27 Aug 2020

Chipping away at duality in the Middle East

Dr. Rabah Arezki and Dr. Mahmoud Mohieldin

Abstract:

Countries in the Middle East and North Africa (MENA) have been hit by a dual shock of Covid-19 and a collapse in oil prices. But social frictions and strained budgets have severely limited the ability of many governments to respond quickly. Nevertheless, there is a potential upside to the crisis if the pandemic and anemic oil prices produce a wave of innovation to replace the rent-seeking that has dominated the region and diminished the role of human capital for the past 20 years.

 In the years before the Covid-19 pandemic, two things stood about the Middle East and North Africa (MENA). The region experienced severe social friction from a disgruntled young population, and the majority of budgets in the region were strained. The level of economic growth was well below what was needed to create hundreds of millions of jobs for the increasingly educated young people, especially women, flooding the labor market (see Figure 1).[1]

Figure 1. Educated but unemployed youth in MENA (in millions)

Educated but unemployed youth in MENA

Several factors, including inadequate economic and social policies, played a role, but at the root of that puny growth rate in recent years was the persistent fall in oil prices – which not only resulted in a direct decline in income to oil producers but also reduced receipts from tourism, aid, and foreign direct investment across the region. Governments had no choice but to stabilize the economies by actively reducing external (current account) and internal (government budget) deficits, mostly through fiscal consolidation. That meant steps such as cutting subsidies on fuel and other goods, increasing indirect taxes such as those on services and value-added, and reducing public employment. Fiscal consolidation took a toll on the poor and the middle class and further weakened an already tepid growth rate (see Figure 2).

 Figure 2. Mediocre growth in MENA

Mediocre growth in MENA

 These macroeconomic stabilization policies broke with the MENA region’s enduring social contract, by which citizens received patronage spending in exchange for accommodating citizen voice and government accountability. While the long-delayed stabilization of external and internal deficits was unavoidable, most MENA countries have shied away from addressing such core issues as entrenched incumbency that have stifled economic growth and exacerbated a sense of inequity among citizens.

Entrenched incumbency without independent and accountable regulation has led to very bad service in vital sectors such as water, electricity, telecommunications, financial services, and transportation – many of which are unavailable to poor people.

 The immediate response

Covid-19 has brought the world economy to a standstill – the result of the lockdowns and social distancing measures imposed to slow the spread of the novel coronavirus (see Figures 3 & 4). Locked-down economies have been hit by a combination of supply and demand shocks threatening mass unemployment and bankruptcies. Western countries and emerging markets used fiscal and monetary policy measures to finance the health response to the virus, forestall collapse in consumption, and protect the economic fabric, including small and medium-sized enterprises (SMEs). The policies also aim to avoid mass unemployment by subsidizing employers who keep workers on the payroll and expanding unemployment insurance.[2]

 Figure 3. Covid-19 (reported) infections

Covid-19 (reported) infections

 

Figure 4. Covid-19 (reported) deaths

Covid-19 (reported) deaths

The global environment has reduced external demand for goods and services from MENA – including oil, other commodities, and tourism – cut remittances and caused capital outflows from the region (see Figure 5).[3] Global hoarding of food and medical equipment has increased MENA’s vulnerability. Moreover, unlike advanced economies, the MENA region’s ability to combat the virus and modulate supply and demand dislocations is constrained by social tensions and limited fiscal buffers.[4]

 Figure 5. Oil price meltdownOil price meltdown

 

Lockdowns aimed at slowing the spread of the virus are difficult to implement when most of the population works hand-to-mouth in the informal sector. In other words, Covid-19 has exacerbated the duality of MENA society.  Workers in the formal economy typically enjoy social protection, to some extent, and a predictable stream of income, faring better during a lockdown than do informal workers who have limited access to social protection and no income if they do not work. Because they exacerbate inequality, lockdowns further raise tensions in a region already low on social harmony (see Mahler et al. 2020). To soften the economic impact, MENA countries have put in place measures such as cash transfers and extended enhanced social protection programs to both existing beneficiaries in the formal sector and non-beneficiaries in the informal sector. These measures come on top of tax breaks and easing access to credit to SMEs. But the ability to sustain these programs is limited by constraints on government capacity to spend (fiscal space) that were further squeezed by the decline in oil prices.

This limited fiscal space has made it difficult for many MENA governments to pay for medical materials – such as testing kits and respiratory devices – and contact tracing technology, and may also impair future access to medicines and vaccines if they are developed. It is a vicious circle. Economic issues limit the MENA countries’ ability to contain the disease, which further worsens economic conditions. But heightened lockdown measures to blunt the spread of the disease might worsen inequality and poverty.[5] Beyond the few countries that can borrow on international markets, MENA countries are mainly restricted to their limited fiscal response.  Monetary policy – such as liquidity injections or money printing – is mainly unfeasible, if for no other reason than that it would put downward pressure on often fixed or tightly managed exchange rates, leading to serious consequences in countries with high levels of debt denominated in dollars or other foreign currencies. That is in contrast with advanced economies, which largely can borrow in their currency.

A partial way around that vicious circle, in the short term, could be provided by the international community, which has stepped in to support the efforts of countries to protect lives and livelihoods. Emergency assistance packages helped MENA countries maintain access to essential medical and food supplies and finance and design cash transfer programs for households and small-medium enterprises (SMEs). Bilateral creditors have an important role in limiting future costs and ameliorating the risk that delayed responses to Covid-19 could result in failed states. For example, to help free up funds to fight the pandemic, the G20 has agreed to debt relief for all low-income countries from official bilateral creditors (G20 Communique, 2020; FT, 2020).[6] Down the road, debt restructuring and cancellation will undoubtedly become the order of the day for heavily indebted countries to help prevent debt overhang from stymying their efforts to re-start growth and transform their economies.

After Covid-19

But while the dual shock of disease and falling oil prices present MENA with a crisis, the shocks also illuminate the MENA economies’ underlying flaws that authorities must fix if the region is to prosper.

There will likely be a ramping up of the state’s role to address the eradication of the virus and protect economies from depression at the global level. The state intervention is already large in the MENA region. How well that size will help countries cope first with the pandemic and its aftermath depends on their ability to refocus, be more transparent, and develop accountability mechanisms.

In many respects, the Covid-19 pandemic is a crisis of preparedness – or lack thereof. Successful models for limiting the spread of the virus – such as in Korea – quickly deployed technology (including digital contact tracing) to fight Covid-19 and targeted assistance to those in need (Foreign Affairs, 2020). These models should be analyzed, replicated, and adjusted – they create issues for data protection and privacy. But MENA countries lag the world in technology adoption. Moreover, the region risks dramatic consequences if governments do not become more transparent and increase information flow. Increased transparency and information availability should reduce citizens’ mistrust of authorities – or force authorities to behave better (see Arezki et al. 2020). By helping ensure that cash transfers get to their targets – and not to government cronies – increased transparency and data disclosure will not only aid government legitimacy, but they will also hasten the economic recovery and limit the rise in poverty.

Because the region has limited resources, it will have to rely on innovative design and development of low-cost and scalable ways to contain or eliminate the spread of Covid-19. Interestingly, the businesses community, civil society, and diasporas have stepped in to propose some solutions in such disparate areas as fund-raising, production of masks and other medical equipment, and communication campaigns. But the health issues cannot be solved without dealing simultaneously with the underlying flaws in MENA economies and societies:

  • Production systems are limited by policies that promote overvalued exchange rates and lack of fair competition.[7]
  • Highly educated young people, especially women, hampered by a lack of access to digital technology and a poor business environment.

That promising innovations that are emerging should be encouraged, and governments should create space for a genuine private sector to replace pork-barrel spending as a new and sustainable engine of growth.

MENA has to take steps to move away from the corrosive duality of a split informal and formal society (see Figure 6). The pandemic has left the informal sector flat-footed and an even riper source of unrest than before the novel coronavirus emerged. And the collapse in oil prices, which shows no signs of abating but lots of potentials to worsen, will essentially end the patronage economy. In other words, events out of control of the authorities will trigger a change in MENA societies. Governments must decide whether that change will be guided or traumatic and unpleasant.

Figure 6. Looming informality in MENA

Looming informality in MENA

To move to more equal and less contentious societies, countries must simplify and promote a universal social protection system to replace the fragmented systems that benefit the few and exclude most. They must provide a universal basic income for all, which would help promote innovation by making it safer to take risks, and universal health systems. To finance them, societies will have to find new revenue sources, including through reforms of the tax system.

Productivity should be enhanced by promoting fair competition and the adoption of digital technology, especially in finance and telecommunication. These enhancements would be especially important to the heretofore informal sector, as it would gain access to services and markets previously accessible only to the privileged few and state-owned enterprises.

Any guided change should be associated with reforms in the role of the state. Most MENA countries have very large employment in public administration and state-owned enterprises – some of it is part of the long-standing social contract and some as employment of last resort. The unraveling of the old, inequitable social contract should be accompanied by public service reforms that retain talented workers and remove unfair protections while providing universal social protection and healthcare.

Such necessary measures will be funded not only by tax and other fiscal reforms but by savings from the large reduction in loss-making redundant commercial activities on the part of the state and increased tax revenues that will occur when the business sector operates in a more transparent manner. Having a more efficient public administration focused on such key state functions as promoting universal health, other social services, and assuring fair competition will end the rent-seeking behavior that has retarded MENA growth and will empower the millions of educated women and men hoping to ride a wave of innovation towards prosperity.

 

References

  • Arezki, Rabah; Ait Ali Slimane, Meriem; Barone, Andrea; Decker, Klaus; Detter, Dag; Fan, Rachel Yuting; Nguyen, Ha; Miralles Murciego, Graciela; Senbet, Lemma. 2019.
  • “Reaching New Heights: Promoting Fair Competition in the Middle East and North Africa.” Middle East and North Africa Economic Update (October), Washington, DC: World Bank.
  • Arezki, Rabah, Daniel Lederman, Amani Abou Harb, Nelly Youssef Elmallakh, William Louis, Yuting Fan, Asif Mohammed Islam, Ha Nguyen, and Marwane Zouaidi. 2020. Middle East and North Africa Economic Update, April 2020: How Transparency Can Help the Middle East and North Africa. World Bank Washington, DC.
  • Baldwin, R and B Weder Mauro (2020a), Economics in the Time of Covid-19, a VoxEU.org eBook, CEPR Press.
  • Baldwin, Richard and Beatrice Weder di Mauro. (2020b). Mitigating the Covid Economic Crisis: Act Fast and Do Whatever It Takes.
  • Barro, Robert and Jong-Wha Lee, 2013, “A New Data Set of Educational Attainment in the World, 1950-2010.” Journal of Development Economics, vol 104, pp.184-198.
  • Bolton, P, L Buchheit, P-O Gourinchas, M Gulati, C-T Hsieh, U Panizza and B Weder di Mauro (2020), “Born Out of Necessity: A Debt Standstill for Covid-19”, CEPR Policy Insight no 103.
  • Focus Economics. 2020. Focus Economics Consensus Forecast: Middle East & North Africa – May 2020.
  • Gali, J (2020), “Helicopter money: the time is now”, VoxEU.org, 17 March.
  • Gatti Roberta, Diego Angel-Urdinola, Joana Silva, and András Bodor (2014). Striving for better jobs: The challenge of informality in the Middle East and North Africa.
  • G20 (2020), Communiqué G20 Finance Ministers and Central Bank Governors Meeting, 15 April 2020.
  • International Energy Agency (IEA) (2020). Oil Market Report - May 2020.
  • International Monetary Fund (2020). Policy Responses to Covid-19, retrieved May 17, 2020.
  • International Monetary Fund. 2020, World Economic Outlook (WEO).
  • JP Morgan (2020). MENA Emerging Markets Research, May 14, 2020 edition.
  • Lakner, Christoph; Mahler, Daniel Gerszon; Negre, Mario; Prydz, Espen Beer. 2019. How Much Does Reducing Inequality Matter for Global Poverty? (English). Policy Research working paper; no. WPS 8869; Paper is funded by the Strategic Research Program (SRP). Washington, D.C.: World Bank Group.
  • Mahler, Daniel, Christoph Laknerr, Andres Castaneda Aguilar and Haoyu Wu (2020) “The impact of Covid-19 (Coronavirus) on global poverty: Why Sub-Saharan Africa might be the region hardest hit.”
  • “G20 agrees debt relief for low income country,” April 15, 2020, Financial Times.
  • “How Civic Technology Can Help Stop a Pandemic,” Foreign Affairs 2020
  • World Bank (2014). Unlocking the Employment Potential in the Middle East and North Africa.
  • World Bank Group. 2020, World Development Indicators (WDI).

[1] See Gatti et al (2014) and World Bank (2014).

[2] See IMF (2020) and JP Morgan (2020) on the policy responses to Covid-19. Where inflation is low, liquidity injection and targeted cash transfers can be financed by so-called helicopter money, that is, money printed by central banks (Gali 2020).

[3] See Focus Economics (2020) & International Energy Agency (2020).

[4] See Baldwin et al. (2020a, 2020b).

[5] See Lakner et al. (2019) on inequality in MENA.

[6] See Bolton and others (2020).

[7] See Arezki et al. (2019)

economy Middle East

Comments

Borhan El Kilany I really appreciate and value very much this great document that profoundly and bravely expresses the reality of the current global challenges.. I also need to read your vision for the future outcome of what’s coming soon!!! Thanks a lot .

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