New tram system in Marina district of Dubai, UAE: Implementing reforms to enhance infrastructure and build up physical capital can raise long-term economic growth (photo: Iain Masterton/incamerastock/Corbis)
Potential Growth
Closing gaps with global peers in these three areas could double long-term growth rates in most countries in the region. For the oil exporters in the Gulf Cooperation Council (GCC) countries and the Caucasus and Central Asia (CCA), the resulting boost to growth would be lower—but still large enough to offset recent declines in long-term growth rates, which threaten future living standards, the study says.
The right policies therefore have the potential to lift the region out of its growth slump, the authors say.
Unprecedented challenges
The Middle East and Central Asia is facing unprecedented challenges stemming from sustained low oil prices that have dampened oil revenues, deepening conflicts, and rising geopolitical and security tensions (see Chart 1).
“Headwinds to long-term growth prospects of the Middle East and Central Asia are unlikely to disappear soon. Improving economic prospects has become an urgent priority for the region,” IMF Deputy Managing Director Mitsuhiro Furusawa said at the report’s unveiling at the Paul H. Nitze School of Advanced International Studies in Washington, D.C.
The study identifies the structural reforms that are most critical for raising long-term economic growth in the region. Drawing on an empirical analysis of country experiences with different types of reforms, it examines the effectiveness of these reforms in strengthening the underlying, supply-side drivers of economic growth, such as capital, labor, and productivity.
Identifying critical reforms to raise productivity growth and, in some countries, build up physical capital—such as machinery, buildings, and computers—is key to unlocking the region’s growth (see Chart 2). Higher productivity and physical capital not only raise long-term economic growth directly but also help absorb the region’s rapidly growing labor force into productive economic activities. The reforms that ignite higher productivity also support the creation of physical capital.
Among a broad array of reform areas, the study points to a competitive business environment and worker talent as the key steps toward boosting productivity in the region, while financial market development is vital for physical capital accumulation.
Multiple shocks
Why is raising the region’s long-term growth important?
The Middle East and Central Asia’s long-term economic prospects are weakening, and at a faster rate than in the rest of the world (see Chart 3).
Deepening conflicts in Iraq, Syria, and Yemen are undermining long-term economic prospects by causing a devastating loss of life, massive economic damage, as well as by forcing large portions of the population to flee abroad. Conflicts are spilling over across the region by damaging economic confidence and heightening security tensions in neighboring countries. In these countries and other parts of the Middle East, North Africa, Afghanistan, and Pakistan (MENAP), populations have been long frustrated with a lack of jobs, economic opportunities, and inclusiveness—all at the core of the 2011 Arab Spring movements. Raising long-term growth is critical to addressing these frustrations, which are also contributing to conflicts in the region.
More recently, the slump in oil prices has started to put living standards in MENAP’s oil-rich economies at risk. Their oil-centered, government-driven growth models have become untenable in the new oil market environment. Oil revenues are no longer sufficient to finance the massive government spending that has fueled growth in the non-oil economy and has allowed governments to become the main source of employment for the populations. Although MENAP’s oil importing countries benefit from lower oil prices, spillovers from their oil-rich neighbors, through trade, remittances, investment, and financing, offset these gains.
The effects of lower oil prices are similar in the CCA, but they are compounded by adverse spillovers from the recession in Russia, an oil exporter that is an important trading partner and a key source of remittances for the CCA. As a result of the joint shocks to the terms of trade and external demand, CCA countries are experiencing its most severe economic difficulties since gaining independence 25 years ago.
With adverse shocks unlikely to disappear soon, improving economic prospects has become an urgent priority for the Middle East and Central Asia.
Policy recommendations
The GCC countries, seeking to reduce their dependence on oil, face the challenge of diversifying their economies and fostering private sector growth. The study finds improving access to finance and ensuring legal rights are especially important for developing financial sectors, which can intermediate savings efficiently to the most viable private sector projects. Better aligning education and training to private sector needs is critical for raising productivity of national workers and improving their employment prospects in the private sector.
Outside the Gulf, in MENAP oil exporters and importers alike, expansion and modernization of infrastructure—bolstered by efficient public investment, improved access to finance and stronger legal rights—is particularly critical. Promoting the rule of law, discouraging corruption, reducing the dominance of large state-owned enterprises in the economy, streamlining business and tax regulations, and reducing red tape would help lower the high cost of doing business. Worker talent can be boosted not only through a better alignment of education with private sector needs, but also by using the knowledge and expertise of large, successful overseas diasporas.
In the CCA countries, greater global trade integration would help raise private sector-led development of physical capital and productivity. To this end, transitioning to higher value-added exports through investment promotion would help attract multinational investment and link the CCA region into international supply chains.
