Speech

The Arab Countries in Transition—Strengthening the Economic Middle by Christine Lagarde

May 8, 2014

Good morning—salaam alaykum! It is a great privilege to come to this beautiful country, a country that twins noble grandeur with modern vitality, ancient wisdom with youthful dynamism.

I would like to thank the prestigious Conseil Economique, Environnemental et Social for inviting me to speak, and especially its president, Nizar Baraka.

Three years ago, the flames of change spread across this region. People rose up to demand greater economic opportunity, greater fairness—and above all, greater dignity.

As the talented Moroccan writer Fatima Mernissi—whom I had the great pleasure of meeting this morning—wrote so eloquently: “Dignity is to have a dream, a strong dream that gives you a vision, a world where you have a place, where your contribution, however small it may be, will change things.”

Three years into the transition, the dream is alive, the vision is strong—despite some setbacks along the way. This morning, beyond the Morocco case—which you know better than I do—I would like to talk about the next phase of the economic transformation in the whole region.

In just a few days time, we are convening a regional conference in Amman, in partnership with the government of Jordan and the Arab Fund for Economic and Social Development. Today, I would like to talk about three things:

• First, the economic progress made to date and the challenges ahead.
• Second, identifying the big issue for the next phase of transition: the importance of strengthening the “middle” in the economy and society—principally, more vibrant small and medium-sized enterprises and a stronger middle class.
• Third, the policies needed to strengthen this “middle” in its different dimensions.

1. Progress to date and challenges ahead

Let me begin with where we stand. The good news is that the economic situation in the Arab transition countries is looking up—higher exports, higher public investment, and signs that private investment will rise. Countries like Morocco are reaping the fruits of their efforts by diversifying and spurring both exports and foreign investment—especially in high value-added areas like cars, aeronautics, and electronics.

None of this is accidental. Over the past three years, countries have made great progress on the policy front. For example, Jordan has moved away from generalized energy subsidies and toward genuine safety nets, while Tunisia is reforming its banking system.

This progress is all the more impressive given that the external environment has not been kind, and—in some countries—internal pressures have been bubbling up on the social, economic, and financial fronts.

Still, progress remains fragile. We can see the dark clouds of political and security tensions hovering over the region—just look at the heartbreaking tragedy that still besets Syria. We also know that a turning tide in the emerging markets, Europe, or the Gulf could have ripple effects in this region.

The bottom line is that economic stability must remain a key priority. Out-of-control government budgets, rising debt, high inflation, or dwindling foreign currency reserves would block further progress and impose the heaviest burden on those who can least afford it—the poor.

Yet stability alone is not enough. The Arab transition countries are today facing a jarring jobs crisis, and this must be addressed. The unemployment rate averages 13 percent, with youth unemployment more than double that at 29 percent—among the highest in the world. Since 2010, the number of people out of work has jumped by 1.5 million.

In addition, the region faces one of the world’s biggest youth population bulges—every year, three million more young people across the Arab world come knocking on the door of the job market.

This could be either a boon or a bane. The “demographic dividend” offers countries an avenue toward higher productivity and higher incomes.

On the other hand, we could see a whole generation cast adrift and kept outside—“lost”—with their dignity denied and their contributions canceled.

So the great challenges for the next step of the transition are clear: How to create the jobs needed to meet the aspirations of a rising generation. How to create a vibrant and dynamic economy that offers opportunities to all.

These tasks are daunting. To make inroads, we would need to see growth rates doubling from the current levels of around 3 percent. We also need to see growth feeding into jobs to a far greater extent than is currently the case.

2. The importance of strengthening the middle

How can we meet these challenges and fulfill the promises of transition? I believe that the solution involves “strengthening the middle”: the middle of the economy, the middle of society—and also a “middle ground” for the state that neither suffocates nor stands aloof from the real economy. This is the second issue I would like to talk about today.

Strengthening the economic middle means giving a shot in the arm to small- and medium-sized enterprises in the formal sector. These are the kinds of firms that form the backbone of a healthy economy, and— in other regions for the world—are the main engines of job creation.

There is still some distance to make up here. Across the region, the number of registered businesses per thousand people is only a quarter that of the OECD, and only half that of Eastern Europe and Central Asia.

The current industrial structure is also a little unbalanced—between a small number of large firms in the formal sector and a large number of small firms in the informal sector. Let me explain why this is not ideal in my view.

The formal sector is dominated by a few large firms—either owned by the state or with strong connections to the state. They are often shielded from competition through a network of patronage and political proximity, reducing the incentive to innovate and stay competitive. As a result, very few firms in the region are in a position to compete on world markets.

On the other side of the equation, a large informal sector is dotted with small firms. Informality rates across the region range from 17 percent in Jordan to 35 percent in Tunisia. Certainly, the informal sector offers some benefits for firms—it can keep them “under the radar”, away from government regulation and taxation. Yet informality also comes with clear costs—less technology, less capital, less skilled labor, and less investment. The end result is lower productivity and lower competitiveness.

Currently, not enough new firms are being created, and existing firms do not have enough opportunities to grow and flourish. It is really a numbers game—countries need to empower enough entrepreneurs to harness the big ideas, ingenuity, and innovation that are plentiful in this region. In that context, I am really looking forward to my meeting with students in Casablanca tomorrow—I want to hear about their perspective.

The bottom line? We must nurture the middle of the economy. The same is true with society. What do I mean by that? I mean a strong middle class.

This idea has ancient roots. It was Aristotle who said that: “Those states are likely to be well-administered in which the middle class is large…where the middle class is large, there are least likely to be factions and dissensions”.

Quoting Aristotle is appropriate here, because it was the Arab philosophers who kept his learning alive at a time when Europe slipped into darkness. I am thinking especially of the great Ibn Rushd, who has such deep roots here in Morocco.

There is a real sense in the Arab transition countries, as in many regions of the globe, that the middle class is losing ground. This was a driving force behind the uprisings in the region—ordinary people felt frustrated with stagnating living standards and shrinking economic opportunities.

In many countries—such as Egypt, Jordan, and Morocco—the middle class share of societal wealth is lower today than in the 1960s; and the relative position of the middle class has not improved since the 1990s—a time when growth was much higher than today. Let me be frank: the dividends of growth have too often gone to the top, leaving too many others out in the cold.

Global experience tells us that we need a strong middle class to drive an economy forward. A strong middle class sustains consumption and invests in the future. A strong middle class makes societies more cohesive, and lays the groundwork for stability and prosperity. A strong middle class is also home to the kinds of entrepreneurs we need for today’s modern economy.

This means that countries must provide their citizens with a ladder so that they can climb out of poverty and into the middle class—and indeed, keep on climbing even after that point. They must also do what they can to make sure that the fruits of prosperity are shared more widely and more fairly.

I have touched on the middle of the economy and the middle of society. Now let me talk about the state—and the “middle road”. What is that?

Right now, in too many countries, the state is too intrusive and the public sector stakes out a position that is too dominant. The state is still seen as the employer of first resort—college graduates hold out for opportunities there, because these jobs have good pay, good benefits, and good job security.

Yet again, global experience tells us that this is not the road to economic dynamism. It is not the road to fairness and inclusion.

Looking ahead, the state needs to step back from some areas and step forward in others. It needs to provide fewer blanket subsidies, and more of a basic safety net for people who fall through the cracks. Perhaps most importantly, it needs to become less of an employer, and more of an effective and impartial regulator and enabler of the private sector—the ultimate source of good jobs.

For if the public sector steps back, the private sector will step forward.

3. Policies for strengthening the middle

What policies can help to strengthen the “middle ground” that I have been describing in economy and society?

As I said at the outset, macroeconomic stability is the core building block of sustained success. So before we build a beautiful new structure, we need to make sure that the foundation is solid.

This includes making the right choices on fiscal policy, making sure that deficits do not lead to rising public debt in a way that threatens structural stability. This means re-orienting spending toward investment in people and infrastructure, for instance by reducing generalized subsidies—especially corrosive energy subsidies—and increasing spending on targeted safety nets, health, education, and public investment.

I know that countries in the region are fully on board with this agenda, and are making great progress. Just look at Morocco. Over the past couple of years, it has managed to cut its subsidy bill while increasing spending on programs aimed at improving access to health and education for the poorest.

Looking beyond macroeconomic stability, strengthening the middle means more of a “participatory” economy and less of a “privilege” economy.

To achieve this, let me propose a three-legged stool of policies—enabling the private sector, engendering jobs for the young, and enforcing rules with impartiality.

The first leg of the stool: enabling the private sector

This begins with the right business environment, which means smarter regulations and greater competition.

This is a big issue right now. Almost a quarter of firms in the Arab countries in transition see business licensing and permits as a constraint on their activities—among the highest in the world. The good news is that countries are working on streamlining the conditions for business entry. This problem varies across countries, but all could do better.

Reforming insolvency regimes is also important—to focus more on reorganizing failed firms instead of resorting to the blunt tool of liquidation. This makes it more likely that entrepreneurs will invest and take risks.

Enabling the private sector also means making sure that firms have adequate finance. At present, this region has the world’s lowest percentage of firms with credit lines or loans, and less than 10 percent of loans go to small- and medium-sized enterprises.

We should also not underestimate the importance of good infrastructure for business success. Right now, it is often hard simply to get goods to market, and both electricity and communications networks could be made more reliable.

Finally, tariff and non-tariff trade barriers are still too high in this region. I often made this point: deepening trade integration would help to create more jobs and boost incomes, and would also increase knowledge and know-how through foreign investment.

With this combination of reforms—regulations, finance, infrastructure, trade—the Arab transition countries should be able to unleash the dynamism of their private sectors.

The second leg of the stool: engendering jobs for the young

Again, global experience tells us that this must surely begin with education: equipping students with the skills needed to thrive in the 21^st economy that they are entering. The good news for this region is that literacy rates are rising overall—and that girls are catching up with boys. Indeed, in recent decades, the region has been a role model in terms of improving educational outcomes.

And yet, this region has always been renowned for its wisdom and learning. Think of the great Almohad period in Moroccan history, when rulers sponsored schools, treasured books, and endowed great libraries. Morocco is also home to one of the world’s oldest universities—Al Qarayine. What a legacy to embrace!

Aside from education, it will be important to make labor markets work better—to make them more welcoming of young people. Today, surveys show that almost a quarter of firms across the region perceive labor regulations as a constraint on hiring. Of course, regulations are needed to protect workers—it is a matter of finding the right balance.

Let me say a word on women’s labor force participation, which is an issue close to my heart. Across the entire Middle East and North Africa region, the gap between male and female participation in the labor force over the past decade was almost triple the average gap for the emerging markets and developing economies. If it had been only double instead of triple, the economic gains would have been enormous—almost $1 trillion in extra output, amounting to annual gains of about 6 percent of GDP.

So it is imperative to let women contribute, by removing outdated obstacles and introducing enabling polices. After all, it was Ibn Rushd who said that “treating women like a burden to the men is one of the reasons for poverty.” The logic is clear—greater opportunities for women means greater rewards for everyone.

The third leg of the stool: enforcing rules with impartiality

“Enabling the private sector”, “engendering jobs for the young”—and now the third leg of my policy stool: “enforcing rules with impartiality”. This is basically about transparency and good governance. You can have the best rules and the best policies in the world, but without the good governance needed to implement them properly, their effectiveness and legitimacy is undermined.

Without this third leg, the stool will topple over.

Where governance is weak, the main casualty is trust, which in turn damages social cohesion. As we all know, it is far easier to lose trust than to gain it. Unfortunately, we have some evidence that trust has been eroding in the last decade across the Arab transition countries.

Weak governance can also undermine economic effectiveness. The leprosy of corruption eats away at an economy and causes valuable resources to be wasted. For instance, more than half of all firms in the Middle East and North Africa region report having been asked for a bribe. Of course, corruption is a two-way street: for every corrupt official there is a corrupter.

One solution is greater transparency in both public and private sectors. Governments could make budget information more widely available, and I know that a number of countries are working on this. The private sector also needs more openness on financial information as well as stronger auditing and reporting standards.

We also need sound regulations that are consistently and predictably enforced. Surveys show that firms in the region perceive an uneven playing field. The region also suffers from long delays in contract enforcement.

Of course, improving governance and fighting corruption is as much about changing hearts and minds as changing laws and institutions. And here, civil society has an important role to play in pushing for higher standards. Individual citizens all across the Arab world are demanding the highest ethical norms in all aspects of economic life. We must listen to them.

Conclusion

Let me conclude. The “middle road” that I have laid out today is one that could meet the legitimate aspirations of the region’s citizens. There may be other ideas, better ideas, on what to do and how to prioritize. This is what we will explore at the conference in Amman in a few days time.

As you know so well, it is not just the “what” of reforms—it is also the “how”. People are understandably impatient, and many of these reforms will take time to deliver. They will often produce winners and losers. For sure, there can be some quick wins, but in other cases, there will be setbacks. Policy perseverance is the key.

Let me promise you this—you do not stand alone. The IMF is an enduring partner in your reform efforts. And when we stand with you, our entire membership of 188 countries also stands with you. As a financier, an advisor, a capacity builder—and also as a facilitator of dialogue with other partners. For example, last year we delivered 55 technical assistance missions to the Arab countries in transition and committed more than $10 billion in financial support.

Ultimately, however, the future of this region lies in your own hands.

I have talked a lot today about the strengthening the middle. There is one last “middle” I would like to mention before closing—a stronger Middle East and North Africa.

The world needs your contribution, your voice, your leadership. You sit at the great crossroads of the global economy—between North and South, East and West.

This region was once the nucleus of a great civilization, stretching from the shores of the Atlantic to the banks of the Euphrates—nourished by wisdom and ingenuity, grounded in human dignity, and fused together by an ironclad sense of common purpose.

Your past provides a window to your future—and ours too.

Thank you very much—ashkurukum!