Much has been written about the weaknesses of the Middle East and North Africa (MENA) economies: their low level of innovation and labour productivity, the lack of dynamism and informality of their private sector, and the decaying capacity of their states and decline in the quality of their services. The social impact of these weaknesses is also well understood: rising poverty, high unemployment and increased inequality. There is a heavy sense of stagnation and unhappiness. The resulting social discontent led to the Arab Spring in 2011, and to repeated eruptions of anger, before Covid-19 put a temporary halt to social mobilization. But this has not yet spurred efforts for fundamental renewal, and performance continues to stagnate.
Economic Crisis and Responses
What is less understood is that the financial situation of the MENA region’s oil-importing countries is about to take a turn for the worse. In these countries, political stability has only been preserved over the past decade through expansionary public spending financed by debt. This process has by now largely run its course. As in many other developing countries around the world, rising global interest rates and higher food and fuel prices means that strategies such as this are no longer tenable.
A regional commission of experts (FDL & ERF, 2022), working under the auspices of the Economic Research Forum (ERF), and the Finance for Development Lab (FDL), was asked to evaluate the macro-economic risks in the future, and to make recommendations on the best course of action to take to avoid them. There are many useful reports by national, regional and international organizations on similar issues. But they tend to be technical in style and diplomatic in tone. The responsibility of the Commission was to not shy away from the very political choices confronting MENA societies at this historic juncture. As a result, the report conveys the risks ahead with brutal honesty. But it also offers a ray of hope by pointing to a unique opportunity for the region to implement long awaited reforms so as to boost its development path.
Relying on austerity alone, with no hope of a better future, risks causing a social explosion
The report makes it clear that the recent macroeconomic shock waves have added fuel to the fire by making what was an already weak economic situation catastrophic. More than at any time in the recent past, this present moment is a grave one, with cascading risks that cannot be smoothed out anymore. Lebanon and Sudan are in the midst of a severe economic and political crisis. Debt sustainability analysis reveals that at current low growth rates, public debts in Egypt, Jordan, Morocco and Tunisia will soon reach explosive levels unless fiscal deficits turn rapidly into large surpluses. This puts these countries between a rock and a hard place. Economic growth is already low, youth unemployment unacceptably large, poverty rising and the middle-class weakened, all threatening a rise in social unrest. Inaction will inevitably lead to devastating financial crises. But relying on austerity alone, with no hope of a better future, risks causing a social explosion. A convincing response is now needed to avoid falling into a vicious cycle of economic, social and political decline.
These grave challenges are forcing MENA societies to mobilize their efforts. Governments will have to adopt courageous decisions. Some reduction in government expenditure is unavoidable. But much of the political capital invested in reducing the risks ahead should go towards improving growth prospects. Growing out of a cycle of debt has always historically been the best solution across the world, and this region is no exception. Reforms favouring economic growth have been avoided for too long here. To avoid a pre-announced disaster, the time has come to stop kicking the can down the road. This will require the region to mobilize its inner resources – work more, save more, invest more. External debt restructuring can only go so far, and countries should not expect too much from it. IMF support will be necessary. It needs to be more generous, but it also needs to be made conditional on launching credible national revival strategies, as opposed to the austerity-only based approaches of the past.
Table 1 GDP Real Growth Rates and Investment Rates before Covid-19
Most importantly, pro-growth, national renewal strategies are essential to ignite growth. Public expenditure should be reoriented to safety nets and pro-growth spending, and monetary policy should push finance to SMEs and the private sector and promote exchange rate competitiveness. But this will not be sufficient. Structural reforms are also needed to unleash the societies’ potential for innovation and hard work. The reform agenda does not only include the “old” challenges, particularly that of improving the business climate for the private sector by fostering competition and moving away from low productivity cronyism (Diwan, Malik &Atiyas, 2019); but rather growth policies should also address the new challenges of digitalization (Mahroum, 2021) and climate change (Duenwald, 2022). On all these fronts, a big push is needed to create a major expectation shock. Reforms will have to unfold over time, but an expectations revolution is needed in the short term: to elicit a strong private sector supply response; to rebuild citizens’ trust in the state and in a better future; and to attract external capital flows and investments.
The Politics of Reforms and the Risks of Vicious Circles
An economic renewal strategy would not be credible without dealing with the political roots of the economic challenges. To initiate a virtuous cycle or economic progress, political elites need to be closely associated with change. They need to mobilize those who stand to gain from the reforms, weaken the opposition to change, ensure a fair distribution of the costs and benefits of reforms, and rebuild trust in the state as well as state capacity.
To be successful, political elites need to convince themselves and society of two evolutions:
- That such change is desirable, because delaying it would ultimately lead to economic collapse;
- That the risks change entails are worth taking, because change now offers greater and more readily available opportunities.
The Arab Spring was triggered by accumulated social discontent and anger – at the lack of dignity, jobs and services. But none of these agenda items have been addressed yet
There are serious risks of socio-political chaos ahead. The use of austerity, with no movement on pro-growth and pro-state reforms, risks unleashing three types of negative forces. First, in response to increased austerity, social grievances could come back with a vengeance. Previous attempts at slashing subsidies without compensations were disastrous, and led to massive riots in the 1970s and 1980s in all the major regional capitals. The adjustments came later in the 1990s in the form of a lost decade of gradual fiscal stabilization, imposed through repressive means. The rise in grievances precluded economic or political reforms. The Arab Spring of 2011 was triggered by accumulated social discontent and anger – at the lack of dignity, jobs and services. But none of these agenda items have been addressed yet.
Second, the business sector is indirectly hurt by the policies of austerity, as the rise in popular grievances will increase political risk and dampen business confidence. While devaluation and improved macro-stability can potentially improve external competitiveness, firms will need to have confidence that business conditions will improve, and that macro-conditions will remain favourable over the medium term for them to invest more and shift to the tradable sector.
Third, when elite groups lose hope in the future, their horizon is cut short. Established actors (e.g. security/military groups, state dependent labour unions, or politically connected business groups) play a central role in shaping policy. A low trust environment shortens the planning horizon and generates little incentives for cooperation. These perverse incentives have been the main reason for the lack of progress in the recent past. Divided politics make it harder for regimes to shape a reformist social coalition. They are less able to mobilize groups that would gain from reforms, such as the unemployed youth or the market-oriented middle class.
As a result of these negative dynamics, Arab societies have witnessed a gradual weakening of institutions, including the justice system, decentralized bodies and political parties. As a consequence of repression and co-optation, intermediate bodies, such as unions and business groups, have grown weaker. Civic and political spaces have been closed down. Parliaments have become an extension of executive power rather than systems of checks and balances. These weak foundations have made the region vulnerable to manipulation by regional and global powers.
A retreat into populism and social polarization is plausible if these trends continue. Opinion polls show that trust in governance is at historically low levels. Equally, confidence in the future has fallen to disastrously low levels, and, as a consequence, a large proportion of youth expresses a desire to emigrate. These are circumstances ripe for the emergence of and popular support for a strong man to miraculously save the day. Populism, however, tends to move away from economic and social concerns, towards identity issues, and to rely on divisive narratives. A strong man is unlikely to lift the real constraints to progress: on the contrary, they will linger and exacerbate over time.
The Conditions for Progress Exist Now
While the overall diagnosis seems bleak, there are also bright lights shining on the horizon. Elements of progress can break the spell of divisive political discourse and ineffective economic policymaking. If governments are well-prepared, the current shocks can be used to engineer a turnaround. Three drivers of change need to come together to be able to pivot towards a more hopeful path of progress: proactive engagement by economic elites, a social movement based on broad sections of civil society, and political leadership. Because of the accumulated experiences of the past decades, the first two can now be mustered, if the third can be mobilized and is able to coordinate them.
In the case of economic elites, the conditions for a positive posture seem more present than at any point in the past. The reforms of the 1990s ushered the growth of politically-connected large private firms, and of a sprawling sector of small informal firms. The emerging economic elites were content to remain politically quiet and enjoy their privileges until the 2000s. However, in the wake of the 2011 uprisings, domestic resistance to privileges grew. As a result, in searching for ways to reestablish political stability, post-2011 regimes have tended to repress established economic elites. The simultaneous collapse of law and order allowed the informal sector to become increasingly infiltrated by criminal activities. It is now clear that political passivity is no longer good for business. The interests of large and small firms have become more united than in the past, as both would benefit from macro-economic stability and a more rigorous application of the rule of law.
Other economic and political elites have now learned that the politics of pushing the cost of reforms to others eventually leads to a destructive, negative-sum “game of chicken.” In Lebanon (Diwan &Yahya, 2020), where huge financial losses need to be distributed before the banking sector can be revived, bankers have started to internalize the need to take a short-term hit, even if massive, for future opportunities to open up again. Elsewhere, as in Tunisia (Diwan, 2019), it has become clear that labour unions can create instability, rather than protect civil servants, if the economy does not grow. Similarly, in all countries where the military has significant economic interests, it has become clear that unfair competition has led to a costly demobilization of the private sector.
The other major political actor, civil society, has also come of age. Its uprisings in 2011, and more recently in 2019, have ushered in sweeping, long-term cultural changes. This has upended politics and excluded the possibility that a repressive regime could be sustainable. Post-2011, large parts of civil society became polarized around identity lines, as political parties competed to fill the political vacuum using divide-to-rule tactics to mobilize popular support. Now, however, it has become patently clear that the religious/secular divide should not be allowed to become the central tenet of political life. Civil society groups now realize that they would be more effective in generating progress by mobilizing around constructive strategies. Civil society is especially well positioned to play positive bridging roles, such as animating national debates, advocating for constructive solutions and championing cooperation between national actors. At the grassroots level, it can also build blocks of progress – such as horizontal accountability mechanisms to help improve the capacity of the public sector, associative efforts to fight corruption and ensure a level playing field in business, or community-driven efforts to protect the environment.
The Arab Spring, despite its poor results so far, has demonstrated the absence of any sustainable alternative to democratization
These actions also authorize a vision of shared citizenship, fostering a new dynamic of cooperation in pursuit of win-win possibilities, as a foundation for more open and inclusive societies. The Arab Spring, despite its poor results so far, has demonstrated the absence of any sustainable alternative to democratization. Citizens have also learned that an effective democracy is not built overnight, but instead requires a long process.
Economic Reforms Are Essentially Political
For decades now we have searched for workable ways to organize the region’s political economies. Political elites, economic elites and civil society actors each have key roles to play in reversing the downward spiral of polarization. Political elites need to explain the risks ahead with brutal honesty and convince fragmented actors that collective action will open up large opportunities for progress. Such convincing can only occur if they showcase an evolution in political openness that allows for collective action to take place. Political reforms are of course valuable in their own right. But they are also a necessary component of any ambitious economic revival plan that can enrol the cooperation of firms and citizens.
The required political evolution means upholding two central principles of democratic life, in ways clearly observable by businesses and citizens at large:
- First, political elites should signal that they are ready to embrace openness. Concretely, they could illustrate this commitment by organizing processes of national consultation and dialogue; the enforcement of a level playing field among all firms; an opening up to civil society, with stricter respect for human rights, and more free spaces for discussion and criticism, including by the media; and greater civilian control over security services.
- Second, political elites need to show that they will support an equitable distribution of both the costs and benefits of reform. A sense of equity fosters trust, and is necessary to shift from a narrative of grievances, to one of aspiration for progress. With rising trust, plans for renewal can start to generate hope – supporting a greater willingness by economic and political agents to consider a longer-term horizon – fuelling a shift from divisiveness and opportunism toward increasingly embracing cooperative, mutually advantageous approaches to collective action challenges. Fairness can be signalled in various ways, from social safety nets to tax reforms, control over cronies, and the neutralization of veto players.
Renewing the Regional and Global Agendas Is also Necessary
Unlike the ineffective Arab League, a strong regional block must be built by sovereign states with common goals. Regional cooperation is needed to address the rising challenges of global warming, displacement of refugees, and where needed, post-conflict reconstruction and improved security.
There are enormous new opportunities to expand economic regional cooperation – particularly relating to digital integration, climate cooperation and collective efforts to improve food security. On the first front, Arabic-speakers represent about 5% of the global population, but Arabic content on the Internet only amounts to 1%. To catch up on digitalization, this content has to see a sharp rise, which can best happen with improved relations across countries. Second, water management of inter-state rivers will become even more important in the future as water scarcity keeps rising – this concerns not just the Nile, Euphrates and Tigris, but also the Jordan river, Asi and many other smaller rivers. Climate adaptation projects, for example, to reduce the risks of floods, also go beyond borders. The production of clean energy and its export would be greatly facilitated by a regional approach (grid, investments, technology). Finally, the MENA region includes some of the most food insecure countries on earth, but also, countries with vast, but undeveloped, agricultural potential, such as Sudan, Morocco and Algeria. Developing food security collectively is of great value.
Massive investment in capital and technology will be needed, and this cannot happen unless deep and trusting relations are built among the countries of the region
In all cases, massive investment in capital and technology will be needed, and this cannot happen unless deep and trusting relations are built among the countries of the region. This relates to at least two different agendas. First, the divergence of the region into highly successful GCC states and an impoverished backwater, is not a stable stage for the region’s development and is, instead, a source of tensions and divisions. Income convergence needs to be encouraged. This will also support the GCC’s transition away from oil – as the GCC starts relying less on oil exports, it will need a regional market for its diversification drive to thrive. Second, progress on the regional front requires more attention to the security agenda. Conflict inflicts enormous economic externalities, in addition to untold human suffering.
After years of civil war, the economies of Yemen and Libya have shrunk by half; that of Syria by more than two thirds. Old conflicts, including the Israeli-Palestinian conflict need more attention and a fair resolution. New conflicts must be extinguished in Syria, Yemen and Libya: new political settlements need to be found, and post-conflict reconstruction engaged. In the meanwhile, refugees and IDPs require support, and this needs to be shared more fairly across the region and globally.
Like other developing regions, MENA expects more from the international community – more focused coordination to help stabilize the world economy, more finance to deal with the climate challenge, and more clarity on the global financial safety net to deal with the rocky period ahead. A united region would have more influence in joining its voice with that of other regions in calling for important reforms in the global financial architecture, to address the climate challenge more forcefully, strengthen the financial muscle of international financial institutions, create structures for quicker debt restructuring agreements when they are needed, and to agree on a fairer global taxation system that limits capital flight and tax evasion. Globally, the polarization of geopolitics is bringing back cold war dynamics. The MENA countries would benefit most if they could manage to unify their ranks in order to benefit from competition between the blocs, and avoid being dominated by one.
Diwan, Ishac, Tunisia’s Upcoming Challenge: Fixing the Economy Before It’s Too Late, Arab Reform Initiative, September 2019. www.arab-reform.net/publication/tunisias-upcoming-challenge-fixing-the-economy-before-its-too-late/
Diwan, Ishac; Malik, Adeel and Atiyas, Izak (eds.), Crony Capitalism in the Middle East – Business and Politics from Liberalization to the Arab Spring, Economic Research Forum, 2019.
Diwan, Ishac and Yahya, Maha Lebanon’s Future in the Balance 1 March 2020 https://ishacdiwan.files.wordpress.com/2020/11/moyen-orient-english.pdf
Duenwald, Christoph et al., “Feeling the heat : adapting to climate change in the Middle East and Central Asia.” IMF Departmental paper, 2022/008. March 2022. www.imf.org/en/Publications/Departmental-Papers-Policy-Papers/Issues/2022/03/25/Feeling-the-Heat-Adapting-to-Climate-Change-in-the-Middle-East-and-Central-Asia-464856
ERF & FDL, “Embarkingon a Path of Renewal.” Policy Research Reports n. 43, Economic Research Forum and FDL Policy Noten. 2, Finance for Development Lab, October 2022. https://findevlab.org/embarking-on-a-path-of-renewal/
Mahroum, Sami “Digitalization, E-Commerce, and Private Sector Development in Arab States.” ERF Working Papers, n. 1487. September 2021. https://erf.org.eg/publications/digitalization-e-commerce-and-private-sector-development-in-arab-states/
(Header photo: Palestinian farmer prepares his land for the new agricultural season, in Beit Lahiya in the northern Gaza Strip. (Photo by Mahmoud Issa / SOPA Images/Sipa USA)No Use Germany.)