Policy Challenges
This pamphlet's historical analysis suggests that, with notable country exceptions, the region's broad policy response has been insufficient to exploit fully its considerable potential. Looking forward, the economic challenge is made more grave by the subdued outlook for the external environment. In this context, this section presents an overview of various countries' policy initiatives and a review of the eight policy issues facing most, if not all, of the economies in the region. Detailed specification, prioritization, and sequencing of the policy measures are left to individual country analyses, which are beyond the scope of this pamphlet.
The oil-exporting economies have also intensified adjustment efforts and structural reform. Initially, these countries focused on expenditure reduction in the face of lower oil revenues and a reduced flow of investment income. Then they concentrated on enhancing non-oil revenues, as illustrated by the measures introduced in the 1995 Saudi Arabian budget. In addition, several countries (including Algeria, Kuwait, the Islamic Republic of Iran, Oman, and Saudi Arabia) have elucidated medium-term programs with a defined path for further deficit reduction, structural reform measures, and human development policies in a general framework emphasizing the private sector in production and investment (Box 2).
A number of other countries (such as Djibouti, Iraq, Libya, Somalia, Sudan, the Syrian Arab Republic, and the Republic of Yemen) are yet to put in place sufficiently comprehensive adjustment and reform programs, although some (including Djibouti, Sudan, and the Republic of Yemen) have initiated important policy efforts. Given the nature of the countries' economic difficulties, these efforts aim, in the first instance, at reducing unsustainable domestic financial imbalances pending the full effectiveness of structural reform measures. In the case of Lebanon, policymakers face the twin challenges of reconstruction and stabilization.
Even countries that have made significant progress in recent years recognize that adjustment and reform are a continuous process. The process places a premium on maintaining the momentum of a comprehensive approach, sequencing major policy initiatives appropriately, undertaking the necessary adjustments in a timely manner especially in response to unanticipated exogenous developments, and establishing and maintaining the required institutional backing and human capabilities.
Most reform measures involve short-term costs. While this is unfortunate, it is virtually unavoidable, given the resource reallocation requirements. The focus must, therefore, be on minimizing these costs through proper planning and sequencing of policies, offsetting the costs by the gains realized by adjustment and reform, and protecting the most vulnerable members of society.
With these factors in mind--and at the cost of unavoidable overgeneralization in a paper covering so many countries--MENA's policy agenda may be thought of as consisting of eight items:
The experience of other countries (industrial and developing) suggests that the region's largely ad hoc approach to privatization will give way to a more systematic approach. This implies the formulation of multiyear programs, which in addition to dealing with small enterprises also extend the policy effort to large corporations in the utilities, airline, finance, and telecommunication sectors (Box 4). The design of these programs must identify the potential sources of financing, including tapping external markets. Finally, the programs need to be closely linked to social safety net/labor retraining measures to minimize associated welfare costs.
Reform of public finances is of utmost importance in most MENA countries to strengthen domestic savings and reduce the vulnerability to exogenous shocks. On the revenue side, efforts need to focus on improving elasticity and the efficiency of the tax system. In several countries, this involves a reorientation away from trade taxes and in favor of broad-based domestic consumption taxes (Box 5). In the oil economies, changes in the structure of revenue would need to reduce dependence on oil revenues. Finally, new tax measures need to be accompanied by improvements in administrative efficiency and tax enforcement.
On the expenditure side, improving the quality of public expenditure programs will enhance their contribution to economic growth. Such a strategy implies reductions in unproductive outlays, including defense spending, and rationalization and better targeting of subsidies. Such efforts need to be accompanied by civil service reform aimed not only at reducing the government's wage bill but also at improving the efficiency of government operations. For some countries in the GCC, civil service reform entails reducing the predominant role of the government as supplier of jobs and removing wage distortions that bias employment in favor of the public sector. In contrast, for other countries (such as Egypt, the Islamic Republic of Iran, and the Syrian Arab Republic), a reduction in numbers would need to be accompanied by upward adjustments in the salary packages of the remaining civil servants. Moreover, most countries in the region would benefit from a rationalization of government departments and agencies.
These factors can improve the overall efficiency of the economy by limiting the cost to the private sector of dealing with the bureaucracy. Surveys of private investment decisions suggest that the now infamous bureaucratic structure of several Middle Eastern economies acts as a major disincentive to investment, especially foreign investment. Once again, it is critical that the civil reform be sequenced properly with social safety net/retraining measures to limit the cost of unemployment.
Reform of the labor markets is the other essential component in limiting unemployment and in improving the potential of MENA countries to create jobs. First, the cost of private employment should be reduced by eliminating various direct and indirect surcharges. Second, the hiring and firing process should be more flexible. International experience indicates that constraints on firing (such as obtaining government approval for layoffs) can be a disincentive to hiring and can increase informal market activity, which in some cases does not provide labor with minimum safeguards. Third, government employment guarantees should be replaced by a transparent system of closed-end unemployment schemes. Moreover, in some countries where wide-scale privatization and public sector reform are needed, labor retraining schemes should be emphasized.
The human resource base of countries in the region must be strengthened through better education systems, particularly the education of women. The experience of other developing countries shows that better female education can also reduce population growth. Recent studies also support shifting limited resources from the tertiary sector to the primary and secondary sectors, and, in some countries, favoring vocational training over academic studies.
These four measures can contribute to enhancing domestic and foreign direct and portfolio investment (Box 6). In several countries, additional steps are needed to facilitate investment procedures at the local level and to reduce barriers to entry for foreign investors. Determined actions in these areas, along with a stable macroeconomic environment, promise greater returns than the current approach based largely on incentives, concessions, and "offset programs." (Under the offset programs in operation in several GCC countries, foreign firms awarded government contracts are required to invest a certain portion of the contract value in joint ventures with locally owned firms.) The current approach entails for certain countries in the region significant fiscal costs without clear additional investment; it can also obfuscate the pricing of contracts.
The strengthening of the financial intermediation system will enhance financial savings, channel resources to the most productive sectors (Box 7), and ensure that larger inflows of foreign investment do not destabilize the domestic financial system. Such strengthening comprises three elements. First, exposing financial institutions to competition involves for some countries privatizing large public sector banks (for example, Algeria, Egypt, and Tunisia), and for others facilitating the entry of foreign financial institutions (for example, in the GCC). Second, removing remaining controls on rates of return, charges for loans, and credit allocation as a further step toward indirect monetary control will facilitate transparent and nondistortionary financing of a wider range of productive activities. Third, bringing the prudential regulatory and supervisory regimes into line with international standards will reduce the risks of costly financial problems and enable institutions in the region to compete in international markets on a more firm footing.
The largely bank-based financial systems of MENA countries need to be broadened and those markets internationalized. Equity markets could mobilize resources from domestic, regional, and international sources and allocate them to productive investments in support of growth and development. The need to exploit this potential is especially important now because aid flows appear to be slowing and international competition for private capital is increasing. Conditions need to be established for clear property rights, more effective settlement and custody systems, more transparent conditions for trading, a level playing field among financial instruments, and appropriate repatriation of capital and dividends.
The liberalization of the external trade and payments regime complements domestic deregulation and enhances welfare-improving competition. It also reduces the cost of production, encourages the inflow of productivity-enhancing foreign capital and technology, and leads to a rapid growth of exports (particularly of the non-oil sector). It removes distortions that undermine economies' ability to respond to unanticipated changes in internal prices and demand and reduces costs to consumers.
Trade reforms should aim to reduce tariffs and simplify the tariff structure. These efforts need to be accompanied by reducing non-tariff barriers, eliminating remaining state trading monopolies, and harmonizing the institutional structure with that in most other market economies.
These efforts are indispensable to the region's attempt to promote non-oil exports and benefit from the globalization and integration of markets. They are also consistent with membership of the World Trade Organization and certain countries' ongoing efforts to increase their economic integration with the EU, as discussed in the previous chapter. It is widely accepted that credible membership in the multilateral trading system can enhance the effectiveness of countries' liberalization policies. Owing to the potential dislocation of trade reforms on certain firms, these efforts should be closely calibrated with the strengthening of the social safety net. Moreover, given the fiscal costs, trade reform must also be considered integral to budgetary-tax and expenditure reform.
The seven measures discussed so far aim at enhancing the supply responsiveness of the economies--an essential component of a sustained growth and development strategy for the MENA region. International experience confirms that since the effectiveness of such measures also depends on the prevailing macroeconomic environment, a consistent and supportive fiscal/monetary/exchange rate policy mix is needed.
An appropriate mix requires careful calibration of these three policies to avoid crowding out private production, to restrain inflationary pressure, and to contribute to a strong and viable external position. Such a mix can be achieved through various configurations of policy measures. It is important in this regard that the measures be sustainable--that is, be part of strengthening the structure of the budgetary accounts (as discussed above in the case of the GCC) and a transparent and predictable system of exchange rate determination.
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