World Development Vol. 45, pp. 296–313, 2013 Ó 2013 Elsevier Ltd. All rights reserved. 0305-750X/$ - see front matter www.elsevier.com/locate/worlddev http://dx.doi.org/10.1016/j.worlddev.2012.12.015

The Economics of the Arab Spring

ADEEL MALIK University of Oxford, United Kingdom

and

BASSEM AWADALLAH * Tomoh Advisory, United Arab Emirates

Summary. — A singular failure of the Arab world is the absence of a private sector that is independent, competitive, and integrated with global markets. This paper argues that private sector development is both a political and regional challenge. In so far as the private sec- tor generates incomes that are independent of the rent streams controlled by the state, it can pose a direct political challenge. It is also a regional challenge, since fragmented markets deny scale economies to firms and entrench the power of insiders. We argue that overcom- ing regional economic barriers constitutes the single most important collective action problem facing the region since the fall of Ottoman Empire. Ó 2013 Elsevier Ltd. All rights reserved.

Key words — Arab spring, private sector, fragmentation, protectionism

1. INTRODUCTION number of people looking for jobs. During the period, 1996–2006, labor force in Middle East and North Africa The real struggle for change in the Arab world 1 will only be- (MENA) has grown three times as much annually as in the gin when the dust from its youth revolutions has finally settled rest of the developing world, resulting in one of the largest down. After emergency laws are lifted, constitutions are rates of youth unemployment globally. Although youth unem- drafted and elections are held, policymakers in the Middle ployment is relatively lower in resource-rich countries with East will be faced with a tough practical challenge: how to cre- smaller populations, where the public sector can better absorb ate economic opportunities for its teeming millions? This chal- new labor market entrants, the challenge is more acute in la- lenge will remain unmet without a strong private sector. A bor abundant countries. This includes even fuel exporters, singular failure of the Arab world is that it has been unsuccess- such as Saudi Arabia and Algeria, where youth unemployment ful in developing a vibrant private sector that survives without is nearly 30%. In Syria and Jordan young people under the age state crutches, is connected with global markets, and generates of 30 constitute more than 70% of the unemployed work- productive employment for its young. The region suffers from force. 4 a dangerous dearth of manufacturing, best manifested in just Over time the Arab world has not only grown younger, it one statistic: in 2003 the combined manufactured exports of has also become more educated. The region might have failed the entire Middle East were less than those from just one on multiple accounts, but it has had a resounding success in South-East Asian nation, the Philippines. 2 With few excep- expanding access to, and closing gender gaps in, education. tions, the private sector is generally weak and dependent on Of the top ten countries that made the most impressive strides state patronage; success in it is determined more by patronage in human development during the last forty years, five were than entrepreneurship. With the public sector as the main ave- Arab countries (Rodriguez & Samman, 2010; United Nations nue for job creation, the region suffers from a precarious Development Programme (UNDP), 2010). Starting from one employment strategy that leaves it unprepared to deal with of the lowest levels of educational achievement in the 1960s, demographic pressures. The unfolding crisis in the Middle adult education rose faster in the Middle East during 1980– East is thus not just about the Arab state—its failed efforts 2000 than any other region in the World (Yousef, 2004). De- to redistribute, reform, and represent ordinary citizen’s inter- spite reservations about the quality of education imparted, ests. It is also about the private sector—or, more appropri- even this quantitative expansion of education has led to a ately, its absence. The centrality of the economic question is evident. Arab rev- olutions were fueled by poverty, unemployment and lack of * Special thanks are due to Tony Venables who provided the initial ins- economic opportunity. Over the last few decades, the Middle piration for this article and to Adrian Wood for his detailed feedback. The East has witnessed an unprecedented youth bulge that has dra- authors wish to thank two anonymous referees for their constructive co- matically changed its demographic profile. A significant pro- mments, and to Mohammad Talib, Fawaz Gerges, Francis Robinson, portion of its working age population (about 34%) consists Richard Makepeace, Eugene Rogan, Richard Auty, Donald Wittman, of young people in the age bracket, 15–24. Although this ratio Tarek Yousef, Matteo Legrenzi, Michael Hudson, Darius Wojcik, Ferd- is somewhat lower in countries with high oil rent per capita inand Eibl, and participants of the panel discussions at NYU Abu Dhabi, (e.g., Qatar, Kuwait, and UAE), all Arab spring countries St. Antony’s College, Oxford, Bonn University, LSE, and the Interna- had high youth bulges, with youth bulge in Yemen standing tional Book Fair in Algiers for helpful feedback. Rafay Khan and Rinc- 3 out at 42%. Together with greater female labor force partic- han Mirza provided excellent research assistance. Final revision accepted: ipation, these demographic trends have greatly enhanced the December 30, 2012. 296 THE ECONOMICS OF THE ARAB SPRING 297 silent revolution of sorts. It is a revolution of aspirations. Even broad economic undercurrents and analyze the challenge of as aspirations have become more mobile with the new gadgets regional collective action. Our analysis also underscores the of globalization, the local systems of governance remain ossi- need to emphasize linkages between various levels of analy- fied, offering limited economic mobility to the region’s youth. sis—economic, political, and geo-political. We aim to capture Even physical mobility across borders is restricted. Unlike spaces within disciplines to paint a rich picture. The adage that Western Europe, where class-based struggles have historically the whole is greater than the sum of its parts holds special rel- driven political change, the Middle East is witnessing a truly evance to scholarship on the Middle East. generational struggle for inclusion. This broad characterization is not entirely unwarranted gi- While coping with these demographic trends is a challenge, ven the existence of several unifying threads. There are at least they also offer an opportunity for economic advancement. five common denominators that cut across commonly recog- Other emerging market economies in Asia have successfully nized conceptual boundaries—for example, whether an Arab harnessed their youth bulges for development. The irony in state is a monarchy or a republic, labor-scarce or labor abun- the Middle East is that there is a vivid mismatch between dant, resource-rich or resource-poor. First, all across the Arab demography and economic structure. While demography is world both economic and political power is concentrated in evolving, the economic structure is unresponsive to the needs the hands of a few. Second, the typical Arab state can be char- of growing populations. Middle Eastern economies are heavily acterized as a security state; its coercive apparatus is both dependent on hydrocarbons, dominated by the public sector, fierce and extensive. Third, the broad contours of demographic and are failing to keep pace with the growing labor force. change and the resulting youth bulges are fairly common The limited economic opportunities that do exist are rationed across the region. Fourth, Arab countries are mostly central- by connection rather than competition. This leads to tremen- ized states with a dominant public sector and, with few excep- dous economic injustice for the young who see little hope tions, weak private enterprise. Fifth, external revenues— for economic and social mobility. whether derived from oil, aid, or remittances—profoundly While the need for a vibrant private sector is widely recog- shape the region’s political economy. nized, it is less clear how to develop it. The challenge of private The remaining article is organized as follows. Section 2 high- sector development is traditionally viewed through a narrow lights the vulnerability of the prevailing development model. technocratic and apolitical lens. When it comes to the Middle Section 3 discusses the region’s puzzling economic fragmenta- East, however, the limits of World Bank’s recipes are particu- tion despite its favorable geography. Section 4 provides a larly evident. Private sector development is not simply a mat- snapshot of the pervasive trade barriers that underlie the re- ter of improving investment climate, reducing the cost of gion’s economic divide and develops the case for an infrastruc- doing business, offering cheap credit, or introducing market ture of economic cooperation. The politics and geo-politics of friendly economic reforms (World Bank, 2005). It is also a trade are discussed in Section 5. Finally, Section 6 concludes. political problem, since a private sector that generates income streams independent of the patronage network of the regime can be viewed as a political threat. 2. THE ORIGINAL SIN The absence of a vibrant private sector is also a regional fail- ure. The Arab world remains fragmented in isolated geo- The state in Arab economies is the most important eco- graphic units with limited economic linkages between them. nomic actor, eclipsing all independent productive sectors. This fragmentation carries a heavy cost: for a private sector When it comes to essentials of life, such as food, energy, jobs, to survive and thrive, the size of the market matters. Frag- shelter, and other public services, it is often both the provider mented markets prevent firms from realizing the benefits of of first and last resort. The functioning of this system rests on producing for a bigger market and locating next to each other a heavy dose of subsidies, economic controls, and a variety of (UNIDO, 2009). These cost advantages, commonly termed as uncompetitive practices. While this centralized bureaucratic economies of scale and agglomeration, have fueled trade and system has worked well for ruling elites and the narrow clien- growth in emerging economies, but are simply absent in the teles that thrive with their support, it has failed to deliver pros- Arab world. Any blueprint for private sector reform must perity and social justice to ordinary citizens. The interests of therefore include as one of its central objectives the creation governing coalitions have proved more enduring than the of regional economic commons. While the need for this is clear force of ideology. Neither socialism of the 1960s and 1970s and urgent, this article argues that political incentives of Arab nor the neo-liberal economic reform of the 1990s has been able elites do not favor an opening of regional markets. The phys- to dismantle this system of centralized control, discretion, and ical and policy barriers that divide the region preserve the privilege. monopoly power of insiders. The question, therefore, is: Can The state-centered development paradigm rests on the unin- the Arab spring, fed by latent demographic pressures, break terrupted flow of external windfalls. In fact, many of the re- this political deadlock? In our opinion, strengthening regional gion’s pathologies—whether it is a weak private sector, economic linkages across the Arab world constitutes the single segmented labor markets, or limited regional trade—are ulti- most important collective action problem facing the region mately rooted in an economic structure that relies overwhelm- since the fall of Ottoman Empire. ingly on rents derived from fuel exports, foreign aid, or Before proceeding, an important clarification is in order. In remittances. Reliance on such unearned income streams is terms of its geographic focus, this article treats the Middle the “original sin” for Arab economies. The region is home East as one analytical object, side-stepping differences within to abundant natural resources, with oil and gas exports consti- the region. This is clearly an over-simplification. The Middle tuting more than 80% of total merchandise exports in many East offers a differentiated tapestry, where countries differ on Arab countries. Even where natural resources are less abun- multiple dimensions, such as size, resources, history, policy, dant, Syria being one example, fuel exports dominate the ex- ideological orientation, and the like. We do not downplay port structure. Up until 2005, around 67% of the total the significance of these, but simply contend that a big picture Syrian exports consisted of fuels. Similarly, in Yemen—a fairly view furnishes additional insights and is particularly relevant insignificant player in oil markets—fuel exports constitute to the main objective of this article, which is to: delineate 70% of total exports (World Bank, 2010). 298 WORLD DEVELOPMENT

Where oil is scarce, foreign aid takes over. Like oil, aid rev- dependent on food imports. 7 Arab governments are now enues can also stifle economic and political incentives, turning spending a vast proportion of their budgets on providing sub- economies away from production to patronage. Egypt and sidized food—a policy that is likely to be even more fiscally Jordan, by virtue of their strategic location, have historically unsustainable in the face of recent predictions of a long-term derived significant external rents through foreign aid. In Egypt spike in food prices. Saudi Arabia alone is spending over a bil- alone—hardly a typical case of resource curse—two-thirds of lion US dollars per month on food imports. In Egypt food foreign exchange revenues are derived from oil, aid, and reve- subsidies (directed mostly at wheat) consumed US$3 billion nues from the Suez Canal. 5 In describing the region’s political in 2010 (Ciezadlo, 2011). 8 The GCC imports 90% of its overall economy, the influence of aid is underemphasized. On a per food requirements. By 2020 total food imports in GCC will capita basis, the Middle East and North Africa received the rise by 105%. 9 Together with the latent demographic pres- highest overseas development assistance in 2008 ($73 com- sures, growing unemployment, and media penetration, this pared to $49 in sub-Saharan Africa) (World Bank, 2011a). provides for a combustible mix. North Africa has consistently been the largest recipient of The inherent volatility of oil markets, despite their present net aid per capita since 1960s (see Figure 1). These aid flows buoyancy, also poses a structural risk to Arab economies. are largely driven by geo-political considerations (Harrigan, Public finance remains vulnerable to the vicissitudes of oil 2011). For resource-poor countries, remittances constitute an- markets. Public expenditures are sticky even when oil prices other important income stream. In Jordan nearly 13% of GDP fall. In fact, when compared to countries with similar levels was derived from remittances in 2010. In Lebanon this ratio of development and resource riches, Middle Eastern oil was 20% (World Bank, 2011a). Resource windfalls from oil exporters are more vulnerable to external shocks (Tenreyro and aid have given rise to an adverse political economy and & Koren, 2010). These shocks are also propagated, through sustained a social pact that trades welfare distribution for re- remittances and investment flows, to lesser fortunate neigh- gime security. External rents have expanded the public sector, bors. In 2007 alone US$ 60 billion were remitted by expatri- bolstering its ability to provide employment and subsidized ates to other MENA and Asian countries. With limited public consumption. natural resources and growingly young populations, it is pre- Traditionally, the Arab state has preserved social order cisely these countries where the states’ ability to provide essen- through a combination of repression and redistribution. But tials is especially strained. that strategy might have run its course. The forces unleashed Recent events in the region provide an apt reminder that the by demography and technology, together with corruption prevailing development model has reached its expiry date and inequality of access, have raised the cost of both repres- (Yousef, 2004). 10 This model built on oil and aid fortunes— sion and redistribution. With the proliferation of electronic and a leviathan state—is fast becoming a liability. While polit- and new social media, traditional modes of repression have be- ically expedient, this development model is fast becoming come less effective. For decades the Arab state, regardless of unsustainable. Apart from questions about its fiscal sustain- whether it is a monarchy or republic, has ruled through the ability, this development model has also bred a colossal failure fear of its security services. It has perfected the art of demol- of expectations. In resource-rich countries labor market en- ishing any commons imaginable—whether civic, political, or trants have an ingrained preference for well-paid public sector economic. Social media has generated new spaces for collec- jobs, where remuneration is de-linked from skills or productiv- tive action, however. These are the virtual commons that ity. This results in high levels of voluntary unemployment but adroitly evade the long arm of the state. leaves the private sector with a shortage of skills. These labor At the same time, the cost of redistribution has also risen market contradictions mean that, often, young people are not significantly. Youth explosion has stretched existing welfare only unemployed, they are also unemployable. This is clearly a systems beyond capacity. 6 Increasing food prices have esca- failing both of the education system and the economic struc- lated the cost of this social bargain. The MENA region is ture. one of the most food deficit regions in the world and, in the Labor markets remain segmented at multiple levels—be- face of falling agricultural production, it is massively tween the public and private sector, formal and informal

Figure 1. Net aid per capita by region, 1960–2009. Source: World Development Indicators (2011), based on OECD DAC database. THE ECONOMICS OF THE ARAB SPRING 299 sector and between nationals and non-nationals. 11 In re- notable for its limited export presence and low productivity. source-rich countries of the Gulf, there is often a perverse divi- This is a profound weakness for a region that is urgently re- sion of labor between the public and private sectors. The quired to generate jobs for its young. The challenges of public sector generates well-paid jobs for nationals, while the demography and diversification are closely intertwined, as nei- private sector runs a competitive job market relying mainly ther the oil sector nor the state can absorb a growing pool of on migrant workers. In the GCC states close to 70% of the la- unemployed youth. Most countries that succeeded in reducing bor force consists of foreign migrant workers (Kapiszewski, poverty and unemployment emphasized labor-intensive manu- 2006). Such labor market contradictions are not just restricted facturing as an essential component of their development to small resource-rich states. In Jordan 20% of the total work- strategy. That is where the failure of the Arab world is most force consists of foreign workers (Rad, 2011). The wage struc- visible. The MENA region holds less than 1% of world market ture offered by the public sector directly militates against the share in non-fuel exports, compared to 10% in East Asia and development of labor-intensive manufacturing. Importantly, 4% in Latin America. such segmentation allows neither citizens nor the state to de- Although government documents frequently cite diversifica- velop real stakes in private sector development. tion as a core development objective, diversification has re- When faced with public unrest Arab governments have typ- mained merely a paper aspiration (apart from partial success ically reinforced this fragile social contract by increasing sub- stories in Oman and Bahrain). Development finance institu- sidies on food and fuel. 12 Oil rich countries placate their tions have, on their part, advanced globalization as a panacea, populace by significantly scaling up government salaries insisting on trade liberalization and deregulation of the domes- (Bresinger, Ecker, & Al-Riffai, 2011). The Arab world needs tic economy. Despite these reforms, Arab economies still re- to imagine a new development paradigm based on a competi- main insignificant players in export markets, with limited tive private sector. It is true that the private sector has recently success in entering new markets or introducing new products. witnessed an impressive growth, especially in the Gulf, there is a This failure is partly rooted in the region’s inability to benefit question as to how genuinely private is this private sector. The from the forces of gravity—forces that create natural advanta- boundaries between the public and the private are notoriously ges of trading with neighbors. Behind a weak private sector lies blurred, with the result that the private sector sometimes oper- a key puzzle: the Arab world’s economic fragmentation despite ates as a disguised public sector—or simply as an extension of its favorable coastal access and high levels of urbanization. the state. 13 Public investment remains the central driver of pri- vate economic activity, especially in times of high oil prices. Although, state-business relationship varies tremendously 3. THE PUZZLE: A FRAGMENTED REGION across the region it is usually a personalized rather than an institutionalized relationship. Businessmen and rulers are con- In the Middle East borders matter—not just politically, but nected through overlapping networks, which usually makes also in economic terms. As the world becomes a more global- their engagement “informal, exclusive, and short-term” ized place, bringing together companies, capital, and people, (Luciani & Hertog, 2010). These “networks of privilege” are the Arab world remains one of the most fragmented regions sometimes manifested through a shadow economy controlled of the world in terms of production, trade, and economic link- by the military. In Algeria, Egypt, and Syria the military has ages. With a population of 350 million people sharing a com- vital economic stakes. This is one reason why internal markets mon language, culture, and a rich trading civilization, the remain so fiercely protected. The overlap between economic Arab world does not function as one economic market. Trade and political power is evident even in Morocco and Tunisia, linkages between Arab countries are surprisingly weak. Regio- countries with a long tradition of state-business relationship. nal markets are cut off from each other and from the rest of In Morocco, when liberalization generated new contests be- the world, playing the role of a bystander rather than an active tween old protectionist elites (e.g., textile manufacturers) and participant in processes of globalization. new players (garment exporters), the system favored old play- Few Arab countries consider their neighbors as their natural ers with established ties to the Makhzan, the executive appara- trading partners. Pan-Arab trade is noticeably insignificant. tus of the state (Heydemann, 2004). 14 Despite having tripled during 2000 and 2005, the share of Historically, the Syrian state had a more antagonistic rela- tionship with business. As a result, mainly businesses affiliated with the state were accommodated even as the traditional bourgeoisie was marginalized (Haddad, 2011). Even in Gulf economies, where business is admittedly more dynamic, boards of listed companies are dominated by a few influential families. The local capitalist class (Khaleeji)is“deeply intertwined” with the very process of state and class formation in the Gulf (Hanieh, 2011). Oil revenues have strengthened a structure of accumulation that privileges merchants in the royal circle. With some exceptions, major business fortunes in the region are thus accumulated through patronage. There are familiar echoes of this in the Arab spring—be it the Trab- elsi family of Tunisia, Ahmed Ezz of Egypt, or Rami Makh- louf of Syria. Such crony capitalism denies a level playing field to potential aspirants and restricts economic mobility. Exploiting new economic opportunities in this environment becomes a game of insiders. That is a running theme in the Arab world. This makes for a poor business environment and adversely affects firm performance. The private sector in MENA is Figure 2. Limited mutual exports. Source: World Bank (2010). 300 WORLD DEVELOPMENT intra-Arab trade in total merchandise trade still hovers around greater complementarity when it comes to non-fuel trade, ser- 10%. Figure 2 plots the share of intra-Arab exports as a share vices, and investment. When non-oil exports are taken into ac- of total exports. It shows that the region has made very limited count, roughly one-quarter of exports are destined for the progress in enhancing regional trade. The share of intra-Arab Arab world (Lo´pez-Ca´lix, Walkenhorst, & Diop, 2010). exports, despite having fluctuated widely, is only marginally Moreover, trade patterns are not uniform, as some countries higher than that in 1960. At the same time, exports from South trade more with their neighbors than others. As Figure 3 Asia to the Arab world have increased from 6% to 18%, with demonstrates, Jordan, Lebanon, Syria, Bahrain, and UAE Turkey expanding its share from 8% to 21% (World Bank, have deeper trade engagements within the region. Even if lim- 2010). Whatever limited trade exists between Arab neighbors ited trade complementary is an irritant it is not an insurmount- is geographically clustered, with countries in the Gulf and able barrier. At least, it has not prevented other emerging North Africa trading predominantly within their own sub-re- economies from forging mutually advantageous trading rela- gions. Nearly 58% of the intra-Arab exports of GCC are with tions. other GCC countries. Trade integration remains particularly limited between North Africa and the remaining Arab world. (a) The costs of fragmentation There have been repeated attempts to forge greater eco- nomic cooperation between Arab neighbors through numer- Fragmentation imposes a wide range of costs, which are not ous regional initiatives, such as the Arab Common Market, simply restricted to the absence of scale economies. Thick bor- the United Arab Republic, Federation of Arab Republics, ders preserve the sanctity of rent streams for insiders and pre- Arab Cooperation Council, Arab Maghreb Union, the Great- vent the emergence of competitive markets, entrenching the er Arab Free Trade Agreement, the Agadir Agreement (Egypt, monopoly power of insiders. This increases the returns to pre- Jordan, Morocco and Tunisia), and the Gulf Cooperation dation relative to the returns to production, and reinforces Council. These have turned out to be a litany of failures. Evi- existing inequalities. Fragmentation also adversely influences dence suggests that the sub-regional trade arrangements have the investment climate by increasing the relative price of cap- especially failed to expand regional trade (Nugent & Yousef, ital goods, which serves as a critical input for the productivity 2005). Attempts at economic integration have been frustrated of investment (Caselli & Feyrer, 2007). This higher price of by internal rivalries, dependence on external powers, and the investment goods (relative to the price of GDP) stems in part absence of a strong domestic constituency for integration. from the greater import content of investment goods and the Many analysts have written off the prospect for regional smaller market available to suppliers of these goods. This re- trade, simply because the basic economics to support mutual sults in a risky business environment. While contemplating trade is missing. A frequent lament is that Arab countries pro- new investments, firms face the classic threat of “hold-up”: duce similar goods, specializing mostly in hydrocarbons, and in the absence of a large market for second hand capital lack the complementary production structures that serve as goods, firms run the risk of being stuck with bad investments the basis for trade. But evidence suggests that there is actually (Collier & Venables, 2010).

Figure 3. Intra-Arab exports, by countries. Source: Shui and Walkenhorst (2010). THE ECONOMICS OF THE ARAB SPRING 301

Another adverse consequence of fragmentation is that regio- An associated puzzle is that growing urbanization in the re- nal public goods are undersupplied, a theme we broach in Sec- gion is not translating into material benefits for Arab firms. tion 4. Another cost of fragmentation, largely ignored in the Cities generate economic prosperity for its people and firms. MENA literature, is the wasteful duplication of defense expen- Empirical evidence suggests that firms can save on their costs ditures. The division of Arab world into separate geographic by locating in mega cities and urban clusters. A firm that oper- units scales up the cost of securing borders. Even smaller Arab ates in a city of 10 million people, for instance, can reduce its nations are allocating vast sums of money to defense. As Fig- cost by 40% compared to a firm operating in a city of 100,000 ure 4 shows, during the last decade average defense spending people (United Nations, 2009). This is because cities offer a in the MENA region has surpassed that of other world re- range of mutually supportive activities. Bringing together gions. The region spent twice as much on defense as South machinery, skills, suppliers, and resources in a single location Asia; the Gulf oil exporters, especially Oman, Saudi Arabia, can be tremendously advantageous for firms. Such agglomer- and UAE, are globally one of the highest spenders on defense ation economies are absent in the Middle East, even if it is (as a percentage of GDP) (see Figure 5). This pattern is not more urbanized today than other developing regions: 58% of just restricted to rich Gulf States; a typical MENA country the region’s population lives in urban areas, compared to spends more on defense than an average country globally 30–37% in sub-Saharan Africa and South Asia (World Bank, (2.43%). In comparative terms, defense spending is high even 2010). In countries such as Egypt three quarters of the popu- in resource-scarce countries (e.g., Morocco, Jordan, Syria, lation lives in urban areas. 16 and Lebanon), and even after accounting for the large outlay Levels of urbanization are even higher when more sophisti- on internal security. 15 The Middle East also serves as one of cated measures of urban concentration are considered. The re- the largest markets for global arms purchases. cently constructed agglomeration index, which combines three dimensions of urban concentration—population density, the (b) Defying the forces of gravity population of a large urban center, and travel time to that large urban center—places the Middle East ahead of all other This economic fragmentation is puzzling given the region’s developing regions, including Latin America that has typically favorable geography. The Arab world is well-positioned to been described as the most heavily urbanized (Uchida & Nel- be a global trade and production hub. Geographically, it lies son, 2008). 17 As Figure 6 shows, with the notable exception of at the cross-roads of major sea and trading routes with easy Yemen, most MENA countries have high urban concentra- access to Europe, Africa, and the near East. Egypt alone has tion. Arab firms are failing to reap the cost advantages that a strategic location that any other emerging economy will be growing urbanization confers on them. In fact, the region’s happy to trade places. Strictly speaking, there is not even a sin- geographic advantage has consistently failed to translate into gle landlocked country in the Arab world, even if Iraq and Jor- a trading advantage (Nugent & Yousef, 2005). Observed levels dan have narrow coastal strips. Some, like Algeria, are blessed of intra-Arab trade are at least 10–15% lower than predictions with a thousand kilometers of coastline and an enviable prox- of the gravity model, which stipulates that size and distance imity to European markets. Yet, this favorable geography fails are important determinants of bilateral trade flows (Al-Atrash to translate into the economics of trade and agglomeration. It & Yousef, 2000). 18 is ironical that a region that connects Asian merchants with In the face of these puzzles, Africa provides a striking con- European markets is itself stuck in primary production. Every- trast. Like the Middle East, it is both rich in natural resources where in the world proximity to coasts is associated with low and a severely fragmented region. But Africa is divided by eth- transport costs and better access to global markets. The Arab nicity and geography. Its ethnic fractionalization and adverse world defies these forces of gravity, however. It has coastal geography, through landlocked regions and sparsely distrib- proximity without market access, in part because both borders uted populations, limits the possibilities for trade. About and sea are difficult to navigate in the region. As subsequent 40% of Africa’s population lives in landlocked countries. Its discussion will show, this difficulty of navigation is not im- resource riches have fueled internecine civil wars. Ethnic divi- posed by nature but induced by policy barriers and limited de- sions, rooted in the history of slave trade, have weakened trust mand. among communities, leading to the under-provision of public

Figure 4. Defense spending, % of GDP (average 2000–09). Source: SIPRI Database and World Bank (2010). 302 WORLD DEVELOPMENT

Figure 5. Variation in defense spending, mena countries, % of GDP. Source: SIPRI Database, World Development Indicators 2010.

Figure 6. Agglomeration index for mena countries, %. Source: Uchida and Nelson (2008). goods (Nunn, 2008). Even if the Arab world is not as structur- effectively in the hands of foreign merchants and local minor- ally disadvantaged as parts of Africa, it lies at the periphery of ities. This was politically expedient: foreign merchants bene- global trade. fited from the economic privileges granted by rulers, but What has then gone wrong in the Middle East? If sub-Sah- seldom challenged their authority. The break-up of the Otto- aran Africa is divided by ethnicity and geography, the Middle man Empire into a multitude of independent states created East is divided by history and policy. The Arab world has new political boundaries, but, over time, these became perma- inherited an unfavorable and divisive legacy. The roots of a nent economic boundaries. 20 The new borders, which were weak private sector run deep in history. Merchants were polit- largely an imperial creation, severed historic trade connec- ically weak under the Ottomans, whose centralized bureau- tions. For example, trade routes linking Aleppo to Mosul cratic rule worked hard to prevent the emergence of and Istanbul became largely dysfunctional; the trade corridor autonomous social groups. 19 A robust private sector was stretching from Damascus to Jerusalem and Nablus was met more feared than favored. When business thrived, it remained with a similar fate. THE ECONOMICS OF THE ARAB SPRING 303

To make matters worse, national independence was usually have fallen in the wake of economic reform, many states, such accompanied with an exodus of European merchants, leaving as Algeria, Libya, and Iran, remain heavily protected. Levels of behind a vacuum that never got properly filled (Henry & trade protection are comparatively high even in countries with Springborg, 2010). When independent Arab states emerged sizeable export presence (Tunisia, Morocco, and Egypt). from the ashes of the Second World War, many of them Importantly, neo-liberal reforms have failed to dismantle the lacked a solid constituency for private sector development. 21 more cumbersome non-tariff barriers that are usually discre- Even a weak indigenous bourgeoisie enjoyed little continuity tionary, non-transparent, and have a more damaging effect after independence. Nationalist governments were often hos- on trade. Non-tariff barriers are more pervasive in the Middle tile to business. Syrian businesses were punished through bor- East. The region lies at the bottom of the pack on the World der closures with Jordan, Saudi Arabia, and Iraq (Ayubi, Bank’s overall trade restrictiveness index, scoring worse than 2001). A wave of mass nationalizations swept through the re- even sub-Saharan Africa (see Figure 7). 23 gion. Although inspired by a socialist rhetoric, they effectively The bureaucratic hand has long stifled entrepreneurship, strengthened the hands of ruling elites who were all too eager, and has kept Arab markets localized, segmented, and cut off like the Ottoman Empire, to preserve their autonomy from from each other. By distorting competition these barriers act society. Morocco was a rare exception, where the Monarchy as road blockers, privileging insiders by assigning them control sided with merchants to stave off the threat of nationalization. over access points to the economy. These administrative con- In Lebanon, where a critical mass of merchants did exist at the trols reflect the absence of an institutionalized framework for time of independence, sectarian divisions and the ensuing civil decision-making. Rules, even when they exist, are subjectively war emaciated private enterprise. and inconsistently applied (World Bank, 1999). Evidence from The nationalist moment in the Arab world largely strength- business surveys indicates a weak enforcement environment ened the state at the expense of the bourgeoisie, crowding out and a disjunction between the de jure and de facto. Nearly an important constituency for pro-business policies and regio- 60% of business managers expressed the view that rules and nal economic integration. A key failure of Arab nationalism regulations, as they appear “on paper,” are not applied consis- was that it had weak economic underpinnings. The discovery tently and predictably. In Egypt, Lebanon, and Syria firms of oil and the birth of political conflict in Palestine generated experienced considerable variation in the time required to ob- new economic rents that froze these patterns and reinforced tain an operating license (IMF, 2011). Such inconsistencies economic divisions. 22 As the state’s fiscal reliance on oil and originate from centralized structures with limited administra- aid revenues increased it became less dependent on merchants. tive coordination. Bureaucracy is often reduced to clienteles In Gulf monarchies oil revenues shifted the balance of power that are vertically integrated but segmented from each other from merchants to rulers, making the private sector more (Hertog, 2010). dependent on state patronage (Crystal, 1990). By closing off markets to ordinary investors, these trade fric- As centralized authoritarian rule took root, policy distor- tions distort the level playing field and restrict the entry of new tions came to play a more divisive role in the Arab world, erod- firms. The number of registered businesses per 1,000 people in ing its natural geographic advantage. While Africa is trapped the Middle East is less than a third of that in Eastern Europe in adverse geography, the Middle East has erected man-made and Central Asia. Markets in the MENA region are domi- barriers through one of the most elaborate and enduring license nated by older, more well-established firms. The average firm raj. The Arab state has a shadowy presence that dominates all in MENA is almost ten years older than that in East Asia or spheres of economic activity, making it one of the most protec- Eastern Europe (World Bank, 1999). The sort of entry and exit tive trade regimes in the world. Although average tariff barriers of firms that raises economic efficiency is largely absent.

Figure 7. Non-tariff barriers in the Middle East. Source: Shui and Walkenhorst (2010). 304 WORLD DEVELOPMENT

Difficult access to credit acts as another entry barrier for youn- shipped (Zarrouk, 2003). Companies can incur around 95 per- ger, less connected firms. Bank loans to SMEs in the MENA son-days a year while dealing with such trade transactions region do not exceed 8% of total lending operations (Rocha, (Zarrouk, 2003). Delays in terminal handling and absence of Farazi, Khouri, & Pearce, 2010). Bank lending is primarily di- cool storage facilities at ports limit the potential for agricul- rected at larger and more connected borrowers. One evidence tural exports. Despite a favorable coastal access, the region for such “connected lending” is that “the ratio of exposure to is only a transit point for major shipping routes. Due to lim- top 20 loans to bank equity is nearly four times higher” in the ited business, shipping companies are compelled to offer costly MENA region than in North America (IMF, 2011). and infrequent services with long and indirect sailing times. Survey evidence suggests that a typical manufacturing firm The voyage from Jordan to New York takes up to 42 days, in Algeria, Morocco, Syria, Egypt, Yemen, and Jordan fi- and sailing times to Hamburg and Tokyo are 30 and 45 days, nances at least 75% of its investment requirements from inter- respectively (Devlin & Yee, 2005). The cost of trade logistics nally generated funds. Few firms have an established line of can be especially high for exporters. The associated costs can credit from a banking institution; in Yemen only 8% firms be as high as 55% of the product price of Yemeni Tuna, had a bank loan. Collateral requirements are cumbersome, 45% for Jordanian okra, 26% for Jordanian potatoes, and with at least 80% loans based on some form of collateral. 24 15% for Egyptian garments (Devlin & Yee, 2005). This leaves Even in an otherwise resource-rich country like Algeria that exporters significantly disadvantaged, especially in markets sits atop US$180 billion of cash reserves 50% firms viewed ac- where producers compete on narrow profit margins. cess to credit as a major constraint. These credit constraints Weak trade logistics also prevent the integration of product are especially biting in a business environment with discourag- and factor markets, undermining the region’s long-term ingly high start-up costs. In Syria and Yemen, for example, growth prospect. Importantly, they prevent the region from “capital required for starting a business is more than 2000% taking advantage of trade in intermediate goods, which has of income per capita” (the comparable global ratio is 115%). grown at a faster pace than other forms of trade and offers a With such high initial thresholds for investment and limited feasible route to export diversification. The importance of access to credit, Arab firms are ill-prepared for the world of trade logistics has heightened in a world where production is manufactured exports. The next section unpacks one aspect becoming footloose, allowing firms to specialize in different of this distorted trade regime: trade logistics. stages of the value chain. Firms are finding it less profitable to run an integrated production process, where all tasks are performed in the confines of a factory. This unbundling of 4. TRAPPED IN TRADE LOGISTICS the production process and the resulting growth of trade in intermediate goods is the new facet of globalization. It has ex- Observers of the Middle East have long bemoaned its polit- panded mutual trade in Asia, with the result that regional ical repression. Few have appreciated the scale and intensity of trade in Asia Pacific is growing faster than its trade with the its economic repression. The region’s fragmentation is partly rest of the world. rooted in arbitrary restrictions and complicated trade logistics This dramatic shift in trade from products to tasks has that make economic exchange both unpredictable and unprof- opened new possibilities for industrialization. For late en- itable. These behind the border barriers can take several trants, specialization in individual components of the produc- forms: cumbersome procedures, regulations, and administra- tion process is less daunting than specializing in the entire tive controls that create costly frictions in transport, commu- product (UNIDO, 2009). But the ability of the Arab world nication, and services. The movement of goods, capital, and to take advantage of these trade possibilities is constrained people is governed by various restrictions that often defy by weak trade logistics. The arbitrary barriers that divide Arab any economic logic. 25 Firms that wish to move goods across economies prevent the emergence of a regional network of borders incur a range of transaction costs associated with suppliers. This hampers investment from multinationals who internal transportation, customs, port handling, warehousing, are increasingly interested in sourcing cheap inputs and shipments, and distribution of goods. Arab countries under- quickly moving them across borders. As a result, its excellent perform on various dimensions of trade facilitation, although location notwithstanding, the region is a net loser on the glo- performance is variable with some in the region—notably, Jor- bal supply chain. 27 This is a significant loss for a region that dan, Tunisia, and the Gulf countries, faring better than others desperately needs to broaden its production base and expand (Hoekman & Nicita, 2008). 26 But, even the Gulf countries fare jobs. Ironically, these trade frictions are more pervasive and worse than countries with comparable income levels (World stringent in labor-abundant countries of the Middle East, pre- Bank, 2011c). cisely where a robust private sector is most needed. These re- Regional connections are a particular weakness, even if source-rich, labor abundant economies have also made the some countries possess world class infrastructure. There is lim- slowest progress on economic reform, and lie at the bottom ited coordination among Arab countries on border proce- third of economies worldwide in terms of success in economic dures; compliance with these alone can be an excruciating reform (World Bank, 2008). experience for firms. Internal transportation is particularly The Middle East is truly caught in a vicious cycle. It has costly due to a fragmented trucking industry that is controlled fragmented markets that increase business uncertainty, deter mainly by cartels and subject to a plethora of procedures. investment, and deprive private firms from realizing econo- Truck drivers have to meet complicated requirements for per- mies of scale. Given that scale economies are more crucial mits, visas, and restrictions even to drive foreign trucks over for exports of manufactures, economic divisions prevent firms weekends. Foreign trucks are sometimes required to return from branching out into high value added activities in the ex- to the country of origin without cargo. Even the movement port sector. A weak private sector, in turn, lacks the political of labor—otherwise an area of success—is also governed by strength to meaningfully influence public policies. And, with a discretionary and heavily regulated regime. production structures that look more similar than different, All of this translates into a high cost of production that re- possibilities for regional trade remain limited. Taken together, duces competitiveness of firms. By one estimate, the cost of this reinforces the region’s dependence on primary commodi- such trade logistics exceeds 10% of the total value of goods ties and a growing reliance on the state for job creation. THE ECONOMICS OF THE ARAB SPRING 305

This development trap can be broken by fostering trade syn- and rail networks. Without better regional access, Arab firms ergies across countries. An infrastructure that connects regio- have little hope of competing in global markets. Many firms nal markets is a public good that is likely to benefit everyone, depend on transit facilities in neighboring countries for access- but the costs of putting it in place are exorbitantly high for any ing global markets. This generates important externalities. For single country to bear. Fragmentation leads to coordination example: if trade logistics improve in Jordan they will benefit failures and the under-provision of regional public goods. not only Jordanian exporters but also firms in the Arab hinter- Even if, individually, some Arab countries have world class land. If there is a rail link connecting Basra in Iraq to Latakya infrastructure, access to the region can sometimes be indirect, in Syria, potential Iraqi exporters can enjoy better access to requiring travelers to make a journey first to Paris or London European markets, saving them considerable sailing distance. before reaching another Arab capital. 28 Even for Arabs visa Governments have been slow to respond to this challenge. requirements for traveling within the region are sometimes This is ironical given that resource-rich governments rarely as cumbersome as the journey itself. A Jordanian firm can find dither from spending on infrastructure. Even if the recent oil importing goods from neighboring Lebanon to be costlier boom has afforded massive investments on infrastructure, they than importing from Britain. There is no direct transport link are mostly inward looking, centered around prestige projects between Qatar and Bahrain. A causeway linking the two coun- that are usually based on political rather than economic rates tries was announced in 2008 but has been delayed by regional of return. There is also an obsession with roads and highways, politics. Border disputes between Morocco and Algeria—a neglecting critical investments in rail infrastructure and other legacy of French imperial rule—have led to prolonged and trade logistics. Rail transport is a particularly weak aspect of costly border closures. trade logistics, as the MENA region has been consistently A deficient infrastructure provides one reason behind the re- ranked below other regions on this dimension (World Bank, gion’s botched attempts at regional integration. 29 It is a fail- 2011b). 30 Rail connectivity presents an important instance ure, in other words, of putting the nuts and bolts of of coordination failure. Specification differences in rail infra- cooperation in place. Neither trade complementarity across structure across Arab countries means that developing regio- Arab countries nor global integration can be effectively pur- nal rail connections entails a high fixed cost, and requires sued without connecting the region through ports, roads, cooperation from all countries (Sabouni, 1997).

Figure 8. Map of the Hejaz Railway. Source: http://en.wikipedia.org/. 306 WORLD DEVELOPMENT

As a result of this neglect, old trade routes and railway sys- small percentage of rural populations in Yemen, Morocco, tems have fallen into disuse. Hejaz Railway, the famous Otto- and Tunisia have access to transport. In fact, rural access to man project that connected Damascus to Medina, provides a transport in Yemen is lower than sub-Saharan Africa (34%). pertinent example. Originally scheduled to terminate in Mec- This keeps rural markets fragmented, which reinforces poverty ca, the project has been in-operational since the First World and inequality. War, despite repeated attempts to revive it (see Figure 8). To- Removing frictions in the movement of goods and people, day, railway coverage in the region is both limited and uneven, both within and across countries, is essential for fostering reflecting the strategic needs of a bygone era rather than its trade complementarities. Existing commitment to improving contemporary economic requirements. 31 physical infrastructure are dominated by grandiose projects. An integrated infrastructure can deliver other un-intended There is too much emphasis on modernizing infrastructure, benefits. It can help arrest food inflation that fires public pro- too little on harmonizing border procedures, and coordinating tests and consumes a growing share of public subsidies. Some trucking standards. The latter might play a more critical role Arab countries depend heavily on food imports from neigh- in reducing internal transport costs and developing a regional boring regions. Transport costs can make up as much as trade corridor. In the modern history of the Middle East the 40% of overall food prices in the region. A better infrastruc- year 2011 will be remembered as a critical juncture that cre- ture can connect agricultural markets and mitigate fluctua- ated a new opening for change. In confronting these infra- tions in food prices. There is considerable regional variation structural challenges, we are struck by a great historic in rural access to transport. In several MENA considerable symbolism. In 1917 the British military officer, T.E. Lawrence, proportions of rural populace have limited transport mobility. led Arab tribes to destroy the tracks of Hejaz Railway that Figure 9 plots the Rural Access Index for selected countries; connected Arabia to Ottoman cities. Then, it was a strategic the Index uses household survey data to estimate the number military imperative to cut off the enemy supply routes. About of people who live within 2 km (or about 25 min walking time) a century later, it is now a strategic economic imperative to re- of the nearest all-weather road. As Figure 9 shows, a relatively vive these communication links.

Figure 9. Rural access index, %. Source: Roberts, Shyam, and Rastogi (2006).

Figure 10. Size of the informal economy, % of GDP. Selected MENA countries. Source: IMF (2011). THE ECONOMICS OF THE ARAB SPRING 307

5. CAN DEMOGRAPHY CHANGE THE POLITICAL through manufacturing and trade, it is likely to generate mid- CALCULUS? dle class incomes that can ultimately pose a challenge to cen- tralized authoritarian rule. Regional trade is thus feared It is clear from the preceding discussion that these relatively because it can displace the incumbent advantage of insiders invisible trade barriers are divisive and impose a heavy cost on who have long monopolized economic opportunity. Therein Arab economies. Dismantling them can entail significant ben- lay the difficulty of change: even as regional cooperation is efits. Evidence suggests that the welfare gains from eliminating welfare enhancing there are few stakeholders for it; by con- non-tariff barriers is at least triple the benefits from conven- trast, the status-quo is fiercely defended by a small, cohesive tional trade reforms that exclude trade facilitation (Dennis, and well-organized elite. In this sense, man-made barriers 2006). Why have these economic divisions endured for so long, can be as difficult to dismantle as geographic barriers to trade. then, and why have reforms been so painfully slow? One expla- The primacy of politics is underscored by contrasting the nation lies in the nature of political incentives. The region’s limited progress on trade reforms with that of flourishing re- extensive trade restrictions are not simply procedural barriers, gional linkages in finance. While trade opening has been re- but also political barriers. The interplay between economics sisted, Arab countries are more financially connected today and politics is central to understanding why trade frictions through growing cross-border investment flows. In resource- have been both pervasive and persistent. scarce, labor-abundant countries of the region, inward FDI The region’s arbitrary trade regime serves a vital political from Gulf countries exceeds 70% of GDP. In Jordan this ratio function: by allocating monopoly rights to insiders and by exceeded 118% of GDP in 2006 (Shui & Walkenhorst, 2010). 34 channeling rents to favored groups, it cements the power of These inward investments were primarily driven by a growing rulers. These institutional rigidities push workers and firms services sector, principally telecommunications, tourism, med- into the domain of the informal sector, which remains sizeable ical, and financial services. Apart from the greater complemen- in several Arab states. Some of the region’s relatively resource- tarity in services sector, these growing financial linkages also scarce countries have a sizeable black economy, which ranges stem from the fact that the politics of financial integration is from 26% of GDP in Jordan to 44% in Morocco (see Fig- usually less complicated than the politics of trade. 35 Regional ure 10)(IMF, 2011). Even fuel endowed economies like Alge- financial opening has been politically more palatable, since the ria (not shown in the graph) have a thriving parallel market. In liberalization of banking and telecommunications—that has many countries, links between the black economy and state been the mainstay of economic reforms—has not competed institutions, such as the military and security forces, can be with existing rents, but simply generated new revenue streams murky. Decades of centralized control has restricted economic for insiders through lucrative contracts and licenses. advantage to those well-entrenched in the system, closing off One reason why this political economy of protectionism has markets to ordinary investors who are willing to compete on endured for so long is that the constituency that could have equal terms but are denied a level playing field. All across championed for greater economic access has been absent. the Arab world a thin layer of the population dominates the Business associations are weak, stratified, and politically economy, controlling everything from banks, businesses to embedded, serving primarily as a means to secure narrow telecom. This has erected a pyramid of privilege, built around interests than to win concessions for the wider business com- a small number of large firms at the top and a large number of munity. They have rarely acted as effective modes of articulat- small and informal firms at the bottom. The result is greater ing the concerns of smaller and under-privileged firms. The economic polarization and limited economic mobility. manufacturing sector, as a whole, has limited lobbying power It is partly for this politics of policy that shaking off the and the key beneficiaries of reform—unemployed youth and bureaucratic stranglehold has proven so difficult, despite an young firms—are not collectively organized to push for mean- era of neo-liberal economic reform. Economic reforms have ingful reforms. In other parts of the world, trade integration is been “uneven, hesitant, and incomplete” (Yousef, 2004). often a matter of necessity—a strategy for economic survival, Although economic reforms have not been a uniform failure, not just growth. In the Arab world rents from oil and aid have they have failed to dismantle the state’s heavy-handed regula- engendered a sense of autonomy from integration. tion. 32 Reforms have not been accompanied with a qualitative If the domestic constituency for reforms is lacking, so is shift in decision-making: policy is still guided by discretion external agency. Economies of the Middle East are essentially rather than rules. As a result, the investment response to re- organized in a honeycomb structure, where individual cells are forms has been weaker: a mere 2% points of GDP, compared insulated from each other but connected to the outside world. with 5–10% points of GDP in Asia, Eastern Europe and Latin Even when globalization was unavoidable, Arab economies America. Neo-liberal reforms have neither leveled the playing have integrated vertically with global structures of trade and field nor dramatically tilted the balance of economic power in finance, while keeping horizontal linkages between regional favor of those systematically excluded from the system. As a economies weak and underdeveloped (see Figure 11). The result, rather than creating a “legitimate constituency” for US, EU, and other emerging economies have preferred to the private sector, reforms have simply strengthened busi- forge bilateral trade pacts with individual MENA countries. nesses that are “embedded with those in power”. Viewed in Washington has actively pursued bilateral trade agreements this light, policy reforms have simply been a vehicle for a with Jordan, Lebanon and Morocco, and individual GCC “re-configuration of political power”—a means for “shoring States. 36 Similar trade initiatives exist between the EU and up regime power rather than dispersing it among social North African countries. Bilateral trade pacts are often nego- groups.” 33 The failure of reforms is thus ultimately rooted tiated in a top-down fashion without effective input from local in the failure to remove the real constraints to growth, which industries or business associations. All of this has happened are mainly institutional in nature. while horizontal linkages between Arab economies have re- The Arab world is faced with not just a vicious development mained minimal. cycle. It is also trapped in an adverse political equilibrium, sus- Attempts at global and regional trade integration need not tained by ruling elites who view a private sector operating out- be mutually exclusive, especially if regional trade does not dis- side their sphere of influence as a possible threat. This is easy criminate against trade with countries outside the region. Both to understand. When the private sector competes for profits can be simultaneously pursued to the region’s benefit. Evi- 308 WORLD DEVELOPMENT

Figure 11. Growth of regional trade agreements. Source: Shui and Walkenhorst (2010). dence suggests that trade with the EU brings welfare gains liberalization. In fact, the opposite might be argued: if market (Denis, 2006), 37 while, at the same time, there is also consid- opening is a concession then it may be easier to accord it selec- erable untapped potential for regional trade between MENA tively and gradually at the regional level. Although preferen- countries. 38 However, the region’s vertical trade engagement tial agreements with advanced partners can “lock-in” trade with the US and EU should not neutralize attempts at regional reforms and necessitate further trade liberalization, evidence integration (Lawson, 2011). 39 Preferring to insist on bilateral from the MENA region is mixed. While average tariff rates relations, foreign powers have sometimes viewed regional have fallen, international trade agreements have not resulted pacts with indifference or, at worst, with suspicion (Hudson, in a significant reduction of non-tariff barriers in MENA 1998). In fact, regional integration in MENA is curiously countries. These “behind-the-border” barriers remain sticky omitted from the emerging foreign policy discourse of major and continue to preserve the region’s reputation as one of powers. This is a notable omission and contrasts sharply with the most protectionists in the world. In fact, some countries recent American efforts to mainstream regional trade in South have witnessed deterioration in their global ranking on trade Asia through a revival of the old Silk Road in the Af–Pak re- restrictiveness (Jordan’s ranking in non-tariff barriers actually gion. While connecting regional markets is fast becoming a deteriorated from 52 in 2008 to 80 in 2010). There is a sense in cornerstone of US foreign policy in South Asia, a similar which trade policy reforms in the MENA region are often a development vision for the Middle East is noticeably absent result of conscious policy decisions rather than the effect of from the policy horizon. externalities and spill-overs from international agreements. Regional integration has not been forcefully pushed by Policymakers have preferred to dismantle trade barriers more international financial institutions. While research conducted selectively and in a piecemeal fashion. under the auspices of the IMF and the World Bank has doc- One can argue that regional trade agreements may be polit- umented inadequate patterns of regional trade and identified ically easy but confer relatively modest benefits, whereas underlying barriers, it has stopped short of turning regional agreements with advanced countries are politically difficult trade into a major plank of its policy advice. This reluctance but confer sizeable benefits. However, evidence on the com- is illustrated by extracts from two reports published, respec- parative benefits of different preferential agreements remains tively, by the Fund and the Bank. Both advocate a question- largely unsettled, in part because the impact of these agree- able precedence of global integration over regional trade: ments is not always well-estimated. While bilateral trade “Rather than set as their first economic policy priority the goal of re- agreements between individual Arab countries and the US gional integration, MENA countries should focus on domestic policy have made trade policy more liberal, their overall impact re- reforms and the associated process of greater integration into the mains modest. As Noland and Pack (2009, Appendix 8) note, world economy” (El-Erian & Fischer, 1996). 40 the net effect of such agreements is unclear for Egypt, whereas A recent World Bank report emphasizes a similar sequence: the benefits are shown to be relatively small in the case of Morocco. Similarly, there is limited evidence that the QIZ “It seems advisable for MENA policy makers to focus first on how to (Qualified Industrial Zone) program in Jordan led to a signif- maintain and strengthen their countries’ competitiveness in the global icant technology transfer or backward linkages. In fact, it led market and only then ask what contribution regional integration can to a “trade-diverting regional allocation of production” from make toward achieving this end” (Shui and Walkenhorst, 2010). UAE to Jordan. However, at the same time, regional trade This emphasis on globalization as a priority policy objective pacts can result in trade diversion for resource-rich countries can be misplaced for several reasons. Assuming that trade bar- (Venables, 2011). riers serve political constituencies, dismantling them for global In short, we do not have unambiguous evidence that trade trade are no more politically expedient than regional agreements with more developed partners generate greater THE ECONOMICS OF THE ARAB SPRING 309 benefits for Arab countries. Nor is it possible to conclude that By integrating regional markets, Arab rulers can offer the the benefits from regional trade are altogether negligible. best form of redistribution to poor neighbors and the most po- What can be said with some degree of confidence is that weak tent economic hand-out to their people—better than doling regional linkages among Arab countries reduce the quality of out billions of dollars in subsidies that keep economies and the region’s engagement with globalization, keep its exports aspirations artificially alive. The Middle East is passing concentrated and private sector under-developed. In fact, through a defining moment that also contains in it the seeds trade liberalization will remain incomplete without actively for creative destruction. Change is more likely where economic contested regional markets. Regional trade can generate more reform is fast becoming a political imperative. The pressures powerful economies of scale that are not just restricted to firms for change are arguably more intense in countries that are la- but accrue more widely to industries and, ultimately, the econ- bor-abundant and where rents are more uncertain and con- omy as a whole. One example of these broader scale econo- tested. Ultimately, however, the possibility of reform will mies is in the provision of regional public goods, such as depend on each country’s initial conditions and its specific transport and communication infrastructure. Regional trade configuration of political and economic power. A full analysis can facilitate deeper integration that goes beyond a mere of these issues goes beyond the scope of this paper. 41 reduction of tariff barriers and helps to dismantle the more The regional dimension remains critical even in countries cumbersome non-tariff barriers. with better reform prospects. For example: its favorable con- By permitting better coordination and harmonization of ditions notwithstanding, Tunisia’s investment shrinkage is dif- policies, regional trade facilitation can improve investment cli- ficult to address without foreign capital inflows, including mate. It is also integral to efforts toward economic diversifica- those from richer Arab neighbors. Dependence on regional tion. The region has little hope of diversifying when firms face capital flows will increase in the face of Europe’s continuing high transaction costs to exporting and fragmented markets fiscal troubles. There is wide scope for regional action. For deny scale economies to firms. To the extent that scale econo- example: in exploiting the potential of Islamic Finance and mies are more important for manufactured exports, a mere Sovereign Wealth Funds in directing credit to firms that are insistence on global integration without comprehensive trade underserved by local financial intermediaries. Regional link- liberalization at the regional level can keep the Middle East ages are important even for relatively rich Gulf countries that locked in primary export structures. Evidence suggests that are less vulnerable to mass revolts but are not fully insulated the basket of goods in intra-Arab trade contains more from the fallout of unrest in neighboring Yemen and Jordan. “dynamic products” with “differentiated export niches” In confronting the region’s development challenges, geogra- (Zarrouk, 2000). Intra-Arab trade can also dampen the phy can play a pivotal role. It presents opportunities for both “negative effects of the patchwork of overlapping trade change as well as status-quo. The region is massively favored agreements” that the Arab world has bilaterally forged with by its geography of trade and investment. Given its superior developed countries (Chauffour, 2012). access to coasts, markets, and resources, the Middle East is Thick economic borders can also disadvantage Arab coun- naturally predisposed toward trade and competitive produc- tries in intra-industry trade which, given the region’s similar tion. This can be an agent for change. At the same time, the factor endowments and production structures, offers a prom- geography of resources and conflict can be a retrogressive ising avenue for economic diversification. With its educated influence, since it generates rents that establish the primacy population, high levels of urbanization, and favorable access of patronage over production. The future of the region hinges to coasts, the Middle East is particularly suited for trade in on how policymakers grapple with this clash of geographies. intermediate goods. But this requires soft economic borders, Can they harness their natural geographic strengths to build regional production linkages, industrial clusters, and efficient a future based on trade and production, or do they fall back trade logistics. Putting in place these “soft technologies” of on the geography of rents and patronage? industrialization requires a well-coordinated regional develop- ment policy, including an effective industrial policy that fosters trade complementarity across the region. To summarize, 6. CONCLUSION: TOWARD AN OPEN ACCESS stronger linkages between Arab economies can generate dy- ORDER namic gains. Rather than treating them as separate policy objectives, there is a strong case for emphasizing the mutually The Arab world lies at the cusp of a new era. It is witnessing reinforcing character of globalization and regional trade facil- an unprecedented demographic transition resulting in one of itation. the “largest youth cohorts” in its history. This is, to quote Tar- The question, then, is: when will real economic opening be- ek Youssef’s prophetic expression, the “generation in wait- come a political possibility? This is a question not just of the ing”—a generation waiting for jobs and justice. The future nature and attributes of reforms, but also of elite incentives. of the Middle East crucially depends on whether it can convert Rarely has any transformation taken place from poverty to this youthful transition into a productive transition. This re- prosperity and from a rentier to a developmental state without quires Arab rulers to concede not just political, but also eco- compatible elite incentives. Repeatedly in history, elites have nomic, space. Political reform alone will be insufficient, only surrendered their privileges and extended rights to com- unless it is accompanied with a re-distribution of economic moners when they are faced with an existential threat. The power. There is a risk that the Arab spring meets the same fate Arab spring offers a creative window for institutional change. as revolutions elsewhere have in the past. That is, they result in There is growing realization in the wake of recent Arab revolts a greater continuity than change. The recent literature on that the status-quo is unsustainable and that governance sys- political economy offers a convincing reason for such institu- tems need to be more responsive to citizens. But, there is less tional persistence. Revolutionary upheavals sometimes lead clarity—hence a greater room for debate—on the nature of to de jure change in political institutions without necessarily economic concessions required from elites. If there is one altering the underlying distribution of economic power. 42 key strategic concession that elites can collectively offer to Even if old political players are replaced with new ones, this the Arab world, it is the creation of regional economic can lead simply to a re-configuration of political power leaving commons. the basic economic structure unaltered. The challenge for the 310 WORLD DEVELOPMENT

Arab world is no different: offering greater political engender creative destruction, defined by healthier firm representation is desirable, but unless coupled with a greater dynamics including both the entry and exit of firms. Viewed access to economic opportunities, it is unlikely to be a game in this light, the struggle for a new Middle East will be won changer. The current impasse in Egypt best illustrates this or lost in the private sector. institutional dilemma. While Hosni Mubarak has departed, The region’s deep economic divisions act as a key hindrance the structure that sustained his authoritarian rule survives. to private sector development. Fragmentation increases the re- As the civil society is now discovering, the power of en- turns to predation, preserves the unequal distribution of eco- trenched insiders is not easy to dislodge. De facto power, nomic opportunity, and enriches elites. Opening economic whether economic or political, resides with the Egyptian mili- access is therefore resisted because it can dissipate the rents tary. It controls vast economic resources, from manufacturing that sustain the stability of ruling coalitions. While the region to real estate and services, and its budget enjoys immunity lacks a solid constituency for private commerce, the demo- from parliamentary scrutiny. The military’s role as a regional graphic and political upheavals across the Arab world have peacemaker further entrenches its power. For the Egypt’s created a new opening for change. Demography poses a youth movement, this generates an important commitment common challenge to Arab governments; it also deserves a problem. The real powers supervising Egypt’s political transi- common response through an opening of regional markets. tion are unlikely to commit to their own dismantling. Regional economic cooperation, which has long received The litmus test of any reform initiative in the Arab world is rhetorical support, assumes a new urgency in this context. 43 whether it expands economic and political access to its citizens The region urgently needs a new logic of economic integration, and whether it promotes, in the conceptual formulation of based on a broader discourse on security that transcends Douglass North, an “open access order” (North, Wallis, & beyond narrow, short-term concerns of regime security, and Weingast, 2009). The Arab state has typically created rents attends to the long-term challenges of human security by restricting access to economic opportunities to a dominant (Ulrichsen, 2010). 44 Connecting regional markets is also an coalition, and used these rents to sustain order. Through cen- essential step toward effectively competing in global markets. tralized economic control and restrictive economic barriers, But, the region’s economic fragmentation is partly a mani- Arab governments have erected a system of economic apart- festation of internally segmented administrative structures. heid that systematically excludes people and firms at the mar- Governance systems in the Middle East are highly centralized gins. Although, by global comparisons, the Middle East has that often function through vertical clienteles that are uncon- modest levels of measured inequality its central challenge is nected from each other. This brings us to a fundamental irony the inequality of access. Everywhere in the region there are that has profound consequences for development: as the strong advantages of incumbency. To create an “open access Middle East has become more centralized, it has also become order,” a new governance paradigm needs to be imagined that more fragmented. The region’s centralized administrative brings people from the margins to the mainstream, offering structures have restricted economic access and prevented the them ladders for economic mobility—ladders that are defined diffusion of economic rents through entrepreneurship and by merit and competition, rather than connections (wasita). trade. Importantly, a segmented state apparatus has prevented This requires that economic rewards are distributed through the emergence of a business class that has direct stakes in more achievement rather than ascription, and that elite privileges open regional markets. This has given rise to massive coordi- are transformed into universal rights. nation failures, with the result that Arab governments and Much of this hinges on whether private economic activity firms today are particularly deficient in capturing positive can take root and proliferate new social groups that ultimately externalities and productive spill-overs. In this milieu, public result in a greater dispersion of power. Arab economies have effort and resources are duplicated, complementary activities long been greased through revenues from oil, aid, and remit- are ignored, and patrimonial ties between firms and the state tances. There is now a need to generate alternative revenue become stronger than their productive linkages with other streams through trade and private sector development that firms (Nabli, Keller, Nassif, & Silva-Jauregui, 2006). This cre- can replace patronage with production. But it is inauspicious ates an inhospitable environment for trade, specialization, and to talk about the necessity of economic reform at a time when competitive production. the region’s political climate is decidedly anti-business. The Monolithic systems are designed to preserve harmony than private sector is at once the most despised as well as the most to induce change. This generates a fundamental contradiction desirable aspect of reform. Business in the Arab world is often with the growth of private enterprise, which demands open comfortably embedded within the state, with the result that it economic access, flexibility, and an ability to adapt and inno- invokes images of crony capitalism. At the same time, an esti- vate. A centralized system is therefore anathema to entrepre- mated 100 million jobs need to be created in the MENA region neurship and innovation. The Middle East’s centralized over the next decade (World Bank, 2003). This employment bureaucratic rule has a long historical lineage, dating back challenge cannot be addressed without a strong private sector. to the Ottoman era. The Ottoman Empire and its successor And, without a strong private sector the human capital gains Arab states have been particularly efficient at protecting their that the Arab world has achieved over time cannot be trans- autonomy from society. But, in this quest for absolutist con- lated into solid productivity gains. trol, bureaucracy has been turned into an impediment for pri- An independent private sector also serves a vital political vate enterprise and regional economic integration (Ayubi, function: it can generate a middle class that can serve as a 2001). 45 At key moments of history, the Arab state has at- powerful constituency for political reform. A robust private tempted to institute reforms in various guises, but these have sector is thus both an economic and political imperative. But mostly ended up centralizing power, rather than dispersing this requires a radically different business life: it requires a pri- it. Whether it is the Tanzimat reforms under Ottoman rule, vate sector that is open, competitive, and can operate outside nationalization of the 1960s or neo-liberal economic reforms the royal circle. This can be achieved through a genuine infitah of the 1980s, they have all served as vehicles for refurbishing (economic opening) that dismantles entry barriers, replaces the state’s power. The key question in this regard is whether privilege with competition, and ensures a decentralized and reforms will once again be a centripetal or a centrifugal force? rules-based framework for decision-making. This would This is the true crucible of the Arab Spring. THE ECONOMICS OF THE ARAB SPRING 311

NOTES

1. The “Arab world” is broadly defined to include the Arab nations of 19. An alternative explanation relates to the inhibiting role of Islamic the Middle East and North Africa. law. See Kuran (2010).

2. See Noland and Pack (2009). 20. The region’s fragmentation, together with the intensity of conflict, also increases military spending by individual states. 3. The proportion of 15–24 year olds in working age populations of other Arab spring countries are: Egypt (34%), Libya (34%), Syria (38%), and 21. The important exceptions in this regard are Morocco, Syria, and Tunisia (31%). Yemen, Iraq and Saudi Arabia are also projected to Lebanon, which had sizeable merchant communities. witness the largest proportionate change in the size of their youth populations till 2025. For further details, see Assad and Roudi-Fahmi 22. For further details, see Malik (in press). (2007). 23. “This index corresponds to the uniform tariff that if imposed on all 4. The exact ratio for Syria is 77%. See Dhillon and Yousef (2010), and imports from partner countries would leave overall imports unchanged.” Manar (2010). For more details, see Shui and Walkenhorst (2010).

5. The importance of Suez Canal can be gauged from the fact that 24. http://www.enterprisesurveys.org/. around 8% of the global sea-borne trade passes through it. It generated US$ 4.8 billion in revenues in 2010 alone. 25. Many countries continue to place stringent restrictions on currency convertibility. This is the case in Algeria, for example, which has a 6. There may also be a feedback from the state’s redistributive system to significant cushion of foreign reserves against a possible run on the demographics, as generous state provision acts as an incentive for a larger currency. family size.

7. The region imports 50% of its food calorie consumption. 26. There has been a significant progress on maritime trans-shipment.

8. See Ciezadlo (2011). 27. Tunisia is a partial exception, since its exports of parts and components have significantly expanded in recent years. 9. Further details available at: http://gitm.kcorp.net/ index.php?id=579569&news_type=Economy&lang=en. 28. Those wishing to travel from Doha to Dubai, or vice-versa, have to transit through Saudi Arabia. 10. For key features of this development model, see Yousef (2004, p. 91– 116). 29. For example: if the Gulf Cooperation Council (GCC) has failed to live up to its dream it is partly the result of ignoring the infrastructure 11. For a detailed analysis, see World Bank (2004). needs. Examples of other failed projects are the Federation of Arab Republics and the Arab Cooperation Council. 12. This has happened in Algeria, Libya, Egypt, Jordan, Morocco, Syria, Tunisia, and Kuwait. 30. See The World Bank (2011b).

13. This is evident in Saudi Arabia, for example, where there are 31. Despite these operational difficulties, there is significant potential for considerable government shares in large business conglomerates. cooperation. A state of the art rail network can connect not just Arab economies, but also open a new trade and investment corridor linking 14. See Heydemann (2004, p. 245–80). these economies to West Asia, Africa, and Europe. There is a belated official realization of this, which has led to a renewed push for better rail 15. Given that some of these defense expenditures are intended for connectivity. The agreement in 2003 to establish the Arab Mashreq internal security, better regional relations would not relieve this regrettable International Railway project, recent proposals to build a rail network internal security motivation for military spending. Unfortunately, the inside Saudi Arabia, and efforts to revive train links with Turkey are absence of disaggregated data and the overlapping nature of expenditures promising steps. But progress on these projects is slow. on internal and external security preclude us from making any firm judgment on this matter. 32. The record of economic reform is mixed in the MENA region. Morocco, Tunisia, Jordan and Egypt were some of the early reformers in 16. See The Economist, 2010, July 17–23 Issue. the region. Reform was partially successful in Egypt; in Tunisia and morocco it led to a revival of FDI. For details, see Yousef (2004). 17. The agglomeration index for the MENA region is 67.5% compared to 62% in Latin America and Caribbean. For more details see Uchida and 33. See Peters and Moore (2009, p. 256–85). Nelson (2008). 34. Jordan, Tunisia, Morocco, Lebanon, and Egypt have been the prime 18. However viewed, the region’s actual performance defies its potential; beneficiaries of these foreign capital flows. For further details, see Shui existing trade can easily double from its current level. and Walkenhorst (2010, chap. 10). 312 WORLD DEVELOPMENT

35. Changing geo-political circumstances in the wake of 9/11 attacks, vibrant civil society, and educated workforce, Tunisia can lead liberalization of the financial sector and the recent oil boom have all reform efforts in the region. Among resource-rich countries, Libya played a helpful part. is a promising case, simply because starting from very low levels of development the private sector has a greater room to catch-up. The 36. Recently, the United States, when faced with the difficulty of main challenge, as in other resource-rich countries, is to avoid the negotiating an FTA, has pushed instead for a Trade and Investment distortionary influences of oil. Egypt is a more difficult case. With Cooperation Agreement with the GCC. its greater reliance on geo-strategic rents (principally, foreign aid) and its well-entrenched military, there are powerful impediments to 37. For evidence on welfare gains from trade with the EU, see Dennis reform. However, much will depend on whether Muslim Brother- (2006). hood can translate its rhetoric on subsidy reform, informal sector, and small enterprises into actionable policies. 38. In particular, trade between MENA countries can generate signif- icant dynamic gains. 42. Whether it is the abolition of slavery and apartheid or the granting of voting and property rights, the underlying lesson is usually the same: de 39. The US trade agreements with the Gulf countries are sometimes jure reforms do not automatically result in effective change. This is because viewed as disruptive for GCC trade. There have been concerns among elites have a remarkable ability to endure; they can reverse change or mold large GCC countries about the entry of US goods into the GCC via it in their favor. For a detailed argument, see Acemoglu and Robinson Bahrain. For details, see Lawson (2011). (2008), and Robinson (2010).

40. As El-Erian and Fischer (1996), argue: “Rather than set as their first 43. In this regard, the proposed accession of Jordan and Morocco to the economic policy priority the goal of regional integration, MENA GCC is a welcome step, but the driving incentive for this should be the countries should focus on domestic policy reforms and the associated integration of markets rather than monarchies. process of greater integration into the world economy.” 44. See Ulrichsen (2010, p. 2). 41. In some respects, North Africa is more favorably disposed to economic reform. Tunisia offers the most hopeful scenario. With its 45. For a further illustration of this point, see Ayubi (2001, chap. 4). limited rent streams, relatively open economy, weaker military,

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