Economic Development of the Arab Countries : Selected Issues

INTERNATIONAL MONETARY FUND

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1993
• eBook ISBN: 9781557753328

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1. Economic Development of the Arab Countries: The Basic Issues

EL-NAGGAR SAID

The prospects for Arab economic development in the nineties is a highly complex subject that does not easily lend itself to generalizations valid for all countries. As is well known, the countries of the region vary greatly. For the oil countries, development will depend to a very large extent on what happens in the oil markets. Despite intensive efforts to diversify their economies, these countries are still heavily dependent on oil as the major source of income. Other countries may not be so heavily dependent on oil, but a good part of their growth is derived from the oil countries through workers’ remittances, development assistance, and Arab investment and trade. Still another group of countries is only remotely affected by the fortunes of the oil countries and is more concerned with developments in the export markets for their principal products. In addition to variations based on oil resources, Arab countries differ a great deal with respect to levels of development, per capita incomes, whether they export or import capital, and the extent to which they follow inward-looking or export-oriented development strategies. These variations complicate the task of assessing development prospects in the current decade.

Nevertheless, it is possible to identify a set of issues that are likely to be of major importance in the context of growth and development. These include the issues covered by the papers presented at the seminar: economic reform, investment and capital flows, intra-Arab labor movements, the environment, the impact of the European Community (EC), and the development of human resources. Obviously this is not the only set of issues that affects Arab economic development in the nineties. Others could have been added to the list. Oil, for instance, is highly indicated. But oil has already been the subject of many seminars. A repeat performance would not have added much that is not already known to researchers and policymakers. At the same time a line has to be drawn on the number of issues that can fruitfully be dealt with in the time assigned for the seminar.

The goals of Arab economic development in the nineties are not difficult to define. As with all developing countries, Arab economic development should satisfy the following terms and conditions:

• It should achieve a rate of growth of GDP exceeding that of the population to ensure a steady improvement in living standards.
• It should provide gainful employment for all comers to the labor market and reduce the stock of existing unemployment, both open and disguised.
• It should be consistent with the imperatives of price stability and external balance.
• It should protect the environment so as to safeguard the quality of life of the present generation as well as the opportunities for development of future generations.
• It should spread the fruits of growth to all segments of society and reduce income gaps both within and among Arab countries.

Development can be said to be successful if it satisfies these terms and conditions. On the basis of these criteria Arab development over the last three decades was less than satisfactory. More precisely, the picture that emerges is something of a mixed bag. A handful of countries were able to make big strides in modernization, institution building, and mobilization of resources, with impressive growth in both quantity and quality. The majority, however, was less successful. The extent to which they will improve their performance depends on their capacity to meet the challenges of the nineties.

Economic Reform

The first issue taken up in the seminar is economic reform. The nature and policy implications of the challenge are set out in the paper by Mohamed El-Erian and Shamsuddin Tareq entitled “Economic Reform in the Arab Countries: A Review of Structural Issues.” The issue was put by the authors in the following terms:

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 render 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.

It is difficult to take issue with the basic thrust of the arguments as enunciated by El-Erian and Tareq. However, a number of points were highlighted in the discussion. It was noted that in many countries that undertook to implement a comprehensive reform package in agreement with the International Monetary Fund and the World Bank, structural reform proved to be much more difficult than macroeconomic adjustment. To illustrate, little progress was made in the area of privatization and liberalization of trade regimes. In contrast, reform yielded fairly quick results as regards inflationary pressures, stabilization of the exchange rate, and budget and balance of payments deficits. The fact that adjustment of the real economy is lagging considerably behind that of the money economy, could, it was pointed out, jeopardize the whole process of reform. There is need to address this problem at both the technical and political levels. With privatization, for instance, the process was hampered by lack of expertise on the techniques of evaluation of assets, financial restructuring of heavily indebted public companies, and on how to deal effectively and equitably with the problem of redundant labor. At the political level it was pointed out that there is need to address opposition from groups whose interests are, or are perceived to be, adversely affected by privatization.

A number of participants felt reform programs supported by the IMF and the World Bank do not adequately address the impact on vulnerable and low-income groups. It was recognized that this aspect of reform programs needs to be strengthened through poverty alleviation measures, better targeting of food subsidies, and the establishment of special funds endowed with sufficient resources to help the most vulnerable groups.

It was further pointed out that developing countries are being pressured to liberalize their trade regimes whereas the industrial countries, which are far more able to shoulder the burden of adjustment, are adopting a protectionist stance. In assessing the merit of this argument it is important to keep in mind that the goal of reform programs is by no means the attainment of completely free trade in developing countries; rather it is to shift from a highly restrictive trade regime that all but eliminates foreign competition to moderate protectionist policies. This shift is realized through the elimination of import bans except for health or security reasons, reduction of extensive quantitative restrictions and other nontariff barriers, and greater reliance on price-based protectionist measures. Once liberalization is so defined, it becomes more or less symmetrical with current trade policies in most industrial countries. The argument that asymmetry largely depends on what happens in the Uruguay Round of Trade Negotiations was also mentioned. If successful, there is every reason to expect a more open international trading system all round. Otherwise, a reversal of policies toward a greater measure of protectionism will probably occur in both developed and developing countries.

Another issue that was raised in the discussion revolved around the role of the state in a market-based economy. The fear was expressed that liberalization, privatization, and deregulation are sometimes construed to mean a virtual absence of the state from the economic arena. The fear is clearly groundless. What is at issue in reform programs is not the principle of state intervention but its nature and extent. Under the dirigiste-socialist model that characterized development strategy for a long time, the state became directly involved in the production of goods and services. As a consequence the public sector came to dominate an extremely wide range of activities, which could not possibly be justified on developmental grounds. The reverse side of the coin was the total absence of the private sector from all important fields. At the same time public sector companies (or most of them) were operating at a low level of efficiency, which impaired the capacity of the economy to grow at rates commensurate with the rate of population growth. Going hand in hand with a dominant public sector was an overregulation of economic activities, which stifled initiative, suppressed innovation, and invited mismanagement and corruption. Under these circumstances it is hardly surprising that reform programs call for privatization and deregulation of the economy. The state is required to withdraw from the production of goods and services except in cases of market failure. But that leaves a great number of functions for the state to perform. Under a market-based economy the state is the organizer, the regulator, and the arbiter. In addition to the traditional functions in defense, security, and the judiciary, the government has an important role to play in education, health, housing, poverty alleviation, and the provision of a social safety net for vulnerable groups. No less important is the regulatory function, including prevention and control of monopolies and monopolistic practices as well as the setting and enforcing of standards in numerous fields.

Finally, it was recognized that the process of economic reform is neither costless nor painless. But a proper assessment of the negative impact of adjustment cannot be made without reference to the situation that would have obtained without adjustment. Before implementation of a reform program the situation is typically characterized by accelerating, if not galloping, inflation, a high rate of unemployment, unsustainable budget and external deficits, and loss of creditworthiness. The situation would probably have grown worse without the reform program. To judge whether it is worth-while to swallow the bitter pill of reform, the point of reference should not be an ideal situation free from inflation, unemployment, and deficits. If that were so, there would have been no reason to seek the help of the Bretton Woods institutions. A proper comparison should be between the post-reform situation and a hypothetical one, which is the one that would have prevailed without adjustment measures. It is most likely that the post-reform situation would be decidedly superior on all counts.

Investment and Capital Flows

The issue of investment and capital flows is covered by two papers, one by Ghassan El-Rifai, “Investment Policies and Major Determinants of Capital Flows to Arab Countries,” the other by Ahmed Abisourour, “Arab Capital Flows: Recent Trends and Policy Implications.” It should be noted that the two papers are different as to the scope of inquiry. El-Rifai’s paper is devoted to foreign direct investment (FDI) to the exclusion of other types of financial flows. Abisourour’s paper is broader in scope, as it covers not only FDI but also portfolio investment in both equities and bonds as well as long-term and short-term capital flows. With respect to FDI, which is common to both papers, there is a wide discrepancy between the figures on the flow to the Arab countries. The discrepancy is hardly surprising in view of differences on the source of data, the number of Arab countries covered, and on whether oil investments and intra-Arab flows are included or not.

The starting point in El-Rifai’s paper is the growing importance of FDI as a source of external financing for developing countries. Over the last decade, it was pointed out, FDI has turned from being a rather small and marginal source of foreign capital in developing countries to becoming a large and significant source replacing the more traditional ones such as official grants and loans and commercial bank borrowing. According to the latest World Bank statistics, net long-term resource flows from industrialized to developing countries increased only marginally, from an annual average of $68.6 billion during 1982–86 to $72.9 billion during 1987–91. During the same periods, FDI to developing countries more than doubled, from under $10 billion, to nearly $23 billion. As a result, the share of FDI in the total net resource flow increased from 14.3 percent to 31.5 percent.

In spite of a significant expansion, the Arab countries were not particularly successful in attracting FDI. This conclusion is substantiated by data on seven Arab countries: Algeria, Egypt, Jordan, Morocco, Oman, Saudi Arabia, and Tunisia. Excluding investments by foreign oil companies, the inflow of FDI to these countries during 1986–90 averaged about $4.7 per capita per annum in 1990 prices, compared with $5.5 for developing countries as a whole. Among major regions, only Africa south of the Sahara had a lower FDI during this period ($2.7), whereas in South America it was substantially higher ($18–19 per capita).

As is to be expected, performance in attracting FDI varied considerably among the seven countries. Average annual FDI inflow ranged from only $0.30 in Algeria to nearly $14 in Saudi Arabia. The two best performers among the seven countries (Saudi Arabia and Tunisia) were successful enough to join the group of 20 top performing developing countries.

One of the important conclusions the author reaches is that for a country to attract meaningful amounts of FDI the investment climate has to be attractive, stable, and predictable. With respect to stability and predictability, the author points out that “FDI is not like a water tap that a government can turn on and off at its convenience; it is more like a fruit tree that needs to be tended and watered carefully for years before it will bear fruit. If in the meantime, the owner loses interest, the young tree will die and the process will have to be started all over again.” As to attractiveness, empirical investigation shows that a sound macroeconomic environment is perhaps the most important single factor in the calculations of the foreign investor. High rates of inflation, an overvalued currency, sudden and sharp devaluation, administratively fixed interest rates, or a weak banking system are not the kinds of conditions that attract foreign investment. Some countries, including Arab countries, have tried to compensate for the absence of sound macroeconomic policies by offering special incentives and exemptions. Not infrequently, foreign investors are exempt from all forms of taxes, duties, and fees for periods extending up to 10 and sometimes 20 years. Experience shows, however, that the quality of macroeconomic policies is far more important than tax holidays and the like. Some countries that offer very few or no special incentives have nevertheless succeeded in attracting a considerable volume of foreign investment. In this category belong countries such as Hong Kong, Singapore, Taiwan Province of China, and the Republic of Korea. In contrast a large number of developing countries have failed to attract any significant amount of FDI despite excessively generous incentives and privileges. In both categories the operative factor was the quality of macroeconomic policies.

It should be remembered, however, that until recently, FDI was viewed with suspicion in many parts of the developing world. For most of the period after World War II developing countries resorted to foreign borrowing rather than foreign direct investment to meet their external financing requirements. Newly independent countries that had just emerged from a long period of colonial domination were anxious to maintain control over their own economic and political affairs. Foreign direct investment being in the majority of cases closely associated with multinational corporations was perceived to be incompatible with this goal. There was also a tendency to discount the presumed advantages of FDI compared with other forms of financing. Multinational corporations were frequently not interested in developing export-oriented industries but rather in displacing national producers as suppliers of the local market behind high walls of protection. The impact on employment was seen as minimal in view of the capital-intensive techniques imported from the home country; the transfer of technology was deemed to be a mirage, as multinational corporations tend to be highly secretive about their techniques of production while the training of local personnel was kept within the narrowest possible limits. Equally important was the concern about the distribution of benefits between the host country and the investing corporations in terms of tax revenue, value added, and reinvestment of profits. The prevailing view in many developing countries was that through dubious methods and practices such as transfer pricing, multinational corporations arrogate to themselves the lion’s share of the benefits from investment.

But it is important to realize that in contrast to the sixties and seventies, the decade of the eighties saw a vigorous revival of interest in FDI. Underlying the change in attitude toward FDI are recent developments in the international financial system. The debt crisis of the early eighties underscored the serious limitations of heavy dependence on foreign borrowing. A heavy debt-service burden combined with variable interest rates on a large proportion of their debt made the heavily indebted countries particularly vulnerable to external shocks. A protracted recession in the industrial countries, in addition to the high cost of energy and the collapse of the prices of principal export commodities, have conspired to undermine their payment capacity. The result was a debt crisis of unprecedented severity, which inflicted untold hardships on the indebted countries and jeopardized their growth prospects—not to mention the integrity of the international credit system.

In contrast, remittances of dividends and profits on FDI are much more responsive to changes in business conditions. By their very nature they increase with prosperity and fall with recession. They are more in tune with changes in the payment capacity of host countries. More important, the debt crisis has had a profound impact on the international sources of finance available to developing countries. Commercial bank lending, which played such a significant role in the seventies, has all but dried up except in the context of adjustment programs supported by the International Monetary Fund or with ironclad collateral and guarantees. Other sources of finance have also become subject to severe constraints. The tight budgetary situation in most industrial countries has been a serious obstacle to expanding bilateral sources of finance whether concessional or nonconcessional. Also, recent developments in the former Soviet Union and the socialist countries of Central and Eastern Europe are certain to give rise to an enormous increase in the demand for financing from the industrial countries, which could easily impinge on the resources available to developing countries.

Such dim prospects for alternative sources of finance have heightened the importance of FDI and induced a significant change in the attitude of developing countries. Multinational corporations made an effort to establish standards for acceptable business conduct. They have become more sensitive to the concerns of host countries and more flexible in the particular forms of investment. There is now greater willingness to accept innovative arrangements such as joint ventures, turnkey projects, build-own-transfer (BOT) arrangements, and licensing agreements rather than the traditional wholly owned subsidiaries. Developing countries, on the other hand, became more experienced and confident in dealing with multinationals. Moreover, they can, if they so wish, receive technical assistance and advice in negotiations with foreign investors from institutions established within the framework of the United Nations and its specialized agencies such as the International Finance Corporation (IFC), the UN Center on Transnational Corporations, and the Investment Promotion Service (IPS) of the United Nations Industrial Development Organization (UNIDO).

This is not to argue in favor of an open-door policy for FDI with no criteria or control. Every country has the right and duty to regulate and make transparent the conditions under which foreign investment is admitted. Some industries may well be closed to foreign investment for security or strategic considerations. Others may be subject to a minimum participation of national capital. Foreign investors may also be required to report to the capital market authority the size of their holdings in any single company once a certain threshold is exceeded.

But certain institutional requirements need to be satisfied if the Arab countries are to compete effectively for foreign investment, whether direct or portfolio. In his paper on Arab capital flows, Abisourour refers to the need to develop a securities market, fairly complete with a range of financial institutions and competent intermediaries as well as a well-structured regulatory framework. Also, it is necessary to establish appropriate accounting standards and financial disclosure rules to improve credibility in the information available from ente...

Table of contents

• Cover
• Copyright
• Content
• Foreword
• Acknowledgment
• 1. Economic Development of the Arab Countries: The Basic Issues
• 2. Economic Reform in the Arab Countries: A Review of Structural Issues
• 3. Investment Policies and Major Determinants of Capital Flows to Arab Countries
• 4. Arab Capital Flows: Recent Trends and Policy Implications
• 5. Inter-Arab Labor Movements: Problems and Prospects
• 6. Environmental Policies and Sustainable Development in the Arab World
• 7. Human Development in the Middle East and North Africa Region
• 8. European Economic Integration and the Arab Countries
• Footnotes