NS4053 Winter Term 2015

Arab Region: Growth and Convergence

OverviewHafez Ghanem, Growth and Convergence in the Arab Region, Brookings October 2014

Main Points

•Arab transitions to democracy are faltering

•Economies of the so called Arab Countries in transition (ACTs) are not doing much better

•Demands for better standards of living and greater social justice are far from being met.

•Situation beyond the five ACTs is even worse

•Is today’s pessimism justified?

•Realistically as seen in other transition countries, the process of building institutions to support democracy and free economies often takes decades

•Lays out an agenda of institutional reform, higher investment and transformative policies to assist countries converge towards OECD income levels

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Patterns of Growth I

• More optimistic picture is that the process towards more open democratic societies has already started

• Suggests need for patience and a long-term vision

• The five ACT countries have been growing fast enough to start converging towards OECD income levels

• However at an extremely low pace

• Wants to show slow convergence can be explained by examining:

• The quality of economic institutions

• Levels of physical investment

• Investment in people and skills; and

• The rate of transformation toward higher productivity sectors

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Patterns of Growth II

Convergence or Divergence

•Are ACT income levels converging?

•Depends on the basis of comparison

• If one compares to U.S. income levels, then they have been converging since the late 1990s

• However if comparisons are made with India and especially China, then they have been diverging

•Historically

• The 1980s and part of the 1990s was period of divergence for most countries including the ACTs

• Situation began to change in the 1990s and especially in the 2000s as most emerging and developing countries including the ACTS started converging towards OECD levels

•For the ACTS convergence very slow

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Patterns of Growth III

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Patterns of Growth IV

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Explanations for Uprising I

• Why did revolts occur in 2010 even though ACT economies were growing and converging (slowly) to OECD levels?

• Two possible explanations

• First Explanation

• The Arab revolutions of 2010-11 may have been about political rights and not economics

• Polls show a huge majority of arabs believe that democracy is the best form of government

• May be as their situation improved, Arabs (especially youth) started demanding more civil and political rights

• They revolted to obtain them.

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Explanations for Uprising II

• Second Explanation• Based on the argument that economic growth in the Arab world

has not been sufficiently inclusive

• Middle class, particularly educated youth have benefitted very little form growth

• Watched politically connected businessmen make huge fortunes through government provided rivileges while they remained unemployed or working for low wage sin the shadow economy

• The global food crisis of 2007-08 led to a huge increase in food prices and a big decline in welfare

• Polls show percentage of those satisfied with the economic situation fell drastically from 2007—2010

• Follows that growing inequality and increasing economic pressures were the main causes of the revolution

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Accelerating Growth

• Ways to accelerate growth

• ACTS can start growing faster by

• Increasing their investments in efficient economic institutions

• Physical and human capital and

• By accelerating the transformation of their economies in favor of higher productive activities.

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Prescription I

Economic Institutions•One school (Acemoglu and Robinson) argue that the main (or even only) explanation for different economic outcomes among countries is different institutions.•Inclusive institutions lead to the creation of inclusive markets that support growth and equality of opportunity•Extractive institutions stifle entrepreneurship and creativity and thus lead to low growth and high inequality•Egypt example – ruled by narrow elite that has organized society for their own benefit at the expense of the vast mass of population•Political power was concentrated, and was used to create great wealth for those who possess it

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Prescription II

• Position supported by analysis by the World bank

• Found politically connected firms in Egypt and Tunisia had many advantages lacked by other firms – closed deals.

• Situation prevented the emergence of job creating competition

• Industrial policies were tailor made to support certain firms.

• These limited market entry and distorted competition

• World Bank concludes these arrangements explain why within-sector productivity in Arab countries lags behind rest of the world

• Report concludes the region’s relatively slow growth is due at least in part to the links between politics and business and the ensuing distortive policies.

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Prescription IIIGovernance patterns•Two dimensions where all five countries fall in the bottom half of countries are:

• Voice and accountability and

• Political stability

•Egypt generally lower than Jordan, Morocco and Tunisia

• Particularly on regulatory quality and control of corruption

•Patterns suggest that ACTs should focus on building inclusive economic institutions that provide a greater voice for citizens•Could include

• building an institutional framework for citizen participation in economic planning and policy making

• Reviewing the legal framework governing civil society organizations to make it more supportive of their operations.

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Prescription IV

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Causes of Decline V

Physical Capital•In addition to institutions, economic growth usually requires the accumulation of physical capital•Several patterns

• ACT investment rates are comparable to Brazil but much lower than India and especially china

• On average ACT investment rates seem to be stagnating or declining (with the exception of Morocco) while rates in India and China (but not Brazil) have been increasing

•In order to catch up with the emerging economies ACTs will probably have to raise their investment rates•Will require both an increase in both public and private investment

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Prescription VI• However government budgets severely strained in ACTS

• In 2013 the budget deficits

• In Egypt and Jordan about 14% of GDP

• In Yemen it was 8% and

• 6% in both Morocco and Tunisia

• Hence increases in public investment can not be achieved through increasing expenditure levels

• Can only occur through expenditure reallocation or foreign assistance

• Price subsidies, especially for energy products are an important expenditure item in most countries – 7% of GDP in Egypt

• Nearly all ACTs are gradually eliminating those subsidies which will create more physical space for investment

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Prescription VII

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Prescription VIII

• Public investment that improves the quality of infrastructure would encourage greater private sector investment through a “crowding-in effect)

• However ACTS also need to improve the business climate and encourage the development of competitive private activities

• Area where institutional reforms could have a direct impact on investment

• Important that the institutions responsible for implementing the regulatory framework affecting the private sector be reformed to be more inclusive

• Important that the private sector has a say in how regulations are implemented

• Should be more accountable so that the institution is judged on its results and quality of services it provides

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Prescription IX

• Economic Transformation• Evidence (Rodrik) that labor productivity in the formal

manufacturing sector in emerging and developing countries

• Converges to that of advanced countries

• Convergence happens regardless of levels of education and institutional development

• Means the convergence process can be accelerated by a sift of resources from low productivity and low growth sectors into manufacturing

• Additional evidence (World Bank) shows that labor productivity in formal manufacturing in MENA countries is converging to that of advanced countries at the same rate as that of other developing countries.

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Prescription X

• Problem – convergence of the formal manufacturing sector did not lead to overall convergence of the economy because of sector’s very small and declining share of region’s labor force

• The proportion of overall labor engaged in formal manufacturing only

• 7% in Egypt and Jordan

• 5% in Morocco

• Moreover these shares have been declining since the mid 1990s.

• Situation suggests for the adoption of government interventions to provide special incentives for the private sector to invest in formal manufacturing and

• For existing formal manufacturers to expand their operations

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Prescription XI

• Another option is to lure manufacturing firms out of the shadow economy and assist their transition into the formal economy

• Raises questions of markets

• Given the slow-down in the Eurozone and intense completion from China

• May have to carve out niches in local market before moving into export markets

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