Choosing Exchange Regimes in the Middle East and North Africa

Creating Employment in the Middle East and North Africa

George T. Abed and Hamid R. Davoodi

2003 International Monetary Fund

Preface

The Middle East and North Africa (MENA) is an economically diverse region that includes countries with a common heritage, at various stages of economic development, and with vastly different endowment of natural resources. Despite undertaking economic reforms in many countries, and having considerable success in avoiding crises and achieving macroeconomic stability, the region’s economic performance in the past 30 years has been below its potential. The purpose of this pamphlet is to take stock of the region’s relatively weak performance, as measured by rate of growth, links to the global economy, and employment generation; explore the reasons for this outcome; and propose an agenda for urgent reforms.

The authors would like to thank Susan Creane for her comments and suggestions, other colleagues in the Middle Eastern Department of the IMF for valuable comments on earlier drafts, Heather Huckstep for administrative support, and Brett Rayner for research assistance. The authors bear the sole responsibility for any remaining errors and omissions.

The Middle East and North Africa (MENA) is an economically diverse region that includes countries with a common heritage, vastly different levels of per capita income, and a common set of challenges (see Box 1 ). Historically, dependence on oil wealth in many countries and a legacy of central planning in other countries have played major roles in shaping the region’s development strategies.

The MENA region benefited immensely from the wealth created by the sharp increase in oil prices in the 1970s. The explosion of investment and growth in the oil-exporting countries resonated in other countries of the region through a sharp rise in worker remittances, trade, and capital flows. Gross capital formation, although volatile, was maintained at exceptionally high rates, supporting a strong increase in growth rates of GDP and a vast improvement in living standards. Substantial financial assets were accumulated abroad as national savings exceeded investment, especially in the oil-producing countries.

However, the region’s economic performance during the next 20 years weakened as growth rates declined and failed to generate the employment opportunities sought by a rapidly expanding labor force. This deterioration in economic conditions brought about pressures for economic reforms, which were undertaken by a number of countries during the mid-to-late 1980s and early 1990s. Fiscal reforms included introducing value-added tax (VAT), phasing out subsidies, and improving management of public expenditure. Monetary policy frameworks were strengthened by introducing indirect monetary policy instruments. Trade regimes were liberalized and foreign direct investment (FDI) was encouraged while exchange rates became more flexible. In subsequent years, the countries that pursued reforms, such as Egypt, Jordan, Mauritania, Morocco, and Tunisia, enjoyed the region’s most rapid growth rates. Although the momentum for reform has slackened more recently, other macroeconomic outcomes have remained positive in much of the region. For example, inflation has been low and on the decline for most of the 1990s; fiscal deficits, while persisting, have narrowed since the mid-1980s to levels below those of other developing countries. Financial crises, which plagued other regions during the past two decades, were averted. In addition, for a large number of countries in the region, external and domestic debts are not high by international standards, and debt service is low.

Box 1. The MENA Region: Some Facts and Figures The MENA region comprises the Arab states in the Middle East and North AfricaAlgeria, Bahrain, Djibouti, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab Republic, Tunisia, the United Arab Emirates, and Yemenplus the Islamic State of Afghanistan, the Islamic Republic of Iran, Pakistan, and the West Bank and Gaza.

Income levels show wide variations within the region. Per capita GDP in 2002 ranged from an estimated high of US$37,600 for Qatar to US$930 for Yemen, both measured using purchasing power parity (PPP) exchange rates that allow for cross-country differences in price levels. The six oil-rich countries of the Gulf Cooperation Council (GCC) have the highest per capita GDP in the region.

The 24 MENA countries and territories, which include about 7.7 percent of the world’s population, are grouped together for analytical purposes only. They share common challenges and cultural links distinct from neighboring economies, including those of Israel and Turkey. The value of the region’s GDP is approximately $2 trillion, measured at PPP exchange rates or 4.3 percent of world GDP, also measured in PPP exchange rates. In terms of current U.S. dollars, the corresponding figures are $800 billion and 2.5 percent of GDP, respectively.

The region accounts for about three-fourths of the world’s proven reserves of crude oil and the GDP of the MENA region’s oil exporters account for about two-thirds of the region’s GDP. Of the 24 countries and territories, 13 are oil-exporting countries. These are Algeria, Bahrain, the Islamic Republic of Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Sudan, the Syrian Arab Republic, the United Arab Emirates, and Yemen.

The dominant religion is Islam, although there are sizable religious minority groups in several countries. Arabic is the principal language spoken throughout the region, except in Afghanistan, the Islamic Republic of Iran, and Pakistan, which make up almost half of the region’s population. French, along with Arabic, is spoken in the Maghreb countries of Algeria, Mauritania, Morocco, and Tunisia. However, there are significant linguistic diversities within some countries, including the Islamic Republic of Iran and Iraq. The countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates formed the GCC in the early 1980s, in addition to launching a customs union in January 2003 with plans to establish a monetary union with a single currency by January 1, 2010.

In sum, while macroeconomic stability was maintained, the MENA region as a whole failed to generate high and sustained growth rates. In contrast to other developing countries, the region underperformed since the 1970s and, as a result, did not reap the full benefits of globalization and world economic integration. In what ways, then, is the region’s growth performance during the past three decades different from that of other developing countries?

The experience of the last 50 years across wide regions of the globe has shown that developing countries, on average, have found it much easier to initiate growth than to sustain it. In this regard, the MENA countries’ experience is not unique. What is unique is the extent to which growth rates since the 1970s have been volatile and low relative to other developing countries. Volatility of real per capita GDP growth in the region has been twice that of developing countries’ average. In the oil-producing countries, the real per capita GDP growth rate (hereafter referred to as growth) was twice as volatile as in the non-oil economies. Of greater concern is the region’s near-zero percent growth rate during the past 30 years, when all other developing countries as a group grew at 2.5 percent per annum. Even as economic performance in the region improved in the 1990s, the region achieved an annual average growth rate of only 1.3 percent, compared with an annual average of 4 percent for all developing countries.

A major consequence of this poor record is persistent high unemployment, which has been reinforced by years of high growth rates of population and labor force. Employment in the MENA region did grow, at times faster than in other developing countries, but rapid population growth inflated the ranks of the young and fed the labor market with a rising tide of job seekers that exceeded the economies’ capacity to absorb them.

Linked to the region’s record on growth and employment is its weak integration into the global economy. The experience accumulated to date indicates that economies that, over extended periods, embrace openness and globalization tend to grow faster than those that adopt inward-looking growth strategies. And, in this regard, the performance of the MENA region has fallen short, depriving many countries of reaping the full benefits of globalization.

The challenges facing the region are daunting. The MENA countries’ economic performance remains below its potential, giving rise to chronic unemployment and poor living conditions in large parts of the region. Countries in the region must achieve higher rates of sustainable growth and integrate more fully into the global economy if they are to succeed in creating meaningful employment for a rapidly rising labor force and, more generally, reduce poverty and improve living conditions.

In this pamphlet, we take a closer look at economic performance in the region, particularly with respect to growth, unemployment, and global integration, followed by an exploration of possible reasons for the weak performance. In conclusion, we outline the reforms needed to improve the region’s economic performance.

Economic Performance in the MENA Region

Real per capita GDP growth in the MENA region during the last 30 years has virtually stagnated compared to the rest of the developing world (Figure 1 ). In part, this reflects the extended weakness in the oil markets as producers outside of the MENA region gained market share at the expense of oil exporters in the region. In addition, the region’s high population growth dragged down the rate of growth of per capita GDP.