligations that not only involve direct and contingent budgetary liabilities but also affect the soundness of the domestic banking system. Some countries have sought to “clean up” enterprises’ balance sheets prior to their transfer to the private sector. This has included the setting up of a fund to cover accumulated losses (Algeria and Tunisia), cross-cancellation of bilateral obligations (Morocco), and a waiver of enterprises’ arrears to the central government (Algeria and Tunisia). The issue of absorbing surplus labor has primarily concerned the extent of concomitant growth in private sector activities—which, as discussed below, has been closely related to policy actions to liberalize production and investment regulations.

More forcefully addressing the institutional and financial constraints constitutes a necessary but insufficient condition for effective reform of public sector enterprises in Arab countries. The process must be accompanied by modifications in the production environment, which includes enhancing competitiveness and market discipline through domestic and external trade liberalization policies supported by appropriate regulatory and supervisory practices; rationalizing the system of credit subsidization through the banking system; modifying labor legislation; and limiting explicit and implicit guarantees for enterprises’ domestic and external nonbank borrowings. While some important steps have been taken (as discussed below), progress so far remains limited in several countries in the region.

Other Fiscal Sector Reforms

The dominant role of the public sector in Arab countries has also been reflected in the structure and size of the central government budget. For some countries—particularly the major oil exporters—the financing of budgetary expenditures did not pose a problem as long as international oil prices were relatively high. However, sharp falls in oil prices and associated budgetary revenues, particularly in the mid-1980s, exposed the vulnerability of the fiscal accounts, requiring sharp cuts in expenditure and mobilization of budgetary financing from domestic and external sources.14 They also highlighted the importance for some countries of diversifying the revenue base by increasing the share of non-oil revenues. As noted earlier, non-oil Arab countries have faced more persistent budgetary problems that have contributed to inflationary and balance of payments pressures.

There is increasing recognition among policymakers that the required effective and permanent reduction in fiscal imbalances necessitates the adoption of measures that also improve the structure of budgetary revenue and expenditure. Without such structural improvements, a series of politically difficult fiscal adjustments would be required periodically to prevent the re-emergence of fiscal imbalances.

In many Arab countries, the tax system has been characterized by a myriad of taxes and rates, differentiated in scope by the type of income and sector of activity, with various levies and fees superimposed thereon, as well as ad hoc concession and exemption schemes. This conglomeration has tended to weaken the elasticity and buoyancy of the tax system, give rise to production and equity distortions, and undermine tax administration. Accordingly, some Arab countries have undertaken comprehensive reforms of their domestic tax systems (Algeria, Morocco, and Tunisia). Several others have initiated a similar effort (Egypt, Jordan, and Mauritania); while others are still at the policy design stage.

The key objectives of the tax reforms implemented in the Arab countries have included simplifying the tax system and rendering it more transparent; improving its buoyancy and elasticity; reducing antiproduction and antiexport biases; enhancing the redistributive features; and reducing the vulnerability of tax collection to adverse movements in the external terms of trade. The main challenge has been reform of direct and indirect taxes, in the context of reduced reliance on international trade taxation. The most comprehensive reforms have provided, inter alia, a broadening of the taxable income base; taxation of all individual income under the same tax schedule; elimination of multiple taxation of corporate profits; clarification of rules determining incomes and profits (including depreciation allowances); rationalization of exemptions (including a uniform minimum exemption floor); and introduction of current-year payments of realized tax liabilities.

On the indirect taxation side, the challenge in most countries has been to rationalize a system characterized by a wide range of turnover levies and excises, with cascading features as a result of taxation of the same activity at multiple levels and rates. The most direct reforms have included replacing various taxes and levies by a single value-added tax (Algeria, Morocco, and Tunisia). Apart from the unification aspect, an important advantage of this measure has been the establishment of clear deduction rules governing taxes paid at earlier stages of production. The new value-added tax has been accompanied by a reduction in the number of rates and a broadening of the coverage to sectors previously excluded. Equity considerations have been addressed through the exemption of basic consumption goods and activities deemed critical for social reasons. Other reforms of the indirect tax system have included the adoption of sales taxes (Egypt) and consumption taxes (Jordan), and shifting excises from a specific to an ad valorem basis (Mauritania).

Despite progress in tax reforms, the region as a whole continues to be heavily dependent on collections from international trade (including petroleum exports). Nevertheless, the strengthening of the domestic taxation base has provided increased scope in some countries for measures to lessen reliance on such taxes. In these countries, the reform of these taxes has been undertaken in the context of a broader trade liberalization effort (Algeria, Egypt, Jordan, Mauritania, Morocco, and Tunisia). Adjustment measures have aimed at rationalizing and liberalizing customs tariffs through a reduction in the average tariff rate and through the dispersion of rates. These measures have also provided for efficiency gains as a result of the accompanying reduction in distortions in effective rates of protection.

Further progress in tax reform efforts also needs to take greater account of regional factors. Indeed, increased emphasis on tax harmonization among Arab countries is an important contributing factor to larger and more efficient intra-Arab economic and financial relations.

As noted earlier, several oil producing countries (including Libya and Saudi Arabia) took steps to reduce expenditures in the face of declining oil revenues. As was true for other countries, the challenge was to curtail expenditure on activities of limited efficiency, including lower-priority infrastructural projects. Other Arab countries have complemented such efforts by imposing strict limits on public sector employment and wages (Jordan). Nevertheless, there is scope in several countries in the region for further cuts in unproductive expenditures and for rationalizing outlays on public sector wages and salaries. This would facilitate the provision of greater resources for education, health, other social services, and infrastructure—an issue that is of particular importance for several of the lower-income countries in the region.

Financial Sector Reforms

As in other developing countries, the reform challenges in the financial sectors of many Arab countries include three key elements: (1) rationalizing the rates of return structure supporting the mobilization and allocation of loanable funds; (2) deepening money and capital markets in the formal sector of the economy; and (3) strengthening prudential regulation and supervision.

The financial sector in many Arab countries has been characterized by strict controls over rates of return, supplemented by quantitative limits on the overall and sectoral allocation of credit. This system grew out of the desire, inter alia, to prevent usurious rates and to provide mechanisms for channeling credit to particular sectors deemed to be a national priority (heavy industrial and export-oriented sectors). In many cases, however, the system of strict controls over rates of return and quantitative credit allocations has contributed to financial disintermediation, currency substitution, and credit rationing of productive activities—particularly with an overexpansionary budgetary stance. In addition, the channeling of subsidized credit to certain sectors has resulted in investments in financially questionable projects, with recurrent funding requirements and a growing portfolio of impaired bank assets. Accordingly, several Arab countries have embarked on a process of financial liberalization as part of their financial sector reforms.

In some of the Arab countries, the first steps toward financial liberalization have included the implementation of greater flexibility in rates through the use of prescribed ceiling and floors (Morocco), subject in some cases to timely changes in view of developments in international financial markets (Qatar). In other countries, the initial phase focused primarily on deposit rates. Eventually, however, most of these countries have also substantially liberalized their rate structures (Algeria, Bahrain, Egypt, Jordan, Morocco, Tunisia, and the United Arab Emirates) and taken steps to terminate preferential credit arrangements for public enterprises (Tunisia). In some countries where the banking system has been burdened by a large portfolio of nonperforming assets, the government has moved to strengthen the financial integrity of the banking system by exchanging a portion of these assets for government obligations (Kuwait) and recapitalization through direct budgetary transfers (Egypt).

The beneficial impact on financial intermediation of the liberalization of the rate structure also depends on a concurrent move away from quantitative credit restrictions and toward indirect monetary control instruments. Accordingly, steps have been implemented for increased reliance on reserve requirements (Morocco), elimination of prior central bank approval for bank credit (Tunisia), and modifications to the rediscount mechanism to render it more sensitive to market conditions (Egypt). Nevertheless, several countries remain encumbered by administrative credit allocation mechanisms that respond weakly to risk/return considerations.

Improving the financial intermediation process in Arab countries also requires a deepening of money and capital markets. This deepening would provide for a wider range of domestic financial instruments—thereby allowing for a shift in portfolio incentives away from both acquiring physical assets (including for consumption purposes) and from holding foreign financial assets. At the same time, it would strengthen the institutional basis for indirect monetary control instruments—thereby also strengthening the allocation of loanable funds.

For most Arab countries, the development and deepening of money and capital markets is an important challenge. In several cases, it involves renewed efforts at institution building. Some Arab countries have had money markets in operation for several years, but their effectiveness has been constrained by the absence of interbank transactions (Algeria), limited central bank rate flexibility in intervention operations (Morocco), and restraints on financial sector participation (Algeria and Morocco). These constraints are being addressed, complemented by the introduction of new financial instruments and auctioning procedures for short-term government securities. Similarly, efforts are under way in certain countries to strengthen existing capital markets, including through improvements in trading, reporting, and accounting systems.

Financial liberalization may under certain circumstances involve increased risk for the soundness of the financial system, which also implies contingent liabilities for public finances, particularly in the context of explicit public sector safety net arrangements. Accordingly, steps to liberalize and deepen the financial system must be accompanied by an appropriate strengthening of prudential regulatory and supervisory practices. The emphasis in Arab countries has been primarily on improving the regulation and supervision of commercial banks. Among recent steps were the introduction of minimum capital and/or net-worth requirements (Algeria, Egypt, Jordan, Morocco, and Oman) and minimum liquidity ratios (Qatar). Explicit guidelines have been issued for improved classification of loans according to risk and provisioning standards (Algeria, Bahrain, Egypt, Morocco, and Tunisia) and for portfolio concentration to individual single customers, and on account of foreign exchange transactions (Algeria, Egypt, Morocco, Qatar, and Tunisia). In most of the Arab countries, steps have been taken to strengthen on-site and off-site surveillance, and to improve and standardize accounting practices.

Despite these advances, the need to continue improving the prudential regulatory and supervisory regimes is recognized, as well as extending it to nonbank financial institutions. This issue takes on added importance in the context of efforts toward the international harmonization of prudential regulatory and supervisory practices, particularly in the context of the Basle Committee’s guidelines.15 Indeed, regulatory strengthening is critical if Arab financial institutions are to compete on an equal and effective footing in financial markets that have become increasingly globally integrated and interdependent.

Other Domestic Liberalization Measures16

Economic surveys of the Arab countries tended to emphasize the prevalence in several economies of rigid systems of administered prices.17 The resulting lack of price flexibility led to distorted market signals regarding the opportunity cost of goods and services, thereby contributing to production and consumption inefficiencies. In recent years, several of these countries (Egypt and Sudan, for example) have taken steps to liberalize their domestic pricing system, including through adjustments in prices for major agricultural crops and for energy products. Moreover, steps have been taken to address the multiplicity of same-product prices associated with different consumer groups (for example, Syria). Nevertheless, the process, although advancing, is far from complete in several economies. As a result, the objective of establishing a “level playing field”—both operationally and legally—for the private and public sectors is still some distance away. Moreover, continuing economic inefficiencies associated with rigidities in the goods, labor, and credit markets are compounded by sociopolitical difficulties resulting from the population at large perceiving the government, rather than international conditions, as the main reason for upward adjustments in domestic prices of tradables.

Price liberalization has been accompanied by increased emphasis on strengthening private investment, within the framework of more appropriate macroeconomic and institutional policies. In addition to the adjustment and reform policies discussed elsewhere in this paper—policies that enhance the average return on private investment due to an improved operating environment18—some Arab countries have adopted a number of specific measures including tax holidays and free zones. Although these may have some impact in attracting investment resources to a specific activity or area, experience in developing countries as a whole suggests that they generally do not constitute cost-effective instruments for net efficient additionality over the medium term. Some Arab countries have curtailed, rather than expanded, such incentives in the context of adjustment and reform programs. They have also taken steps to establish unified investment codes that avoid intersectoral biases, limit the duration of concessions, and provide for more efficient and transparent criteria for eligibility, approval, and monitoring (Morocco and Tunisia).19 Some countries that have retained investment licensing procedures have taken steps to shorten the time lag for approving projects (Mauritania).

External Sector Issues

The emphasis on public-sector-led growth in several Arab countries was associated with an import-substitution industrialization strategy. As in many other developing countries, the strategy resulted in weakening the market discipline emanating from international competition. This is particularly true for most of the non-oil Arab countries, with the resulting inefficiencies in the tradable sector contributing to welfare losses in both production and consumption. By restraining export diversification, the process has also contributed to more pronounced vulnerability to unanticipated adverse developments in international price and demand conditions. Recognition of these tendencies has led most Arab countries to take steps, with varying degrees of success, to liberalize their external sectors. These steps have emphasized (1) relaxing trade restrictions; (2) reforming the exchange and payments system; and (3) enhancing inflows of foreign direct investment.

With the exception of several oil producing countries, the trade regime in the Arab world has been characterized by extensive quantitative restrictions, high nominal tariffs, and cumbersome administrative procedures. Some countries have also imposed export restrictions in an attempt to provide domestic consumers with a relatively cheap and steady supply of domestically produced tradables. The main thrust of trade reforms in such countries has been to evolve toward a more open system, with reduced reliance on quantitative restrictions. Accordingly, countries have begun to streamline administrative procedures and reduce the number of products subject to outright bans or prior authorization (Algeria, Egypt, Morocco, and Tunisia). As noted earlier, countries have also reduced the level and dispersion of tariffs (Tunisia).

In several Arab countries, the maintenance of an overvalued “official” exchange rate led to the emergence of a parallel rate in the informal market. With continuing financial imbalances putting strains on the official rate and the balance of payments, several countries (Algeria, Egypt, Morocco, Sudan, Syria, and the former Yemen Arab Republic) adopted multiple exchange rate regimes—effectively legalizing the more depreciated parallel rate. Initially, this move was to promote earnings from exports of specific goods, services, and factor transfers (workers’ remittances, and to a lesser extent, tourism receipts).20 The perceived attractiveness of such regimes to policymakers was closely correlated to the severity of the balance of payments pressures and the relative importance of sources of foreign exchange receipts not easily controllable by the authorities through the use of quantitative restrictions. The alternative of a comprehensive exchange rate adjustment was not pursued owing, inter alia, to concern as to the resulting upward pressure on the prices of certain imports deemed sensitive from a sociopolitical viewpoint. In some countries, fiscal considerations also played a role. However, the provision to the budget and public sector enterprises of foreign exchange at a relatively inexpensive rate was offset by central bank losses (implying an offsetting quasi fiscal loss) and/or implicit taxes on private sector activities.

The prolonged use of multiple exchange rate regimes was accompanied in several cases by increased complexity in the structure of foreign exchange pricing. As was true with multipricing of single goods, this had distortionary effects, with adverse implications for efficiency of production and consumption. At the same time, the implicit subsidization through the exchange rate mechanism tended to obfuscate the underlying magnitude, nature, and implications of the overall subsidy program. Moreover, the implementation of multiple exchange rate regimes involved considerable administrative costs associated with attempts to separate the different exchange markets through monitoring and control of underlying transactions. It is in this context that steps to tinker with the multiple exchange rate regime have given way to more ambitious efforts at exchange rate unification at a market-related level (Algeria, Egypt, Morocco, Sudan, and the Yemen Arab Republic). Success in such efforts has reflected the concurrent adoption of appropriate financial and structural reform policies.

Several Arab countries have also taken steps to reform the exchange system by liberalizing the external payments mechanisms. Progress in this area has tended to be slower, reflecting hesitancy about allowing market forces to fully determine the allocation of foreign exchange. Thus, countries have allowed exporters to retain a portion of their foreign exchange earnings (Libya and Tunisia). Rules governing the use by residents of foreign currency accounts in domestic banks have also been liberalized (Morocco and Tunisia).

Steps have also been taken to enhance inflows of foreign direct investment. This move reflects three main objectives: first, to increase the availability of nondebt-creating external inflows (inflows whose “servicing” is linked to the performance of the underlying investment rather than subject to fixed contractual terms);21 and second, to benefit from technology transfers, including upgrading the existing capital stock; and third, to facilitate the penetration of key export markets in industrial countries. In this regard, measures have been implemented to reduce limitations on sectors open to foreign investment and to liberalize restrictions on the repatriation of capital, dividends, and profits (Algeria and Tunisia).

Protecting Vulnerable Segments of the Population22

A sound macroeconomic framework is an essential ingredient of an effective poverty alleviation effort. Specifically, by facilitating improved investment and production performance, it provides the best environment for sustained improvements in employment and living standards. At the same time, the potential short-term adverse effects of adjustment and reform policies on the economically most vulnerable segments of the population are increasingly recognized. Such effects are associated, in part, with resource reallocations induced by the new relative price structures, in the context of limitations on full capital and labor mobility. Concerns are compounded in some countries by rapid population growth, which strains the already-stretched delivery mechanism for social services.

Reflecting the above, reform efforts in Arab countries have increasingly included specific measures seeking to protect vulnerable segments of the population.23 These measures have included direct cash transfers (Algeria and Jordan), improved targeting of food subsidies (Jordan), and food-for-work programs (Mauritania). Some countries have also set up special funds that, with assistance from external creditors and donors, seek to finance projects designed to mitigate the adverse impact of adjustment and reform measures on dislocated segments of the labor force (the Social Fund in Egypt and the Employment and Development Fund in Jordan).

Conclusion

Arab countries’ economic and financial performance in the 1980s was mixed relative to that of developing countries as a whole, notwithstanding the impact of adverse exogenous factors. To improve their performance—and thereby sustain medium-term economic growth and domestic and external financial stability—Arab countries will need to confront more forcefully structural rigidities inherited from the past. Indeed, the need for sustained and comprehensive policy actions becomes more important in the context of some countries’ rapidly growing populations, uncertainties about the prospects for the natural resource base, and the tendency outside the Middle East toward preferential regional trading blocs.

While the nature, extent, and implications of the policy challenge differ among individual Arab economies, several aspects are common to a large number of countries in the region. In this context this paper has attempted to identify a “core” group of required structural reforms. Broadly speaking, this group includes the need to rationalize a large public enterprise sector so as to concentrate its efforts in those areas where it performs most effectively and that are warranted by market failures; strengthen the structure of government budgets to make them more elastic and increase their developmental impact; improve the mobilization and allocation of loanable funds from domestic and external sectors; enhance the institutional framework for private investment and production activities; and rationalize the external trade and payments system. To be successful, these policies will need to be supported by prudent demand management, as well as an open international trading system and, for some countries, the provision of timely external financial assistance. Moreover, given the relatively low-income status of some Arab countries and their rapid population growth, the paper has referred to the importance of policies to protect the most vulnerable segments of the population during the adjustment and reform program as part of a more comprehensive approach to poverty alleviation and environmental sustainability.

Although the adjustment and reform effort is yet to gain significant momentum in the region as a whole, several countries have implemented policies aimed at addressing the identified structural weaknesses. The key challenge for individual Arab countries is therefore twofold: first, to draw upon the experience of their neighbors in formulating and implementing appropriate policies; second, to ensure that these policies are implemented in the context of a comprehensive medium-term program, rather than in a piecemeal fashion. Successfully meeting these two challenges in a sustained manner is essential if the Arab world is to exploit its considerable economic potential in the remainder of the 1990s.

COMMENT

MUSTAPHA KARA 1

In their paper, the authors provide a broad survey of the problems the Arab countries are facing and their experience in implementing some structural policy measures within the context of adjustment. Moreover, they identify a number of widely accepted structural challenges facing the Arab countries in the 1990s and review in a general manner their policy implications.

It is of importance to note, however, that not all the Arab countries are confronted with the same challenges nor do they address them in a uniform manner. These countries—as the paper rightly mentions—differ in their economic structures, resource endowments, and levels of development. Consequently, they also vary in terms of the nature and scope of the problems they encounter, and the magnitude and the urgency of the policies required to meet the challenges, even though these policies may be similar in their general direction.

Thus, to give a clear picture of the challenges confronting the Arab countries in the 1990s as well as their magnitude, it may be analytically more appropriate to look at the Arab countries as two main groups, namely, one that includes the members of the Gulf Cooperation Council (GCC) and the other, the rest of the Arab countries.

For the GCC countries, the main economic challenge is that of prudent macroeconomic management, or, in other words, the implementation of cautious domestic economic and financial policies in the face of the uncertainty prevailing in the world oil markets and the fluctuations in oil revenues. To reduce their vulnerability to external factors, these countries are also faced with longer-term issues such as the diversification of their economies and the establishment of appropriate tax and expenditure policies that will allow prompt and flexible responses to changes in the external environment.

For the rest of the Arab countries, on the other hand, the main economic challenge is one of redressing the imbalances in their economies and fostering growth in the face of a rapidly growing population, increasing unemployment and only marginal access to foreign capital markets.

Furthermore, one of the main challenges that is faced solely by the countries in the second group and whose weight constitutes the main pressure for structural adjustment in these countries is the debt problem and debt-servicing difficulties. To illustrate the magnitude of this problem, in Egypt, foreign debt rose from $22 billion in 1982 to $50 billion in 1990, and debt service as a proportion of foreign receipts increased from 25 percent to 43 percent during the same period. Similarly, in Algeria, foreign debt increased from $17 billion in 1982 to $26 billion in 1990, and annual debt service averaged 61 percent of exports of goods and services in 1986–90. In the face of declining domestic savings rates, these countries resorted to increased external borrowing to attain high investment rates. Although Egypt succeeded in getting the creditor governments to forgive half of its external debts and, along with other indebted countries, in securing rescheduling on favorable terms, the constraint posed by the external debt overhang still remains a central challenge to be dealt with in the 1990s.

Within the second group, countries also differ quite significantly in terms of macroeconomic management. Some were able to arrest and reverse the deterioration of their economies by adopting strong adjustment programs; others have responded by introducing ad hoc adjustment measures that resulted in volatile macroeconomic performance; while a few others have just started to address their economic problems. Consequently, although these countries face similar problems, they are differently positioned to face the challenges in the remainder of the 1990s. In this context, a brief review of recent economic developments in these countries shows the following.

Prominent among the countries that adopted adjustment programs and made significant progress are Tunisia and Morocco. Their success has attracted much international praise. Following the adoption of a comprehensive program in 1986, Tunisia made important strides toward domestic and external equilibria and diversification of exports. The current account deficit of the balance of payments was reduced from 8 percent of GDP on the average over 1980–85 to some 3 percent over 1986–89. Fiscal trends were also positive, with substantial improvement in current and overall balances. Helped by the devaluation of the dinar, the growth rate of non-oil exports rose from 4 percent to 17 percent over the same period (1986—89). Similarly, in Morocco, substantial progress has been made in implementing structural policies in the productive sectors, in public finance, in financial and trade liberalization, and in providing incentives and promoting the private sector since the start of the adjustment program in 1983. In the wake of these measures, GDP growth rates averaged some 5 percent a year in 1983–90 compared with 2 percent in 1980–82. The fiscal deficit as a proportion of GDP was reduced from 11.2 percent to 4.2 percent over the same period. Furthermore, Morocco also made significant steps toward restoring viability to its balance of payments. Fueled by a series of exchange rate devaluations, exports increased by 20 percent on average in 1983–90, and the share of manufacturing exports in total exports rose from 41 percent to 56 percent over the same period. The current account deficit in the balance of payments as a proportion of GDP decreased from 8 percent to 3.2 percent over the two periods (1980–82 and 1983–90).

Two other countries adopted adjustment programs but experienced a reversal in economic performance and therefore had to slow down their implementation: Mauritania and Jordan. In both cases, the shortcomings were in large part due to the decline in foreign aid in the aftermath of the Middle East crisis. The impact was more severe in Mauritania, however, as it experienced a significant deterioration in its economic and financial situation and was thus unable to service its foreign debt.

Algeria, on the other hand, after a bold attempt at opening up its economy in 1989, seems to be experiencing a reversal in economic policies as some measures taken with the aim of freeing the allocation of foreign exchange, liberalizing trade, as well as providing greater autonomy to public enterprises and the Central Bank, are being reviewed. This is best exemplified by the recent introduction of trade restrictions to curtail imports and limit the foreign exchange allocation to imports of essential goods.

The countries that resorted to ad hoc measures were Sudan, the Syrian Arab Republic, and the Republic of Yemen. In Sudan the implementation of partial measures did not help in containing the macroeconomic imbalances in the economy. The budget deficit remained at 15 percent of GDP, and the increase in inflationary pressures continued unabated. The Government announced a comprehensive program in July 1992, but at a time when foreign assistance seemed remote and the armed conflict in the south was still prevailing.

Similarly, the main adjustment efforts in the Syrian Arab Republic and the Republic of Yemen were limited to the fiscal sector in an attempt to contain the fiscal deficit while imbalances in the other sectors were tackled in an ad hoc manner. The recent unification of both parts of Yemen—while creating greater potential for long-term development—complicated the transition toward a market economy. At the same time, the existing macroeconomic imbalances were aggravated following the Middle East crisis with the return of migrant workers and the decline in foreign assistance. Thus, it has become apparent that there is a need for these two countries to formulate policies within a comprehensive adjustment program to restore external and internal equilibria and remove distortions in the economy.

Egypt started to implement an adjustment program recently (1991). Indications are that improvements have been realized on the balance of payments, budget, and exchange rate fronts. Yet the policy implementation in the area of public enterprises and trade liberalization has been less than envisaged in the program. This brings us to Iraq, Somalia, and Lebanon, countries that in fact are in need of reconstruction programs.

It is clear that Morocco and Tunisia, which have successfully stabilized their economies, will need to maintain the momentum of policy reforms to consolidate the gains realized by strengthening and enhancing their structural adjustment efforts during the remainder of the 1990s. Algeria, Egypt, Sudan, Mauritania, Jordan, Syria, and Yemen, on the other hand, remain confronted with large economic imbalances in their economies. Their challenge will be to reorient their policies to eliminate unsustainable domestic and external imbalances. Thus, the immediate priority for these economies is stabilization, that is, the use of monetary, fiscal, and exchange rate instruments to ensure that their balance of payments remains managable and that domestic stability is restored with a minimum cost to medium-term growth. This will need to be concomitantly supplemented by structural policy reforms directed toward increasing efficiency, to pave the way for the achievement of sustainable growth in investment and income and a viable balance of payments over the medium- and long-term. Finally, Iraq, Somalia, and Lebanon will need, as I said earlier, reconstruction programs.

In the long run, certain development issues will also need to be addressed by these countries, namely, rapid population growth, human resource development, and protection of the environment. Without a lowering of population growth, the efforts made to increase savings and achieve development will simply be absorbed in maintaining per capita income. Moreover, improved health, education, and training are important in raising labor productivity and incomes. Water scarcity, soil erosion, desertification, and depletion of natural resources will have to be tackled as well.

Finally, I would like to say a few words about the regional dimension of adjustment in the Arab region. Recent developments, as is widely acknowledged, have shown how some countries such as Jordan and Yemen have benefited from the spillover effect of the growth in neighboring countries in terms of export and employment, as well as financial transfers. For these small economies, which are characterized by a limited domestic resource base and market, an adjustment program will be more effective when it encompasses a regional dimension. In so doing, the issues of trade, labor, and financial and fiscal policies can be formulated in a regional framework, thus consolidating and enhancing the process of adjustment in these countries and rendering it more effective.

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1The views expressed in the paper are those of the authors and do not necessarily reflect those of the International Monetary fund.
2Aggregates for Arab countries are compiled on the basis of computed GDP-weighted averages for individual members of the Arab League for which comprehensive data are currently available (Algeria, Bahrain, Djibouti, Egypt, Jordan, Kuwait, Lebanon, the Libyan Arab Jamahiriya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab Republic, Tunisia, the United Arab Emirates, and the Republic of Yemen).
3The comparisons with the developing country group are sensitive to the starting point for the comparison periods. Thus, the choice of 1980 as the base year biases the comparison downward, as 1980 was associated with an historically high oil price level. Indeed, the nominal oil revenues of the Arab members of the Organization of the Petroleum Exporting Countries (OPEC) increased from $56 billion in 1975 to $278 billion in 1980. Following the sharp fall in international prices, they declined to $49 billion in 1986, Additional information is contained in Et-Kuwaiz (1990).
4For this purpose, oil countries are defined as those deriving more than half of their domestic output from the extraction of crude oil. As in the case of the coverage used by the Arab Monetary fund (1991), the grouping includes Algeria, Bahrain, Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. As noted by Et-Kuwaiz (1990), there are substantial differences even within this subgroup of Arab countries. Various attempts have been made to classify Arab countries on the basis of other criteria such as per capita income, population density, and debt burdens.
5Real GDP in oil producing countries is heavily influenced by fluctuations in oil production. For a discussion of related national accounting issues, refer to Ahmad, El-Serafy, and Lutz (1989).
6For example, El-Naggar (1987).
7A related issue that is not addressed directly in this paper is the scope for efficient economic cooperation among Arab countries. For a discussion of Arab economic integration, see Shafik (1992) It may be noted, however, that progress among countries in the identified policy areas would be an important contribution to the process of “policy convergence” that would be essential to underpin effective Arab economic integration.
8Unless accompanied by appropriate fiscal, monetary, and exchange rate policies, the structural reform measures discussed below will not result in a sustainable improvement in economic and financial performance. At the same time, it is worth noting that several of the structural reforms discussed below can lead to an improvement in public sector finances, facilitating the reduction of macroeconomic disequilibria and more efficient resource allocation. For a discussion of the developing country experience in this regard, refer to International Monetary Fund (1992). Selected aspects of demand management policies in Arab countries are discussed in Shaalan (1987).
9See El-Naggar (1989a). Fl-Naggar notes that several other countries (for example, Jordan, Morocco, Tunisia, and the former Yemen Arab Republic, as well as members of the Gulf Cooperation Council (GCC) may be viewed as belonging to the group of “pragmatic interventionism,” where sociopolitical considerations tended to play a relatively less important role.
10The impact of fiscal policy on macroeconomic aggregates in these countries during the 1970s is discussed in Morgan (1979). Indicators of public sector activities for some other Arab countries are presented in I Heller and Schiller (1989).
11For a more detailed discussion of this issue, see Wall (1990).
12In Tunisia, privatization of the loss-making public enterprises identified in the study has been virtully completed. The authorities are now preparing to undertake the privatization of the other enterprises.
13Further country-specific information is contained in Candoy-Sekse (1988) and Heller and Schiller (1989). More detailed analyses of privatization in Egypt, the GCC countries, Jordan, and Tunisia are contained in, respectively, Abdel-Rahman and Sultan (1989), Khatrawi (1989), Anani and Khalaf (1989), and Bouaouaja (1989).
14The- links between oil prices and fiscal policy developments in the Arab oil producing countries are discussed in El-Kuwaiz (1990) and Morgan (1979).
15Information on these guidelines is contained in Leipold and others (1991).
16This section does not address the issue of industrial development policies in Arab countries. A study by the Economic and Social Commission for Western Asia (ESCWA) (1990) considers this one of the important policy challenges, arguing that “on the whole, Arab industrialization efforts remained fairly modest and confined to small enclaves, without ever reaching the level of an integrated and mature industrial structure.”
17For example, Hasan (1987).
18Indeed, a stable macroeconomic environment has been viewed as the single most important factor for investment promotion in Arab countries. See Shihata (1990). Handoussa (1990) analyzes the Egyptian case.
19Prior to these reform measures, Morocco had seven investment codes and Tunisia had six.
20This may be contrasted with the experience in Latin America, where the adoption of multiple exchange rate regimes was motivated by policymakers’ desire to insulate the real economy from what were viewed as transitory shocks emanating from financial markets, See Kamin (1992).
21The increased emphasis on nondebt-creating flows has also reflected the fact that several Arab countries face heavy debt-service burdens, with a number of them (Egypt, Jordan, Morocco, Somalia, and Sudan) resorting, at some stage, to nonpayment and/or formal debt-restructuring arrangements.
22This paper does not address the important issue of family planning and related policies, including human resource development.
23A recent analysis of Tunisia’s adjustment program indicates that the country’s relatively well-developed social safely net system was instrumental in protecting the more vulnerable segments of the population in the transitional stages of adjustment and reform. See Duran and Feler (1992).
1 The views expressed in this comment are those of the author and should not he attributed to the Arab Monetary Fund.

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