A robust private sector has never fully developed in the Arab world, which remains heavily reliant on natural resources and aid. But without economic diversification, the gains made in the region in literacy and health cannot be translated into lasting economic prosperity. Political reforms, unless accompanied by a levelling of the economic playing field, are unlikely to be sufficient: during the next decade an estimated 100 million jobs need to be created in the Middle East and the public sector is unprepared to meet this challenge.
WHY IS THERE NO STRONG PRIVATE SECTOR?
Until now, diversification has largely remained a paper aspiration in the Middle East. But against the backdrop of the latest political upheavals it has acquired a new urgency. The question is: what has prevented the emergence of a strong private sector and why has diversification been so difficult to achieve? In this post I identify one crucial barrier to private sector development: the persistent economic fragmentation of the Arab world into isolated geographic units that are, at best, only weakly connected with each other.
Despite its rich trading past and common cultural heritage, the Arab world is one of the most divided regions in the world in terms of production and trade. Mutual trade between Arab economies remains minimal. Even as the region’s trade with the rest of the world has expanded considerably, the share of intra-Arab trade has remained virtually stagnant since the 1960s. This is a colossal economic failure and has wide repercussions for the region:
- The absence of a large connected market denies Arab firms economies of scale and removes the opportunity for the private sector to become an independent constituency for socio-economic change.
- Thin markets are often more protected, preserve the monopoly power of insiders and increase the returns to predatory behaviour.
- The market for second-hand capital goods is smaller, which can make new investments particularly risky and create an adverse business environment, which reinforces existing inequalities.
- Defence expenditures are duplicated. As a region, the Middle East and North Africa (MENA) is the largest spender on defence (as a share of GDP).
- Regional public goods, such as an infrastructure connecting regional economies, are underprovided, which generates a massive coordination failure.
MAN-MADE BARRIERS TO TRADE
The Arab world’s economic fragmentation is puzzling given its favourable geography. The MENA region lies at the inter-section of major trading routes, with easy access to markets in Africa, Asia and Europe. Compared to Africa, where nearly 40 per cent of the population lives in landlocked countries, there is not a single landlocked country in the Arab world. Almost everywhere else in the world, access to sea translates into lower transport costs and better prospects for manufacturing, but the Middle East has coastal access without market access.
As well as its favourable location, the MENA region is one of the most urbanized in the world. Recent evidence suggests that urbanization can deliver concrete benefits to firms: by locating in urban centres, firms enjoy not only proximity to markets but superior access to a range of mutually supportive activities (skills, machinery, suppliers, resources, and the like). These agglomeration economies are simply absent in the Middle East.
Arab economies do not suffer from structural geographic barriers, but the region has built pervasive man-made barriers to trade. Severe restrictions are placed on the movement of goods and labour across borders. Centralized control and arbitrary regulations mar the business climate and, although tariff barriers have been slashed, the more cumbersome and invisible behind-the-border barriers continue to be a source of trade frictions. Dismantling these barriers is not easy, since they are an important source of income for those who use them to manipulate the economic system to their advantage.
AN OPENING FOR CHANGE
Until recently, dismantling regional trade barriers has been an economically desirable but a politically inexpedient step. Internal rivalries, dependence on external powers and the absence of a strong domestic constituency have frustrated numerous past attempts at integration of regional economies. Dependence on external windfalls from oil and aid has insulated the region from pressures for economic cooperation. Now, however, there is an opening for change. The demographic and political shifts in the region call for a new logic of economic integration. Given the multiple costs of fragmentation outlined above, it is clear that the failure to develop a vigorous private sector is not simply a failure of national economic policies but a regional failure. For genuine private economic activity to take root, the region needs soft borders and thick markets.
Fostering regional economic cooperation is arguably the most important collective action challenge that the region has faced since the fall of the Ottoman Empire. The starting point should be a connective infrastructure and greater economic access for small and medium enterprises. So far, it has been easier to forge a consensus in the Arab world on matters of security. But issues of economic security are likely to have more far-reaching implications in years to come, and deserve a similarly swift and unified response.
Some positive signals are already visible. The GCC (the Cooperation Council for the Arab States of the Gulf) is planning to spend US$142 billion on regional infrastructure projects. This includes an outlay of US$79 billion on developing a rail network that aims to connect GCC economies. But there is a need to mainstream the agenda of regional economic cooperation beyond the exclusive confines of GCC. Existing discourse in the region has centred on the necessity of political reforms. This is important. But the gains made in political freedoms cannot be consolidated without meaningful economic change. Ultimately, the Arab world will need not just political commons, but also regional economic commons that serve as incubators for entrepreneurship and growth.