Economic Developm.ent of the Arab Countries Selected Issues

Edited by Said El-Naggar

International Monetary Fund Economic Development of the Arab Countries SelectedIssues

Edited by Said El-Naggar

Papers presented at a Seminar held in Bahrain

February 1-3, 1993

International Monetary Fund 1993

©International Monetary Fund. Not for Redistribution © International Monetary Fund, 1993

Library of Congress Cataloging-in-Publication Data

Economic development of the Arab countries: selected issues I edited by Said EI-Naggar. p. em. "Papers presented at a seminar held in Bahrain, February 1-3. 1993.'' Includes bibliographical references. ISBN 1-55775-332-6 I. Arab countries-Economic conditions-Congresses. I. El-Naggar. Sa'id, 1920- II. International Monetary Fund. HC498.E24 1993 338.9'00917' 4927-dc20 93-25694 CIP

Price: US$22.00

Address orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. Telephone: (202) 623-7430 Telefax: (202) 623-7201 Cable: lnterfund

©International Monetary Fund. Not for Redistribution Sponsoring Organizations

• The Arab Fund for Economic and Social Development

• The Arab Monetary Fund

• The International Monetary Fund

• The World Bank

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©International Monetary Fund. Not for Redistribution Foreword

he current rrospects for economic develorment of the Arab Tregion as a whole in the nineties conceal wide variations between the countries of the region. Nevertheless, some of the issues that are likely to be of major imponance in the comext of growth and develorment can he idemified and were covered in this seminar held in Bahrain on February 1-3. 1993. The lMF wa:­ again pleased ro have been associated with the Arab Fund for Economic and Social Develorment, the Arab Monetary Fund. and the World Bank in sronsoring this seminar. and this fifth \'Olume of seminar proceedings ruhlished joirnly by the lMF and the Arab Monetary Fund is a worthwhile and timely addition to the series. The issues taken up at the seminar by its distinguished author.s and discussants included economic reform, investment and carital flows, intra-Arab labor movements, the environmem. the imract of the Eurorean Community on the region, and the develorment of human resources-topics of relevance for all developing coun­ tries, but dealt with here specifically with regard to the Arab coun­ tries. Some of these countrit.::s have progressed significantly toward modernization, institution building, and mobilization of resources in the last three clecaclcs, although many still have far to go. I hore that the publication of this volume will contribute to an improved understanding of these issues and of their significance for imrrm·ing the economic performance of the Arab region in the coming years.

MICIIEL CA.\II)ESSl s Managing Oirector !ntemalional MoneiCII)' Fund

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©International Monetary Fund. Not for Redistribution Acknowledgment

his is the fifth seminar in a series of seminars dealing with Teconomic issues of particular importance to the Arab countries. It is the fruit of collaborative effort between the Arab Fund for Economic and Social Development, the Arab Monetary Fund, the International Monetary Fund, and the World Bank. The seminar, held in Manama, Bahrain, on February 1-3, 1993, provided an excellent opportunity for a number of high-level experts and policy­ makers to exchange views on topics pertaining to economic devel­ opment of the Arab countries in the nineties. The seven papers that were presented at the seminar are included in this publication, together with the written comments of the discussants and an intro­ duction by the moderator. I would like on the occasion of this publication to express my thanks to all those who made this event possible. A special word of thanks is due to the Government of Bahrain for hosting the seminar, to Abdlatif AI-Hamad, Director General and Chairman of the Board, Arab Fund for Economic and Social Development, to Osama Faquih, Director General and Chairman of the Board, Arab Monetary Fund, and to their assistants for the excellent organization of the seminar and for their hospitality during our stay in Bahrain. I would also like to thank Elin Knotter of the External Relations Department of the International Monetary Fund for editing this volume and directing it from draft through publication.

SAID EL-NAGGAR Moderator

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©International Monetary Fund. Not for Redistribution Contents

Pap,e

Foreword u

Acknowledgment vii

I. Economic Development of the Arab Countries: The Basic Issues

Said El-Naggar 1

2. Economic Reform in the Arab Countries: A Review of Structural Issues

Mohamed El-Erian Shamsuddin Tareq 26

Comment: Mustapha Kara 51

3. Investment Policies and Major Determinants of Capital Flows to Arab Countries

Ghassan El-Rifai 56

4. Arab Capital Flows: Recent Trends and Policy Implications

Ahmed Abisourour 94

Comment: Samih Masoud� 139

•This comment covers Chapters 3 :1nd 4.

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5. Inter-Arab Labor Movements: Problems and Prospects

Tayseer Abdel Jaber 145

Comment: Mohamed AL-Amin Fares 163

6. Environmental Policies and Sustainable Development in the Arab World

Mostafa K. Tolba 173

Comment: Salah El Serafy 197

7. Human Development in the Middle East and North Africa Region

Stephen P. Heyneman 204

Comment: Badr Malalia 227

8. European Economic Integration and the Arab Countries

Rolff. Langhammer 235

Comments: Assia Bensalah Alaoui 267 Mabid Al-jarhi 279

List of Pa1ticipants 285

The following symbols have been used throughout thas volume:

co mdicate that data are not available:

co indicate that the figure as zero or kss than half the final d1g1t shown, or that the uem does not exist:

berween years or momhs (e.g. . 1991-92 or January-June) to indicate the years or momhs cove red, including the begmmng and cndmg years or months:

bcrwecn years (e.g .• 1991/92) to mdicate a crop or fiscal (finanCial) year.

"BiUion" means a thousand nulhon.

Minor discrepancies berween consriruent figures and corals are due to roundang.

The term "coumry,'' as used in this volume, docs riOt aU cases refer ro territorial enmy an a that is a state as understood by international law and practice; the term also covers some territorial emities that are not states, but for whach statistical data are rnamramed and provided internationally on a separate and independent basis.

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Economic Development of the Arab Countries: The Basic Issues

SAID EL-NAGGAR

he prospects for Arab economic development in the nineties Tis a highly complex subject that does not easily lend itself to generalizations valid for all countries. As is well known, the coun­ tries of the region vary greatly. For the oil countries, development will depend to a very large extent on what happens in the oil markets. Despite intensive efforts to diversify their economies, these countries are still heavily dependent on oil as the major source of income. Other countries may not be so heavily dependent on oil, but a good part of their growth is derived from the oil countries through workers' remittances, development assistance, and Arah investment and trade. Still another group of countries is only remotely affected by the fortunes of the oil countries and is more concerned with developments in the export markets for their princi­ pal products. In addition to variations based on oil resources, Arab countries differ a great deal with respect to levels of development, per capita incomes, whether they export or import capital, and the extent to which they follow inward-looking or export-oriented development strategies. These variations complicate the task of assessing development prospects in the current decade. Nevertheless, it is possible to identify a set of issues that are likely to be of major importance in the context of growth and development. These include the issues covered hy the papers pre­ sented at the seminar: economic reform, investment and capital flows, intra-Arab labor movements, the environment, the impact of the European Community (EC), and the development of human resources. Obviously this is not the only set of issues that affects

©International Monetary Fund. Not for Redistribution 2 Said EI-Naggar

Arab economic development in the nineties. Others could have been added to the list. Oil, for instance, is highly indicated. But oil has already been the subject of many seminars. A repeat perfor­ mance would not have added much that is not already known to researchers and policymakers. At the same time a line has to be drawn on the number of issues that can fruitfully be dealt with in the time assigned for the seminar. The goals of Arab economic development in the nineties are not difficult to define. As with all developing countries. Arab economic development should satisfy the following terms and conditions:

• It should achieve a rate of growth of GDP exceeding that of the population to ensure a steady improvement in living standards.

• It should provide gainful employment for all comers to the labor market and reduce the stock of existing unemployment, both open and disguised.

• It should be consistent with the imperatives of price stability and external balance.

• It should protect the environment so as to safeguard the quality of life of the present generation as well as the opportunities for development of future generations.

• It should spread the fruits of growth to all segments of society and reduce income gaps both within and among Arab coumrics.

Development can be said to be successful if it satisfies these terms and conditions. On the basis of these criteria Arab development over the last three decades was less than satisfactory. More precisely, the picture that emerges is something of a mixed bag. A handful of countries were able to make big strides in modernization, institution building, and mobilization of resources, with impressive growth in both quantity and quality. The majority, however, was less success­ ful. The extent to which they will improve their performance depends on their capacity to meet the challenges of the nineties.

Economic Reform

The first issue taken up in the seminar is economic reform. The nature and policy implications of the challenge are set out in the paper by Mohamed EI-Erian and Shamsudclin Tareq entitled "Eco­ nomic Reform in the Arab Countries: A Review of Structural Issues." The issue was put by the authors in the following terms:

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While the nature, extent, and implications of the policy challenge differ among individual Arab economic�. several aspects are common to large number of countries in the region. In this context this a paper has anemptcd to identify a "core" group of required structural reforms. Broadly speaking, this group includes the need to rationalize a large public enterprise sector so as to concentrate its efforts in those areas where it performs most effectively and that arc warranted by market failures; strengthen the structure of government budgets to render them more clastic and increase their developmental impact; improve the mobilization and allocation of loanable fund� from domestic and external sectors; enhance the institutional framework for private investment and production activities; and rationalize the external trade and payments system. To he successful, these policies will need tO be supported by prudent demand managemenr, as well as an open international trading system and, for some countries, the provision of timely external financial assistance. Moreover, given the relatively low-income status of some Ar.th countries and their rapid population growth, the paper has referred to the importance of poli­ cies to protect the most vulnerable segmems of the population during the adjustment and reform program as part of a more comprehensive approach to poverty alleviation and environmental sustainability.

1£ is difficult to take issue with the basic thrust of the argumenb as enunciated by El-Erian and Tareq. However, a number of point!> were highlighted in the discussion. It was noted that in many coun­ tries that undertook to implement a comprehensive reform package in agreement with the International Monetary Fund and the World Bank, structural reform proved to be much more diffkult than macroeconomic adjustment. To illustrate, little progress was made in the area of privatization and liberalization of trade regimes. In contrast, reform yielded fairly quick results as regards inflationary pressures, stabilization of the exchange rate, and budget and bal­ ance of payments deficits. The fact that adjustment of the real economy is lagging considerably behind that of the money econ­ omy, could, it was pointed out, jeopardize the whole process of reform. There is need to address this problem at both the technical and political levels. With privatization, for instance, the process was hampered by lack of expertise on the techniques of evaluation of assets, financial restructuring of heavily indebted public compa­ nies, and on how to deal effectively and equitably with the problem of redundant labor. At the political level it was pointed out that

©International Monetary Fund. Not for Redistribution 4 Said EI-Naggar

there is need to address opposition from groups whose interests are, or are perceived to be, adversely affected by privatization. A number of participants felt reform programs supported by the IMF and the World Bank do not adequately address the impact on vulnerable and low-income groups. It was recognized that this aspect of reform programs needs to be strengthened through pov­ erty alleviation measures, better targeting of food subsidies, and the establishment of special funds endowed with sufficient resources to help the most vulnerable groups. It was further pointed out that developing countries are being pressured to liberalize their trade regimes whereas the industrial countries, which are far more able to shoulder the burden of adjust­ ment, are adopting a protectionist stance. In assessing the merit of this argument it is important to keep in mind that the goal of reform programs is by no means the attainment of completely free trade in developing countries; rather it is to shift from a highly restrictive trade regime that all but eliminates foreign competition to moderate protectionist policies. This shift is realized through the elimination of import bans except for health or security reasons, reduction of extensive quantitative restrictions and other nontariff barriers, and greater reliance on price-based protectionist measures. Once liber­ alization is so defined, it becomes more or less symmetrical with current trade policies in most industrial countries. The argument that asymmetry largely depends on what happens in the Uruguay Round of Trade Negotiations was also mentioned. If successful, there is every reason to expect a more open international trading system all round. Otherwise, a reversal of policies toward a greater measure of protectionism will probably occur in both developed and developing countries. Another issue that was raised in the discussion revolved around the role of the state in a market-based economy. The fear was expressed that liberalization, privatization, and deregulation are sometimes construed to mean a virtual absence of the state from the economic arena. The fear is clearly groundless. What is at issue in reform programs is not the principle of state intervention but its nature and extent. Under the dirigiste-socialist model that character­ ized development strategy for a long time, the state became directly involved in the production of goods and services.As a consequence the public sector came to dominate an extremely wide range of

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activities, which could nor possibly be justified on developmental grounds. The reverse side of the coin was the total absence of the private sector from all important fields. At the same time public sector companies (or most of them) were operating at a low level of efficiency, which impaired the capacity of the economy to grow at rates commensurate with the rate of population growth. Going hand in hand with a dominant public sector was an overregulation of economic activities, which stifled initiative, suppressed innova­ tion, and invited mismanagement and corruption. Under these cir­ cumstances it is hardly surprising that reform programs call for privatization and deregulation of the economy. The state is required to withdraw from the production of goods and services except in cases of market failure. But that leaves a great number of functions for the state to perform. Under a market-based economy the state is the organizer, the regulator, and the arbiter. In addition to the traditional functions in defense, security, and the judiciary, the government has an impoitant role to play in education, health, housing, poveny alleviation, and the provision of a social safety net for vulnerable groups. No less imponant is the regulato1y function, including prevention and control of monopolies and monopolistic practices as well as the setting and enforcing of standards in numer­ ous fields. Finally, it was recognized that the process of economic reform is neither costless nor painless. But a proper assessment of the negative impact of adjustment cannot be made without reference to the situation that would have obtained without adjustment. Before implementation of a reform program the situation is typically charac­ terized by accelerating, if not galloping, inflation, a high rate of unemployment, unsustainable budget and external deficits, and loss of creditworthiness. The situation would probably have grown worse without the reform program. To judge whether it is worth­ while to swallow the bitter pill of reform, the point of reference should not be an ideal situation free from inflation, unemployment, and deficits. If that were so, there would have been no reason to seek the help of the Bretton Woods institutions. A proper compari­ son should be between the post-reform situation and a hypothetical one, which is the one that would have prevailed without adjustment measures. It is most likely that the post-reform situation would be decidedly superior on all counts.

©International Monetary Fund. Not for Redistribution 6 Said EI-Naggar

Investment and Capital Flows

The issue of investmenr and capital flows is covered by two papers, one by Ghassan EI-Rifai, "Investment Policies and Major Determinants of Capital Flows to Arab Coumries," the other by Ahmed Abisourour, "Arab Capital Flows: Recent Trends and Policy Implications." It should be noted that the two papers are different as to the scope of inquiry. EI-Rifai's paper is devoted to foreign direct investment (FDI) to the exclusion of other types of financial flows. Abisourour's paper is broader in scope, as it covers not only FDI but also portfolio investment in both equities and bonds as well as long-term and short-term capital flows. With respect to FDI, which is common to both papers, there is a wide discrepancy between the figures on the flow to the Arab countries. The discrep­ ancy is hardly surprising in view of differences on the source of data, the number of Arab countries covered, and on whether oil investments and intra-Arab flows are included or not. The starting point in EI-Rifai's paper is the growing importance of FDI as a source of external financing for developing counrries. Over the last decade, it was pointed out, FDI has turned from being a rather small and marginal source of foreign capital in developing countries to becoming a large and significant source replacing the more traditional ones such as official grants and loans and commer­ cial bank borrowing. According to the latest World Bank statistics, net long-term resource flows from industrialized to developing countries increased only marginally, from an annual average of $68.6 billion during 1982-86 to $72.9 billion during 1987-91. During the same periods, FDI to developing countries more than doubled, from under $10 billion, to nearly $23 billion. As a result, the share of FDI in the total net resource flow increased from 14.3 percent to 31.5 percent. In spite of a significant expansion, the Arab countries were not particularly successful in attracting FDI. This conclusion is substanti­ ated by data on seven Arab countries: Algeria, Egypt, Jordan, Morocco, Oman, Saudi Arabia, and Tunisia. Excluding investments by foreign oil companies, the inflow of FDI to these countries during 1986-90 averaged about $4.7 per capita per annum in 1990 prices, compared with $5.5 for developing countries as a whole. Among major regions, only Africa south of the Sahara had a lower

©International Monetary Fund. Not for Redistribution I • Economic Development of the Arab Countries 7

FDI during this period ($2.7), whereas in South America it was substantially higher ($18-19 per capita). As is to be expected, performance in attracting FDI varied consid­ erably among the seven countries. Average annual FDI inflow ranged from only S0.30 in Algeria to nearly $14 in Saudi Arabia. The two best performers among the seven countries (Saudi Arabia and Tunisia) were successful enough to join the group of 20 top performing developing countries. One of the important conclusions the author reaches is that for a country to attract meaningful amounts of FDI the investment climate has to be attractive, stable, and predictable. With respect to stability and predictability, the author points out that "FDI is not like a water tap that a government can turn on and off at its convenience; it is more like a fruit tree that needs to be tended and watered carefully for years before it will bear fruit. If in the meantime, the owner loses interest, the young tree will die and the process will have to be started all over again." As to attractiveness, empirical investigation shows that a sound macroeconomic envi­ ronment is perhaps the most important single factor in the calcula­ tions of the foreign investor. High rates of inflation, an overvalued currency, sudden and sharp devaluation, administratively fixed interest rates, or a weak banking system are not the kinds of concli­ tions that attract foreign investment. Some countries, including Arab countries, have tried to compensate for the absence of sound macro­ economic policies by offering special incentives and exemptions. Not infrequently, foreign investors are exempt from all forms of taxes, duties, and fees for periods extending up to 10 and sometimes 20 years. Experience shows, however, that the quality of macroeco­ nomic policies is far more important than tax holidays and the like. Some countries that offer very few or no special incentives have nevertheless succeeded in attracting a considerable volume of for­ eign investment. In this category belong countries such as Hong Kong, Singapore, Taiwan Province of China, and the Republic of Korea. In contrast a large number of developing countries have failed to attract any significant amount of FDI despite excessively generous incentives and privileges. In both categories the operative factor was the quality of macroeconomic policies. It should be remembered, however, that until recently, FDI was viewed with suspicion in many parts of the developing world. For

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most of the period after World War II developing countries resorted to foreign borrowing rather than foreign direct investment to meet their external financing requirements. Newly independent countries that had just emerged from a long period of colonial domination were anxious to maintain control over their own economic and political affairs. Foreign direct investment being in the majority of cases closely associated with multinational corporations was perceived to be incompatible with this goal. There was also a tendency to discount the presumed advantages of FDI compared with other forms of financing. Multinational corporations were fre­ quently not interested in developing export-oriented industries but rather in displacing national producers as suppliers of the local market behind high walls of protection. The impact on employment was seen as minimal in view of the capital-intensive techniques imported from the home country; the transfer of technology was deemed to be a mirage, as multinational corporations tend to be highly secretive about their techniques of production while the training of local personnel was kept within the narrowest possible limits. Equally important was the concern about the distribution of benefits between the host country and the investing corporations in terms of tax revenue, value added, and reinvestment of profits. The prevailing view in many developing countries was that through dubious methods and practices such as transfer pricing, multina­ tional corporations arrogate to themselves the lion's share of the benefits from investment. But it is important to realize that in contrast to the sixties and seventies, the decade of the eighties saw a vigorous revival of interest in FDI. Underlying the change in attitude toward FDI are recent developments in the international financial system. The debt crisis of the early eighties underscored the serious limitations of heavy dependence on foreign borrowing. A heavy debt-service burden combined with variable interest rates on a large proportion of their debt made the heavily indebted countries particularly vul­ nerable to external shocks. A protracted recession in the industrial countries, in addition to the high cost of energy and the collapse of the prices of principal export commodities, have conspired to underrnine their payment capacity. The result was a debt crisis of unprecedented severity, which inflicted untold hardships on the

©International Monetary Fund. Not for Redistribution I Economic Development of the Arab Countries 9 • indebted countries and jeopardized their growth prospects-not to mention the integrity of the international credit system. In contrast, remittances of dividends and profits on FDI are much more responsive to changes in business conditions. By their very nature they increase with prosperity and fall with recession. They are more in rune with changes in the payment capacity of host countries. More important, the debt crisis has had a profound impact on the international sources of finance available to developing countries. Commercial bank lending, which played such a signifi­ cant role in the seventies, has all but dried up except in the context of adjustment programs supported by the International Moneta1y Fund or with ironclad collateral and guarantees. Other sources of finance have also become subject to severe constraints. The tight budgetary situation in most industrial countries has been a serious obstacle to expanding bilateral sources of finance whether conces­ sional or nonconcessional. Also, recent developments in the former Soviet Union and the socialist countries of Central and Eastern Europe are certain to give rise to an enormous increase in the demand for financing from the industrial countries, which could easily impinge on the resources available to developing countries. Such dim prospects for alternativesources of finance have height­ ened the importance of FDI and induced a significant change in the attitude of developing countries. Multinational corporations made an effort to establish standards for acceptable business con­ duct. They have become more sensitive to the concerns of host countries and more flexible in the particular forms of investment. There is now greater willingness to accept innovative arrangements such as joim vemures, turnkey projects, build-own-transfer (BOT) arrangements, and licensing agreements rather than the traditional wholly owned subsidiaries. Developing countries, on the other hand, became more experienced and confident in dealing with multinationals. Moreover, they can, if they so wish, receive technical assistance and advice in negotiations with foreign investors from institutions established within the framework of the United Nations and its specialized agencies such as the International finance Cor­ poration CIFC), the UN Center on Transnational Corporations, and the Investment Promotion Service (IPS) of the United Nations Indus­ trial Development Organization (UNIDO).

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This is not to argue in favor of an open-door policy for FDl with no criteria or control. Every country has the right and duty to regulate and make transparent the conditions under which foreign investment is admitted. Some industries may well be closed to foreign investment for security or strategic considerations. Others may be subject to a minimum participation of national capital. Foreign investors may also be required to report to the capital market authority the size of their holdings in any single company once a certain threshold is exceeded. But certain institutional requirements need to be satisfied if the Arab countries are to compete effectively for foreign investment, whether direct or portfolio. In his paper on Arab capital flows, Abisourour refers to the need to develop a securities market, fairly complete with a range of financial institutions and competent inter­ mediaries as well as a well-structured regulato1y framework. Also. it is necessary to establish appropriate accounting standards and financial disclosure rules to improve credibility in the information available from enterprises. Furthermore, it is essential to ensure the protection of minority investors and to promote a more balanced financial system between equity investment and bank deposits. In many Arab countries interest income from bank depositc; is tax free while dividends and profits are subject to high rates of income or corporate taxes. Such discriminatory treatment creates a bias by investors in favor of bank deposits ro the detriment of equity invest­ ment. Finally, attempts should be made to establish country funds that invest in a large number of companies in a specific country or group of countries. As pointed out by Abisourour, this seems to be a logical first step, as the task of selecting companies in which investments are to be made is left to the professional managers, whereas investors themselves do not need to have detailed knowl­ edge of the various companies in each country. Regional or multi­ country funds could also prove instrumental in encouraging inter­ Arab capital flows.

Inter-Arab Labor Movements

It is recognized that inter-Arab labor movements have played an important role in the economic development of both labor-surplus and labor-deficit countries. From the viewpoint of the former, migrant labor has been a significant source of foreign exchange

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earnings, particularly since the increase in oil prices in 1973. Work­ ers' remittances reached their peak in the early eighties when the annual oil revenue of the Gulf Cooperation Council (GCC) countries hit a high of over $250 billion. According to a srudy by the Interna­ tional Monetary Fund, workers' remittances amounted to S 10 bill ion annually from 1980 to 1984 and to S6 billion thereafter. In his paper on inter-Arab labor movements, Tayseer Abele! Jaber puts the combined workers' remittances to four labor-sending countries during the eighties at some $57.7 billion, of which $32 billion went to Egypt, $11.8 billion to the Republic of Yemen, $9.9 billion to jordan, and $4 billion to the Syrian Arab Republic. Being based on remittances reponed by banks in the labor-sending countries, these figures significantly underestimate the size of the flow. A good pan of the transfer was effected outside the banking system whereas another pan took the form of goods exponed from the host coun­ tries. When most of the labor-sending countries were suffering from a severe foreign exchange sho11age, a certain proportion of impo1ts was financed by expatriates. If account is taken of these types of transfers the amount of workers' remittances would he some 30-50 percent more than the figures reported in balance of payments statistics. Thus adjusted, remittances would easily constitute the primary source of foreign exchange earnings for most of the labor­ sending Arab countries. As for the labor-receiving countries the period since the advent of the oil boom in the early seventies has been one of intensive development, which could not have been sustained without calling on the lahor resources-l">oth skilled and unskilled-of the labor-surplus countries. Although inter-Arab labor flows played an important role in the last two decades, it is far from certain that they will continue on the same scale in the years to come. The Middle East war dealt a heavy blow to this particular form of inter-Arab cooperation. According to Abdel Jaber, as many as 1.5 million Arab workers were forced to return to their home countries as a result of rhe Iraqi occupation of Kuwait on August 2, 1990 and the subsequent outbreak of hostilities. It is estimated that 732,000 Yemeni workers had to return, mostly from SaLJdi Arabia. Other returnees included 250,000 Palestinian/jordanian workers returning mostly from Kuwait, and 390,000 Egyptians returning mostly from Iraq. Other Arab workers, though in much smaller numbers, included Suda-

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nese, Syrians, and Lebanese. It is highly doubtful that movement of inter-Arab labor will be restored in the fo reseeable future to the situation that prevailed before the war. Apart from strained political relations between the GCC countries and some of the labor-sending countries caused by the war, there are long-term trends that are likely to have a negative impact on inter-Arab labor movement. During the seventies and eighties the demand for labor by the oil countries was driven by the requirements of large-scale construction and infrastructure projects as well as by institution-building at all levels. Most of these projects tend to be highly labor intensive, which meant demand for large numbers of skilled and unskilled workers and for professionals of various categories. This is no longer so. Practically all the oil countries are past that stage. Most of the large infrastructure projects have been completed, and institu­ tions have already been set up. At the present stage of their develop­ ment the process of capital formation is mostly taking place in the industrial, agricultural, and service sectors. Compared with the earlier stage, projects are less labor intensive and more skill oriented. This is likely to affect both the quantity and composition of the demand for labor. A given increase of GOP will probably be associ­ ated with a smaller number of wage earners and a larger component of technical and professional skills. At the same rime a process of substitution of nationals for expatri­ ates was under way well before the war. The process was given impetus at the managerial and professional levels with the steady increase in the number and variety of highly qualified nationals. In addition, there appears to be a new concern about the national identity of some of the thinly populated oil countries. Before the war the proportion of nonnationals in the total labor force was high enough to call into question the original identity of the country. Estimates by Abdel Jaber put the number of nonnationals in the GCC countries in 1975 at 1.1 million or about 46 percent of the total labor force. In 1990 the figure roseto 5.2 million, representing 67.7 percent. According to the same source the percentage was considerably higher in some individual countries: 92 percenr in Qatar, 89 percent in the Unired Arab Emirates, and 86 percent in Kuwait. Following rhe departure of large numbers of exparriates during and after the war, some of rhe GCC counrries are apparently reassessing their labor importation policies to forestall the recur-

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renee of the previous situation in which nationals were perceived to be overwhelmed hy nonnationals. This is particularly true in Kuwait and, tO a lesser extent, in Saudi Arahia, where only a small number of former expatriates are allowed back and more stringent requirements are enforced with respect to the issue of new work permits. The demand for Arab labor is further eroded by competition from Asian labor. Available fragmentary data point to a significant decline in the share of Arab labor. It is believed that the trend, observed during the first half of the eighties, continued during the rest of the decade. It should he realized, however, that competition between the two groups is limited to certain types of employment. Some jobs, such as nursing and domestic service, are not covered by Arab labor, whereas others, such as those in which knowledge of the Arabic language is necessary, are not available to Asian lahor. For jobs open to both groups, preference for Asian employment is largely a function of wage differentials. According to Abele! Jaber, the wage paid to an Arab worker in the private sector in institutions employing 100 employees and more in Saudi Arahia was about twice that paid to an Asian worker in 1987 and rose to three rimes as much in 1989. In spire of the setback caused by the war and some adverse long­ term trends, the inrer-Arah lahor movement will conrinue to play an important role in the economic development of borh lahor­ surplus and labor-deficit countries. The experience of the last two decades poims clearly to the need to improve the conditions of work-especially of unskilled workers in the private sector-and to eliminate certain practices that seem to be inconsistenr with international and inter-Arab conventions. This is the joint responsi­ bility of borh labor-sending and labor-receiving countries.

Environment and Development

Recent years have witnessed a growing concern about the interac­ tion between the environment and development-more precisely about the extent to which both environmental constraints may put a limit on development and development may cause environmemal damage and degradation to the poinr of jeopardizing the quality of life as well as the opportunities for growth for present and future generations. The nature and policy implications of this relationship

©International Monetary Fund. Not for Redistribution 14 Said EI-Naggar

and their relevance to the Arab world are explored in the paper by Mostafa Tolba, "Environmental Policies and Sustainable Devel­ opment in the Arab World." The author sums up the increased concern about environment in the following terms:

The studies by the Club of Rome, the establishment of the United Nations Environment Program (UNEP) following the Stockholm con­ ference of 1972, the reports of the Willy Brandt, the Olaf Palme, and the Gro Harlem Brundtland Commissions, the Charter of Nature, the two World Conservation Strategies, the Global Strategy for the Conservation of Biodiversity, and several other efforts were all steps toward responding to these [environmental! problems and toward establishing a firmi l nk between the environment and development and toward giving real operational meaning to the term sustainable development that was coined by the Governing Council of UNEP 17 years ago. All this culminated in the Rio Conference on Environment and Development in june 1992. Agenda 21 was adopted at that conference by almost all governments of the world, including more than 100 heads of state and government. Agenda 21 puts under one roof the whole effort of the past 20 years. It cove rs almost every aspect of human endeavor and puts it within the context of what makes it environmentally sound and sustainable. Most of Agenda 21 is directed to governments, and it sets the tone for what needs to be done.

A number of points were raised in the discussion of this issue:

• That the environment is an important part of human patrimony, on the same footing as man-made capital, and should not be treated as a free resource. This is not to say that natural resources have a sanctity and that human society is an intruder to be pre­ vented from using the environment for its own benefit. What it does mean is that the exploitation of the biosphere should be based on full and prior knowledge of its real cost to society. It also means that excessive use of the environment could cause irreparable damage to growth and development prospects.

• That the real cost of exploiting nonrenewable natural resources is not fully reflected in market prices as it does not take into account the fact that, after a certain number of years, income derived from this source will cease to exist. By the same token, the national income of countries, which is heavily dependent on this kind of resource, does not represent real income in its entirety

©International Monetary Fund. Not for Redistribution I • Economic Development of the Arob Countries I 5

as it includes a certain element that is more akin to the sale of capital assets. There can be an income illusion similar to the money illusion under inflationary conditions. The real wealth of some countries may be significantly less than is suggested by conventional national accounts. This calls for reconsideration of the methodology by which the national income is calculated. The point at issue is of particular significance in the context of the Arab region, where a major part of income is derived from oil and natural gas, both of which are nonrenewable resources. The degree by which the conventional methods of accounting overstate the level of income varies greatly from one country to another depending on several factors, including the relative importance of nonrenewable resources in income structure, the length of time to elapse before depletion, and the rate at which the future stream of income is discounted. The 1992 World Devel­ opment Report of the World Bank refers to a pilot study on Mexico. Although it includes some renewable as well as nonrenewable resources, it is indicative of the orders of magnitude. When an adjustment was made for the depletion of oil, forests, and ground­ water, Mexico's net national product was almost 7 percent lower. A further adjustment for the costs of avoiding environmental deg­ radation, patticularly air and water pollution and soil erosion, brought the national product down by another 7 percent. In his comment on Tolba's paper, El-Serafy, whose contribution in the field is widely recognized, refers to formidable efforts to change the United Nations System of National Accounts so that environ­ mental change is incorporated in economic measurement of income and wealth. This initiative was sustained for many years by UNEP under Tolba's leadership, jointly with the World Bank, on whose behalf El-Serafy played an important role. The new United Nations System of National Accounts, to be enunciated later this year, will contain a set of national satellite accounts in which adjustment ro the national accounts can be made to reflect environmental degradation.

• That economic activity-whether in the form of production or consumption-is sometimes associated with environmental pol­ lution. In most cases the cost of pollution falls, not on the polluter, but on a third party. These cases are known as external disecono­ mies. The polluter pays principle (PPP) is intended to internalize

©International Monetary Fund. Not for Redistribution 16 Said EI-Naggar

the external diseconomies so that the cost of pollution is carried by the polluter. PPP is supposed to serve a double purpose: to penalize the culprit as a matter of equity and to equalize the private with the social cost of production or consumption. The equalization of private and social costs, it should be pointed out, is a condition for an optimum allocation of resources wherever externalities are involved. The principle has been widely accepted as a guide for environmental policymaking by governments and aid agencies. It is, however, capable of two imerpretations: as requiring polluters to pay only the costs of pollution conrrol and cleanups (standard PPP) or, in addition, to compensate citizens for the damages they suffer from pollution (extended PPP)­ an interpretation that gives citizens an entitlement to a clean environment. Also, where environmental effects spill over national borders and jurisdictions, it may be necessary to pay polluting or resource-using countries to cooperate in implement­ ing cost-effective solutions. The World Developmenl Report mentions the example of bio­ diversity losses owing to tropical deforestation and sulfur dioxide emissions thar contribute to acid rain outside the originating coun­ tly. These inducements or side-payments convert rhe polluter pays principle into the victim pays principle, but without them there may be linle or no incentive to cooperate in improving environmental quality.

• That there is a close link between population growth, poverty, and environmenral degraclarion. At the global level world popula­ tion is now growing by about 1.7 percent a year. During 1990-2030 the world's population is likely to grow hy 3.7 hill ion­ an increase much greater than in any previous generation. inery percent of this increase will occur in developing countries. Over the next four decades sub-Saharan Africa's population is expected to rise from 500 million to 1.5 billion, Asia's from 3.1 billion to 5.1 billion, Latin America from 450 million to 750 million, and the Arab world from 200 million to 350 million. Unless there is a change in current policies and practices, such a rate of population growth is likely to result in damage to the environment. A larger population means a greater volume of economic activity, a more intensive demand on land and other natural resources, higher levels of air and water pollution, more encroachment on biodiver-

©International Monetary Fund. Not for Redistribution I Economic Development o( the Arab Countries I 7 •

sity, and more wastes produced, thereby threatening local health conditions and taxing the earth's assimilative capacity. Environmental problems are exacerbated by the fact that most of the increase in population will be living in urban centers. According to the World Bank, most people in 1990 lived in rural areas. By the year 2030 the opposite will be true: urban popula­ tions will be twice the size of rural populations. Developing coun­ try cities as a group will grow by 160 percent over this period, whereas rural populations will grow by only 10 percent. By the year 2000 it is estimated that there will be 21 cities in the world with more than 10 million inhabitants, and 17 of them will be in developing countries. Urban congestion and degradation of the environment go hand in hand. Given the limited capacity of most developing countries in running huge cities, air, water, and noise pollution, in addition to sprawling slums, are likely to characterize the urban environment. Although high rates of population growth pose a serious threat to the the environment at the global level, this is not necessarily so at the country level. A great deal depends on the size of the population in relation to available resources. In the Arab region there is a world of difference between the demographic situation in countries like Saudi Arabia or Kuwait on the one hand and that in a country like Egypt on the other. In view of the rich endowment of the first two countries in oil resources and the relatively small populations, there is still much room for growth before the canying capacity of land and biosphere is reached. The situation is quire different in Egypt where the population of Cairo alone is well over that of the orher two countries combined. Along with population pressure, poverty is perhaps the worst enemy of the environment. Poor families often lack the resources to avoid degrading their environment. If they live in rural area� they are driven to cultivate poor and semiarid land where soil degradation is rapid. Struggling on the edge of subsistence with fragile and limited resources and preoccupied with day-to-day survival, they are in no position to invest as much as is needed to protect the environment. The situation is even worse in urhan areas where the poor are crowded in slums and shantytowns that lack the essential sanir�uy facilities. For these reasons poveny

©International Monetary Fund. Not for Redistribution 18 Said EI-Naggar

alleviation becomes not only a moral imperative but a prerequisite for sustainable development.

• That there is a wide gap between environmental concept:-., which are widely accepted, and their translation into workable policies. This is as true of the Arab countries as it is of developing countries at large. Policies have lagged considerably behind concepts, and implementation behind policies. This is due £O the fact that envi­ ronmental policies frequently clash with deeply entrenched vested interests. Stopping environmental damage often involves taking rights away from people who have long been accustomed to polluting and exploiting resources without being held account­ able for their actions. Not infrequently the biggest polluter is the government itself or the public sector. As producers of goods and services, public sector companies are interested only in reduc­ ing their cost even if that means shifting the cost of pollution to others. As a regulator with responsibility to prevent and control pollution, the government issues laws and regulations and sets health and technical standards. However, its own public compa­ nies are often the first to break the laws and ignore the standards with impunity. In this respect there is a basic conflict of interest between government involvement in the production of goods and services and its function as protector of the environment. It is not by accident that the worst cases of pollution are found in the former Soviet Union and in the former socialist countries of Eastern Europe. In the words of the World Development Report, "Being both poacher and gamekeeper does not work." There is no simple solution to the gap between intentions and performance. The problem needs to be attacked on all fronts. There is need for a greater separation between the regulator and the regulated, better information about the high cost of environ­ mental degradation, a stronger commitment to the goal of environ­ mental protection, more realistic standards together with better­ equipped and more effective enforcement agencies, and, finally, greater cooperation at both the regional and international levels.

Human Resources Development

The term human development is used by Stephen Heyneman to mean improvement in the quality of the population through education, health, nutrition, housing, a social safety net, and meet-

©International Monetary Fund. Not for Redistribution I • Economic Development of the Arab Countries 19

ing basic needs. Special emphasis is, however, placed on basic education as the most important element in the development of human resources. Enhancing the quality of human capital, it is well recognized, is essential for both efficiency and equity. By improving the productivity of labor, countries are made more competitive in the home market as well as internationally. This is particularly important in a world economy that has become characterized by a high degree of interdependence, spectacular technological prog­ ress, and giant trading blocs in Europe and orth America. To gain a foothold in today's world economy requires a literate, well-trained. and educated labor force. Recent studies of factors underlying the success story of the four tigers (th·e Republic of Korea, Hong Kong, Taiwan Province of China, and Singapore) indicate that a high literacy rate together with high-quality education have been one of the major determinants. Development of human resources is also important from the viewpoint of bridging the gap between rich and poor. Experience shows that one of the most effective ways of reducing income inequality is by raising the productivity of the poor by providing better access to basic services. It is impo1tant to note that Heyneman's study does not cover all Arab countries. It covers Algeria, Egypt, jordan, Tunisia, Yemen, and, occasionally, Iraq, the Syrian Arab Republic, Lebanon, and the Libyan Arab Jamahiriya. These are referred to as ME A countries, using the World Bank jargon for countries in the Middle East and North Africa. GCC Arab countries are not included in the study, nor are some other countries that belong geographically to the Middle East and North Africa. When the term Arab region is used in the context of this study it is in this special and limited sense. However, generalizations made with respect to this sample of coun­ tries are probably valid for the rest of the region except for the rich GCC countries. Development of human resources in these countries is influenced by a variety of factors. The dynamics of demographic change, in particular, play a major role. Most countries of the region share the common characteristic of being in the low mortality/high fertility transitional phase, with total fe1tility rates between 4 and 6 per woman. Despite recent dramatic declines in fertility, the overall rate of population growth is not likely to fall below 2 percent in the foreseeable future. According to Heyneman, no country's

©International Monetary Fund. Not for Redistribution 20 Said EI-Naggar

population will be stationary (replacement-level fertility and con­ stant-age composition) before about the year 2025. As a result the age structure of the population displays an exceptionally high dependency ratio. Approximately one person in three is of school age. The combination of high rates of population growth and high dependency ratios imposes a heavy burden in terms of providing basic services and infrastructural facilities. Another common feature pointed out by the author is that ME A countries invest relatively heavily, but achieve only modest returns, in human development. The proportion of public expenditure directed at human development-amounting on average to about 6-8 percent of GDP-is in fact comparable to the average in Organi­ zation for Economic Cooperation and Development (OECD) coun­ tries. However, the proportion of military expenditure is strikingly higher for MENA countries as a whole-about 15 percent of GDP compared with 6 percent in countries of the OECD-suggesting that a decline in regional tensions could have a significant impact on human resource investments in the aggregate. The problem with human development expenditure in the Arab region is not the overall average but its intersectoral distribution, illustrated by the distribution of public expenditures between primary education on the one hand and higher education on the other. Morocco, for instance, spends about 14 percent more on an elementary school student than it spends on a student in tertiary education, jordan spends about 12 percent, Tunisia, 8 percent. In contrast, japan spends the same amount on a primary school student as on a student in tertiary education, whereas the average for OECD countries is about 49 percent. This is not the only kind of imbalance, however, in the allocation of resources devoted to human development. There are imbalances with respect to the distribution of facilities between rural and urban areas, capital and recurrent expenditure, salaries and equipment, and finally, between girls and boys as to availability of educational facilities. These shortcomings are not peculiar to the Arab region. They tend to be characteristic of the situation in most developing countries and are ascribable to a combination of financial, political, and, in some instances, cultural pressures. The result has been a poor rate of return on investments in human development as reflected in the state of some social inclicawrs. As pointed out by

©International Monetary Fund. Not for Redistribution I • Economic Development of the Arab Countries 21

the author, only two countries-jordan and Iraq-have brought adult illiteracy below 40 percent. In some counrries the illiteracy rare is well over 50 percent, with a much higher rare among female�. A number of countries have failed to attain universal primary educa­ tion. Only Jordan, Tunisia, and Syria have infant monality below 50 per thousand. A third characteristic of human development in the region is the existence of wide gaps in the fulfillment of basic needs and in the social safety net. In theory. most countries have an extensive net­ work of social services, including guaranteed employment, unlim­ ited free access to basic education, free higher education, and free preventive and curative medical services in addition tosubsidization of basic consumers' goods and services as well as essential elements of a social safety net. However, the resources needed to fund such a far-flung welfare system exceed by far the financial capacity of the state. As a consequence cenain types of services were more or less left unattended while others were maintained at less than satisfactory levels. The fourth characteristic is the heavy involvement of the state in the provision of human development services. The overwhelming proportion of schools and hospitals are owned and managed by the public sector. Private provision of social services is still rare, except for general practitioners and some educational establish­ ments catering to the urban elites. In some countries the situation has recently been moving toward a greater role for the private sector. This is panicularly so in countries that entered into agreements with the Bretton Woods institutions aimed at liberalization, privatization, and deregulation of the economy. But progress has been rather slow in the face of deep-rooted tradition of statism especially in the area of social services. University education in Egypt is a case in point. For a long time university education has been virtually a state monopoly. Except for the American University, all establish­ ments of higher education belong to the Government and are almost completely financedfrom the state budget. Recently, attempts have been launched ro establish rwo private universities. So far, however, little has been accomplished and the final result of these efforts is still very much in question. The extent to which the Arab countries are able to improve the condition of human development services will largely depend on

©International Monetary Fund. Not for Redistribution 22 Said EI-Naggar the availability of financial resources, better allocation among and within sectors, wider application of the cost-recovery principle, a precise definition of target groups that need special help from the government, and a larger role for the private sector. In some coun­ tries a fair amount of resources could be redirected from the military budget to human resource development once tensions in the region are reduced and peace is established. o less important is the implementation of comprehensive reform programs designed to eliminate rigidities and distortions and to ensure more efficient utilization of resources. With higher growth rates, the economy can generate enough resources to support human development at an acceptable level.

European Economic Integration As the foremost trading partner, the European Community (EC) is of special importance for the growth and development of the Arab countries. This is particularly so for the Maghreb countries where the share of the Community in their export structure is more than 50 percent. But it is also true with respect to other countries that depend on the European market for an average of about 30 percent of their exports. On the import side, the EC occupies a position of more or less equal importance. The same cannot be said with respect to the relative position of the Arab countries in the foreign trade of the EC. This is hardly surprising, since the EC accoums for more than one-fourth of total world exports and imports. Nevertheless, the share of the Arab market in the total exports of the EC averaged about 12.5 percent for 1988-91. As to imports by the EC from the Arab countries, oil represents the main component of this trade flow. Excluding oil, the share of the Arab countries would be a modest 2.5 percent of total imports.However, trade is not the only channel through which the EC has an impact on the growth of the Arab countries. It figures prominently in financial flows, development assistance, and labor migration. In his paper, "European Economic Integration and the Arab Countries," Rolf Langhammer offers an analysis of the possible effect of recent developments in the EC on the Arab countries. He rightly refers to the difficulty of assessing the impact because a process of integration deepening has recently coincided with one

©International Monetary Fund. Not for Redistribution I Economic Development of the Arab Countries 23 • of integration widening. Integration deepening means the comple­ tion of the single market program-or EC-1992-involving the removal of all barriers to intra-Community trade as well as all sorts of border controls and liberalization of factor movements. At the same time a process of integration widening has been under way in two directions. The first is the establishment of the so-called European Economic Space (EES), which extended the free move­ ment of goods and services to member countries of the European Free Trade Association (EFTA) without the benefit of a common external tariff. In the author's view, this is not particularly significant. Much more important from the viewpoint of assessing the impact on developing countries, including the Arab countries, is integration widening through the so-called Europe Agreements negotiated in December 1991 with the former Czech and Slovak Federal Republic, Poland, and Hungary. These are association agreements that could eventually lead to full membership. In the interim they provide for basically free trade arrangements in manufactures to be achieved over ten years. Concessions are given first by the EC to be followed by concessions by the other party. In addition to integration deepening and integration widening, the position of Arab countries in the European marker is defined by special preferential arrangements. In 1976 and 1977, the EC concluded cooperation agreements with the Maghreb and Mashreq countries, respectively. These agreements offered free access to EC markets for manufactured goods and some special provisions for selected agricultural products on a nonreciprocal basis, plus finan­ cial aid and improved social security for Maghreb and Mashreq workers in the Community. Taking all these factors into account, the author does not seem to be particularly sanguine about the prospects for the Arab coun­ tries in EC markets. His conclusions can be summed up as fo llows:

• During the three years preceding EC-1992 the Arab countries failed to capture a larger share in EC imports even though it was a period of rapid economic growth. Gains in trade shares in specific sectors like textiles, clothing, and agricultural goods could not compensate for the weak competitive position of the Arab countries in labor-intensive products-the most rapidly growing import sector. Similarly, the gains scored by the Maghreb countries

©International Monetary Fund. Not for Redistribution 24 Said EI-Naggar

in non-oil imports were offset by the losses suffered by the mem­ bers of the Organization of the Petroleum Exporting Countrie:-. (OPEC). The poor performance of the Arab countries is explained by the author in terms of both demand and supply factors. On the demand side, the second enlargement of the EC by the acces­ sion of some countries (Portugal, Greece, and Spain) whose export structure is similar to that of Arab suppliers was responsible for a certain measure of trade diversion. On the supply side, trade performance was adversely affected by macroeconomic distor­ tions and imbalances.

• As to the probable impact of EC-1992, the author bases his conclu­ sions on studies by Michael Davenportand Sheila Page. Following the Vinerian tradition, a distinction is made between trade diver­ sion caused by changes in relative prices of different suppliers and trade creation arising from higher growth rates. The basic finding is that Arab suppliers of primary commodities are likely to gain through the trade creation effect. But this again is going to be outweighed by the losses endured by exporters of manufac­ tured goods through unfavorable trade diversion effects. The out­ look for textiles and clothing under the Multifiber Arrangement (MFA) is anything but optimistic. The protection extended to Mediterranean suppliers is likely to be eroded once national quo­ tas are dropped in the context of EC-1992. Their problem in the EC market will be compounded if MFA is completely phased out.

• With respect to foreign direct investment, it is concluded that the Arab countries neither succeeded in attracting FDI from EC member states nor have they suffered a significant outflow in that direction. According to the author, the poor performance of the Arab countries in this sector is consonant with the general observa­ tion that developing countries have increasingly been bypassed by OECD investors except for a very few newly industrializing countries. It is rightly pointed out that the major portion of FDI tends to flow toward the industrial countries on account of impor­ tant advantages in terms of macroeconomic stability and low transaction costs.

• In the relationship between the Maghreb countries and the EC, labor migration has always played an important role. It is esti­ mated that the number of migrants from the Maghreb countries residing in the EC amounted in 1989 to some 1.9 million, or about

©International Monetary Fund. Not for Redistribution I • Economic Development of the Arab Countries 25 one-fourth of total migrants from all ongms. It is argued that, given the widening income gaps between Europe and its southern and eastern neighbors, and the ra pidly rising number of migrants and refugees, it is most likely that defensive measures to control and contain migration will be one of the early effects of EC integration. Looking at the picture as a whole it is imponant to keep in mind that the assessment of the EC impact on trade, investment, and migration is subject to a high degree of uncertainty. Indeed the author himself was careful to refer to this difficulty at the outset of his study. The conclusions outlined above could be significantly modified by a host of fa ctors. Most of the countries in the Arab region, for instance, are undertaking comprehensive reform programs with far-reaching implications for international competitiveness and macroeconomic stability. Also, the last decade has witnessed a rising trend toward the regionalization of the world economy. It is not clear how far the dynamics of the situation will give impetus to parallel integration efforts in the Arab region. Presently, all integration schemes except for the Gulf Cooperation Council are either dormant or ineffective. But there is no reason to rule out a revival of interest in closer inter­ Arab cooperation that could have a profound impact on Arab­ European relations. Finally, the Uruguay Round of Trade Negotia­ tions is still hanging in the balance. Whether it succeeds or fails could exercise a powerful influence on the international trading system as well as on the world economy. Any one of these factors, or a combination of them, could upset conclusions reached under quite different assumptions.

©International Monetary Fund. Not for Redistribution Economic Reform in the Arab Countries: A Review of Structural Issues

MOHAMED A. EL-ERIAN and SHAMSUDDIN TA REQ1

espite adverse exogenous fa ctors, Arab countries have Dachieved imponant economic gains in recent years. Never­ theless, many of them remain subject to internal and external constraints that prevent the full realization of their considerable economic potential. The welfare gains forgone are of particular relevance in the current environment, characterized, inter alia, by rapid population growth in some countries in the region, concerns about the availability of natural resources (namely, water), uncertain oil prices, and a move outside rhe Middle East toward regional economic blocs combined with slow progress in multilateral trade liberalization efforts. There is growing recognition among Arab countries on the need to strengthen their economic performance in a sustainable manner. This involves the implementation of comprehensive measures to enhance the mobilization, and increase the efflcient use, of produc­ tive resources. Indeed, several Arab countries have taken structural reform and adjustment measures aimed at improving the supply responsiveness of their economies and containing excessive aggre­ gate demand pressures. Given the considerable economic and financial diversity of the Arab world, there is no single approach to identify concisely and comprehensively the challenges facing individual countries in the region as well as their policy implications. At the same time, how-

1The views expressed in the paper are those or the authors and do nm necessarily renect those of the International Monetary Fund.

26

©International Monetary Fund. Not for Redistribution 2 Structural issues in the Arab Counuies 27 •

ever, several of these countries share �imilar policy issues, particu­ larly in the area of structural reform, and some of them have already taken actions to address these issues. Accordingly, by reviewing the broad economic issues and the policies taken so fa r, this paper specifies an overall framework that may he applied to individual countries, taking account of their specific circumstances. The first section of the paper briefly reviews economic and finan­ cial developments in Arab countries in the 1980s, using the experi­ ence of developing countries as a whole as a basis for comparison. This review provides the background for the discussion in the following section of a "'core" set of structural policy challenge� fa cing Arab countries in the 1990s. After briefly analyzing these challenges, the paper reviews specific reform measures drawing on the experience of countries in the region. It concludes with a summary of the main findings.

Developments in the 1980s The decade of the 1980s was relatively disappointing one for a developing countries as a group. Compared with the 1970s, it was characterized by weaker macroeconomic performance (Chart 1). Specifically, (1) real G DP growth was lower in the decade of the 1980s compared with that of the 1970s; (2) the consumer price index increased significantlyfa ster in the 1 980s; and (3) the accumu­ lation of external debt was higher in the l980s despite the sharp curtailment in the availability of spontaneous financing. These country averages conceal important differences among regional groupings, with relatively weak performance hy African and Latin American countries, particularly relative toAsian economies. Under­ lying the macroeconomic developments were adverse exogenous developments (including unfavorable Lerms of trade) and domestic policy weaknesses (including large financial imbalances associated with overexpansionary fiscal and monetary policies). Arab countries' performance was mixed relative to the developing country average.2 Real GOP expanded at an average annual rate

lAggregates for An1b countries are compiled on the basis of computed GDP­ weighted averages for individual members of the Arab League for which comprt:­ hensive data are currently available (Algeria, 13ahrain, Djibouti, Egypt , Jordan, Kuwait. Lebanon, the Libyan Arab jamahiriya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab Republic, Tunisia, the United Arab Emirates, and the Republic of Yemen).

©International Monetary Fund. Not for Redistribution 28 Mohamed A. EI-Erian and Shamsuddin Tareq

Chart 1. Developing Countries: Selected Indicators (Index numbers)

190 .------� Real GOP Growth 170 1970-79 150

1 30 ------7980-89 - - -- 110 - - -- 90 �--�--�----�--�--�--��--�---L--�--� 2 3 5 8 10 4 6 7 9 2 . ------000 - .� Inflation ' 1980-89 , 1500 , ,, � 1000 � � � 1970-79 :=:: :::::=, � 500 =: - _:, , ------:-::-::- :====-_j - - == - : 0 L-=����==···-�- 2 3 4 5 6 7 8 9 10

190 r------� Debt/GOP Ratio 170

1 50 1970-79 130 110 90 L---�--�----�--�--�--��--�--�--�--� 2 3 4 5 6 8 9 10

Source: International Monetary Fund, Data Fund.

of some 2 percent in the 1980s (Chart 2). With a relatively high population growth, per capita incomes declined at an average annual rate of about 1 percent.3 Inflation performance in the Arab countries was considerably better than that for developing countries

.Yfhe comparisons with the developing country group are sensitive to the staning point for the comparison periods. Thus, the hoi e of 1980 as the base year biases c c the comparison downward, as 1980 was associated with an historically high oil

©International Monetary Fund. Not for Redistribution 2 • Struaural lssues in the Arab Countries 29

Chart 2. Arab Countries: Growth of Real GDPl (A nnual changes in percent)

1 0 .------�

Arab countries excluding major oil producers .. I ' 1\ I I \ 5 I I \ I ·. I \ ' ' , I \ ,, \ ... \ .... '*'""'

...... � . or-----��--������----�-.. -�------1

·.;

Major ail producing countries

-5 �--�--�--�----�--�--�---L--�----�--�--� 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source: International Monetary Fund Data Fund. , 1 Weighted geometric average.

as a whole, in spite of the acceleration in the rate of inllation in the later part of the decade (Chart 3). Finally, the group's current account position improved after 1984, despite the lower interna­ tional petroleum prices. As with the developing country group, macroeconomic aggre­ gates for Arab countries as a whole conceal important differences between individual countries-countries that differ (substantially price level. Indeed, the nominal oil revenues of the Arab members of the Org;miza­ tion of the Petroleum Exporting Countries (OPEC) increased from SS6 billi n in o 1975 to S278 billion in 1980. Following the sharp fall in international prict:s. they declined to $49 billion in 1986. Additional inf rm tion is contained in EI­ o a Kuwaiz ( 1990).

©International Monetary Fund. Not for Redistribution 30 Mohamed A. EI-Erian and Shamsuddin Tareq

Chart 3. Arab Countries: Consumer Pricesl (Annual changes in percent)

30 .------·

, , , 25 , ' , ' I ' I ' I ' , , ...... _.- 20 1 I I , Arab countries I ' excluding major ,.. ' ... ""' " oil producers , 15 ', , ___, ,

...... ,,'

10

5

0 �--�----�--�--�----�---L--�----�--�----�--� 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Source: International Monetary Fund, Data Fund. 1 Weighted geometric average.

in some cases) in their natural resource base, labor endowments, and financial resources. This difference is most apparent when comparing oil and non-oil countries' growth performance--and despite strong interrelationships among the rwo groups (including those resulting from remittance and aid flows, both of which have been affected by changes in oil export receipts).'' As expected, the

�For this purpose, oil countries arc defined as those deriving more than half of their domestic output from the extra ti n of crude oil. As in the case of the c o coverage used by the Arab Monetary Fund 0991 ) the grouping includes Algeria, , Bahrain, Kuwait, Libya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. As noted by EI-Kuwaiz 0990), there are substantial differences even within this subgroup of Arab countries. Various anempts have been made to classify Arah

©International Monetary Fund. Not for Redistribution 2 • Structural Issues in the Arab Countries 3 I fall in oil prices, compounded by a reduction in production and exports, affected more severely growth performance in the oil pro­ ducing countries.' Thus, while non-oil countries' rer capita income gains exceeded those of developing countries as a group, the oil producing countries recorded negative per capita growth rates in several years during the 1980s. The non-oil countries' inflation performance was also berter than that of developing countries as a whole but fell sho11 of that of the oil rroducing countries. This differentiated performance was consistent with monetary develop­ ments, with non-oil countries recording larger domestic liquidity growth throughout the period (Chart 4). This rrimarily reflected the financing requirements of fiscal deficits in the context, inter alia, of limited reserve funding.

Major Policy Issues for the Remainder of the 1990s and Reform Experiences Arab countries face important economic challenges and opportu­ nities in the remainder of the 1990s. Of course, their exact nature and magnitude vary, depending on the country being considered. In addition to differences in economic and financial conditions­ including the degree to which they were affected by the 1990-91 Middle East crisis-countries vary in the extem to which they have already embarked on comprehensive economic adjustmem and reform programs. Thus, some countries have imrlememed some corrective measures but as yet do not appear to have reached the critical policy mass required to address decisively the economic and financial imbalances. In contrast, others have persevered with comprehensive adjustment and reform rrograms, rlacing them more firmly on the road to sustained medium-term economic growth and financial stability. In view of these factors-which are compounded by differences in the "reserve cushion" available to countries in the region and their vulnerability to exogenous

countries on the basis of other criteria such as pt:r capita income. population density, and debt burdens. 5Real GOP in oil p oducing cou ries is heavily inOuenced hy nuctuations in r m oil production. For a discussion of related national accounting issues, refer to Ahmad, EI-Serafy, and Lutz ( 1989).

©International Monetary Fund. Not for Redistribution 32 Mohamed A. EI Erian and Shamsuddin Tareq -

Chart 4. Arab Countries: Broad Money Aggregates 1 (Annual changes in percent)

4Q r------�

I\• I \ I \ I \ I \ I \ \ \ \ \ Arab countries \ excluding mojor .1', ., " \ oil producers 11 ' , \ " ., " \ I ' I '--- " \ ... I ...... " \ ... \ "" \ " .,

·· . ·· ...... · · . .. · . Major oil . · ...... ·· producing countries .. . ..

0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1 989 1 990

Source: International Monetary Fund, Data fund. 1 Weighted geometric average. shocks-the type of approach taken in this section will, by neces­ sity, involve a certain degree of aggregation and generalization. There is widespread agreement that most countries in the region stand to benefit from sustained domestic policy efforts aimed m improving the efficiency of resource use. Indeed, some observers have noted that the real issue is not whether to implement adjust­ ment and reform measures, but rather the nature of the required measures.c' This issue assumes added importance given some coun­ tries' rapid population growth and concern about water supplies and oil prices. Moreover, the international environment facing Arab

�For example, EI-Naggar ( 1987).

©International Monetary Fund. Not for Redistribution 2 • Structural Issues in the Arab Countries 3 3 countries includes movements toward regional trading blocs out­ side the region (for example, in Europe, Asia, and the Americas) in the context of slow progress in multilateral trade liberalization efforts.7 This section seeks to identify, in a summary fa shion, some of the major stmctural economic challenges facing countries in the Arab world. Their policy implications are discussed, and the experi­ ence of selected Arab countries' in implementing appropriate reform measures is reviewed.!!

Reforming Public Enterprises

One of the important fe atures of many countries in the Arab world is the dominant role played by the public sector. Thus, over the years, the public sector has increasingly participated directly in a wide range of economic activities, many of which bore little relation to arguments of strategic importance, natural monopolies, public goods, and other market failures. In many countries, rhe growth of the public sector initially had its roots in considerations relating to the establishment of "essential industries" (such as steel, fertilizers, and chemicals)-industries deemed imperative for the development of the economy bur considered beyond the capacity of the private sector. In several countries, these factors were accom­ panied by sociopolitical considerations (Algeria, Egypt, Iraq, Sudan, Syria, and the former People's Democratic Republic of Yemen), including the wish to reduce the influence of external forces and

'A related issue that is not addressed directly in this paper is the scope for efficient economic cooperation among Arab countries. For a discussion of Arab economic integration, see Shafik (1992). It may be noted, however, that progress among countries in the identified policy areas would be an important contribution to the processof"policy convergence" that would be essential to underpin effective Arab economic integration. �Unle�s accompanied by appropriate fiscal, monetary, and exchange rate poli­ cies, the structural reform measures discussed below will not result in a sustainable improvement in economic and financial performance. At the same time, it is worth noting that several of the structural reforms discussed below can lead to an improvement in public sector finances, facilitating the reduction ofmacroeconomic disequilibria and more efficient resource allocation. For a discussion of the devel­ oping country experience in this regard, refer to International Monetary Fund (1992). Selected aspects of demand management policies in Arab countries are discussed in Shaalan (1987).

©International Monetary Fund. Not for Redistribution 34 Mohamed A. EI-Erian and Shamsuddin Tareq certainsegments of domestic society.''In some countries, the impor­ tance to the government of securing control over the exploitation of a strategic natural endowment also played an important role. Thus, the private sector came to perform an increasingly residual role in a number of economic and financialsectors, with administra­ tive allocation of resources replacing market signals. Moreover, in the 1970s, the increased dominance of the public sector in several oil countries reflected the structure of these economies, particularly the relatively I imited role of the private sector in production activities in the context of large windfalls accruing to the public sector as a result of the oil price increase of 1973-74. Indeed, public finance policy was the primary determinant of domestic liquidity, aggregate demand, and non-oil GOP growth.10 Economic performance of public enterprises in Arab countries has been far from satisfactory in most cases.11 The enterprises' earnings have tended to fa ll short of their current financial obliga­ tions, let alone provide for an adequate return on capital. As in other developing countries, production efficiency has been under­ mined by insufficient commercial orientation and management accountability-including exogenously determined investment, pricing, and employment considerations. In addition to receiving direct transfers from the budget to subsidize mounting losses, some of the public enterprises were provided with subsidized inputs and credit-placing a heavy burden on already strained budgetary and monetary policies. In some cases, the banking systems' nonper­ forming claims on public enterprises have also weakened the integ­ rity of the financialsystem. These problems have been compounded by rigid labor legislation in a number of countries-an issue that also has adversely affected private sector production and investment.

9See EI-Naggar ( J989a). El-Naggar notes that several other countries (for exam­ ple, jordan, Morocco, Tunisia, and the former Yemen Arab Republic, as well as members of the Gulf Cooperation Council (GCC)) may be viewed as belonging to the group of '·pragmatic interventionism," where sociopolitical considerations tended to play a relatively less important role. 1<>'fhe impact of fiscal policy on macroeconomic aggregates in these countries during the 1970s is discussed in Morgan (1979). Indicators of public sector activilie� for some other Arab countries are presented in Heller and Schiller (1989). 11For a more detailed discussion of this issue, see Wall (1990).

©International Monetary Fund. Not for Redistribution 2 • Struaura/ lssues in the Arab Countries 35

There is increasing recognition of the need to rationalize the public sector's activities to those operations that it undertakes most efficiently and that are warranted by market failures. In some Arab countries, this recognition has been translated into efforts at enter­ prise reform incorporating the provision of greater autonomy and accountability, financial restructuring, and privatization. However, compared with other developing country regions, the scale of privatization in the Arab world has been limited. Thus, with one exception, no country in the region may be regarded as having implemented a comprehensive rrogram of wholesale divestiture of public sector enterprises-in contrast to the experience in Asia, Central and Eastern Europe, and Latin America. In Arab countries implementing public sector restructuring pro­ grams, the initial stages included diagnostic studies to assess the financial viability of enterprises and the rationale for public owner­ ship and control (Mauritania, Morocco, and Tunisia).12 Decisions have also been made regarding the best institutional setup to imple­ ment the restructuring program. Thus, in some countries, the pro­ cess of granting greater autonomy to enterprises has involved the use of a holding company construct (Algeria and Egypt), which, while still under public ownership, was to be free from administra­ tive interference. The holding companies were given the authority to approve business plans, restructure, merge, liquidate, or privatize the enterprises under their control. Progress, however, has been slower than anticipated, reflecting, inter alia, constraints inherent in the construct itself-and has resulted in further policy adaptations. Other-albeit less comprehensive-approaches have also been implemented in the region. These approaches include transfers to workers' cooperatives (Libya and Somalia); sales of some shares to the public (Oman, Qatar, and Saudi Arabia), to foreign minority partners (Qatar), and through joint ventures (GCC countries); employee buyouts (Morocco); use of management performance contracts (Algeria); and assumption by the central government of enterprise obligations to the banking system (Mauritania).13

12ln Tunisia, privatization of the loss-making public enterprises identified in the study has been virtuallycompleted. Th� authorities are now preparing to undertake the privatization of the other enterprises. 1JFurther country-specific information is contained in Candoy-Sekse 0988) and Heller and Schiller 0989). More detailed analyses of privatization in Egypt, the

©International Monetary Fund. Not for Redistribution 36 Mohamed A. EI-Erian and Shamsuddin Tareq

In addition to institutional constraints (including the absence in some countries of sufficiently deep capital markets), public enter­ prise reform has been delayed by concerns about the absorption of surplus labor and by difficulties in addressing the large financial obligations of the enterprises-obligations that not only involve direct and contingent budgetary liabilities but also affect the sound­ ness of the domestic banking system. Some countries have sought to "clean up" enterprises' balance sheets prior to their transfer to the private sector. This has included the setting up of a fund to cover accumulated losses (AJgeria and Tunisia), cross-cancellation of bilateral obligations (Morocco), and a waiver of enterprises' arrears to the central government (Algeria and Tunisia). The issue of absorbing surplus labor has primarily concerned the extent of concomitant growth in private sector activities-which, as dis­ cussed below, has been closely related to policy actions to liberalize production and investment regulations. More forcefully addressing the institutional and financial con­ straints constitutes a necessary but insufficient condition for effec­ tive reform of public sector enterprises in Arab countries. The pro­ cess must be accompanied by modifications in the production envi­ ronment, which includes enhancing competitiveness and market discipline through domestic and external trade liberalization poli­ cies supported by appropriate regula£Oryand supervisory practices; rationalizing the system of credit subsidization through the banking system; modifying labor legislation; and limiting explicit and implicit guarantees for enterprises' domestic and external nonbank borrow­ ings. While some important steps have been taken (as discussed below), progress so far remains limited in several countries in the region.

Other Fiscal Sector Reforms The dominant role of the public seClor in Arab countries has also been reflected in the structure and size of the central government budget. For some countries-particularly the major oil exporters­ the financing of budgetary expenditures did nor pose a problem

GCC countries, jordan, and Tunisia are contained in, respectively, Abdei-Rahman and Sultan (1989), Khatrawi 0989), Anani and Khalaf 0989), and 13ouaouaja (1989).

©International Monetary Fund. Not for Redistribution 2 • Structural Issues in the Arab Countries 3 7 as long as internation�l oil prices were relatively high. However, sharp falls in oil prices and associated budgetary revenues. particu­ larly in the mid-1980s, exposed the vulnerability of the fiscal accounts, requiring sharp cuts in expenditure and mobilization of budgetaty financing from domestic and external sources.'' They also highlighted the importance for some countries of diversifying the revenue base by increasing the share of non-oil revenues. As noted earlier, non-oil Arab countries have fJced more persistent budgetary problems that have contributed to inflationary and bal­ ance of payments pressures. There is increasing recognition among policymakers that the required effective and permanent red uction in fiscal imbalances necessitates the adoption of measures that also improve the struc­ ture of budgetary revenue and expenditure. Without such structural improvements, a series of politically difficult fiscal adjustments would be required periodically to prevent the re-emergence of fiscal imbalances. In many Arab countries, the wx system has been characterized by a myriad of taxes and rates, differentiated in scope by the type of income and sector of activity, with various levies and fees super­ imposed thereon, as well as ad hoc concession and exemption schemes. This conglomeration has tended to weaken the elasticity and buoyancy of the tax system, give rise to production and equity distortions, and undermine tax administration. Accordingly, some Arab countries have undertaken comprehensive reforms of th<:ir domestic tax systems (Algeria, Morocco, and Tunisia). Several oth­ ers have initiated a similar effort (Egypt, jordan, and Mauritania); while others are still at the policy design stage. The key objectives of the tax reforms implemented in the Arab countries have included simplifying the tax system and rendering it more transparent; improving its buoyancy and elasticity; reducing anriproduction and antiexport biases; enhancing the redistributive features; and reducing the vulnerability of tax collection to adverse movements in the external terms of trade. The main challenge has been reform of direct and indirect taxes, in the context of reduced reliance on international trade taxation. The most comprehensive

1-i'fhe links between oil prices and flscal roliqr developments in the Arab oil producing countries are discussed in EI-Kuwaiz ( 1990) and Morgan ( 1979).

©International Monetary Fund. Not for Redistribution 38 Mohamed A EI-Erian and Shamsuddin Tareq reforms have provided, inter alia, a broadening of the taxable income base; taxation of all individual income under the same tax schedule; elimination of multiple taxation of corporate profits; clarification of rules determining incomes and profits (including depreciation allowances); rationalization of exemptions (including a uniform minimum exemption floor); and introduction of current­ year payments of realized tax liabilities. On the indirect taxation side, the challenge in most countries has been to ra tionalize a system characterized by a wide range of turnover levies and excises, with cascading fe atures as a result of taxation of the same activity at multiple levels and rates. The most direct reforms have included replacing various taxes and levies by a single value-added tax (Algeria, Morocco, and Tunisia). Apart from the unification aspect, an important advantage of this measure has been the establishment of clear deduction rules governing taxes paid at earlier stages of production. The new value-added tax has been accompanied by a reduction in the number of rates and a broadening of the coverage to sectors previously excluded. Equity considerations have been addressed through the exemption of basic consumption goods and activities deemed critical for social reasons. Other reforms of the indirect tax system have included the adoption of sales taxes (Egypt) and consumption taxes (jordan), and shifting excises from a specific to an ad valorem basis (Mauritania). Despite progress in tax reforms, the region as a whole continues to be heavily dependent on collections from international trade (including petroleum exports). Nevertheless, the strengthening of the domestic taxation base has provided increased scope in some countries for measures to les!>en reliance on such taxes. In these countries, the reform of these taxes has been undertaken in the context of a broader trade liberalization effort (Algeria, Egypt, jor­ dan, Mauritania, Morocco, and Tunisia). Adjustment measures have aimed at rationalizing and liberalizing customs tariffs through a reduction in the average tariff rate and through the dispersion of rates. These measures have also provided for efficiency gains as a result of the accompanying reduction in distortions in effective rates of protection. Further progress in tax reform efforts also needs to take greater account of regional factors. Indeed, increased emphasis on tax harmonization among Arab countries is an important contributing

©International Monetary Fund. Not for Redistribution 2 Structural Issues in the Arab Countries • 39 factor to larger and more efficient intra-Arab economic and finan­ cial relations. As noted earlier, several oil producing countries (including Libya and Saudi Arabia) took steps to reduce expenditures in the face of declining oil revenues. As was true for other countries, the challenge was to curtail expenditure on activities of limited efficiency, includ­ ing lower-priority infrastructural projects. Other Arab countries have complemented such efforts by imposing strict limits on public sector employment and wages Qordan). Nevertheless, there is scope in several countries in the region for further curs in unproductive expenditures and for rationalizing outlays on public sector wages and salaries. This would fa cilitate the provision of greater resources for education, health, other social services, and infrastructure-an issue that is of particular importance for several of the lower-income countries in the region.

Financial Sector Reforms As in other developing countries, the reform challenges in the financial sectors of many Arab countries include three key elements: (1) rationalizing the rates of return structure supporting the mobili­ zation and allocation of loanable funds; (2) deepening money and capital markets in the formal sector of the economy; and (3) strengthening prudential regulation and supervision. The financial sector in many Arab countries has been character­ ized by strict controls over rates of return, supplemented by quanti­ tative limits on the overall and sectoral allocation of credit. This system grew out of the desire, inter alia, to prevent usurious rates and to provide mechanisms for channeling credit to particular sec­ tors deemed to be a national priority (heavy industrial and export­ oriented sectors). In many cases, however, the system of strict controls over rates of return and quantitative credit allocations has contributed to financial disintermediation, currency substitution, and credit rationing of productive activities-particularly with an overexpansionary budgetary stance. In addition, the channeling of subsidized credit to certain sectors has resulted in investments in financially questionable projects, with recurrent funding require­ ments and a growing portfolio of impaired bank assets. Accordingly, several Arab countries have embarked on a process of financial liberalization as part of their financial sector reforms.

©International Monetary Fund. Not for Redistribution 40 Mohamed A. EI-Erian and Shamsuddin Tareq

In some of the Arab countries, the first steps toward financial liberalization have included the implementation of greater flexibility in rates through the use of prescribed ceiling and floors (Morocco), subject in some cases to timely changes in view of developmenrs in international financial markets (Qatar). In other countries, the initial phase focused primarily on deposit rates. Eventually, how­ ever, most of these countries have also substantially liberalized their rate structures (Algeria, Bahrain, Egypt, jordan, Morocco, Tunisia, and the United Arab Emirates) and taken steps to terminate prefer­ ential credit arrangements for public enterprises (Tunisia). In some countries where the banking system has been burdened by a large portfolio of nonperforming assets, the government has moved to strengthen the financial integrity of the banking system by exchang­ ing a portion of these assets for government obligations (Kuwait) and recapitalization through direct budgeta•y transfers (Egypt). The beneficial impact on financialintermed iation of the liberaliza­ tion of the rate structure also depends on a concurrent move away from quantitative credit restrictions and toward indirect monetary control instruments. Accordingly, steps have been implemented for increased reliance on reserve requirements (Morocco), elimination of prior central bank approval for bank credit (Tunisia), and modifi­ cations to the rediscount mechanism to render it more sensitive to market conditions (Egypt). Nevertheless, several coumries remain encumbered by administrative credit allocation mechanisms that respond weakly to risk/rerum considerations. Lmproving the financial intermediation process in Arab countries also requires a deepening of money and capital markets. This deep­ ening would provide for a wider ra nge of domestic financial instru­ ments-thereby allowing for a shift in portfolio incemives away from both acquiring physical assets (including for consumption purposes) and from holding foreign financial assets. At rhe same time, it would strengthen the institutional basis for indirect monetary control instruments-thereby also strengthening the allocation of loanable funds. For most Arab countries, the development and deepening of money and capital markets is an important challenge. In several cases, it involves renewed efforts at institution building. Some Arab countries have had money markets in operation for several years, but their effectiveness has been constrained by the absence of

©International Monetary Fund. Not for Redistribution 2 Structural Issues in the Arab Countries 41 •

interbank transactions (Algeria), limited central bank rate flexibility in intervention operations (Morocco), and restraints on financial sector participation (Algeria and Morocco). These constraints are being addressed, complemented by the introduction of new finan­ cial instruments and auctioning procedures for short-term govern­ ment securities. Similarly, efforts are under way in certain countries to strengthen existing capital markets. including through improve­ ments in trading, reporting, and accounting systems. Financial liberalization may under certain circumstances involve increased risk for the soundness of the financial system, which also implies contingent liabilities for public finances, particularly in the context of explicit public sector safery net arrangements. Accord­ ingly, steps to liberalize and deepen the financial system must be accompanied by an appropriate strengthening of prudential regulatory and supervisory practices. The emphasis in Arab coun­ tries has been primarily on improving the regulation and supervision of commercial banks. Among recent steps were the introduction of minimum capital and/or net-worth requirements (Algeria, Egypt. jordan, Morocco, and Oman) and minimum liquidiry ratios (Qatar). Explicit guidelines have been issued for improved classification of loans according to risk and provisioning standards (Algeria. Bah­ rain, Egypt, Morocco, and Tunisia) and for portfolio concentration to individual single customers, and on account of foreign exchange transactions (Algeria, Egypt, Morocco, Qatar, and Tunisia). In most of the Arab countries, steps have been taken to strengthen on-site and off-site surveillance, and to improve and standardize account­ ing practices. Despite these advances, the need to continue improving the prudential regulatory and supervisory regimes is recognized, as well as extending it to nonbank financial institutions. This issue takes on added impottance in the context of efforts toward the international harmonization of prudential regulatoty and supervi­ sory practices, particularly in the context of the Basle Committee's guidelines.•s Indeed, regulatory strengthening is critical if Arab financial institutions are to compete on an equal and effective footing in financial markets that have become increasingly globally integrated and interdependent.

•srnformation on these guidelines is contained in Leipold and others ( 1991 ).

©International Monetary Fund. Not for Redistribution 42 Mohamed A. EI-Erian and Shamsuddin Tareq

Other Domestic Liberalization Measures'(' Economic surveys of the Arab countries tended to emphasize the prevalence in several economies of rigid systems of administered prices. 17 The resulting lack of price flexibility led to distorted marker signals regarding the opportunity cost of goods and services, thereby contributing to production and consumption inefficiencies. In recent years, several of these countries (Egypt and Sudan, for example) have taken steps to liberalize their domestic pricing sys­ tem, including through adjustments in prices for major agricultural crops and for energy products. Moreover, steps have been taken to address the multiplicity of same-product prices associated with different consumer groups (for example, Syria). Nevertheless, the process, although advancing, is far from complete in several econo­ mies. As a result, the objective of establishing a "level playing field"-both operationally and legally-for the private and public sectors is still some distance away. Moreover, continuing economic inefficiencies associated with rigidities in the goods, labor, and credit markers are compounded by sociopolitical difficulties result­ ing from the population at large perceiving the government, rather than international conditions, as the main reason for upward adjust­ ments in domestic prices of tradables. Price liberalization has been accompanied by increased emphasis on strengthening private investment, within the framework of more appropriate macroeconomic and institutional policies. In addition to the adjustment and reform policies discussed elsewhere in this paper-policies that enhance the average return on private invest­ ment due to an improved operating environment11:l-some Arab countries have adopted a number of specific measures including tax holidays and free zones. Although these may have some impact

16-fhis section does not address the issue of industrial development policies in Arab countries. A study by the Economic and Social Commission for Western Asia (ESCWA) (1990) considers this one of the important policy challenges, arguing rhat "on the whole, Arab industrialization efforL� remained fairly modest and confined to smaJI enclaves, without ever reaching the level of an integrated and mature industrial structure." 17For example, Hasan 0987). 18lndeed, a stable macroeconomic environment has been viewed as the single most important factor for investment promotion in Arab countries. See Shibata (1990). Handoussa 0990) analyzes the Egyptian case.

©International Monetary Fund. Not for Redistribution 2 Structural Issues in the Arab Countries 43 • in attracting investment resources to a specific act1v1ty or area, experience in developing countries as a whole suggests that they generally do not constitute cost-effective instruments for net effi­ cient additionality over the medium term. Some Arab countries have curtailed, rather than expanded, such incentives in the context of adjustment and reform programs. They have also taken steps to establish unified investment codes that avoid intersectoral biases, limit the duration of concessions, and provide for more efficient and transparent criteria for eligibility, approval, and monitoring (Morocco and Tunisia).'9 Some countries that have retained invest­ ment licensing procedures have taken steps to shorten the time lag for approving projects (Mauritania).

External Sector Issues The emphasis on public-sector-led growth in several Arab coun­ tries was associated with an import-substitution industrialization strategy. As in many other developing countries, the strategy resulted in weakening the market discipline emanating from inter­ national competition. This is particularly true for most of the non­ oil Arab countries, with the resulting inefficiencies in the tradable sector contributing to welfare losses in both production and con­ sumption. By restraining export diversification, the process has also contributed to more pronounced vulnerability to unanticipated adverse developments in international price and demand condi­ tions. Recognition of these tendencies has led most Arab countries to take steps, with varying degrees of success, to liberalize their external sectors. These steps have emphasized (1) relaxing trade restrictions; (2) reforming the exchange and payments system; and (3) enhancing inflows of foreign direct investment. With the exception of several oil producing countries, the trade regime in the Arab world has been characterized by extensive quantitative restrictions, high nominal tariffs, and cumbersome administrative procedures. Some counrries have also imposed export restrictions in an attempt to provide domestic consumers with a relatively cheap and steady supply of domestically produced tradables. The main thrust of trade reforms in such countries has

19J'rior to these reform measures, Morocco had seven investment codes and Tunisia had six.

©International Monetary Fund. Not for Redistribution 44 Mohamed A. EI-Erian and Shamsuddin Tareq been to evolve toward a more open system, with reduced reliance on quantitative restrictions. Accordingly, countries have begun to streamline administrative procedures and reduce the number of products subject to outright bans or prior authorization (Algeria, Egypt, Morocco, and Tunisia). As noted earlier, countries have also reduced the level and dispersion of tariffs (Tunisia). In several Arab countries, the maintenance of an overvalued "official" exchange rate led to the emergence of a parallel rate in the informal market. With continuing financial imbalances putting strains on the official rate and the balance of payments, several countries (Algeria, Egypt, Morocco, Sudan, Syria, and the former Yemen Arab Republic) adopted multiple exchange rate regimes­ effectively legalizing the more depreciated parallel rate. Initially, this move was to promote earnings from exports of specificgoods, services, and factor transfers (workers' remittances, and to a lesser extent, tourism receipts).l0 The perceived attractiveness of such regimes to policymakers was closely correlated to the severity of the balance of payments pressures and the relative importance of sources of foreign exchange receipts not easily controllable by the authorities through the use of quantitative restrictions. The alternative of a comprehensive exchange rate adjustment was not pursued owing, inter alia, to concern as to the resulting upward pressure on the prices of certain imports deemed sensitive from a sociopolitical viewpoint. In some countries, fiscal considerations also played a role. However, the provision to the budget and public sector enterprises of foreign exchange at a relatively inexpensive rate was offset by central bank losses (implying an offsetting quasi­ fiscal loss) and/or implicit taxes on private sector activities. The prolonged use of multiple exchange rate regimes was accom­ panied in several cases by increased complexity in the structure of foreign exchange pricing. As was true with multipricing of single goods, this had distortionary effects, with adverse implications for efficiency of production and consumption. At the same time, the

�his may be contrasted with the experience in Latin America, where the adoption of multiple exchange rate regimes was motivated by policymakers' desire to insulate the real economy from what were viewed as transitory shocks emanating from financial markets. See Kamin (1992).

©International Monetary Fund. Not for Redistribution 2 • Structural Issues in the Arab Countries 45 implicit subsidization through the exchange rate mechanism tended to obfuscate the underlying magnitude, nature, and implications of the overall subsidy program. Moreover, the implementation of multiple exchange rate regimes involved considerable administra­ tive costs associated with attempts to separate the different exchange markets through monitoring and control of underlying transactions. It is in this context that steps to tinker with the multiple exchange rate regime have given way to more ambitious efforts at exchange rate unification at a market-related level (Algeria, Egypt, Morocco, Sudan, and the Yemen Arab Republic). Success in such efforts has reflected the concurrent adoption of appropriate finan­ cial and structural reform policies. Several Arab countries have also taken steps to reform the exchange system by liberalizing the external payments mechanisms. Progress in this area has tended to be slower, reflecting hesitancy about allowing market forces to ful ly determine the allocation of foreign exchange. Thus, countries have allowed exporters to retain a portion of their foreign exchange earnings (Libya and Tunisia). Rules governing the use by residents of foreign currency accounts in domestic banks have also been liberalized (Morocco and Tunisia). Steps have also been taken to enhance inflows of foreign direct investment. This move reflects three main objectives: first, w increase the availability of nondebt-creating external inflows (inflows whose "servicing" is linked to the performance of the underlying investment rather than subject to fixed contractual rerms)/1 and second, to benefitfrom technology transfers, including upgrading the existing capital stock; and third, to facilitate the penetration of key export markets in industrial countries. In this regard, measures have been implemented ro reduce limitations on sectors open to foreign investment and to liberalize restrictions on the repatriation of capital, dividends, and profits (Algeria and Tunisia).

21The increased emphasis on nondcht-crcating Oows has also retlected the f:.1ct that several Arab countries face he:.1vy debt-service burdens, with a number of them (Egypt, jordan, Morocco, Somalia, and Sudan) resorting, at some stage, to nonpayment and/or formal debl-reslructuring arrangemems.

©International Monetary Fund. Not for Redistribution 46 Mohamed A. EI-Erian and Shamsuddin Tareq

Protecting Vulnerable Segments of the Population22 A sound macroeconomic fra mework is an essential ingredient of an effective poverty alleviation effort. Specifically, by facilitating improved investment and production performance, it provides the best environment for sustained improvements in employment and living standards. At the same time, the potential shon-term adverse effects of adjustment and reform policies on the economically most vulnerable segments of the population are increasingly recognized. Such effects are associated, in pan, with resource reallocations induced by the new relative price structures, in the context of limitations on full capital and labor mobility. Concerns are com­ pounded in some countries by rapid population growth, which strains the already-stretched delivery mechanism for social services. Reflecting the above, reform efforts in Arab counrries have increasingly included specific measures seeking to protect vulnera­ ble segments of the popularion.z3 These measures have included direct cash transfers (Algeria and jordan), improved targeting of food subsidies Oordan), and food-for-work programs (Mauritania). Some countries have also set up special funds that, with assistance from external creditors and donors, seek to finance projects designed to mitigate the adverse impact of adjustment and reform measures on dislocated segments of the labor force (the Social Fund in Egypt and the Employment and Development Fund in jordan).

Conclusion Arab countries' economic and financial performance in the 1980s was mixed relative to that of developing countries as a whole, notwithstanding the impact of adverse exogenous factors. To improve their performance-and thereby sustain medium-term economic growth and domestic and external financial stability­ Arab countries will need to confront more forcefully structural rigidi-

uThis paper does not address the important issue of family planning and rdat<.:d policies, including human resource development. 2jA recent analysis of Tunisia's adjustment program indicates that the country's relatively well-developed social safety net system was instrumental in protecting the more vulnerable segments of the population in the transitional stages of adjustment and refom1. Sec Duran and Feler 0992).

©International Monetary Fund. Not for Redistribution 2 • Struaural lssues in the Arab Countries 47 ties inherited from the pasr. Indeed, the need for sustained and comprehensive policy actions becomes more important in the con­ text of some countries' rapidly growing populations, uncertainties about the prospects for the natural resource base, and the tendency outside the Middle East toward preferential regional trading blocs. While the nature, extent, and implications of the policy challenge differ among individual Arab economies, several aspects are com­ mon to a large number of countries in the region. In this context this paper has attempted to identify a "core" group of required structural reforms. Broadly speaking, this group includes the need to rationalize a large public enterprise sector so as to concentrate its efforts in those areas where it performs most effectively and that are warranted by marker failures; strengthen the structure of government budgets to make them more elastic and increase their developmental impact; improve the mobilization and allocation of loanable funds from domestic and external sectors; enhance the institutional fra mework for private investment and production activ­ ities; and rationalize the external trade and payments system. To be successful, these policies will need to be supported by prudent demand management, as welt as an open international trading system and, for some countries, the provision of timely external financial assistance. Moreover, given the relatively low-income sta­ tus of some Arab countries and their rapid population growth, the paper has referred to the importance of policies ro protect the most vulnerable segments of the population during the adjustment and reform program as pan of a more comprehensive approach to pove1ty alleviation and environmental sustainabiliry. Although the adjustment and reform effort is yet togain significant momentum in the region as a whole, several countries have imple­ mented policies aimed at addressing the identified structural weak­ nesses. The key challenge for individual Arab countries is therefore twofold: first, to draw upon the experience of their neighbors in formulating and implementing appropriate policies; second, w ensure that these policies are implemented in the context of a comprehensive medium-term program, rather than in a piecemeal fashion. Successfully meeting these rwo challenges in a sustained manner is essential if the Arab world is to exploit its considerable economic potential in the remainder of the 1990s.

©International Monetary Fund. Not for Redistribution 48 Mohamed A EI-Erian and Shamsuddin Tareq

References Abdei-Rahman, Ibrahim Helmy, and Mohammed Sultan Abu Ali, "Role of the Public and Private Sectors with Special Reference ro Privatization: The Case of Egypt," in Privatization and Structural Adjustment in the Arab Countries, ed. by Said EI-Naggar (Washington: International Monetary Fund, 1989), pp. 141-81. Ahmad, Yusuf, Salah EI-Serafy, and Ernst Lutz, eds., Environmental Accounting fo r Sustainable Develop ment (Washington: World Bank, 1989). Anani,jawad, and Rima Khalaf, "Privatization in Jordan," in Privatization and Stntctural Adjustment in the Arab Co untries, ed. hy Said EI-Naggar (Washington: International Monetary Fund, 1989), pp. 210-25. Arab Monetary Fund, Unified Arab Eco nomic Report (Abu Dhabi: Arab Monetary Fund, 1991) (in Arabic). Bouaouaja, Mohammed, "Privatization in Tunisia: Objectives and Limits," in Privatization and St ructural Adjustment in the Arab Co untties, ed. by Said EI-Naggar (Washington: International Monetary Fund, 1989), pp. 234-46. Candoy-Sekse, Rebecca, Te chniques of Privatization of State-Owned Entetpn·ses, Technical Paper No. 90 (Washington: World Bank, 1988). Corbo, Vittorio, Morris Goldstein, and Mohsin Khan, eds., Growth­ Oriented Adjustment Programs (Washington: International Monetary Fund, 1987). Duran, Paul J., and Alain Jean-Pierre Feler, "Tunisia Achieves Higher Growth with Lower Inflation Under Extended Arrangement," IMF Sur­ vey, November 9, 1992, pp. 347-50. Economic and Social Commission for Westt:rn Asia, "The Role of the Arab Economy in the World Economy in the 1990s: egoriating the Arab Future," E/ESCWA/DPD/1990/4 0990). EI-Kuwaiz, Abdullah, "Oil Exports and Public Finance in Arab Countries," in Fiscal Policy in Open Developing Economies, ed. by Vito Tanzi (Wash­ ington: International Monetary Fund, 1990), pp. 131-43. EI-Naggar, Said (1989a), "Privatization and Structural Adjustmen<: The Basic Issues," in Privatization and St ructural Adjustment in the Arab Co unl1ies, ed. by Said El-Naggar (Washington: International Monetary Fund, 1989), pp. 1-17. EI-Naggar, Said, ed., Adjustment Policies and Development Strategies in the Arab Co untries (Washington: International Monetary Fund, 1987).

___ Cl989b), Privatization and Stntctural Adjustment in the Arab Countries (Washington: International Monetary Fund, 1989).

---, Investment Policies in the Arab Countries (Washington: Interna­ tional Monetary Fund, 1990).

©International Monetary Fund. Not for Redistribution 2 • Struaurol Issues in the Arab Countries 49

---· Foreign and !ntratrade Policies of the Arab Countries (Washing­ ton: International Monetary Fund, 1992). Handoussa, Heba, "Egypt's Investment Strategy, Policies, and Performance Since the lnfitah," in Investment Policies in the Arab Coumries, ed. by Said EI-Naggar (Washington: [nternational Monetary Fund. 1990), pp. 143-80. Hasan, Parvez, ··Structural Adjustment in Selected Arab Countries: eed, Challenge, and Approaches," in Adjustment Policies and Development Strategies in the Arab World, ed. by Said EI-Naggar (Washington: Inter­ national Monetary Fund, 1987), pp. 49-67. Heller, Peter S., and Christian Schiller, "The Fiscal Impact of Privatization, with Some Examples from Arab Countries," in Privatization and Stmc­ turat Adjustment in the Arab Cou nlries, ed. by Said EI-Naggar (Washing­ ton: International Monetary Fund, 1989), pp. 85-112. Heyneman, Stephen P., "Human Development in the Middle East and North Africa Region," Chap. 7 in this volume. International Moneta1y Fund, Wo rld Economic Outlook. October 1992. World Economic and Financial Surveys(Washington: International Mon­ etary Fund, 1992). Kamin, Steven, "Parallel Markets and the Effectiveness of Exchange Con­ trols in Argentina: 1981-89" (unpublished, 1992). Khatrawi, Mohammed F., ''Privatization and the Regional Public joint Ventures in the Gulf Cooperation Council Region," in Privatization and Structural Adjustment in the Arab Countries, ed. by Said El- aggar (Washington: International Monetary Fund, 1989), pp. 189-206. Langhammer, Rolf, ''European Economic Integration and the Arab Coun­ tries," Chap. 8 in this volume. Leipold, Alessandro, and others, International Cap ital Markets-Develop­ ments and Prospects, World Economic and Financial Surveys (Washing­ ton: International Monetary Fund, 1991 ). Morgan, David, "Fiscal Policy in Oil Exporring Countries, 1972-78," Finance & Development, Vol. 17 (December 1979), pp. 14-17. Nashashibi, Karim, and others, The Fiscal Dimensions of Adjustment in Low-Income Co untries, Occasional Paper 95 (Washington: International Monetary Fund, 1992). Shaalan, A. Shakour, "Adjustment Challenges and Strategies Facing Arab Countries in Light of Recent Expernence and New Initiatives," in Adjust­ ment Policies and Development Strategies in the Arab World, cd. by Said El-Naggar(Washington: International Monetary Fund, 1987), pp. 24-43. Shafik, Nemat, "Has Labor Migation Promoted Economic Integration in the Middle East?" World Bank Middle East and North Africa Discussion Paper No. 1 (Washington: World Bank, 1992).

©International Monetary Fund. Not for Redistribution 50 Mohamed A. EI-Erian and Shamsuddin Tareq

Shihata, Ibrahim F.I., "Promotion of Arab and Foreign Investment-Gen­ eral Remarks," in Investment Policies in the ArabCoun tries, ed. by Said EI-Naggar (Washington: International Monetary Fund, l 990), pp. 127-42. Tanzi, Vito, ed., Fiscal Policy in Open Developing Economies(Wa hington s : Intemational Monetary Fund, 1990). Wall, John W., "Efficiency of Public Investment: Lessons from World Bank Experience," in Investment Policies in the Arab Co untries, ed. by Said El-Naggar (Washington: Tntemational Monetary Fund, 1990), pp. 46-63.

©International Monetary Fund. Not for Redistribution COMMENT

MUSTAPHA K.ARA1

n their paper, the authors provide a broad survey of the problems Ithe Arab countries are fa cing and their experience in implement­ ing some structural policy measures within the context of adjust­ ment. Moreover, they identify a number of widely accepted struc­ tural challenges facing the Arab countries in the 1990s and review in a general manner their policy implications. It is of importanceto note, however, that not all the Arab countries are confronted with the same challenges nor do they address them in a uniform manner. These countries-as the paper rightly men­ tions-differ in their economic structures, resource endowments, and levels of development. Consequently. they also va1y in term!'> of the nature and scope of the problems they encounter, and the magnitude and the urgency of the policies required to meet the challenges, even though these policies may be similar in their gen­ eral direction. Thus, to give a clear picture of the challenges confronting the Arab countries in the 1990s as well as their magnitude, it may be analytically more appropriate to look at the Arab countries as two main groups, namely, one that includes the members of the Gulf Cooperation Council (GCC) and the other, the rest of the Arab countries. For the GCC countries, the main economic challenge is that of prudent macroeconomic management, or, in other words, the implementation of cautious domestic economic and financial poli­ cies in the face of the uncertainty prevailing in the world oil markets and the fluctuations in oil revenues. To reduce their vulnerability to external factors, these countries are also faced with longer-term issues such as the diversification of their economies and the estab­ lishment of appropriate tax and expenditure policies that will

1The views expressed in this comment arc those of the author and should not be anributed to the Arab Monetary Fund.

51

©International Monetary Fund. Not for Redistribution 52 Mustapha Kara

allow prompt and flexible responses to changes in the external environment. For the rest of the Arab countries, on the other hand, the main economic challenge is one of redressing the imbalances in their economies and fostering growth in the face of a rapidly growing population, increasing unemployment and only marginal access to foreign capital markets. Furthermore, one of the main challenges that is faced solely by the countries in the second group and whose weight constitutes the main pressure for structural adjustment in these countries is the debt problem and debt-servicing difficulties. To illustrate the magnitude of this problem, in Egypt, foreign debt rose from $22 billion in 1982 to $50 billion in 1990, and debt service as a proportion of foreign receipts increased from 25 percent to 43 percent during the same period. Similarly, in Algeria, foreign debt increased from $17 billion in 1982 to $26 billion in 1990, and annual debt service averaged 61 percent of exports of goods and services in 1986-90. In the face of declining domestic savings rates, these countries resorted to increased external borrowing to attain high investment rates. Although Egypt succeeded in getting the creditor govern­ ments to forgive half of its external debts and, along with other indebted countries, in securing rescheduling on favorable terms, the constraint posed by the external debt overhang still remains a central challenge to be dealt with in the 1990s. Within the second group, countries also differ quite significantly in terms of macroeconomic management. Some were able to arrest and reverse the deterioration of their economies by adopting strong adjustment programs; others have responded by introducing ad hoc adjustment measures that resulted in volatile macroeconomic performance; while a few others have just started to address their economic problems. Consequently, although these countries face similar problems, they are differently positioned to face the chal­ lenges in the remainder of the 1990s. In this context, a brief review of recent economic developments in these countries shows the following. Prominent among the countries that adopted adjustmenr pro­ grams and made significanr progress are Tunisia and Morocco. Their success has attracted much international praise. Following the adoption of a comprehensive program in 1986, Tunisia made

©International Monetary Fund. Not for Redistribution 2 Comment 53 •

important strides toward domestic and external equilibria and diver­ sification of exports. The current account deficit of the balance of payments was reduced from 8 percent of GOP on the average over 1980-85 to some 3 percent over 1986-89. Fiscal trends were also positive, with substamial improvement in current and overall bal­ ances. Helped by the devaluation of the dinar, the growth rate of non-oil exports rose from 4 percem to 17 percent over the same period (1986-89). Similarly, in Morocco, substantial progress has been made in implementing structural policies in the productive sectors, in public finance, in financial and trade liberalization, and in providing incentives and promoting the private sector since the start of the adjustment program in 1983. In the wake of these measures, GOP growth rates averaged some 5 percent a year in 1983-90 compared with 2 percent in 1980-82. The fiscal deficit as a proportion of GOP was reduced from 11.2 percent to 4.2 percent over the same period. Furthermore, Morocco also made significant steps toward restoring viability to its balance of payments. Fueled by a series of exchange rate devaluations, exports increased by 20 percent on average in 1983-90, and the share of manufacturing exports in total exports rose from 41 percent to 56 percent over the same period . The current account deficit in the balance of payments as a proportion of GOP decreased from 8 percent to 3.2 percent over the two periods (1980-82 and 1983-90). Two other countries adopted adjustment programs but experi­ enced a reversal in economic performance and therefore had to slow down their implementation: Mauritania and jordan. In both cases, the shortcomings were in large part due to the decline in foreign aid in the aftermathof the Middle East crisis. The impact was more severe in Mauritania, however, as it experienced a significant deterioration in its economic and financial situation and was rhus unable to service its foreign debt. Algeria, on the other hand, after a bold attempt at opening up its economy in 1989, seems to he experiencing a reversal in economic policies as some measures taken with the aim of freeing the alloca­ tion of foreign exchange, liberalizing trade, as well as providing greater autonomy to public enterprises and the Central Bank, are being reviewed. This is best exemplified by the recent introduction of trade restrictions to curtail imports and limit the foreign exchange allocation to imports of essential goods.

©International Monetary Fund. Not for Redistribution 54 Mustapha Kara

The countries that resorted to ad hoc measures were Sudan, the Syrian Arab Republic, and the Republic of Yemen. In Sudan the implementation of partial measures did not help in containing the macroeconomic imbalances in the economy. The budget deficit remained at 15 percent of GOP, and the increase in inflationary pressures continued unabated. The Government announced a com­ prehensive program in July 1992, but at a time when foreign assis­ tance seemed remote and the armed conflict in the south was still prevailing. Similarly, the main adjustment efforts in the Syrian Arab Republic and the Republic of Yemen were limited to the fiscal sector in an attempt to contain the fiscal deficit while imbalances in the other sectors were tackled in an ad hoc manner. The recenr unification of both parts of Yemen-while creating greater potential for long­ term development-complicated the transition toward a market economy. At the same time, the existing macroeconomic imbal­ ances were aggravated following the Middle East crisis with the return of migrant workers and the decline in foreign assistance. Thus, it has become apparent that there is a need for these two countries to formulate policies within a comprehensive adjustment program to restore external and internal equilibria and remove distortions in the economy. Egypt started to implement an adjustment program recently 0991). Indications are that improvements have been realized on the balance of payments, budget, and exchange rate fronts. Yet the policy implementation in the area of public enterprises and trade liberalization has been less than envisaged in the program. This brings us to Iraq, Somalia, and Lebanon, countries that in fact are in need of reconstruction programs. It is clear that Morocco and Tunisia, which have successfully stabilized their economies, will need to maintain the momentum of policy reforms to consolidate the gains realized by strengthening and enhancing their structural adjustment efforts during the remain­ der of the 1990s. Algeria, Egypt, Sudan, Mauritania, Jordan, Syria, and Yemen, on the other hand, remain confronted with large eco­ nomic imbalances in their economies. Their challenge will be to reorient their policies to eliminate unsustainable domestic and external imbalances. Thus, the immediate priority for these econo­ mies is stabilization, that is, the use of monetary, fiscal, and

©International Monetary Fund. Not for Redistribution 2 Comment 55 • exchange rate instruments to ensure that their balance of payments remains managable and that domeslic stability is restored with a minimum cost to medium-term growth. This will need to he con­ comitantly supplemented by structural policy reforms directed toward increasing efficiency, to pave the way for the achievement of sustainable growth in investmenr and income and a viable bal­ ance of payments over the medium- and long-term. Finally, Iraq, Somalia, and Lebanon will need, as I said earlier, reconstruction programs. In the long run, certain development issues will also need ro be addressed by these countries, namely, rapid population growth. human resource development, and protection of the environment. Without a lowering of population growth, the efforts made to increase savings and achieve development will simply he absorbed in maintaining per capita income. Moreover, improved health, edu­ cation, and training are imponant in raising labor productivity and incomes. Water scarcity, soil erosion, desenification, and depletion of natural resources will have to he tackled as well. Finally, l would like to say a few words about the regional dimension of adjustment in the Arab region. Recent developments, as is widely acknowledged, have shown how some countries such as jordan and Yemen have benefited from the spillover effect of the growth in neighboring countries in terms of export and employ­ ment, as well as financial transfers. For these small economics, which are characterized by a limited domestic resource base and market, an adjustment program will be more effective when it encompasses a regional dimension. In so doing, the issues of trade. labor, and financial and fiscal policies can be formulated in a regional fra mework, thus consolidating and enhancing the process of adjustment in these countries and rendering it more effective.

©International Monetary Fund. Not for Redistribution · 3 ·

Investment Policies and Major Determinants of Capital Flows to Arab Countries

GHASSAN EL-RIFA/

Objectives and the Global Framework

his paper examines the flow of foreign direct investment (FDI) Tinto the Arab countries, its developments during 1970-90, dif­ ferences among countries, and reasons explaining these trends. The paper's main purpose is to assess how successful Arab countries have been in attracting FDI into sectors other than oil and gas as a means to expand and diversify their economic base and their exports, and to create high-quality employment. The growing pre­ occupation with FDI in developing countries in general and in Arab countries in particular reflects the fact that over the last decade FOI has changed from being a rather small and marginal source of foreign capital in the developing world to become a large and significant source; it is rapidly becoming a very important single source of long-term foreign capital available to developing coun­ tries, replacing the more traditional sources such as official grants and loans as well as commercial bank borrowing. According to the latest World Bank statistics, net long-term resource flows from industrial to developing countries increased only marginally over the last ten years, from an annual average of $68.6 billion during 1982-86 to $72.9 billion during 1987-91, or by less than inflation (Table 1). During the same periods, however, FDI to developing countries more than doubled, from under $10 billion to nearly $23 billion. As a result, the share of FDI in the total net resource flow increased from 14.3 percent to 31.5 percent.

56

©International Monetary Fund. Not for Redistribution 3 • Investment Polides and Capital Flows 57

Table 1. Long-Term Financial Flows to Developing Countries (Annual averages in billion U.S. dollars; current prices)

1982-86 1987-91

Official development finance Grants 12.1 21 .4 Loans (net) 22.7 22.1

Private loans• 24.0 6.5 Foreign direct investment 9.8 22.9

Aggregate net resource flows 68.6 72.9

Source: World Bank, Financial Flows to De-veloping Countries (September 1992). 'Including commercial banks.

With few exceptions, developing countries are in need of foreign resources to cover the gap in the current account of their balance of payments and to supplement domestic savings. During the 1960s and until the early 1980s, this search for funds steered them toward commodity cartels, commercial bank borrowing, and multilateral and bilateral aid. FDI remained small, as many developing countries shunned this source of financing for ideological reasons, and most of them did not really need it because considerable commercial bank credit was available (from recycled petrodollars), and their creditworthiness was largely intact. The debt crisis, however, dried up bank credit and compelled developing countries, Arab as well as others, to ease their restrictions on FDl and actively to encourage and promote FDI inflows. Hence, it is appropriate now to take stock of the present situation and recent developments and to analyze some of the reasons for recent trends. In recent years, developing countries initiated considerable insti­ tutional and policy changes that have made their overall economic environment more attractive for foreign investors to the point where there is increasingly sharp competition among these countries for the limited amount of FDI available. In pursuing structural adjust­ ment policies, sectors have been opened up to private investment (including FDI), ownership limitations relaxed, application pro­ cesses streamlined, incentives made transparent, and regulations on the repatriation of profits relaxed. In sub-Saharan Africa alone more than 20 countries have revised their investment codes since 1982 or introduced new ones. Argentinean oil exploration has been

©International Monetary Fund. Not for Redistribution 58 Ghassan EI-Rifai opened up to foreign participation; the Republic of Korea opened up 80 percent of its industrial sector, compared with 50 percent ten years ago, and abolished restrictions on profit repatriation; automatic approval systems are in place in Korea and Venezuela; and licenses have been simplified for Mexico. In Malaysia if the enterprise expo1ts 50 percent or more of its output and employ� 350 full-time local staff, 100 percent foreign ownership in the enter­ prise is allowed; China allows 100 percent ownership in areas where the technology is desired; and so on. Equally important has been the recognition by many developing countries that centrally planned economies have performed less well than market-driven economies. Hence, the structural adjust­ ment programs supported by the World Bank and the IMF have promoted more private sector involvement, borh domestic and foreign, opening the door w increased FOI. It is now generally accepted that market-based prices are critical indicators for entre­ preneurs and other economic operators so that resources are directed to the most valuable uses and that it is the alertness of the entrepreneur that creates and introduces innovations in the marketplace. There has been a recognition that impeding or prohib­ iting the competitive process by central planning (or even excessive regulation) deprives the economy of its fundamental engine of growth. However, attracting FDI has turned out to be more difficu lr and time consuming than expected. The expectation that once the mac­ roeconomic issues have been tackled through a structural adjust­ ment program FOI will start to flow in en masse has turned out to be over optimistic; this issue is one addressed in this paper.

Data Base

As is well known, both the data and the literature on foreign direct investment in developing countries are unfortunately not very reliable or comprehensive. This is particularly true for Arab countries, given the insignificance of the existing levels of FDI in the Arab world (other than oil) and the low importance that until recently Arab countries placed on promoting FDJ. Most of these countries have started to promote themselves actively as FDI loca­ tions outside the oil sector only over the last decade or two, whereas

©International Monetary Fund. Not for Redistribution 3 • Investment Policies and Capitol Flows 59

in Latin America, for instance, FOr has a long history, often dating back to the last century. There are fundamental differences in the data available from the data base sources.1 These diffe rences are not only related to issues of differing reporting periods and variations in cleAning foreign direct investment and in recording worker's remittances but also to variations in accounting procedures, such as ways of reporting financialtransfers of oil companies between subsidiaries and parent companies. Other reasons for discrepancy are that some data are collected on a fiscal-year basis while others are on a calendar-year basis. Finally, FDI is defined differently in different countries: In theory, most definitions agree that FDI is an investment made to acquire a management interest and influence in a foreign enterprise; in reality, however, the thresholds used vary between 10 percent (OECD, United States, and japan) and 25 percent (Germany) of ownership of the voting stock; they also vary over time (japan reduced the threshold in 1980 from 20 percent to 10 percent). The key characteristic in determining FOJ is having an "effective management voice," and this depends on firm specific circum­ stances. In theory, two principal data series-the IMF balance of payments data and the OECD/DAC data are the same two streams of data examined from different ends. The IMF data look at the inflow of FDI into the host country and include reinvestments and disinvestments as positive or negative FDI. The data reflect the:: inflow of FDI irrespective of source, thus making it difficult to distinguish regional links or links between Arab and non-Arab FDI for the purpose of our analysis. The data are supplied by the host country and are subject to the institutional data collection limitations prevailing in the country. The OECD/DAC data look at investments from the other end of this tlow, that is, from the point of view of the investing country (the home country). Furthermore, the data cover only OECD member countries and therefore exclude invest­ ments made by one Arab country in another, more generally, or, among any developing countries.

'International Monetary Fund (IMF), World Bank Economic and Social Data £3ase (BESD), and other World Bank report:-., the Organi at ion for Ee<>nomir z Cooperation and Development

©International Monetary Fund. Not for Redistribution 60 Ghassan EI-Rifai

Owing to the limitations of reliable data, the literature on FOI in the Arab world is not empirical and relies on surveys and mission reports that focus primarily on other more comprehensive subjects. Under these circumstances, this form of analysis provides some perspective on the nature of FDI that cannot be gleaned from the raw data. As a result, it is difficult to determine empirically what is happening. Some of the reports appear to be recycled information that has appeared elsewhere, in others, conclusions are drawn from groups that are neither large nor representative. There is considerable analysis of stocks of FDI, and cross-country compari­ sons of FOI are made over time. This approach ignores the account­ ing limitation that most investment is valued at its historical book value and is not brought up to market prices at regular intervals. This approach usually results in older investments being undervalued in comparison to more current investments. The stock of investment dating from the 1940s cannot be compared with recent FDI to conclude that the percentage share of, say, Asian FDI has grown dramatically. No doubt the growth of Asian FDI is real but, by ignoring the book and market valuation, discrepancy is exagger­ ated. The problem is accentuated where inflation is high. This paper therefore focuses on annual flows over the last twenty years rather than on accumulated stocks. For the purposes of this paper, seven Arab developing countries were analyzed-three Maghreb and four Mashreq countries (Morocco, Algeria, Tunisia, Egypt, jordan, Saudi Arabia, and Oman). The selection took into account both the importance of the countries as hosts of FDI and the availability of consistent data on FOI flows. Excluded are countries considered high-income economies by the World Bank Group, such as the United Arab Emirates and Kuwajt.

Overall Setting

Relative Position of Arab Countries in the World

In spite of major efforts to decontrol and liberalize their econo­ mies and to stimulate and encourage private investment-domestic and foreign-and notwithstanding the urgent need for such funds, the flow of FDI to developing countries has grown rather modestly over the last twenty years (less than 5.5 percent a year in real terms)

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 61 • and remains low today. During the same period, FDI flows among industrial countries expanded by over 8 percent a year starting from a much larger base. During the second half of the 1980s, FOI flows among industrialized countries averaged over $168 per capita in 1990 prices, while those to developing countries averaged barely $5.5 (Table 2). Furthermore, the limited amount of FDI flowing to the developing world was very unevenly distributed. It was concentrated heavily in a small number of countries, and the overwhelming majority of developing countries received virtually nothing. Thus, in 1990 nearly 70 percent of total FDI flowing to developing countries went to the 20 top performers, which accounted for only 15 percent of the total population, whereas the remaining 81 developing coun­ tries listed in the 1992 World Development Report (totaling about 85 percent of the population) received a little over 30 percent of all FDI (Appendix Table 7). As a result of their remarkable success in attracting FDI, the 20 top performers averaged a quite satisfactory $28 per capita, whereas the remaining 81 developing countries remained largely unsuccessful, receiving on average only a meager $2.3 per capita. As a group, the seven Arab countries studied were not particularly successful in attracting FDI. Excluding investments by foreign oil companies, which follow very special rules, inflows ofFDI averaged a low $4.7 per capita a year during 1986-90, measured in 1990 prices, or only 0.2 percent of GDP. This was substantially lower

Table 2. Foreign Direct Investment Flows (Yearly averages; 1990 prices)

1970-74 1976-80 1981 -85 1986-90

Total flows (billion U.S. dollars) Into developing countries 9.1 11.4 16.1 21.6 Into developed countries 37.8 43.0 59.6 131.9

Total 46.9 54.4 75.7 153.5

Per capita flows (U.S. dollars) Into developing countries 3.2 3.6 4.6 5.5 Into developed countries 55.6 61.0 81.8 168.3

Total 13.3 14.1 17.9 32.5

Source: International Monetary Fund, Balance of Payments Statistics Yearbook.

©International Monetary Fund. Not for Redistribution 62 Ghassan EI-Rifai than the already low averages of the developing world as a whole ($5.5 and 0.3 percent, respectively). Among major regions, only Africa south of the Sahara had a lower FDI inflow during this period ($2.7), whereas in South America it was substantially higher ($1H-19 per capita). However, the same phenomenon already observed for the devel­ oping world as a whole existed also within the group of Arab countries-performance among countries in attracting FO! was very uneven. In fact, the average annual FDI inflow among the seven Arab countries during 1986-90 ranged from only $0.30 in Algeria to nearly $14 in Saudi Arabia (Table 3). The two best performers among the seven countries (Saudi Arabia and Tunisia) were success­ ful enough to join the group of 20 top performing developing countries worldwide, performing better than such important coun­ tries as the Philippines and Turkey (Appendix Table 6). The other

Table 3. Inflows of FDI, 1986-90 (Annual averages)

FDI per Capita FDI FDI (U. 5. dollars) (Percent of GOP) (Percent of GO/)

Some Top Performing Developing Countries

Portugal 109 2.3 8.6 Greece 82 1.5 7.9 Malaysia 80 3.4 12.5 Costa Rica 37 2.0 8.4 Mexico 34 1.5 7.8 Argentina 34 1.2 11.2 Thailand 23 1.7 6.1 Chile 19 1.0 5.6

Arab Countries

Saudi Arabia 14 0.2 1 .1 Tunisia 10 0.7 3.2 jordan 6 0.3 1.8 Oman 6 0.1 0.5 Morocco 4 0.4 1.6 Egypt 3 0.3 1.3 Algeria 0.3

Group Weighted Average 4.7 0.2 1.0

Sources: Appendix Tables 3-6.

©International Monetary Fund. Not for Redistribution 3 • Investment Policies and Capital Flows 63

five, however, all fa ll within the group of less successful develop­ ing countries.

Recent Trends Among Arab Countries

A more detailed analysis of FDI data for the seven Arab countries during 1970-90 perio the level of economic development is an important factor in attract-

Chart 1 . FDI Per Capita in 1990 U.S. Dollars (Five-year averages)

40 .------.

Up 6 3 4 Flat 1 Down 3 3 30

20 Saud1 Arab1a

------1 0

Egypt

· . .

. . · .. · ..· oman · · ... -10 �--�------�------�------�� 1970-74 1976-80 1981-85 1986-90

Source: Appendix Table 3.

1Excluding oil and gas investments as much as possible.

©International Monetary Fund. Not for Redistribution 64 Ghassan EI-Rifai ing FDI; and ( 4) favorable economic policies are of crucial impor­ tance in attracting FDI. These points are analyzed briefly below. Co mmon Trend. Even a cursory glance at Chart 1 is sufficient to realize that there is hardly any common trend among the seven countries concerning the inflow of FDI over the last twenty years. Except during the second half of the 1970s when six of the seven countries achieved an increase in the inflow of FDI at the same time-massive for four, rather modest for two-during no other period did more than four countries experience the same trend at the same time; while about half of them improved their perfor­ mance, the other half deteriorated. Some of the countries, like Algeria, did well during the 1970s but badly during the 1980s; others, like Egypt, did much better during the 1980s; others, such as jordan, did well during the late 1970s and early 1980s but badly thereafter. During the five-year period in the early 1980s when jordan experienced its greatest success in attracting FDI, Oman and Algeria suffered their most severe declines, while five years later the situation had reversed. Furthermore, FDI flows into only one country-Saudi Arabia-showed a steady trend over the four peri­ ods; in the six other countries, these flows moved up and down in an apparently random fa shion. In consequence, little generaliza­ tion is possible except that for six of the seven countries FDI inflows during 1986-90 were substantially larger than twenty years earlier. These apparently quite haphazard trends reflect the combined impact of a number of natural, political, and economic factors that influence FDI flows in different ways and to a different extent. Since economic policies are among the most determinant of these factors, it is quite obvious that the seven countries pursued few common policies concerning FDI. Each followed its own policy, suffered its own setbacks, and enjoyed its own successes indepen­ dently of what its neighbors did and/or experienced. Co untry Size. Contrary to general belief, this study does not show that the size of a country has been important in attracting FDI. In fact, the three sample countries with the largest popula­ tions-Egypt, Morocco, and Algeria-are the ones with the lowest inflow of FDI per capita, an observation lasting for most of the four periods under consideration. On the other hand, Tunisia, which has the third-lowest population, had the second-largest inflow of

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 65 •

FDI, while the two smallest countries Qordan and Oman) occupied a good third place among the seven countries. The old theory (still often heard) that large countries have a built-in advantage in attracting FDI because they offer an attractive domestic market has not been confirmed by the findings of this study. With export­ oriented FDI increasingly replacing both traditional import­ substituting investments (automobiles in Mexico, Brazil, and Argentina) and resource-based investments (copper in Chile, oil in Saudi Arabia), the size of a country becomes less and less relevanr as a factor in attracting foreign investment. As discussed below, other factors such as political stability and consistently attractive economic policies become increasingly decisive; in both respects Tunisia has been doing well. In fa ct, small countries with a light, approachable, and flexible administrative apparatus have some definite advantages over their larger competitors with heavy and rigid bureaucracies. The findings related to the Arab world are corroborated by earlier analysis carried out by MIGA on Africa south of the Sahara.·� It found that not a single African country with a population of over 2 million was successful in attracting FDI in the last twenty years, excluding oil and gas. The few African success stories-and there are some-are limited to small countries such as Mauritius, Sey­ chelles, and Swaziland, largely deprived of natural resources, but pursuing strongly market-based and export-oriented economic pol­ icies. FDI inflow into these three countries averaged close to $20 per capita during 1986-90. Level of Economic Development. Although the size of a country might not be crucial in attracting FDl, a country's level of develop­ ment (as measured by the level of GDP per capita) is important. More developed countries tend to be more successful in attracting FDI. In this study's sample, this correlation is particularly strong at the tail end of the line: The two sample countries with the lowest GOP per capita-Morocco and Egypt-experienced well below average inflows of FDI during 1986-90, occupying fifth and sixth

3Roundtable on Foreign Direct Investment Policies in Africa, June 9-11, 1992, Opening S ta tement by Ghassan EI-Rifai.

©International Monetary Fund. Not for Redistribution 66 Ghassan EI-Rifai positions respectively, among the seven countries (Table 4). On the other hand, Saudi Arabia anracted the highest inflow of FDJ. To a large extent, this reflects the fact that good, reliable infrastruc­ ture-physical as well as human-is an important factor in attracting foreign investors. Hence the close correlation her;veen FOI inflows and the literacy rate as discussed below. In countries where per capita GOP runs ahead of infrastructural development as a result of recent, large developments in hydrocarbon, the correlation between levels of per capita GOP and FDI inflow is much weaker. This is an imponam reason why Oman, with a per capita GOP close to that of Saudi Arabia, was much Jess successful in anracting FDI, reaching only fourth place among the seven countries. ravurable Economic Policies. Whereas Oman did nor deviate too substantially from the norm, two other countries-Tunisia and Algeria-deviate much more so, albeit in different directions and for different reasons. Tunisia is doing much better in artracring FDI than its per capita GOP suggests, while Algeria is not doing well. Whereas Tunisia ranks only fourth in the level of GOP per capita, it was a strong second in the level of FDI it managed to attract, consistemly in all four periods. Algeria on the other hand, which has the third-highest per capita GOP of the group, saw its inflow of FDI decline ro viitually zero during the 1980s, occupying last place during 1986-90. Both cases reflect the vital importance of appropriate macroeconomic policies in attracting FDI-that is, the existence of an attractive, stable, and predictable investment eli­ mare. In Tunisia, macroeconomic policies strongly supponive of FOI inflow (much of it from other Arab countries) showed positive

Table 4. FDI and Level of Development, 1986-90

Ranking According to FDI per capita GDP per capita

Saudi Arabia 1 1 Tunisia 2 4 jordan 3 5 Oman 4 2 Morocco 5 6 Egypt 6 7 Algeria 7 3

Sources: Appendix Table 5; World Bank, World Development Report.

©International Monetary Fund. Not for Redistribution 3 Investment Policies ond Capital Flows 67 •

results; in Algeria, the lack of such policies. and an ambivalent policy stance vis-a-vis FDI until very recenrly, contributed to th<.: virtual collapse of FDI inflows in spite of the high level of GIW. These issues are assessed in some derail in the next two s<:ctions. In addition to the ahove fo ur points, political stability is an impor­ tant factor influencing the tlow of FDL. Political turmoil in Algeria during the late 1980s as well as political uncertainties around .Jordan during the same period explain much of the sudden decline in FDI inflows into these countries after extended periods of quite satisfactory performance.

Source Countries

Data limitations make it difficult to assess flows of FDI among Arab countries. In fact, the following analysis is limited to flow� from OECD countries. As a caveat, it is important to know that during 1981-90 OECD/DAC figures totaled about half the TMF fig­ ures, and in some individual countries the differences were even larger. Among the 12 OECD member countries that report regularly to the DAC, 6 accounted for over 99 percent of total net FDI flows to the 7 sample countries during 1981-90. They were (in declining order of importance) the United States, France, Germany, Italy, .Japan, and the Netherlands (Table 5). The small FDI flows of the

Table 5. FDI Inflows by Country of Origin and Country of Destination (DAC Countries Only) (Percentage overage, 1981-90)

O ig n/ Saudt T tal r i o Destination geria gy pt Jordan' o o Oman' Arabia Tunisia (net) Al E Mo r cc France - 1 1 2.2 25.0 - 25.3 61.3 -1,440.0 5.2 42.3 12.5 Germany 28.0 20.3 38.0 10.2 -16.0 0.1 11.5 11.8 Italy 18.9 2.5 13.9 24.6 -8.0 4.4 25.4 8.1 japan -0.2 3.7 12.7 0.1 708.0 9.7 0.7 7.1 Netherlands -0.6 4.0 6.3 1.3 828.0 3.3 9.8 4.9 United Kingdom - 3.4 - 227.8 -0.2 - 1.3 1.5 - 2.6 United States 38.9 77.5 54.8 Others2 -33.9 9.0 82.2 2.9 28.0 1.1 8.8 3.4 Total 100 100 100 100 100 100 100 100

Source: rgan at on for Economic oo ration and Development, Development Assistance Commillee (DAC). O iz i C pe 'Net ll to lordan and Oman were very small (S7.9 mi l on and million, respectively). This e

©International Monetary Fund. Not for Redistribution 68 Ghassan EI-Rifai

other 6 source countries canceled each other out almost completely, with a sizable return flowhack into the United Kingdom nearly canceling out the flows of FDl from the other 5 countries. Among those 12 source countries, the United States was by far the most important, accounting by itself for nearly 55 percent of total net FDI flows into the 7 host countries. Investments by U.S. private corporations were concentrated exclusively on 2 host countries­ Egypt and Saudi Arabia-while no U.S. investments were reported to have taken place in any of the other 5 countries. France and Germany, the two next largest source countries, had a share of approximately 12 percent each. France's net share, however, was depressed by some large disinvestments in Algeria during the first half of the 1980s. Excluding Algeria, France's share exceeded 18 percent, making it clearly the second most important provider of FDI to the region. As could be expected, French private companies focus particularly on Tunisia and Morocco, where they were by far the most important source of FDI; they were also quite active in Egypt. German investments were spread widely throughout the region; the zero net flow to Saudi Arabia was the result of a substan­ tial inflow during the first half of the 1980s, nearly offset by an equally large outflow recorded during the second half of the decade. Investments by Italian, Japanese, and Dutch companies (between 8 percent and 5 percent of the total) were spread quite widely among the seven host countries, except that they have all kept out of Egypt. U.S., French, and German investors together accounted for nearly 85 percent of total FDI inflows from DAC countries into Egypt. British companies were the only net clisinvestors repatriating investment capital from Egypt, Jordan, Morocco, and Saudi Arabia.

Case Studies

Algeria

ln spite of its exceptionally advantageous geographical location, its historically close links with Europe, its fairly well-developed physical and human infrastructure, and its relatively high level of private fixed investments, Algeria has been successful in attracting FDI over the last ten years. It was quite successful during the 1970s, attracting substantial FDI inflows particularly from France and less from Arab countries. Starting in 1981, these flows almost ceased;

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 69 • in fact, in the early 1980s there were two large disinvestments by French companies, and for the rest of the decade FDI inflows stagnated at insignificantly low levels. During the later years, IMF and DAC figures are close and uniformly low, suggesting that there were no inflows of FDI from either the industrial countries or the Arab countries. This lack of success by one of the more developed Arab countries is largely due to three factors, which are major determinants of FDI in all developing countries: (1) the macroeconomic situation, including growth of GOP and of private domestic investment; (2) economic policies pursued by the Government; and (3) overall political situation and political stability. In the case of Algeria, factors one and three were quite positive during the 1970s but worsened markedly during the 1980s; factor two improved gradually during the 1980s, but too late in the decade to have a major impact and too little to overcome the two other negative elements. The overall economic situation in Algeria was very satisfactory during the 1970s, with total GOP expanding at an average annual rate of 7.3 percent in real terms between 1971 and 1980 as a result of high hydrocarbon prices and the rapid pace of industrialization. These boom years created attractive prospects for foreign investors even though the economy remained heavily regulated and suffered from serious distortions and inefficiencies. During the 1980s, the situation deteriorated dramatically: First, over­ all economic growth slowed to only 2.6 percent a year, particularly after the 1986 oil price collapse; the balance of payments became a major bottleneck, with the current account balance moving from a surplus of 0.6 percent of GOP in 1980 to a deficit of 4.3 percent in 1989; and foreign debt accumulated rapidly with foreign debt­ service charges increasing from less than 27 percent of exports in 1980 to nearly 64 percent in 1991.4 Second, and as important, the overall political situation became increasingly volatile, unstable, and unpredictable starting in late 1989. Together, this created a most unattractive climate for foreign investors. In this situation of economic slowdown and political uncertainty, the increasing, courageous attempts to liberalize and decontrol the economy, initiated in 1987 and pursued since, had no chance to

4 World Bank data.

©International Monetary Fund. Not for Redistribution 70 Ghassan EI-Rifai exercise the expected stimulating impact on FDI and cannot be expected to do so as long as the other two handicaps remain. Even the fact that the Algerian private sector continued to invest heavily during the 1980s (on average a high 18.6 percent of GOP a year)5- usually an attractive sign to foreign investors-did not stimulate any interest by foreign investors.

Egypt6

After a long hiatus during the fifties and sixties, Egypt very slowly and gradually managed to attract some FDI starting in 1975, the beginning of the open door policy. In absolute amounts, FOI has increased considerably since then, from virtually zero up to 1975 to $200 million a year (in 1990 prices) during the first half of the 1980s before declining slightly, to $173 million a year during the late 1980s (Appendix Table 2). These were among the highest absolute figures achieved by an Arab country over these twenty years, excluding oil investment. Considering Egypt's size, however, on a per capita basis, FOT inflows remained rather low, averaging only $4.5 during the 1981-85 peak years, and declining to an even lower $3.5 during 1986-90 (Appendix Table 5). Given the relatively large Egyptian market, its considerable export potential, attractive geographical location, and fairly well­ developed physical and human infrastructure, this performance was not very strong. Even more so, as private sector investment in general (domestic and foreign) was fairly high, at 16.4 percent of GOP during the 1980s, and overall economic growth was quite high during the 1970s (at 10.4 percent a year during 1973-80) and still a respectable 4.7 percent a year during 1980-91.7 Hence, from an overall economic point of view, conditions appeared quite favor­ able to attract foreign investors. A number of factors, however, discouraged a more rapid growth in FOI. First, the difficult balance of payments and foreign debt

World Bank, World Tables, 1992. 5 6 The following analysis is based largely on OECD/DAC data for the 1970s and World Bank data for Lhe 1980s. They exclude oil investment. The World Bank figures used from 1982 onward are substantially higher than the DAC data for the same years, as they also include Arab investment, but are lower than the IMF balance of payments figures, which include oil investments. 'World Bank, World Tables, 1992.

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 71 • situation raised the danger of developing foreign exchange short­ ages, which to a great extent hampered the importation of spare parts and raw materials as welt as the transfer of dividends and capital. This perceived danger was highlighted by the widely shared perception that public enterprises received preferential treatment in the allocation of scarce foreign exchange, which was tightly controlled by the Central Bank and could pay their impons at a more advantageous exchange rate than private enterprises. Egypt was running a substantial cun-ent account deficit already in the 1970s, averaging 5-6 percent of GOP; it increased to an average of7.5 percent during the 1980s.HThis deficitcreated increas­ ingly severe foreign debt problems with the debt-service ratio exceeding 20 percent of exports in the 1970s;9 in spite of several deht reschedulings, this ratio did not improve throughout the 1980s, 10 resulting in serious debt arrears and severely limiting the country's capacity to impon and to transfer dividends abroad. In fact, over the last twenty years, tight impo1t restrictions had to be imposed frequently, and financial transfers were limited and/or often delayed. Second, the frequent balance of payments difficulties experi­ enced in Egypt during the last rwenry years were largely the result of the strongly inward-looking, impoit-substituting development strategies introduced in the fifties and sixties and changed only gradually since. The exchange rate was consistently overvalued, discouraging all non-oil exports, which in fact declined substan­ tially. The economic climate therefore discouraged foreign investors from setting up export-oriented industries, while the domestic mar­ ket remained dominated by public enterprises little disposed to accept private competitors, foreign as well as domestic, except in a few joint ventures. The limited amount of FDI coming into the country focused largely therefore on nonmanufacturing sectors such as tourism and some other services such as real estate and banking. Third, while macroeconomic policies have improved substan­ tially since the mid-1980s when the first reforms-suppoited by

srbid. 9World Bank, World Debt Tahles, 1981. 10World Bank, World Ta bles. 7992.

©International Monetary Fund. Not for Redistribution 72 Ghassan EI-Rifai

the IMF and the World Bank-were initiated, the attitude of the public authorities vis-a-vis private investment in general and foreign private investment in particular has largely remained ambivalent, often with a significant difference between policy formulation at the policymaking level and policy implementation at the working level. Much has in fact improved in the way of liberalizing foreign trade, making the Egyptian exchange rate competitive, decontrol­ ling investments, and freeing prices; as a result, the investment climate has improved considerably. Unfortunately, the changes that took place in the mid- to late 1980s are too recent to have yet produced tangible results, considering that the normal period is five to six years for foreign investors to wait before they come back on any significant scale into a country undergoing a fundamental structural adjustment of its economy. This situation, however, can be expected to improve within the next years. Finally, political stability has been a positive factor in Egypt. Administrations have survived political setbacks and proved their ability to adapt in a flexible and orderly manner to changing circumstances.

Jordan

Between the early 1970s and the rnid-1980sJordan was increas­ ingly successful in stimulating the inflow of FDI, with the average annual inflow increasing from slightly over $3 per capita (in 1990 prices) to a very high $30 per capita (Appendix Table 5). The level of $30 reached during 1981-85 was the best result achieved by any of the seven sample countries during any of the four periods analyzed in this paper. If it had continued, it would have brought Jordan into the group of 20 top performing developing countries. During the second half of the 1980s, however, FDI inflows declined sharply, to a little over $6 per capita. This fall paralleled a general decline in Jordan's economic activities during 1986-90, triggered by the regional crisis in the aftermath of the 1982 oil price decline, and worsened by the 1990 crisis in the region. Given its small domestic market, Jordan is a classical case of a developing country that can attract significant amounts FDIof only for export-oriented projects, and in fact has done so successfully for a time. Although this has rewards, it also has risks. Taking advantage of its proximity to and familiarity with the neighboring

©International Monetary Fund. Not for Redistribution 3 • Investment Policies and Capital Flows 73

oil-rich region, Jordan's economy had grown rapidly during the 1970s and early 1980s. During these years, the Government pursued a strongly export-oriented growth strategy based on free and unim­ peded private economic initiative. Foreign trade and foreign finan­ cial transactions were largely free, and the exchange rate remained competitive in spite of large workers' remittances and substantial inflows of aid from some Arab countries. As a result, exports of goods and services to neighboring countries increased rapidly; at the same time the number ofJordanians working in these countries, most of whom were well trained, expanded markedly. Rapid export growth together with an expanding domestic demand, fueled by large workers' remittances, led to a GOP growth of over 8 percent a year in reaJ terms during the 1970s11 and about 6 percent during 1980-87. Private investment grew rapidly, from under 16 percent of GOP during the mid-1970s to a high 24 percent during 1980-82. The combination of political stability, highly favorable economic policies pursued consistently by the Government,good export pros­ pects, a booming domestic market, and a well-trained labor force created ideal conditions for attracting foreign direct investment, and foreign investors responded strongly and positively. During the peak years 1980-82, 9-10 percent of private investment (5 percent of total investment) was undertaken and financed by FDI originating largely in other Arab countries (Appendix Table 4). This share is very high even in a worldwide comparison. The situation deteriorated dramatically during the course of the 1980s as Jordan was hit by the rapid fall in the price of oil in 1982 and the subsequent slowdown in regional economies. Exports, workers' remittances, and Arab aid all declined considerably. The most immediate and dramatic impact was on investments: fixed, private investments started to decline in 1983 and continued to do so throughout the rest of the decade to a level of little more than 10 percent of the 1982 peak; GDP continued to grow slightly for a little longer, reaching a peak in 1987, but it declined during the following four years.12 Finally, with the government budget and the balance of payments running large deficits andthe foreign debt becoming increasingly burdensome (total foreign debt outstanding

11World Bank Economic Reports. 12World Bank data.

©International Monetary Fund. Not for Redistribution 74 Ghassan EI-Rifai

and disbursed tripled as a share of GOP from 60 to 180 percent during the 1980s), 13 the risk of foreign exchange shortages became more and more real. In spite of significant and successful adjust­ ments in government policies since 1988-89, supported by IBRD and IMF assistance, a major decline in FDI inflows could not be avoided, with foreign investors largely waiting on the sidelines until the situation has clarified sufficiently. Different from many developing countries, the sharp setback during the late 1980s was caused largely by exogenous factors outside the Government's control. Once the political and economic situation in the region has stabilized, a renewed growth in FDI inflows can be expected, focusing increasingly on export-oriented manufacturing industries.

Morocco

Over the 1970-90 period, Morocco experienced a relatively steady, but rather mediocre inflow of FDI, fluctuating between a low of a little over $2 per capita a year (in 1990 prices) during the early 1970s and a high of nearly $5 during the late 1970s (Appendix Table 5). Results in the 1980s were between these two extremes. This lack of success in attracting FDI is somewhat surprising, as the country profits from an attractive geographic location for European investors and other investors interested in the European market; it enjoyed long years of political stability; it has achieved satisfactory economic growth over the past twenty years; and it is successful in implementing an economic stabilization and structural adjustment program started during the first half of the 1980s that made Morocco one of the best performing developing countries during the second half of the decade. The single most important factor explaining the low level of FDI inflows during the 1980s was the short time since the economic reforms really started to bite, given the rather long phase-in period. Experience in many other developing countries indicates that a delay of six to eight years is not unusual between actual implementa­ tion of far-reaching economic policy changes and a real change in attitude by private foreign investors. Morocco's economic reform program was indeed far reaching. To reduce an unsustainable cur-

13Ibid.

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 75 •

rent deficit of the balance of paymenrs of 13 percent of GDP11 in 1980 and 1981 to manageable levels, painful stabilization measures had to be maintained for years, including a sharp reduction in public investment outlays. Among others, these measures resulted in a slowdown of overall economic growth, from about 6.5 percent a year during the late 1970s to 3.3 percent a year during the early 1980s. This environment is not an attractive one for foreign invest­ ors. Furthermore, while the reform program succeeded in opening up the trade regime and improving Morocco's competitiveness in the world market, actual export performance, although much improved during the late 1980s, still remains relatively low. On a per capita basis, Moroccan exports of manufactures were only half those of jordan during 1986-90, and little more than one-fourth those of Tunisia (Appendix Table 8). The effects of the largely inward-looking economic policies Morocco pursued up to the early 1980s cannot disappear overnight. These policies shaped the nature of the old, established foreign companies, largely French, that were accustomed to an unchallenged and highly profitable existence well protected from any disturbing import competition; the few foreign direct investments of recenr years were mostly small expan­ sions made by such companies in line with the slowly expanding domestic demand. This situation is changing only slowly. In spite of the major opening of the economy since 1985, an increasing liberalization and reform of fo reign trade, and a substantial real devaluation of the dirham, the nature of foreign investment is chang­ ing only very gradually from imp011 substitution. to exports. To some extent, the slow growth ofFOI reflects the same ambiva­ lence in the attitude of the public authorities vis-a-vis FDI as was observed in Egypt. Although high-level officials are generally open­ minded and committed to pursuing the path of economic decontrol , modernization, and export orientation, the lower level of the gov­ ernment bureaucracy, with whom foreign companies have most of their day-to-clay contacts, often unfottunately do not share the same goodwill hut continue to exhibit a strong preference for command and control, reflecting the old attitude of mistrust vis-a-vis the private sector in general and FDI in patticular.

14\Xiorld Bank, World Tables, 1992

©International Monetary Fund. Not for Redistribution 76 Ghassan EI-Rifai

The still relatively high production costs in Morocco, in particular labor and transpo1t costs, are a further negative factor (even after the devaluations). This is a major handicap for any export-oriented FDI activity. While the minimum wage is not high, lack of well­ trained workers, including fo remen and mid-level technicians, force foreign employers to pay salaries substantially above rhe minimum, or even to bring in expensive expatriates. This situation reflects Morocco's large illiteracy rate (51 percent), which is the highest in North Africa and one of the highest in the Arab world (Appendix Table 9). Substantial improvements and expansion in education and training infrastructure are needed to overcome this bottleneck. Transport costs are high, because the port of Casablanca is not performing to expectations and road transport, although mostly private, is badly overregulated and controlled. Shortcomings in infrastructure-physical as well as human-are in pan the res ult of the sharp cuts in public investment over the last few years, in the context of the economic adjustment effon. Over the coming years substantial increases in outlays on infrastructure will be required to allow Morocco full use of its economic potential.

Oman

According to the limited information available, the inflow of FDI into Oman (other than oil related) has remained very small. Only two investments of any substantive size are recorded, one Dutch in 1986 and one japanese in 1987, both about $15 million each. On the other hand, there seems to have been substantial disinvestment, panicularly by French companies, during several years between 1974 and 1988. The lack of any significant FDI until the late 1980s is certainly not a reflection of lack of political stability or fu ndamentally misguided macroeconomic policies. To the contrary, after the politi­ cal changes in 1970, Oman enjoyed a very stable political regime. Similarly, macroeconomic policies were largely private-sector­ oriented and largely suppo1tive of exports. Finally, per capita GDP was fa irly high-nearly $1,300 in 1975 and over $3,600 by 1980.1' These positive factors, however, were more than offset by a number of negative ones, in particular Jack of easily developable economic potential, lack of physical infrastructure, and lack of a large and

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 77 • well-trained labor force. These limiting factors were particularly strong during the 1970s and early 1980s. Oman is one of the most typical examples of a country where. as a res ult of sudden, large oil discoveries, economic wealth ran way ahead of economic and social development for a number of years. As was to be expected in this kind of situation, the country was not in a position to turn its newly fo und oil wealth immediately into broad-based economic development. This task was particularly complicated in Oman by the country's limited natural resource base and the low level of development prevailing when oil production began. Judged by its per capita GOP of about $150 in the late 1960s,16 Oman was then one of the least developed countries in the world. An even more serious impediment to rapid economic growth was the exceptionally low educational level of its population as a result of the low school anendance rate, estimated at a little over 4 percent of total school-age population,17 including pupil� attending Koranic schools. In spite of enormous efforts undertaken since 1970, this educational handicap could not possibly be fu lly overcome within two decades. Oman is therefore still suffering from a severe shortage of well-trained personnel at all levels. Lack of human resources is particularly damaging in a counrry with a very small domestic market and a very limited amount of natural resources, where the only chance to attract foreign investment is for fairly sophisticated, export-oriented projects. A counrry with hardly any domestic market or domestic raw materials to exploit and process and only a small and inadequately trained labor force has linle to offer a foreign private investor. The limited capacity of the Oman economy to generate and directly absorb productive investments during the 1970s was recognized even by the Govern­ ment, which for many years invested substantial parts of its oil revenues abroad rather than waste them in an economy not yet able to use them effectively and efficiently. The situation, however, is clearly improving: Primary school attendance is now virtually universal and half the school-age popu­ lation attends secondary schools. Infrastructure for transport and power has been expanded considerably and is now quite satisfac-

16World Bank Atlas, September 1969. 11World Bank data.

©International Monetary Fund. Not for Redistribution 78 Ghassan EI-Rifai

tory. With these bottlenecks largely overcome, the inflow of FDI is expected to grow, and in fact it has grown during the second half of the 1980s.

Saudi Arabia

Saudi Arabia has done well in attracting non-oil FDI. Together with Tunisia, it is one of only two Arab countries that are part of the group of 20 top-performing developing countries worldwide. With inflows of FDI per capita (in 1990 prices) increasing regularly, from an average of$10 in 1976-80 to nearly $14 in 1986-90 (Appen­ dix Table 5), Saudi Arabia ranged thirteenth and fourteenth among that group (Appendix Table 6). It was first among Arab countries during the second half of the 1980s. This successful performance resulted from the combined effect of a number of existing fa ctors together with attractive economic policies as well as political stabil­ ity and predictability. Saudi Arabia was the preferred host country for U.S. and japanese investors in the Arab world. During the 1980s, over 70 percent of all U.S. and 68 percent of all .Japanese direct private investment in Arab countries was made in Saudi Arabia, and close to 90 percent of all foreign investment in Saudi Arabia was made by U.S. and .Japanese companies. With a total GOP of about $100 billion, Saudi Arabia is the largest economy in the Arab world, about the same size as Norway, or two and one-half times the size of the next largest Arab country, Algeria. Although the economy has grown little since the oil price collapse of 1982, it still represents a substantial domestic market, widened by export possibilities in the Middle Eastern markets, including the countries of the Gulf Cooperation Council (GCC). In addition, Saudi Arabia has an abundance of cheap energy; a strong industrial base in petrochemicals built up over the last decade; excellent and inexpensive infrastructure, including a well-educated labor force; and an ample supply of capital to cofinance foreign investments. These "physical" advantages are reinforced by very attractive economic policies. Except for oil extraction, Saudi Arabia has always been a largely free-enterprise-oriented economy, with little govern­ ment interference and control. Foreign trade is mostly free, and the foreign exchange regime is free and stable, including capital

©International Monetary Fund. Not for Redistribution 3 • Investment Policies ond Capital Flows 79 transfers. Non-oil exports are encouraged and have in fact increased from almost zero in 1970 to a respectable 4 percent of GOP hy 1990,18 most of it manufactured products, including petrochemicals. The virtual absence of inflation during the 1980s together with the lack of further growth pur considerable pressure on wages and salaries, which in a way led to marked improvements in the coun­ try's competitiveness. Thus, FDI continued to grow during the last decade in spite of a stagnating domestic marker. Saudi Arabia and Oman were the only two of the seven sample countries that did not need to go through an economic stabilization and adjustment program during the 1980s. In addition to this attractive and stable macroeconomic environ­ ment, the Government further stimulated FDJ by introducing a number of tax incentives. Saudi Arabia, however, has not made many promotional efforts to attract FDI. In fact, investment promo­ tion remains low, and as a result, smaller and medium-sized foreign investments have not heen common in Saudi Arabia. Finally, Saudi Arabia's well-known political stability is an impor­ tant consideration for foreign investors, particularly for highly capital-intensive investments, with a lengthy payback period.

Tunisia

Tunisia has been quite successful in attracting FDI, particularly up to the mid-1980s, and somewhat less during 1986-90. In FDI per capita, it has ranked consistently in either firstor second position among the seven sample countries during the fo ur time periods under review; the same is true for FDI as a share of domestic investments (Appendix Table 4). Even in a worldwide comparison, Tunisia did well; it has been one of the 20 top-performing develop­ ing countries with regard to FDI since the mid-1970s. From 197S to 1985 Tunisia was ranked tenth or eleventh among the 20 coun­ tries, with an FDI-per-capita inflow of over $17 a year in 1990 prices (Appendix Table 6). During the second half of the 1980s it slipped to sixteenth position, as per capita FDI fell to a little over $10. What explains this very good performance as well as the sizable worsening during the last five years?

•�world Bank, World Tahles. 1992.

©International Monetary Fund. Not for Redistribution 80 Ghassan EI-Rifai

First, Tunisia has a number of natural advantages; second, it has made good use of these advantages-better than other countries in a similar situation. Tunisia has a very advantageous geographical location; strong historical links with Western Europe reinforced by an unusually smooth transition to independence; remarkable political stability with a demonstrated ability to master peacefully even difficult political problems; well-developed physical and human infrastructure (with the lowest adult illiteracy rate in North Africa and the third lowest in the Arab world). More important, however, Tunisia's economic policies have consistently been mod­ erate and reasonable; extreme swings were largely avoided, and damages created by such swings remained limited. As much less was broken than in otl1er countries, less had to be fixed, and the adjustment process was less disruptive and painful. Hence, even when the rapid increase in the balance of payments current account deficit reached 8.6 percent of GDP in 1982-84 and the budget deficit exceeded 6.3 percent, which made implementation of a stabilization program unavoidable in the late 1980s, the difficulties were more limited than in many other developing countries and did not have the same devastating effect on FDI. In spite ofsome nationalizations and "Tunisification" and consid­ erable government intervention and control, Tunisia's economic policies never veered as far to the left as in some other Arab coun­ tries. Furthermore, being a small country helped to avoid the worse excesses of import-substituting policies and to provoke a reversal in overall policy direction sooner than in many larger countries. In fact, as early as 1970 when countries like Egypt and Algeria still followed economic policies that were strongly public sector con­ trolled and inward looking, the overall policy stance in Tunisia started to change gradually but persistently in favor of stronger private sector development, relaxed administrative controls, and the stimulation and diversification of exports other than fuel . These policies were pursued, with some ups and downs, during most of the following two decades. As a result, already during the early 1980s, when Tunisia's fuel exports hit their peak, exports of manu­ factures exceeded 10 percent of GDP, a remarkable achievement for any developing country and the best proof of a successful export-driven growth strategy; during the second half of the 1980s such exports averaged over 16 percent of GDP (Appendix Table

©International Monetary Fund. Not for Redistribution 3 • Investment Policies and Capital Flows 81

8) and reached a peak of close to 22 percent in 1990, or nearly the same level as Germany.19 In addition to slowly but steadily decontrolling and liberalizing the economy, the Tunisian Government also began actively to attract more FDI by providing special incentives to export-oriented offshore companies in 1972 and on a more general level in 1974. These policies led to a substantial increase of foreign manufacturing investments during the second half of the 1970s, producing much of the increase in manufactured exports mentioned above (Table 6). The increasing overvaluation of the dinar during the early 1980s at a time of high oil prices and large Tunisian oil exports discouraged the further establishment of export industries. The marked decline in FDI in this sector was more than compensated, however, by large foreign investments in hotels and banks, often by Arab invest­ ors, and was strongly encouraged by the Government. A growing saturation in the banking sector and a certain dissatisfaction with the low level of profitability of these semipublic banks-together with Tunisia's growing balance of payments difficulties and the strong decline in oil earnings in the Middle East-led to a sharp decline in Arab investments in the banking sector during 1986-90, the main factor for the overall decline in FDI inflows during this period. But FDl in tourism continued to grow, while FD! in export industries started to recover toward the end of the period, when the reform measures of the mid-1980s began to show the first results, in particular the substantial devaluation of the dinar, which declined by nearly half vis-a-vis the U.S. dollar between 1981 and 1989.

Table 6. Tunisia: FDI Inflows by Major Sectors (Annual averages in million U.S. dollars; 1990 prices) 1976-80 1981-85 1986-90

Manufacturing 64.0 30.8 38.7 Tourism 8.2 15.4 23.4 Banking 62.0 13.4 } 30.2 Others 10.5 3.6

Total 102.4 118.7 79.1

Source: Government of Tunisia, Budgets Economiques.

©International Monetary Fund. Not for Redistribution 82 Ghassan EI-Rifai

Conclusions The general analysis provided in the section on overall setting, but even more so in the brief country analyses in the previow> section, brought our a number of fa ctors that determined the level of FDI inflows into the seven Arab countries assessed in this paper. As mentioned before, each of these fa ctors influences FDI in differ­ ent ways and to a different degree, depending on the individual setting in each country. Hence, the present situation and recent trends, as observed ex post for each country, reflect the impact of different factors often pulling in different directions: while economic policies might be attractive for FDI, the political situation might not, and even if both are positive, lack of economic resources might discourage large inflows of FDI. These factors can be grouped under three headings: (1) natural fa ctors; (2) political factors; and (3) economic factors. Our analysis will concentrate on the last group-economic fa ctors-nor only because these are the most important but also because they are the most amenable for eco­ nomic policymakers. Bur first, the other two groups of factors will be assessed briefly.

Natural Factors

Location is possibly the most important natural factor. lt provides a clear advantage to the Maghreb countries with their closeness to

Europe and well-established transport links. Location was also a fa ctor in explaining Jordan's strong success up to the mid-1980s. It is important to realize, however, that good location alone is no guarantee for success in attracting FDI. Algeria is a vivid reminder in this respect. As mentioned above, the size of the population is of linle conse­ quence. Although a large and expanding domestic market might provide some attraction, other factors, such as appropriate eco­ nomic policies, have become much more important. The same is true for the availability of natural resources. Of course, an almost complete absence of such resources (other than oil), as in Oman, is a handicap. On the other hand, an easily exploitable potential for tourism (as in Tunisia and Egypt) or for the cultivation of high-quality agricultural crops (as in Morocco or the Jordan Valley) helps to some extent as does the availability of large amounts of cheap energy. But again, these factors are not

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 83 • crucial. While Morocco and Tunisia are similarly endowed with natural resources, their success in attracting FDI has been quite different. Among the seven sample countries, Oman is the only one where lack of natural resources can be considered to have slowed down the inflow of FDI in any significant amount.

Political Stability

Political stability and predictability are of vital importance for anracting FDI. Political turmoil and instability are among the key factors explaining Algeria's sudden lack of success in attracting FDI during the 1980s after a quite successful decade in the 1970s. Politi­ cal instability and uncertainty-not so much in the country itself, but all around it-added to the sharp decline in FD! flows into Jordan during the second half of the 1980s after a decade of increas­ ingly successful performance. In actual or expected political uncer­ tainty, even the most attractive economic policies can do little to attract FDI.

Economic and Social Factors

The single most important factor determining FDI flows into these seven countries was the economic policies pursued by their governments. Except in the few instances mentioned above, the FDI flows into these countries observed over the last twenty years were largely determined by economic factors. They explain most of the differences in FDI inflows between the seven countries as well as changes over time. As discussed below, among economic fa ctors, the macroeconomic policies pursued by the host govern­ ments are the most crucial. In addition, provision of an adequate infrastructure-physical as well as human-is also an important element for attracting more FOI. Finally, targeting investment pro­ motion can play an important role in this respect. Macroeconomic Policies. For a country to attract meaningful amounts of FDI, two sets of economic conditions have to be fulfilled: the investment climate has to be attractive; and the investmenr climate has to be stable and predictable. The second of these factors is often ignored by developing countries, which, after years of economic policies that are inward looking and public sector ori­ ented, embark on courageous and far-reaching structural reforms and as a result expect a rapid resumption of FOI inflows. Experi-

©International Monetary Fund. Not for Redistribution 84 Ghassan EI-Rifai

ences over the last decade in many developing countries, including Arab countries, indicate quite clearly that FDI is not like a water tap that a government can turn on and off at its convenience; it is more like a fruit tree that needs to be tended and watered carefully for years before it will bear fruit. If in the meantime the owner loses interest, the young tree will die and the process will have to be started all over again. This is the main reason for the five to six years' delay observed in most developing countries between the time a structural adjustment program is implemented in earnest and the time foreign investors start to regain confidence. This phenomenon of delayed reaction plays a crucial role in recent trends in FDI inflows into the seven sample countries. As mentioned above, except for Oman and Saudi Arabia, all sample countries had to implement stabilization with structural adjustment programs at some point during the 1980s. While the depth and timing of the crisis triggering that implementation varied, and the overall economic context within which it occurred differed from country to country, there were some remarkable similarities in the five countries: after years of worsening budget and balance of payment deficits during the late 1970s and early 1980s, the foreign debt situation became so tight and fragile that even a minor exoge­ nous shock was sufficient to trigger a serious economic crisis. Such shocks were numerous during the 1980s, when prices of oil and fe rtilizer declined and the whole region suffered from serious eco­ nomic malaise. To deal with the crisis, a reform program was initi­ ated, almost invariably painful and resulting in a major slowdown of economic growth for several years. Inflows of FDI were doubly affected by these developments. First, during the years leading up to the crisis when the economic imbalances were rapidly becoming unmanageable and tight foreign exchange restrictions had to be introduced, the investment climate obviously deteriorated and foreign investors moved to the sidelines waiting for improvement. Second, once the reforms were being implemented, a delayed reaction syndrome set in, with foreign investors taking their time to ensure that the governments were indeed serious about their programs, had the stamina and political clout to carry them through, and were successful in doing so. Much of the decline in FDI inflows observed at some time or another during the 1980s in Algeria, Egypt, jordan, Morocco, and Tunisia

©International Monetary Fund. Not for Redistribution 3 lnvescmenc Policies and Capital Flows 85 • were the result of this double impact. Although macroeconomic stabilization in most of these countries has been achieved by now and structural reform is well advanced, the five to six years· "waiting period" for FDI to resume has only just come to an end.1n Ic is not by accident that Saudi Arabia, the only one of the seven sample countries that has shown a consistent upward trend in FDI inflow and by the late 1980s had emerged as the most successful of the group, did not experience an economic crisis and did nor have to go through a reform program. In addition to economic stability and predictability, a further factor explains foreign investors' reluctance to resume investments rapidly after an adjustment program has been initiated. Foreign investors are sensitive not only to such macroeconomic factors as foreign exchange shortages, price controls, and investment condi­ tions but they give equal importance to the government's attitude to the private sector in general, and foreign private investment in particular, and not just in the form of policy declarations but in the form of actions and results. These actions include privatization, or at least a more efficient management of public enterprises along the lines of a private company. In this respect, changes have come slowly in most of the counrries analyzed in this paper. It has proved much easier to devalue the exchange rate, liberalize imports, decon­ trol prices, and reduce budget deficits than to bring about a basic change in the attitude of public administration toward the private sector and to achieve meaningful reform of public enterprises. Hence, a major disincentive for stronger FDI inflows remains. Besides the phenomenon of delayed reaction, an equally impor­ tant macroeconomic factor in influencing FDI flows is the attractive­ ness of the investment climate. Among the different macroeconomic policies that make for an attractive investment climate, three are of particular importance:

• Policies oriented to a free market with a minimum of government interference and control, where prices as well as the use and

20Preliminary data for 1991 and 1992 seem to indicate that Morocco, which started its adjustment early, and Tunisia, which needed only a relatively mild adjustment, reached the end of the tunnel by 1990, and jordan might not be far behind. Algeria and Egypt, however, still have some way to go, given the major adjustment effons needed in these two countries and their rather late starting date.

©International Monetary Fund. Not for Redistribution 86 Ghassan EI-Rifai

allocation of resources are determined by market fo rce�, and where private enterprises are free to operate on their own initiative and in line with their own interests, without discrimination in favor of the public sector.

• Ourward-looking, export-orienred policies, rather than inward­ looking impo!t-substituting policies, where the exchange rate is competitive, foreign trade is largely free, and exports are encour­ aged by the government, rather than hampered by heavy adminis­ trative controls.

• Foreign exchange policies that guarantee a sufficiem availability of foreign exchange to allow for the necessary imports to run the foreign investment and for the transfer of dividends and capital.

Of the four top performers in attracting FDI, three had always pursued largely private sector oriented, outward-looking economic policies (Saudi Arabia, jordan, and Oman); the fo unh, Tunisia, went through a period of considerable state intervention and inward­ looking policies but less than in other developing countries and for a much shorter time, and started to change course gradually more than twenty years ago. Furthermore, while some of these four countries have experienced periods of considerable foreign exchange shortages, none has ever experienced a fully blown for­ eign debt crisis requiring major debt rescheduling. The three least successful countries have all gone through long periods of heavy state intervention and strongly inward-looking economic policies (particularly Algeria and Egypt, Morocco some­ what less). As a result, at the time they hit the economic crisis and had to adjust, their economies were much more distorted and investment misallocations and inefficiencieswere much worse than in Tunisia and jordan. As the need for adjustment was larger, more complicated, and more painful, the adjustment process necessarily took more time. This explains the relatively small increase in FDI inflows during the late 1980s. Across the board, the structural adjustment policies have not yet borne much fruit. Contrary to expectations, most countries with adjustment programs have not so far succeeded in substantially increasing their exports of nontraditional goods, in panicular manu­ factures. This is important because, whereas thirty to forty years ago foreign companies invested in developing counrries mostly to

©International Monetary Fund. Not for Redistribution 3 • lnveslment Policies and Capitol Flows 87 exploit a natural resource (mining) or to penetrate t11e domestic market of the host country (automobiles), today FDI is undertaken increasingly as a means to produce goods cheaply for export. There­ fore, countries that are successful exporters of manufactures tend to become attractive host countries for FDI. The close link between FDI inflows and exports of manufactures (implementation of export-oriented macroeconomic policies) is clearly apparent in the seven sample countries (Table 7): the three countries least success­ ful in attracting FDI (Algeria, Egypt, and Morocco) were at the same time the three countries least successful in exporting manufactured products. On the other hand, Tunisia-the leading exporter of manufactures among the seven counrries-has been the second most successful host country for FDI. During 1986-90 Tunisian exports of manufactures exceeded $216 per capita and per year, or 16 percent of GOP (Appendix Table 8), while Morocco's exports of such goods averaged Jess than $65 per capita and per year, or 7 percent of GOP, in spite of its much broader resource base. In consequence, economic policies designed to stimulate nontradi­ tional exports also make a country more attractive for foreign investors. It is often argued that too much dependence on exports is too risky, and the example of jordan during the late 1980s seems to strengthen that argument. But there is no a priori reason why exports should inherently be more volatile than domestic demand. Over the last years, experience in many countries, including the United States, has shown that during an economic downturn, export mar­ kers often hold up better than domestic demand.

Table 7. FDI, Exports of Manufactures, and Literacy, 1986-90

Ranking According to FDI per Exports of manufactures Literacy capita per capita rate Saudi Arabia 1 3 3 Tunisia 2 1 2 jordan 3a 4 1 Oman 3b 2 (low) Morocco 5 5 5 Egypt 6 6 6 Algeria 7 7 4

Sources: Appendix Tables 5, 8, and 9.

©International Monetary Fund. Not for Redistribution 88 Ghassan EI-Rifai

Infrastntcture. In addition to macroeconomic policies, the qual­ ity of human infrastructure has a major impact on FDI flows to developing countries. Among the seven sample countries there is a strong correlation between FDI flows and literacy rates; the three countries most successful in auracting FDI are also the three with the highest literacy rate (Table 7). Only for Algeria does this correla­ tion not hold; as a result of the serious political and economic problems mentioned above, the inflow of FDI into Algeria during the 1980s was well below what irs literacy rare would suggest; during the 1970s, however, this correlation was much stronger. This close relation between FI)I and literacy reflects the importance of a foreign investor of finding sufficient and well-trained labor on the spot. This is particularly true for export industries that have to compete on the world marker and for which the quality of labor and its cost are key factors in deciding on investment abroad. Hence, in any strategy aimed at increasing the inflow of FDI, much importance must be given to improving and expanding the school­ ing and training of the domestic labor force. Inadequate and insufficient physical infrastructure, particularly in the fields of transport and energy, can be a major handicap for attracting FDI. However, with the possible exception of Oman until a few years ago, all seven countries have a fa irly well-developed infrastructure, and the differences that do exist among them are nor large enough to explain much of the differences in their respec­ tive FDI inflows. Investment Promotion. While most of the seven countries have undertaken efforts over the last years to adjust their economic policies, and, in the process, LO make their economies more attrac­ tive to foreign investors, their efforts at active investment promotion have remained limited. Even though it is not the purpose of this paper to assess in detail the institution-building and policy changes necessary tO improve and streamline investment promotion, invest­ ment approval, and investment implementation, it is important to point our that in most of the seven countries analyzed in this paper there is substantial room for improvement in this respect. Given the toughening international competition for the limited amounts ofFDI in the world, such improvements ought to be initiated without delay. They should be realized hand in hand with improvements

©International Monetary Fund. Not for Redistribution 3 Investment Polides and Capital Flows 89 • in macroeconomic policies, including privatization, and in the pro­ vision of adequate human and physical infrastructure.

Recommendations

Based on the above analysis, two sets of recommendations emerge. As a means to stimulate and increase the inflow of FDI, governments ought to

• pursue attractive macroeconomic policies, guaranteeing and encouraging the free play of market forces and private initiative;

• maintain a level playing field between private and public enter- prises;

• encourage exports of nontraditional goode; and services;

• avoid foreign exchange crises requiring major stabilization efforts;

• improve the training and efficiency of the domestic labor force;

• provide adequate physical infrastructure; and

• pursue all these policies in a steady, stable, and predictable man­ ner, to regain and maintain the confidence of foreign private investors.

Of course, all these efforts will be in vain if a country finds itself in the midst of a political crisis that might well have little to do with the state of its economy, but this situation is out of the hands of economic policymakers.

©International Monetary Fund. Not for Redistribution 90 Ghassan EI-Rifai

APPENDIX

Appendix Table 1. FDI Inflow (Annual averages in million U.S. dollars; current prices)

1970-74 1976-80 1981-85 1986-90

Algeria1 65.16 175.00 -7.76 6.88 Egypt 0.762 24.282 139.562•3 155.803 jordan1 1.90 24.07 67.52 16.94' Morocco1 6.89 54.10 50.24 95.37 Oman2 0.70 1.24 -6.46 6.96 Saudi Arabia2 5.44 48.94 94.96 184.48 Tunisia5 5.66 43.64 82.90 72.26

Total 86.51 371.27 420.96 538.69

11nternational Monetary Fund. 20ECD/DAC, excluding petroleum. lWorld Bank. 'Excluding 1990. 5Government of Tunisia (Budget Economique), excluding petroleum.

Appendix Table 2. FDI Inflow (Annual averages in million U.S. dollars; 7 990 prices)

1970-74 1976-80 1981-85 1986-90

Algeria1 144.55 303.90 -10.94 7.49 Egypt 2.772 40.702 200.512-3 173.203 jordan1 8.40 38.10 95.77 24.03' Morocco1 31.73 92.24 71.47 99.61 Oman2 2.90 1.55 -8.99 8.22 Saudi Arabia2 18.85 85.07 137.38 195.76 Tunisia5 22.70 102.39 118.66 79.07

Total 231 .90 663.95 603.86 587.38

11nternational Monetary Fund. 20ECD/DAC, excluding petroleum. 3World Bank. 'Excluding 1990. 5Government of Tunisia (Budget Economique).

©International Monetary Fund. Not for Redistribution 3 • Investment Policies ond Capital Flows 91

Appendix Table 3. FDI as Percent of GOP

1970-74 1976-80 1981-85 1986-90

Algeria1 0.38 0.69 -0.02 0.01 Egypt2 0.01 0.14 0.40 0.28 jordan• 0.36 0.47 1.49 0.343 Morocco• 0.21 0.40 0.35 0.36 Oman� 0.30 0.02 -0.09 0.09 Saudi Arabia 0.05 0.07 0.10 0.22 Tunisia5 0.35 0.72 1.01 0.71

'International Monetary Fund. 20ECD/DAC (1970-81 ); World Bank (1982-90). 3Excluding 1990. 'OECD/DAC, excluding petroleum. 5Government of Tunisia (Budget Economique), excluding petroleum.

Appendix Table 4. FDI as Percent of Domestic Investment (GDI)

1970-74 1976-80 1981-85 1986-90

Algeria 1.0 1.5 -0.1 0.0 Egypt 0.1 0.5 1.4 1.3 jordan 1.8 1.2 5.0 1.8 Morocco 1.2 1.6 1 .4 1.6 Oman 1.2 0.1 -0.3 0.5 Saudi Arabia 0.4 0.3 0.4 1.1 Tunisia 1.6 2.4 3.3 3.2

Source: See Appendix Table 3.

Appendix Table 5. FDI Per Capita (Annual averages in 7 990 U.S. dollars)

1970-74 1976-80 1981-85 1986-90

Algeria 8.59 16.95 -0.54 0.31 Egypt 0.10 1.01 4.50 3.48 jordan 3.25 13.55 30.14 6.36 Morocco 2.1 1 4.87 3.42 4.08 Oman 4.43 1.50 -8.60 6.20 Saudi Arabia 2.92 10.09 11.72 13.77 Tunisia 4.39 17.13 17.26 10.16 Unweighted average 3.68 9.30 8.27 6.34

Source: See Appendix Table 3.

©International Monetary Fund. Not for Redistribution 1 -o Appendix Table 6. Twe nty Developing Countries Most Successful in Attracting FDI N (Annual averages) G) :::r .. .. Million U.S.. Ooi\Jn FDI FDI P Capita "' "' Cum!nt Percent olGDI' Percentol GOI u.s. .. prKI!S 1990 prices dolars, 1990 prKes ::I 1976-80 1931 -8.5 1986-90 1976-80 1931-8.5 1986-90 1976-80 1 931 -415 1986-90 \976-80 1 981-415 1986-90 1976-80 1981-415 1986-90 !!! � Portugal &4.43 182.10 1,097..20 l-41.30 l60AO 1,121.60 0.40 O.BO 2.30 1.90 3.50 8.SS 14.80 26.00 109.00 Greec" 492..35 466.10 763..60 811.<10 666.50 819.40 1.65 1.30 1.50 6.1 0 5.80 7.90 86.00 67.70 81.90 � Malaysia S58.90 1,082.92 1,286.88 939.1 0 1,548.60 1,3-46..60 3.20 3110 3.40 12..90 11.90 12.4S 71.50 104.00 79.50 l'apuaNewGu0ea 19..31 102.00 135.20' 65.00 145.90 1� 2..20 4.1 0 4.1 0' 11.00 1 4.60 1 7.60' 22.30 43.80 4\.60' coua Rial 53-..34 57.00 98..20 97.30 81.50 105.80 1..60 1..60 2.00 6.70 6.70 8.40 45.30 33.00 37.10 Mexico 1,099·.26 1,166.SS 2,.606..60 1,791.00 1,668..20 2,.82&.40 1 .1 0 0..60 1.50 4.30 2.70 7.80 27.30 2230 34.10 Argefl!ina 255.27 487.24 95337 396.40 696.80 1,064.40 0.'40 0.80 1.20 1.70 4.90 11.20 14.50 13.50 3}.30 Thailand 96.60 279.05 1,174.48 166.40 399.00 1,225.20 0.40 0.70 1.70 I.SS 2.90 6.10 3.70 &.00 22.50 Chile 131.60 212..20 230.80 204.00 303.40 241.20 0.70 0.90 1.00 S.40 7.80 5.60 1&.90 25.90 18.90 Gual.omala 93.00 69..30 142.00 155.10 99.80 153.40 1.50 0.80 1.90 7.SO 6.10 1-4.70 23.70 13.30 17.70 Korea, Rep. of 61.44 116.75 676.00 117.00 167.00 731.20 0.16 0.15 0.40 o.so 0.50 1..20 3.20 4..20 17.40 Colombio 96.20 S71..20 454.60 156.40 81690 522 80 0.40 1.50 1.20 180 6.80 6_25 6.30 29.80 17.30 DonWIK-.n � 61.00 4&.24 98.58 108.60 6&.1 0 105.80 1 .20 0.80 1.70 5.30 3.70 7.10 20.00 10.80 15.40 Saudi Arabia 48.94 94.96 184.48 85.07 137.38 195..67 0.07 0.10 0.22 0.27 0.40 1.10 1 0.09 11.72 13.77 Brazil 1,944.80 1,987.20 1,424.20 3,379.80 2,. 841.70 1,516.80 1.00 0.80 0.40 4.30 4.30 1.90 29.20 21.90 10.50 Tunisia 43.64 82.90 72.26 10239 118.66 79.07 o.n 1.01 0.71 240 3.34 3.15 1 7.1 3 17.26 10.16 Phili,Pnes 68.48 62..80 492.60 148.. 90 89.80 522.60 0.30 0..20 1..20 1.00 0"80 7.00 l.30 1.70 8.90 HondU"" 12.26 1 5.83 39.40 20.60 22..60 42..40 0.70 0.50 1.00 280 270 &.80 6.00 5.50 8.80 Eruado< l9.l2 52.40 77.40 60.60 74.30 84.40 0.50 0.40 0.70 1.90 1.90 3.20 7.90 8.50 8.30 Turkey 32.80 81.41 390.97 54.80 116.40 411.80 0.10 0.20 0.50 0.40 0.90 2.10 1.30 2.40 7.70

Sour.:es: lntanalional MonetaryFood. s.lance ofP� da!a base;OKOIOAC (SaudiArabia); GovemrnenlTunrsia. ol 'Mth populationsol """' 2 ,..,_ liste:! in order dFDI perc.apita during 1986-90. '1986-89only.

©International Monetary Fund. Not for Redistribution 3 Investment Policies and Capital Flows 93 •

Appendix Table 7. Differing Performance Among Developing Countries in Attracting FDI, 1990 FDI FDI Inflow Population (Billion FDI Per Capita (Percent (Percent (Millions) U.S. dollars) (U.S. dollars) of GOP) of GDI)

20 Most successful 629 17.8 28.2 1.2 3.2 developing countries' 81 Other developing countries 3,5 17 7 . 9 2.3 0.4 1 .4 Total average 4,146 25.7 6.2 0.8 2.2

Sources: World Bank, World D•v•lopment R•port, International Monetary Fund, Bo/anc• o/ Poym•nll 1992; SIOIISIIC:S Yeorboolc, 1991. 'Excluding Singapore.

Appendix Table 8. Exports of Manufactures (Annual averages, 1986-90)

In Million In Percent U.S. Dollars U.S. Dollars of GOP Per Capita

Algeria 316.2 0.56 13.31 Egypt 81 7.8 2.25 16.39 jordan 399.1 7.53 135.75 Morocco 1,553.5 7.36 64.84 Oman 248.8 2.98 175.18 Saudi Arabia 2,150.2 2.65 153.37 Tunisia 1,672.8 16.30 216.88 United States 228,050.0 4.77 927.00 Germany 287,460.0 24.57 4,689.40

Source: World Bank, World Tables, 1992.

Appendix Table 9. Literacy Rates (Percent literate, aged 15 plus, 1990)

Algeria 57 Egypt 48 Jordan 80 Morocco 49 Oman n.a. Saudi Arabia 62 Tunisia 65 Turkey 81 Malaysia 78

Source: World Bank, Social Indicators of Development, 1991-92.

©International Monetary Fund. Not for Redistribution Arab Capital Flows: Recent Trends and Policy Implications

AHMED AB/SOUROUR1

nternational financial intermediation since the mid-eighties has Imade an enormous leap in apparent efficiency going hand in hand with the unprecedented explosion of cross-border capital flows, as new financial instruments have been created and competi­ tion among borrowers, lenders, and financial intermediaries has strengthened markedly. This process was facilitated by the equally unprecedented emer­ gence of persistent current account imbalances. From an average of less than $50 billion for most of the century, the sum of the 14 larger industrial countries' imbalances (surpluses and deficits together) climbed to $100 billion in 1982 and reached $350 billion by 1987. But even though the imbalances stabilized at that level for the rest of the decade, international gross capital flows were double their size. By 1989, foreign exchange trading grew at a much faster rate than did international trade in goods and services: the comparative ratio of daily transactions reached almost 40 to 1 by the end of the decade. Private capital movements tend to be driven largely by expecta­ tions of exchange rate realignments, which in turn are driven by current account developments. Typically, economies in deficit have to confront pressures of private capital outflows, which in rum exacerbate downward exchange rate pressure, whereas surplus countries are usually confronted with sizable ex ante capital inflows

1The views expressed in Lhis paper are the author's and do noL necessarily represent those of the Arab Monetary Fund.

94

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flows 95

that further compound the initial external disequilibrium. Hence, private flows during much of the eighties tended to compound, rather than offset, current account imbalances. The gradual erosion of controls on international capital flows that started in the seventies resulted in an explosion of capital movements during the eighties. Deregulation, internationalization, and liberalization paved the way for a growing range of innovative financial instruments being traded within and across borders at increasing speed and with dramatically reduced costs. Gross capital inflows to industrial countries were enormous both in nominal and real terms. In contrast, and unlike the earlier period, in the eighties public sector capital inflows to developing countries remained virtually stagnant, private sector inflows were somewhat weaker, and devel­ oping countries were confronted with a massive decline in commer­ cial bank financing. The failure of the international financial system, with all the sophistication it had acquired, to channel much-needed finance from industrial to developing economies reflects a multitude of shortcomings and imperfections in the system, which cannot be discussed here, given the scope of the subject. Nevertheless, inappropriate macroeconomic policies, extensive controls, and uncertainties in government policies in many developing countries contributed to the creation of a business environment conducive to domestic capital flight and hostile to foreign investment in domes­ tic assets. Another important consideration that may account for the relative decline in capital inflows to developing economies is that industrial countries' financial markets tend to act as a powerful magnet to foreign investors who are naturally attracted to a deep and liquid financial environment that offers a diversified array of financial instruments. U.S. assets, for instance, at the end of the decade attracted one-fourth of the rest of the world's private assets. Arab countries share most, if not all, of the problems and obstacles faced by the developing world, sometimes with more intensity, sometimes with less. But the Arab region has one clearly distinguish­ able feature: it comprises both capital-surplus and capital-deficit economies, a feature that presents as many challenges for integra-

©International Monetary Fund. Not for Redistribution 96 Ahmed Abisourour

tion as it offers opportunities for the region's mediunHerm develop­ ment strategy to enhance financial coordination. This paper discusses these challenges and their policy implica­ tions, and then argues that perhaps the most urgent task that lies ahead for both national and regional specialized development insti­ tutions is to propose an agenda for capital market development in the region through the remainder of the decade of the 1990s to help establish the necessary infrastructure for intra-Arab financial cooperation and econornic growth.

Arab Capital Flows

A blief analysis of recent developments in Arab capital flows/ against the backdrop of international financial developmems, reveals the weakness of Arab financial intermediation and the struc­ tural imbalance in the nature of Arab capital flows, as well as their size, composition, direction, and geographic distribution. Four major capital account categories are discussed here: foreign direct investment, portfolio investment, and long-term and short-term cap­ ital flows.

Foreign Direct Investment (FDI)

International FDI flows rose almost fourfold during the 1980s, to reach $192 billion by 1989, and although they declined slightly, to $180 billion in 1990, they represent well over 1 percent of the combined GNP of major industrial countries. The reasons for this sharp increase are mainly the desire of particular industries to relo­ cate production abroad because of fear of protectionism, lower labor costs, and/or trends in effective exchange rates. The underlying structure of international FDI flows during the second half of the 1980s, however, took a drastically different turn from the earlier period. Aggregate inflows into the developing world fell from one-half of the size of flows into developed countries experienced early in the decade to less than one-fifth by 1990. At the same time, the global distribution of f1ows into developing countries shifted in favor of the dynamic economies of Asia ar the expense of indebted countries elsewhere, making their financial adjustment effotts even more painful.

2Defined basically as balance of payments capital account transactions.

©International Monetary Fund. Not for Redistribution 4 Arab Capital Flows 97 •

The share of Arab countries in global FDI inflows, as Table 1 shows, remains small and erratic. Balance of payments statistics show an average inflow of over $1 billion yearly for Egypt; about $150 million for Bahrain, the Libyan Arab Jamahiriya, Morocco, and Oman; less than $100 million for Tunisia; and insignificant amounts for the other countries. Saudi Arabia, where FDI inflows amounted to almost $5 billion annually during the early part of the 1980s but declined since then and shifted to a net disinvestment of about $300 million a year in 1988-89, is a striking example. Although no breakdown is available for the sources of FDI flows into the Arab countries, indications are that a significant part origi­ nated from Arab sources, mainly the United Arab Emirates and Kuwait. On outflows (as shown in the appendix tables), Kuwaiti direct investment abroad has progressively increased over the decade, to reach an annual amount of $0.5 billion in 1989. Saudi statistics do not record any of its sizable capital outflows under FDI abroad. Arab countries may have remained impervious to the rising ride of FDI inflows because of the existence of restrictions in practically all capital surplus countries and, until recently, in most capital deficit countries, on the acquisition of real assets by foreigners and because of a general nationalistic resistance to FDI. In spite of recenr steps by some counrries to adopt outward-looking investment policies

Table 1. Direct Investment Inflows (Millions of U.S. dollars)

1984 1985 1986 1987 1988 1989 1990

Arab countries 6,100 2,209 2,216 -127 1,459 1,645 2,582

Bahrain 141 101 -32 -36 222 181 -4 Egypt 729 1,178 1,217 948 1,190 1,250 734 Libya -17 119 -177 -98 98 125 159 Morocco 47 20 1 60 85 167 165 Oman 158 161 140 35 92 112 144 Saudi Arabia 4,850 491 967 -1,175 -328 -288 1,271 Tunisia 113 108 63 92 61 79 75 Others 79 31 37 -174 39 19 38

Developing countries 15,253 12,476 12,369 14,690 22,293 26,252 29,958 Industrial countries 38,455 38,500 63,684 107,485 128,156 164,234 170,476 Global FDI inflows 48,261 50,975 76,052 122,175 150,449 190,486 200,434

Sources: IMF, Balance ofPayments Statistics, and Arab Monetary Fund (AMF) calculations.

©International Monetary Fund. Not for Redistribution 98 Ahmed Abisourour

(Egypt, Jordan, Morocco, and Tunisia), administrative bmtlenecks and red tape remain. Also, takeover bids by foreigners of domestic corporate shares have been frowned upon, often with the absence of well-developed equity markets that would allow foreign participation in existing companies. This fa ctor is critical when takeover bids through secu­ rities markets have been the major form of FDI in developed countries.

Portfolio Investment

On the international scene, portfolio investment rose markedly during the 1980s mainly owing to the huge expansion in assets of nonbank financial intermediaries (investment trusts, insurance companies, and pension funds) and the radical diversification from domestic to foreign assets. The increase in transactions took place, of course, almost entirely among the developed countries. Interna­ tional bond issues by developing countries, and by international institutions on their behalf, remained broadly unchanged. More­ over, half of developing countries' issues during the second half of the eighties was accounted for by the seven dynamic Asian economies. Portfolio flows into equities remained weak throughout the period, a direct reflection of the limited development of secu­ rities markets in developing countries. As for Arab countries, only Saudi Arabia and Kuwait were active in portfolio investment abroad, whereas investment flows into the Arab region remained insignificant. Equity Investment. Global international holdings of equities increased tenfold over the 1980s, to reach $10.9 trillion. Although nonresident holdings represent only 7 percent of that amount, the value of their aggregate u·ansactions rose twentyfold during the same period, to $1.5 trillion annually, an even faster increase than that registered by domestic transactions. In volume terms, the increase was fivefold. For developing countries, foreign portfolio flows into equity markets remain limited, a direct reflection of their small level of capitalization which is estimated at only 6 percent of that of markets in developed countries (Table 2). The status of Arab securities markets is even more drastic. Too small and virtually closed to outside investors, they have no share of the fa st-growing market for international equities, as Table 3 shows.

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Table 2. Equities Markets (Billions of U.S. dollars) 1984 1988 1989 1990

Stock market capitalization

Arab countries 40 Developing countries 130 467 725 544 Developed countries 3,294 9,403 11,005 8,985

Aggregate international transactions

Value 385 1,213 1,598 1,500 Percentage of world trade 10.4 11.4 13.6 13.5

Source: Bank for International Settlements (1991 ).

On outflows, although balance of paymentS statistics on portfolio investment of developing countries are incomplete, available data (Table 3) show that Libya is the only Arab country registering significant transactions in corporate equity investment, amounting since 1986 to a net sale of domestically owned foreign assets of about $100 million annually, with an exceptionally high figure of $3 billion in 1987. The structural imbalance of Arab equity invest­ ment flows compared with other categories of capital flows is in clear contrast with the recent trend in international equity invest­ ment, which traditionally amounts to between one-fifth and one­ fourth of the size ofgross flows into bonds; the proportion is higher in times of stress and heightened volatility than in relatively quiet periods, because the correlation between returns on different inter­ national stock markets increases when the markets' interaction becomes more intense. Investment in Bonds. During the 1980s, global international hold­ ings of bonds tripled, to reach $10.6 trillion in 1989, of which nonresident holdings amounted to 12.8 percent. This development explains the general belief that securitization of international capital flows is progressively replacing traditional bank lending. Available figures show, however, that the share of bond financing, which became just as important as bank financing at the onset of the debt crisis, lost ground as the latter rebounded to about three-fourths of international financing by 1989.

©International Monetary Fund. Not for Redistribution Table 3. Total Portfolio Investment Flows1 (Millions of U.S. dollars) 0 0 1984 1985 1986 1987 1988 1989 1990 > Outflows2 -:r �3 Arab countries � )o Algeria3 2 ,<7 ,;;;- Egypt1 1 20 2 '0 r::: Kuwaiti -7 -392 -506 -720 -422 ..... 0 c: libya4 47 55 -67 -2,976 -221 -52 -115 ..... Saudi Arabia3 13,406 8,412 3,451 6,150 3,057 -1,786 1,1 11 Tunisia3 -8 -5 -5 -7 -5 -1 -1 Developing countries1 13,180 7,232 2,090 2,597 581 -3,169 -11,882 fndustriol countries1 -67,610 -121,881 -186,879 -118,586 -202,1 74 -268,328 -163,552 lnflows2

Arab countries 314 81 59 238 243 86 Kuwait3 216 47 21 219 233 92 Tunisia3 99 35 38 18 10 -6 19 Yemeni -1 -1 1 Developing countries1 2,757 4,331 972 1,1 87 4,087 4, 170 16,855 Industrial countries1 71 ,61 7 149,506 176, 189 119,257 184,127 301,543 140,776

Sources: International Monetary Fund, Balance o.fPayment5 Statistics, and AMF calculations. 11ndudes net investment in c01p0rate equities, public sector bonds, and other bonds. 2A minus sign under outflows indicates a net sale of dome.sticallyowned foreign assets; under inflows, it indicates a net sale of foreign-owned domestic as.set.s. 3AII public sector bonds; equity investment is zero. •Ail equities. ©International Monetary Fund. Not for Redistribution 4 Arab Capital Flows I 0 I •

Another important development is that private capital investment in bonds has increasingly been taking the form of the issue of overseas bonds by domestic enterprises rather than of nonresident purchases of domestically issued bonds. About one-half of bonds outstanding are denominated in U.S. dollars, which offer more liquidity, a wider variety of instn1ments, and extensive hedging opportunities. With respect to Arab countries, as clearly shown in Table 3, two countries-Saudi Arabia and Kuwait-have been the largest investors in internationally issued government bonds. Kuwait has been a net seller of domestically owned foreign bonds since 1984, while recording net capital inflows from foreign-owned domestic assets. Saudi Arabia, on the other hand, recorded the highest invest­ ment in foreign government bonds of $13.4 billion in 1984, and another $21 billion during 1985-88, before it became a net seller in 1989. Saudi figures are believed also to include some of the loans extended abroad, to be discussed in more detail below. Intra-Arab bond investment flows are nonexistent except for some past Kuwaiti bond issues. In contrast, foreign penetration of government bond markets in the industrial countries increased from 10 percent in 1983 to an average of 15 percent in 1989. The ratio exceeded one-third for Canada, Germany, and the Netherlands (Table 4).

Table 4. Bond Markets' Foreign Penetration Ratios (In percent) 1983 1985 1988 1989

Arab countries

Industrial countries (average) 10 13 13 15

Canada 16 21 31 37 France 4 2 6 15 Germany 9 17 31 34 Italy 3 4 4 6 Japan 6 6 4 4 Spain 2 5 United Kingdom 9 11 15 15 United States 13 14 17 19

Source: J.P. Morgan, World Financial Markets (1989).

©International Monetary Fund. Not for Redistribution I 02 Ahmed Abisourour

The increase in foreign penetration ratios of bond markets around the world is explained by two elements: first, is the significant shift of household savings from ordinary bank accounts to institutional investors generated by the rise in demand for insurance and pension schemes; and second, in the wake of liberalization and deregulation, the enormous increase in institutional investors' funds has led to a massive drive for diversification of their portfolios into foreign assets. Institutional investors in Arab countries are not yet able to play a similar portfolio investment role within the region because of a lack of sufficient financial instruments and proper market mech­ anisms on the one hand, and because of the existence of legal restrictions on foreign penetration of domestic securities markets on the other.

Long-Term Lending A clear distinction exists between two groups: the group of Arab donor countries that comprises Algeria, Iraq, Kuwait, Libya, Qatar, Saudi Arabia, and the United Arab Emirates; and the group of recipient countries with capital deficits, including Bahrain, Egypt, jordan, Lebanon, Mauritania, Morocco, Oman, Somalia, Sudan, Syria, Tunisia, and the Republic of Yemen. Algeria and Iraq have at times also been recipients of Arab aid. The general pattern of net disbursements of loans and grants by Arab donor countries has been closely correlated with their economic development and with oil price fluctuations. Disburse­ ments of financial aid to developing countries increased from $2.6 billion in 1973 to about $8 billion annually during 1975-77. Dis­ bursements rose again, in line with the major increase in oil reve­ nues, to their highest level of $11 billion annually in 1980-81. Levels of financial assistance by Arab donor countries declined afterwards to reach very low levels in 1988-89, partly because of decreasing accumulated reserves over the years, and partly as a reflection of reflows coming due of payments of principal on loans extended in earlier years. All in all, Arab donor countries contributed $99.7 billion to devel­ oping countries in development and balance of payments financing during 1973-89; this figure excludes military assistance and certain other transactions. Moreover, about 85 percent of Arab financial aid was extended on concessional terms, and as a share of the

©International Monetary Fund. Not for Redistribution 4 + Arab Capital Flows I 03 donors' GNP represented on average 4.72 percent during most of the 1970s. The ratio declined to 0.84 percent in 1988, but remained more than double that of officialdevelopment assistance and Devel­ opment Assistance Committee countries, which fluctuated between 0.30 and 0.38 percent. Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates pro­ vided more than 90 percent of net Arab aid. Saudi Arabia's share alone was 52 percent during the 1970s, and grew to 70 percent during the 1980s. On the receiving end, Arab capital deficit countries received about $60 billion or 61 percent of total Arab financial assistance between 1973 and 1989.3 These flows from Arab sources represented 2.1 percent of the GNP of the Arab recipients, comprised nearly 7.1 percent of their cumulative imports, and fluctuated between 10.5 percent and 24.0 percent of their total investments. Looking at individual recipient countries, the highest ratios were recorded by Jordan, the Republic of Yemen, Egypt, the Syrian Arab Republic, Sudan, Mauritania, and Morocco. Arab aid, by its very concessional nature, has undoubtedly accel­ erated economic development in the recipient countries beyond what would have been otherwise possible. But some countries were inclined to rely increasingly on foreign borrowing to finance their budget deficits and allowed their imports to grow nearly twice as fast as their exports, which resulted in an increasingly weakened balance of payments position. Regarding the pattern of drawings and repayments of long-term loans for Arab countries (Table 5), first, it is practically all nonbank borrowing; second, public sector flows mainly reflect drawings and repayments of loans received by Algeria, Egypt, Jordan, Morocco, and most recently Syria and Tunisia; and third, Algeria accounts for more than three-fourths of "other sectors' " long-term capital flows. The remainder is mostly accounted for by Egypt, Morocco, and Tunisia.

'Outside the capital account, total remittances of Arab workers, who represent most of the imported labor in Arab donor countries, are estimated to have reached about $85 billion during the same period and to have exceeded $100 billion by 1991 (Table A14).

©International Monetary Fund. Not for Redistribution I 04 Ahmed Abisourour

Table 5. Drawings and Repayments of Long-Term Loans by Arab Countries• (Millions of U.S. dollars)

1984 1985 1 986 1987 1988 1989 1990

Public sector Outflows -2,715 -3,557 -3,638 -3,830 -4,220 -4,629 -12,623 Inflows 5,000 4,505 5,107 4,473 5,673 5,627 2,949

Banking sector Outflows -2 -6 -3 255 395 4 Inflows 21 -10 51 -24

Other sectors Outflows -5,416 -4,656 -5,358 -4,776 -6,234 -6,252 - 7,278 Inflows 4,614 5,161 5,409 5,494 7,460 7,794 6,403

Sources: IMF, Balance of Payments Statistics and AMF calculations. 1A minus sign under outflows indicates drawings on loans extended or repayment of loans received; under inflows it indicates payments of loans extended or drawings on loans received.

Shore-Term Capital Flows

International capital account transactions are, wherever possible, classified under direct investment, portfolio investment, or official reserves. Since banks act only as agents (not principals) in virtually all those transactions, balance of payments statistics treat the cate­ gory of short-term capital of the banking sector as a residual cate­ gory. Nevertheless, figures compiled show that the total volume of capital transactions through the international banking system rose to huge dimensions during the 1980s. One indicator-foreign exchange transactions conducted by banks-was estimated by the BIS to have reached $650 billion daily in 1989. Most open positions, however, are closed within the same trading day and do not usually give rise to measurable capital flows. But aggregate net short-term bank flows for the major industrial countries averaged almost $80 billion annually during the second half of the 1980s. The major players in the markets for short-term capital have been, on the one hand, the United States and the United Kingdom with sizable current account deficits, and on the other, the surplus coun­ tries, Germany andjapan. The role of the latter has been particularly prominent because Japanese banks are subject to only an overall limit on foreign exchange exposure regardless of maturity. Further-

©International Monetary Fund. Not for Redistribution 4 • Arab Capitol Flows I 05 more, huge rises in the value of Japanese equities during the 1980s contributed to the capital base for much of the expansion in interna­ tional lending. The dangers attached to this trend would quickly materialize if short-term interest rates rose unexpectedly and/or if equity prices fell substantially. If this happened, the consequences could be destabilizing for the banking sector in the surplus coun­ tries, would further enhance the inherent fragility of balance of payments financing in the deficit countries, as well as affect their nonbanking sectors, which financedmuch of the foreign investment in bonds by short-term borrowing in foreign currencies. Arab countries have not, generally speaking, been active in the markets for short-term capital. But there are exceptions: almost 90 percent of short-term capital movements of the public sector in Arab countries is explained by the steady sale of foreign assets by the Kuwaiti Government of about $5-6 billion annually since 1984. The remainder relates to transactions by the public sector in Syria, whereas public sectors in other Arab countries did not effect any significant short-term capital transactions during the 1980s (Table 6 and relevant appendix tables). With regard to the banking sector, Saudi Arabia, Kuwait, Bahrain, and Egypt accounted for almost all of the recorded sales of foreign assets and increases in liabilities. As for other sectors' short-term capital flows shown in Table 6, they are almost exclusively explained by an increase in Saudi Arabian private holdings of foreign assets and movements in the liabilities of Kuwait, Libya, Morocco, and Syria.

Table 6. Short-Term Capital Transactions of Arab Countries (Millions of U.S. dollars) 1984 1985 1986 1987 1988 1989 1990

Public sector Outflows -5,932 -2,184 -6,141 -4,199 -5,149 -6,543 -393 Inflows 924 774 941 1,302 423 1,759 11138

Banking sector Outflows -2,329 -4,316 -5,223 -5,214 -4,165 -4,870 -5,023 Inflows 378 498 764 2,174 1,353 2,758 -292

Other sectors Outflows 624 7,530 4,511 12,107 5,315 7,91 3 368 Inflows 430 603 907 -988 -930 61 1,071

Sources: IMF, Balance of Payments Statistics and AMF calculations.

©International Monetary Fund. Not for Redistribution I 06 Ahmed Abisourour

Conclusions

Perhaps the most important conclusions that can he derived from the analysis of Arab capital flow developments are as follows: The three revolutions-deregulation, internationalization, and innovation-that the world financial system has been undergoing at the same time have not as yet had any significant positive impact on Arab capital markets. As these remain underdeveloped and generally restrictive, international financial markets will continue to act as a powerful magnet offering more arrractive investment opportunities to savers from the Arab surplus countries, thereby reducing intra-Arab capital flows, and even further worsening the problem of domestic capital flight faced by the Arab deficit economies. The notion of "reversibility," which underlies international capi­ tal movements among developed countries and the dynamic devel­ oping countries, whereby capital withdrawn by certain temporary factors would soon flow back in once the outside attractions waned, does not relate to the Arab economies. With a business environment burdened by administrative restrictions and price distortions, and unattractive financial market intermediation, there is little room for channeling Arab or foreign capital into direct or portfolio investment opportunities in most Arab countries. Arab private capital, which sometimes flows back to the Arab region, is thought to be frequently driven by speculative motives in the financial and real estate markets. By all accounts, as explained above, the past two decades have shown that Arab donor countries remain the most generous of all donors. Arab recipient countries have also benefited most from Arab official development assistance, bilaterally and multilaterally. By comrast, Arab private capital has not been able to flow as freely within the Arab region. Hence, the most logical proposition would be that the major challenge for the region during the 1990s is the development and integration of Arab financial markets with a clear strategic objective to foster and facilitate the free movement of Arab capital between Arab countries. This challenging task cannot be undertaken without policies conducive to a stable macroeconomic foundation, healthy financial structure, and improved investment environment.

©International Monetary Fund. Not for Redistribution 4 Arab Capital Flows I 07 •

Policy Implications

PoJjcy Objectives Whatever the development objectives of a country may be, it is essential to aim at achieving and maintaining financial balance. This balance requires that the demand for investment resources hy the deficitsectors (which in most countries include the government and the corporate sector) be met hy the supply of required resources from the surplus sectors, including primarily the household sector. The transfer of resources may take place either directly or through financial intermediaries. For the developing countries, the external sector may also be a major provider of financial resources in the form of official external assistance and private foreign investment. Most of the success of economic planning in developing countries relies heavily on the ability to achieve a rapid and balanced growth of investment in both the government sector and the private corpo­ rate sector. This in turn would not be possible without an adequate transfer of household savings and foreign capital inflows to these sectors. The transfer can be facilitated only if, on the one hand, a major part of household sector saving is in the form of financial assets whereas, on the other, the inflow of private foreign capital requires the availability of diversified financial instruments and proper financial intermediation. Financial policies should therefore aim at quickening the development of financial institutions and instruments, which suit savers' and foreign investors' preferences, until saving in the form of financial assets and the flow of funds through financial institutions dominates the local financial scene. A number of Arab countries have been and still are undergoing major economic structural adjustment, including the adoption of outward-oriented development policies, far-reaching trade and financial reforms based on "managed" economic liberalization, and attempts at regional policy coordination. Policy objectives include the structuring, or restructuring, of the financial sector, by relaxing the legal and regulatory framework, fostering financial institutions' development, streamlining the administrative process, and opening up the capital account by red ucing exchange rate distortions and restrictions on foreign capital mobility. The resulting free flow of funds, it is hoped, will increase the availability of financialresources, eliminate distortions in their allocation, increase competition, and

©International Monetary Fund. Not for Redistribution I 08 Ahmed Abisourour encourage productivity to achieve higher and sustainable rates of growth. Leaving aside fundamental differences in the level of economic growth and the development of financial intermediation and finan­ cial resource needs, the causes limiting intra-Arab capital and for­ eign capital inflows seem mainly to be governmental policies that either maintain various obstacles, uncertainties, and restrictions on foreign private investment and/or favor debt instruments over equi­ ties and financial intermediation in banking over the securities markets. The policy challenge is therefore two dimensional: to increase capital inflows and to balance their direction. The solution for financial development and coordination in the region, therefore, requires that market-oriented countries adopt such outward­ oriented financial policies by relaxing regulations and reducing restrictions on regional/international capital mobility, and that these countries seek to balance those policies better, and promote the proper institutional framework to ensure that an adequate propor­ tion of financial savings flows into the equities markets. A stable macroeconomic foundation and policy predictability obviously remain key ingredients in an action plan to promote private investment, spur inflows of foreign capital, and establish a healthy financial structure for economic growth.

Promotion of Capital Flows Various studies have shown that capital flowstake place in devel­ oping countries, both legally and by evading controls, with much greater frequency and ease than expected. Routine capital flight and evasion of controls through smuggling and overinvoicing of imports and underinvoicing of exports is common practice, which reflects the ineffectiveness of controls. This finding has important implications for macroeconomic pol­ icy and financial reform: fiscal policy is more effective in directing domestic demand and influencing the trade balance, whereas the use of monetary policy is a better way of influencing the capital account flows. In fact, anticipated exchange rate adjustments can quickly be reflected in capital outflows, which to some degree helps explain the unsatisfactory performance of private investment in some Arab deficit economies.

©International Monetary Fund. Not for Redistribution 4 Arab Capital Flows I 09 •

On the other hand, when governments overspend, the results have often been large deficits, excessive taxation, borrowing and/ or monetary expansion, which ultimately lead to the crowding our of the private sector, higher interest rates, a lower expected real return on investment, and, consequently, reduced capital inflows. These have been quickly followed by higher rates of inflation, overvaluation of the currency, external debt problems, and lower economic growth. In reappraising their spending priorities and reforming the finan­ cial sector, governments may be hard pressed to meet the goals of microeconomic efficiency and macroeconomic stability at the same time. But a coordinated regional policy that aims at fostering intrare­ gional capital flows may prove to be tl1e proper shortcut to reaching these goals with minimum sacrifice in terms of overall economic growth. Some key prerequisites are necessary for the development of financial policy alternatives. First, Arab countries need to mainrain political and economic stability. No rational outside saver can be expected to invest his savings in a given country without having reasonable confidence in the stability and economic health of that country over the long tenn. Second, government economic and financialpolicies should help create a healthy business environment mat would make savers (domestic and foreign) feel that they can expect a reasonable return on their domestic investment. A fair and predictable fiscal policy would be instrumental in achieving this goal. Third, deficit countries should open up their capital account, eliminate exchange restrictions, and maintain a stable and pre­ dictable exchange rare policy. Fourth, a securities marker, fairly complete with a range of financial institutions and competent intermediaries as well as a well-structured regulatory framework, needs to be developed. Fifth, it is necessary to establish appropriate accounting standards and financial disclosure rules to improve credibility in the information available from enterprises. Sixth, it is essential to ensure the protection of minority investors and promote a more balanced financial system, where the channeling of savings into equities is equal vis-a-vis the activity of banking and other institutions in the business of promoting savings of the deposit type from the public.

©International Monetary Fund. Not for Redistribution I I 0 Ahmed Abisourour

Seventh, the attitude toward foreign investment needs to be improved. In fact, most Arab countries had foreign investment laws that historically resulted from a fear of foreign domination and a desire to protect domestic entrepreneurs. Unfortunately, the dis­ crimination affected both direct and portfolio investmenc by foreign­ ers, even though portfolio investment is a minority investment and is aimed at an attractive economic return rather than at control. An increasing number of Arab countries have become aware of the significant role that foreign portfolio investment can play in developing of local capital markets, either directly or through mutual funds. It not only adds to the demand for stocks, but also introduces a new group of sophisticated investors to the market who may be more inclined than local investors to require securities analysis, thereby indirectly increasing the level of the market's sophistication. Moreover, a step-by-step policy process, similar to that followed in parts of the developing world with assistance from the Interna­ tional Finance Corporation, could beadopted to help develop intra­ Arab capital flows. Initially, attempts should be made to establish country funds that invest in a large number of companies in a specific country or group of countries. This seems to be a logical first step, as the task of selecting companies in which investments are made is left to the professional fund managers, whereas invest­ ors themselves do not need to be concerned about the detailed knowledge of the various companies in each country. Regional or multicountry funds could also prove instrumental in encouraging intra-Arab capital flows. If a country is still hesitant to allow certain types of direct invest­ ment, it can use several methods to promote portfolio investment while maintaining control of the nature and size of foreign participa­ tion through:

• a ceiling on foreign shareholdings in certain strategic industries;

• a requirement for a minimum period of investment before pro­ ceeds (including capital gains) can be remitted; this could only be useful when the country is facing highly speculative foreign capital inflows, otherwise it would discourage outside investors;

• limiting foreign investment through mutual funds controlled by local authorities. This is currently being adopted by some capital

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flaws I I I

surplus countries of the Gulf Corporation Council (GCC), but iL should be considered only as a first step in the financial develop­ ment process;

• separating the "economic" (dividends and capital gains) and "voting" aspects of ownership through a trustee arrangemem whereby the trustee exercises voting right'>.

Another step (promoted by IFC) that could be adopted in the region is to assist individual companies in the capital deficit coun­ tries in particular in issuing securities regionally/internationally. Initial securities issues should generally be undertaken by large companies with significant project-related funding needs and able to issue a sufficient volume of securities to ensure some liquidity for investors in the financial markets. This two-step process may further encourage institutional invest­ ors in the Arab region, such as pension funds and insurance compa­ nies, to widen their involvement across the Arab world and to diversify their assets further, and in so doing to increase capital mobility in the Arab region.

Development of Securities Markets

In a number of Arab countries, namely, those with a colonial past, stock markets developed many years ago; for example, the Alexandria and Cairo stock markets are nearly a century old. How­ ever, many of these securities markets have been forced by historical shifts in development strategy goals to be dormant until recently. During the past few years, other new securities markets were also established; some emerged more or less spontaneously (sometimes with disastrous consequences as in souk AI Manakh in Kuwait), while in most cases promotional efforts by government authorities induced the creation of stock exchanges and promoted active trad­ ing in securities (Bahrain, jordan, and Oman). Only 7 out of 20 Arab countries have established formal securities markets: Bahrain, Egypt,Jordan, Kuwait, Morocco, Oman, and Tuni­ sia. Saudi Arabia has developed an electronic mechanism for securi­ ties trading managed by the Saudi Arabian Monetary Agency. Six other countries, the United Arab Emirates, Qatar, Syria, Sudan, Algeria, and Iraq are in different stages of preparing for the establish­ ment of more formal securities markets in some form or another.

©International Monetary Fund. Not for Redistribution I 12 Ahmed Abisourour

By the end of the 1980s, the number of listed companies in formally operating Arab securities markets had reached 1,063, with total capitalization equivalent to $40.2 billion including about $10 billion for Kuwaiti companies before the market closure in August 1990. Relative to GOP, the size of Arab equity markets is way behind compared with the rest of the world. Total capitalization amounted to less than 10 percent of GDP in 1990, compared with the 30 percent average reached by developing countries and the 60 percem for developed countries. Futthermore, a great discrepancy exists between Arab securities markets themselves, with the capitalization to GDP ratio reaching 48 percent in Jordan and 43 percent in Kuwait (before August 1990) whereas the ratios in Egypt and Morocco do not exceed 7 percent and 3 percent of their respective GDPs. In absolute terms, Saudi Arabia has the largest market, with a total capitalization equivalent to $15 billion for 78 listed companies. Next is the United Arab Emirates' informal market, with a $7 billion capitalization and 22 companies, representing an average capital of $320 million per company. In contrast, the Egyptian market has 627 listed companies with a total capitalization of $2.5 billion, which amounts to an average capital of no more than $4 million per company. Currently, GCC companies represent about 85 percent of the total capitalization ofArab securities markets. The ratio may become better balanced if and when the proposed privatization programs in the capital deficit countries (such as Egypt, Morocco, and Tunisia) are implemented. As far as trading volume is concerned, the Saudi Arabian market recorded the highest figure among Arab markets in 1991, with 29 million shares for a total value of $2.2 billion. The Amman financial market, on the other hand, traded 162 million shares for a total value of $445 million. In general, however, capitalization and trad­ ing activity in most Arab markets are not exactly representative of the potential size that these markets may reach in a fairly short time now that comprehensive macroeconomic adjustment is being implemented and financial policy reforms are under way more or less successfully in at least some of them. Moreover, the fluctuating prices of securities worldwide have prompted Arab investors to be more discriminating. This healthy ani tude will progressively prompt the development of more sophisticated domestic markets with more

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flows I 13 transparency in trading practices, reliance upon timely disclosure of accurate corporate information, improved analytical capabilities of market intermediaries, and more efficientclearing and settlemenr arrangements in the market system. Several basic prerequisites exist for the establishment and contin­ ued success of a stock exchange. As mentioned earlier, a stable political environment conducive to economic growth and an eco­ nomic development strategy in which private enterprise plays a significantrole as well as a favorable government attitude and policy environment are all necessary ingredients without which a healthy financial market may not take root, and the country may be con­ fronted with pressures from domestic capital flight, while foreign capital would be even harder to obtain. Governments should there­ fore foster the role of securities commissions and ensure that appro­ priate institutional, fiscal, and monetary policies are devised and implemented to pave the way for capital market development. Specifically, such an agenda should spell out the tasks and priori­ ties and set an objective time frame for enhancing the status of local securities markets, reviewing present legal and regulatory frameworks in the various countries, improving the fiscal environ­ ment for both securities investors and issuers, streamlining the administrative process of existing financial institutions, and espe­ cially promoting the regionalization, if not internationalization, of securities markets, all within the context of growth-oriented policies needed to encourage and maintain capital inflows. Another essen­ tial ingredient for the development of Arab securities markets and the promotion of capital inflows is the protection of outside invest­ ors and small investors in general by establishing high standards for professional conduct by brokers and underwriters and by avoiding excessive speculation caused by market rumors and overly easy availability of margin loans. Such protection can be exercised by a securities commission or by another type of government body, usually the stock exchange itself, or through self-regulation by an association of stockbrokers and underwriters. The policy measures should include development of: Professional Standards fo r Brokers and Un derwriters. These standards can be established by legislation or through self-regulation by brokers' and underwriters' associations. Regulations should include minimum capital for the incorporation of brokers and

©International Monetary Fund. Not for Redistribution I 14 Ahmed Abisourour should also ensure that brokers and securities analysts are qualified tO deal with the public or to analyze corporate statements. Enforcement of Generally Accepted Accounting and Auditing Standards. These are to ensure the accuracy of financial informa­ tion and to make it comparable from company to company. A strong auditing profession should be developed that is adequately remunerated and plays an independent role. Disclosure and Financial ReportingRequirements. These should include a prospectus at the time of a new issue, but also regular publication of financial information thereafter through annual reports, quarterly earnings reports to the stock market, etc. Outside investors and their intermediaries need to be able to make an informed judgment about the operations of a company, its profit­ ability, financial health, growth, and prospects. ListingRequirements. These may include minimum capital, mini­ mum number of shareholders, minimum "float," minimum history of profitability, and free transfer of shares, to ensure a company's health before it can be listed for trading. Trading Floor Procedures. Fraud by trading floor personnel and collusion between brokers to effect purchases for their own account before purchases are made for clients are common problems in the absence of regulations. All Arab operating stock exchanges set daily limits on price changes in order to control speculation in the short run. Margin Loans. Without some general guidance, brokers (essen­ tially banks in most Arab countries) tend to overextend margin loans to customers, thereby fueling speculation and endangering their own financial health. Desirable limitations include specific margin limits, margin calls, margin loan contracts between brokers and clients, and stringent collateral arrangements. Insider Trading. Legislation in this area is usually difficult to enforce and should be formalized progressively while control is exercised informally during early development of the securities market. Insiders may be asked to disclose their sales and purchases of a company's stock periodically. While each of the above measures may be introduced in distinct stages, a balance in timing should be maintained, as an approach that is too gradual could lead to uncertainty and confusion in the market.

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flows I 15

Promotion of Financial Balance: Equity Versus Debt

The main purpose of this paper is to make a case for gremcr attention to be paid by Arab policymakers to encouraging an increased intraregional flow of savings (especially private sector savings) into equities, both directly through the securities markets and indirectly through mutual funds, pension funds, and venture capital companies that invest principally in equities. The reason for making this point is that emphasis on encouraging financial flows into debt instruments through the banking system, and especially deposit-type short-term instruments, has oftenled in Arab countries, as elsewhere, to increasingly dangerous levels of financial instability. In most Arab deficit economies, government intervention in the financial markets in the form of tax policies and banking support (for the latter also in the GCC surplus economies), tended to acceler­ ate the trend away from equity toward debt, and thus contributed to the deterioration in corporate debt/equity ratios, thereby endan­ gering the health of the financial system. In fact, significant differ­ ences occur in the tax treatment of equities on the one hand and bank deposits and other debt instruments on the other, which bias financial flows in favor of the latter. rn some cases (Morocco and Tunisia) interest paid on bank deposits, government bonds, and other types of debt instruments, is free of income tax, whereas dividends on corporate shares are subject to tax. This different tax treatment, coupled with the treatment of corporate interest expense as a tax-deductible item and the double taxation of corporate divi­ dends, provides banking institutions in these countries with a dou­ ble advantage vis-a-vis d1e equity markets and disrupts the balance of savings and the alJocation of foreign capital flows within the financial system. Policymakers therefore need to consider alternative strategies in their individual countries to reduce the risks attached to policies leading to excessive borrowing and insufficient financial flows toward equity investments. The situation naturally differs from country to country as the degree to which savers, both domestic and foreign, are prepared to conunit their resources to equity invest­ ments in a given count1y is a function of all of the historic circum­ stances and the accumulated measures that have brought the spe­ cific country to its present position.

©International Monetary Fund. Not for Redistribution I 16 Ahmed Abisourour

Even for indebted countries, there are two major opportunities: the first relates to the benefits that may be derived from securitizing debt and the accompanying debt-to-equity conversion schemes; the second could only be reached, given a suitable policy environ­ ment, by joining the global equity market at a time when portfolio investment managers around the world are seeking greater geo­ graphic diversification, including investments in developing coun­ tries' securities markets. A prudent securitization of debt into bond and equity issues amounts to treating it as an opponunity, rather than simply as a problem. In this sense, the conversion of nonper­ forming loans into equity in otherwise viable companies would not only alleviate the debt problem, but would also contribute to the debtor countries' efforts to achieve faster capital market develop­ ment, encourage foreign portfolio investment, and realize a more balanced financial standing with more equity participation and less country debt exposure. Finally, the building of an efficient regional mechanism for invest­ ment in equities will only happen if a clear-cut agenda is in place, and a significant amount of regional cooperation takes effect in working together to establish and strengthen domestic securities markets and to improve and standardize issuance regulations and trading procedures as well as investor protection standards.

The Role of Specialized Regional and International Organizations Organizations such as the AMF, the IMF, the IFC, and the World Bank have different basic objectives and provide different services in various areas, including policy advice on developing financial systems for their member countries and technical assistance to implement specific measures of a financial development program. Their roles are to serve as catalysts in helping to focus government objectives and activities on the more important issues, for instance, financial system development. leaving aside the differences in the present basic strategies of the various international, regional, and national agencies, developing a more formalized system of cooperation among them in this sensitive area-so that a given country might receive the best advice and assistance available-would result in more effective utilization of available resources. Enhanced cooperation would also help to

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flows I I 7

ensure that the recipient countries in the region are aware what types of assistance are available, which type might best suit their needs, and guarantee that the institutions directly involved in a specific counuy receive the full support from others not directly involved, but with the specific expertise that might be required. Each count1y in the region may be viewed as unique in its institu­ tional details, which means that the techniques of financial marker development have to be tailored accordingly. To determine a logical program for contributing to financial devel­ opment in each of its member countries, and to develop the neces­ sary linkages to promote intra-Arab capital flows, the AMP began first by conducting domestic financial sector surveys to ascertain the current status, to identify prevailing problems, bottlenecks, and inconsistencies, and to define the prospects for future development. The surveys include specific recommendations for restructuring the legal and regulatory frameworks and suggest possible areas where performance may be improved by introducing new techniques and services and strengthening existing components. Second, a process of fundamental data gathering is being initiated through the establishment of an Arab Markets Data Base (AMDB) with the cooperation ofiFC and in conformity with its own Emerging Markets Data Base (EMDB). This would help to launch methodolog­ ical analysis and make possible reasonable coun[ly comparisons, so that the maxin1um use can be made of countries' earlier experience where similar problems arose or similar conditions were faced. Third, the AMF aims to engage in further consultation with each willing member country to help develop an action program tailored to its specific needs and covering specific steps to be taken over a defined period to achieve the objectives as defined by survey findings and as indicated by future AMDB analysis. The implementation stage in itself may include such matters as reform of the overall legislative structure as it pertains to capital market functioning, the establishment of relevant regulatory institu­ tions to ensure healthy growth, and the implementation of effective fiscal and monetary policies as they relate to dividends from finan­ cial instruments and corporate profits. These policies have special significance for the pattern of financing flows, both domestic and foreign.

©International Monetary Fund. Not for Redistribution I 18 Ahmed Abisourour

Fourth, the broad area of appropriate financial institutions, their proper mix of services, and the types of financial instruments issued by public and private sectors in which they would deal would have to be developed. Finally, the business environment should be improved, appro­ priate standards of accounting practice and ethics developed, and standards of financial disclosure developed, all of fundamemal importance to provide bmh reasonable information, protection, and the right signals to investors (national and foreign) as well as accu­ rate information to policymakers concerned with financial planning and development. Obviously, the provision of training for individu­ als concerned with all these matters would also be an important part of future technical assistance activity. This brief description of the steps taken so far to help define the major components of an action program to be jointly elaborated with the countries concerned barely touches on the complexities of the problem, especially for those countries that have to undo most of their restrictive regulatory apparatus, that has essentially evolved from a system of centralized planning with little room for private enterprise. It is also essential to emphasize that any action program can only endure for a limited period. Continuous updating and review is required to adjust both the ultimate objectives and the program details to the changing patternsof the financialenviron­ ment, and, consequently, the various technical assistance activities deployed in its implementation. Moreover, priority must be given to consolidating macroeco­ nomic stabilization during the design of an action program for financial adjustment. Sustainable policies may prove to be bener at promoting financial market development and at encouraging foreign capital inflows than are premature and inconsistent attempts at liberalization and deregulation, or establishment of a stock exchange, which may need to be reversed because solid macroeco­ nomic and financial fo undations are lacking.

Bibliography

Bank for InternationalSettlements, International Banking and Financial Market Developments (Baste: Bank for International Settlements, May 1992).

©International Monetary Fund. Not for Redistribution 4 • Arab Capital Flows I 19

InternationalFin anee Corporation, Emerging Stock Market Factbook, 1991 (Washington: International Finance Corporation, 1991).

___, Annual Reports, various issues, and Capital Markets publication�. International Monetary Fund, Balance of Payments Statsticsi Yearbook (Washington: International Monetary Fund, December 1991). Turner, Philip, Capital Flows in the 1980s: A Survey of Major Trends, BIS Economic Papers, No. 30 (Basle: Bank for International Settlements, April 1991). van den Boogaerde, Pierre, Financial Assistance from Arab Countries and Arab Regional Institutions, IMF Occasional Paper 87 (Washington: International Moneta1y Fund, 1991).

©International Monetary Fund. Not for Redistribution APPENDIX N 0

::r> Table A 1. Direct Investment 1113 (Millions of U.S. dollars) Q. CT> Outflows ... 0 c Inflows 1983 1984 1985 1986 1987 1988 1989 1990 19911 � 0 c Algeria 0 -15 -15 -2 5 -15 -5 -8 -5 � I 1 5 4 13 12

Bahrain 0 I 64 141 101 - 32 - 36 222 181 -4 -7

Egypt 0 -19 -16 -3 -6 -19 -12 -23 -12 -62 I 490 729 1,178 1,21 7 948 1,190 1,250 734 253

Jordan 0 -5 -3 1 -4 -1 -17 32 -14 I 35 77 25 23 40 24 -1 38 -12

Kuwalt 0 -240 -95 -70 -248 -115 -254 -507 I

Libya 0 -114 - 56 -35 -105 I -327 - 17 119 -177 -98 98 125 159

Mauritania 0 -1 -1 I 1 9 7 4 2 2 4

Morocco 0 I 46 47 20 1 60 85 167 165 320

Oman 0 I 155 158 161 140 35 92 112 144

©International Monetary Fund. Not for Redistribution Saudi Arabia 0 I 4,944 4,850 491 967 -1'1 75 -328 -288 1,271 26,385 Somalia 0 I -8 -15 -1 Sudan 0 I 9 -3 4

Tunisia 0 1 1 6 -1 -1 2 -5 -3 I 184 113 108 63 92 61 79 75 150 Yemen 0 (north) I 8 7 3 5 Others 0 I

Totail 0 -279 -120 -68 -255 -265 -326 -595 -90 -79 I 5,591 6, 100 2,209 2,216 -127 1,459 1,645 2,582 27,089

Sources: IMf, Bclome ofPayments Statistics, and AMF cakulations. 'Except Iraq, Leba non, Qatar, and the United Arab Emirates, for which detailed balance of payments clata are not available.

©International Monetary Fund. Not for Redistribution Table A2. Portfolio Investment in Public Sector Bonds N (Millions of U.S. dollars) N )> OutfloW'S ;;r 3 lntlov.rs 1983 1984 1985 1 986 1987 1988 1989 1990 1991 ... a. Algeria 0 2 2 )> CT I ., 0 c: ., Egypt 0 0 c: I 15 21 .,

Kuwait 0 -213 -7 -392 - 506 -720 -422 I 216 47 21 21 9 233 92

libya 0 I -8

Saudi Arabia 0 7,529 13,406 8_412 3,451 6,1 50 3,057 -1, 7&6 l,lll I

Tunisia 0 -8 -5 -5 -7 -5 -1 -1 I 38 99 35 38 18 10 -6 19

Others 0 I

Tota l' 0 7, 318 13,391 8,01 5 2, 940 6, 143 2,334 -2,209 -1,078 I 30 315 82 59 237 243 86 34 21

Sources: IMF, Balance of Payments Statistics, and AMF cakulations. 'Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

©International Monetary Fund. Not for Redistribution 4 Arab Capital Flows 123 •

Table A3. Portfolio Investment in Other Bonds (Millions of U.S. dollars)

Outflows Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991

Egypt 0 6 20 2 I

Yemen (north) 0 I -2 -1 -1 Others 0 I Total' 0 6 1 20 2 I -2 -1 -1 1

Sources: Sources: IMF, Balance of Payments Statistics, and AMF calculations. 'Except Iraq, lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

Table A4. Investment in Corporate Equities (Millions of U.S. dollars)

Outflows Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 Bahrain 0 -48 I -81 -35 libya 0 -98 47 55 -67 -2,976 - 22 1 -52 -115 I Others 0 I Total' 0 -146 47 55 -67 -2,976 -221 -52 -196 -35 I

Sources: IMF, Balance of Payments Statistics, and AMF calculations. 'Except Iraq, lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

©International Monetary Fund. Not for Redistribution Table A5. Public Sector (Long·Term) N .,. (Millions of U.S. dollars) > � Outflows 3 n Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 a. )> Algeria 0 -357 -183 -277 -219 -239 -229 -545 -301 o- ;;;· I 100 88 21 1 277 206 612 548 660 0 c ., Bahrain 0 -19 -19 -74 -32 -26 -25 -95 -22 -20 ,g I 7 30 6 10 5 7 8 10 3 ., Egypt 0 -406 -393 -672 -552 -889 -419 -539 -8,636 -3,191 I 1,237 1,040 959 1,21 5 800 532 926 -1,415 3,41 1

Jordan 0 -469 -660 -564 -647 -607 -971 -388 -270 -310 I 871 749 842 775 795 985 591 623 607

Kuwait 0 -775 -544 -439 -957 -373 -624 -446 I 86 98 100 151 194 229 306

li bya 0 -165 100 -128 -5 -305 -184 -34 I 32 50 45 12 47 41 63

Mauritania 0 -6 -11 -78 -42 -36 -66 -14 I 88 71 161 193 234 99 47

Morocco 0 -317 -115 -443 -399 - 444 -497 -499 -481 -642 I 931 822 996 694 589 861 81 8 1,468 1,268

Oman 0 -182 -147 -215 -228 -455 -387 -551 -541 I 552 565 362 775 320 569 600 148

Somalia 0 -22 4 -22 -63 -89 -85 -62 I 99 114 99 96 166 51 36

©International Monetary Fund. Not for Redistribution Sudan 0 -65 -17 -19 -57 - 119 -54 -37 -73 -25 I 80 -56 -85 -52 -117 117 148 176 51 2

Syria 0 -466 -465 -367 -91 -118 -101 -789 -1,145 I 655 755 247 235 324 398 31 7 350

Tunisia 0 -140 -171 -179 -251 -304 -333 -384 -438 -475 I 256 301 270 437 385 502 601 495 764 Yemen (north) 0 -24 -62 -42 -48 -96 -100 -77 I 220 21 1 141 111 31 3 355 247

Yemen (south) 0 - 1 2 -24 -38 -47 -35 -24 -19 I 207 162 151 178 2]12 315 371 Others 0 I

Tot al' 0 -3,427 -2,71 5 -3,557 -3,638 -3,830 -4,220 -4,629 -12,623 -4,663 I 5,421 5,000 4,505 5,107 4,4 73 5,673 5,627 2,949 6,565

Sources.: IMF, Balance of Payments Statistics, and AMF carculatioru. 'Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

•

N IJ1

©International Monetary Fund. Not for Redistribution 126 Ahmed Abisourour

Table A6. Long-Term Bank Lending (Millions of U.S. dollars)

Outflows Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 Ubya 0 -1 257 400 4 I 21 -10 51 -24 Mauritania 0 -2 -6 -2 -2 -5 I

Others 0 I

Total' 0 -2 - 6 -3 225 395 4 I 21 -10 51 -24

Source: IMF, Balance of Payments Statistics. 'Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

©International Monetary Fund. Not for Redistribution Table A7. Other Sectors' Long-Term Capital (Miflions of U.S. dollars)

Outflows Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 Algeria 0 -3,276 -3,246 -3,1 33 -3,396 -3,500 -4,329 -4,523 -6,427 I 2,697 2,950 3,164 3,692 3,566 4,905 5,299 5,201

Bahrain 0 -28 -33 -6 I 37 1

Egypt 0 -1,283 -921 -877 - 895 -333 -427 -536 -106 - 71 I 710 927 1 '111 790 595 622 790 75 101

Kuwait 0 -96 -757 -80 -499 -215 -32 -252 I 336 14 123 62 50 548 286

Libya 0 -2 -590 -165 -9 I 339 356 -115 -106

Mauritania 0 -15 -26 -18 -33 -39 -35 -44 I 10l 40 30 64 50 74 57 � Morocco 0 -197 -123 -75 -161 -156 -284 -212 -288 -363 • I 304 185 142 290 305 334 337 849 762 )>a Sudan 0 -1 -1 0" I 1 &" 0 ""\?. Tunisia -208 -202 -219 -298 -379 -389 -414 -448 -366 [ I 495 400 389 330 328 253 250 384 326 0::!:! Yemen (north) 0 -27 -141 -166 -33 -121 -136 -105 � I 89 176 169 261 367 428 ,.._, .....,

©International Monetary Fund. Not for Redistribution Table A7 (concluded). N CD Outflows )> Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 J 3 0 0. Yemen (south) 0 -59 -9 -25 -12 )> I 58 9 25 12 CT

... 0 Others 0 c ..., 0 I c ..., Total1 0 -5,102 -5,41 6 -4,656 -5,358 -4,776 -6,234 -6,252 -7,278 -800 I 4,738 4,614 5,161 5,409 5,494 7,460 7,794 6_403 1,189

Sources: IMF, Balance ofPayments Statistics, and AMF cakulations.. 'Except Iraq.. lebanon, Qatar, and the United Arab Emirates, for which detailed balance of paymenu data are not available.

©International Monetary Fund. Not for Redistribution Table AS. Public Sector (Short-Term) (Millions of U.S. doffars)

Outflows Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991

Algeria 0 -25 14 I 8 -10 11 24 8 7 -6

Bahrain 0 I 12 -12 17 16 17 Egypt 0 I -1 774

Jordan 0 -77 21 3 -112 -77 -14 110 -242 I 170 -133 5

Kuwait 0 1,376 -5,671 -1,899 -5,795 -3,872 -5,161 -6,100 I

Libya 0 43 114 12 81 I -49 100 -112 -5 -137 196 599 -130 0 � Mauritania • I 8 19 -11 25 9 -1 a)> Morocco 0 -16 -28 0" I 61 -60 -4 -35 -1 4 5 �I;' Somalia 0 � I 2 18 107 11 109 163 0::t! � Sudan 0 -135 -33 180 80 I -9 66 423 21 7 463 364 240 269 428 N �

©International Monetary Fund. Not for Redistribution w 0 Table AS (concluded).

� Outflows 3 tl> Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 �

c-> Syria 0 - 51 -20 -38 -236 -511 -196 -455 -584 ;;;· 0 I 284 744 463 499 776 -68 724 979 c ..., 0 Tunisia 0 -199 c ..., I -15 57 -53 96 - 39 Yemen (north) 0 I 29 4 20 8 18 -3 -4 Yemen (south) 0 I -7 3 3 6 -1 -8 23

Others 0 I

TotaJI 0 1,033 - 5,932 -2,184 -6,141 -4,1 99 -5,147 -6,543 -393 -242 I 310 924 774 941 1,302 423 1,759 1,1 38 1,224

Source$: IMF, 8<11once ofPayments Stotirtics, and AMF calculations. 'Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

©International Monetary Fund. Not for Redistribution Table A9. Short-Term Bank lending (Millions of U.5. dollars)

Outflows Inflows 1983 l984 1985 1986 1987 1988 1989 1990 1991

Algeria 0 226 116 -199 52 195 -86 -83 -226 I 20 11 8 32 18 8 138 162

Bahrain 0 -298 91 -402 -287 1 -429 -837 608 -339 I 66 - 1 1 9 60 64 -13 36 441

Egypt 0 -376 500 -352 483 -898 571 -1,249 -1,904 -2,234 I -1 -40 16 -316 -537 -749 -138 237 -333 jordan 0 I 128 173 57 30 100 457 -76 -67 1,169

Kuwait 0 -172 -699 924 179 -370 -699 -1,236 I 69 34 -665 -502 -29 201 742

Libya 0 207 21 150 40 177 212 -53 -95 I 315 -57 -145 169 -145 1 2 45

� Mauritania 0 3 1 7 -8 11 -6 • I -7 5 -1 2 -2 7 11 a)> Morocco 0 -53 -32 -66 -31 -6 -78 -65 -202 76 0' I C"\ 15 17 30 -27 35 25 101 38 Q 0 1! Oman -270 -76 222 57 -13 -117 -29 -3 §. I 2 -8 -12 116 -59 31 -46 -47 ::!:! 0 5audi Arabia 0 -2,1 19 -2,282 -4,263 -5,61 7 -4,147 -3,348 -1,095 -1,234 -1,204 � I 240 332 663 1,056 2,724 1,132 1,567 -1,183 -603 ......

©International Monetary Fund. Not for Redistribution Table A9 (concluded). w N Outflows )> Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 =r 3 c Somalia 0 a. )> I -7 a- ;:;· 0 Sudan 0 -120 -42 -363 124 -63 -146 -40 -28 -74 c , I -5 6 148 -50 35 -6 -2 12 16 0 c ... Syria 0 48 103 -12 -71 -18 -60 -199 -493 I 269 -62 260 99 48 45 -64 -143

Tunisia 0 -72 -32 31 -18 -124 -62 -22 -230 -2.55 I 57 41 -16 -14 104 129 135 591 230

Yemen (north) 0 2 -52 18 -130 167 16 3 1: -18 55 86 51 -52 14 18

Yemen (south) 0 21 54 -3 -11 -107 50 41 I -11 7 22 4 9 12 5

Others 0 I

Tota11 0 -2,973 -2,329 -4,31 6 -5,223 -5,21 4 -4,165 -4,870 5,023 -4,030 I 1,1 39 378 498 764 2, 174 1,353 2_758 -292 51 7

Sources: IMF, Balance of Payments Stotstia,i and AMF calculations. 'Except Iraq. lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available.

©International Monetary Fund. Not for Redistribution Table Al O. Other Sectors' Short-Term Capita!l (Millions of U.S. dollars)

Outtlmvs Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991

Algeria 0 I 65 76 95 117 92 33 -9 -11

Bahrain 0 -9 -102 I 34 -57 -111 236 10 -26 19 34 36

jordan 0 I -17 13 - 34 -5 - 3

Kuwait 0 209 142 209 685 165 222 238 I -456 -182 -193 -96 -463 -713 -398

libya 0 - 37 153 438 -426 3,200 97 409 - 607 I 223 434 362 30 -484 - 50 136 237

Mauritania 0 -1 -8 -7 -10 16 -9 -3 I 7 4 4 13 6 14 -4

� Morocco 0 -89 -104 61 -189 -85 -278 - 10 - 41 -266 • I 13 135 164 342 -148 -367 260 314 277 )> - a Oman 0 69 -52 -61 154 18 34 -65 -211 tr I � � Saudi Arabia2 0 4,750 615 6,919 4,319 8,862 5,308 7,346 1,147 1,21 1 [ I ::.n 0 Syrian Arab Rep. 0 � I -27 -19 236 157 -102 68 13 278 w w

©International Monetary Fund. Not for Redistribution Table A 10 (concluded). w � Outflows )> Inflows 1983 1984 1985 1986 1987 1988 1989 1990 1991 =r tD3 � Tunisia 0 - 29 - 17 -29 -23 -33 -59 -12 80 )> I 15 39 42 86 100 94 78 224 CT ;;;· 0 Yemen {south) 0 1 c: ., 0 I 4 22 18 4 c: ., Others 0 I

Total 0 4,863 627 7,530 4,511 12,1 07 5, 315 7,903 368 945 I -99 430 603 907 -988 -930 61 1,071 310

Sources: IMF, Balance of Payments Statistics, and AMFcalculations. 'Except Iraq. lebanon, Qatar, and the Un ited Arab Emirates, for which detailed balance of payments data not available. 2Reflect mainly movements in private capital and include errors and omissions.

©International Monetary Fund. Not for Redistribution Ta ble A 11. Public Sector Reserves• (Outflows) (Millions of U.S. dollars)

1983 1984 1985 1986 1987 1988 1989 1990 1991

Algeria 421 333 -1,020 1,498 352 759 705 -138 Bahrain 108 10 -357 179 350 100 188 -569 105 Egypt -161 37 -150 - 339 - 580 95 41 1 -2,556 -2,776 Jordan -53 189 42 -43 -141 -204 -465 - 421 -2,025 Kuwait 988 32 -545 83 1,847 1,996 -1,255 libya 1,786 1,721 -2,362 -212 1,000 1,390 -929 -1,159 Mauritania 20 8 23 19 3 9 -17 Morocco 166 163 51 -330 -297 -264 -21 -1,697 -1,167 Oman -351 -319 -122 61 3 -108 467 -282 -304 Saudi Arabia 1,508 1,480 709 7,619 -2,640 1,519 3,508 5,376 -49 Somalia 78 18 -7 -27 -16 3 20 Sudan 157 11 -10 -45 36 -5 -4 3 4 Syria 145 -216 186 -61 -79 32 -789 -721 Tunisia -35 100 2.25 84 -128 -441 - 65 123 55 Yemen (north) 189 79 31 - 85 - 76 240 10 Yemen (south) -15 6 90 55 47 5 -1

Source: IMF, Balance of Payments Statistics.. 'Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balan

..... VI

©International Monetary Fund. Not for Redistribution Table A1 2. Errors and Omissions1 .... (Millions of U.S. dollars) o-

:::r> 1983 1984 1985 1986 1987 1988 1989 1990 1991 "'3 Q. Algeria 193 -197 127 142 -802 335 -448 -336 Bahra in -45 -193 766 -60 -112 93 180 -132 974 I� ;:;;· Egypt 131 23 585 -156 892 -362 414 631 730 0 c jord an -40 -48 -30 -17 28 123 75 420 .., 0 c Kuwa it -6,398 1,046 -1,936 2,036 -1,409 290 506 .., Ubya -236 -1,096 -328 798 172 270 130 -37 Mauritania 13 -1 -6 -6 -101 -16 -4 Morocco 25 97 42 -37 38 22 -11 9 88 Oman -466 -421 -323 -588 -486 -379 -64 -282 Somalia -4 23 15 19 41 21 -1 Sudan 176 -2 -113 -89 -186 8 -160 11 98 Syria -15 -25 -17 -26 -23 34 71 -348 Tunisia 228 48 -19 94 48 27 -73 -336 -253 Yemen (north) 182 112 22 78 37 -59 58 Yemen (south) -57 36 36 -36 11 63 -2

Source: IMF, Bolonce of Paymen ts Statistics. 1Except Iraq, Lebanon, Qatar, and the United Arab Emirates, for which detailed balance of payments data are not available. Errors and omissions are reflected in short-term capital data for Saudi Arabia.

©International Monetary Fund. Not for Redistribution Table A 13. Net Disbursements of Financial Aid by Arab Donor Countries (Millions of U.S. doffars)

1973 1977 1980 1983 1986 1989 Total Percent Concessional (ODA) 2,1 38 5,761 9,586 4,798 4,498 1,487 85,123 85.4 Bilateral 2,058 3,978 8,808 3,863 3,859 1,317 73,41 3 73.6 Arab recipients {1,234) (3,221) (4,885) (2,499) (1,804) (364) (44,268) (44.4) Other developing countries (824) (757) {3,923) (1,364) (2,055) (953) (29, 145) (29.2) Multilateral 80 1,783 778 935 639 170 11,71 0 11.7

Nonconcessional 434 1,488 1,391 4,302 -178 -3,688 14,577 1 4.6 Bilateral 152 740 932 276 52 8,683 8.7 Multi Ia tera I 282 748 459 4,026 -230 -3,688 5,894 5.9 Total flows 2,572 7,248 10,977 9,100 4,320 -2,201 99,700 100.0 Bilateral 2, 210 4,718 9,740 4,1 39 3,911 1,31 7 82,096 82.3 M ultilatera I 362 2,530 1,237 4,961 409 -3,51 8 17,604 17.7

. Source: International Monetary Fund (1991 ) � • )>

0'a !"'\ c � [

c:n "'�

......

©International Monetary Fund. Not for Redistribution Table A 14. Net Workers' Remittances to Arab Countries w (X) (Millions of U.S. dollars)

;r)> 1973 1977 1980 1983 1986 1989 1990 1991 1973-89 1973-91 .,3 0.. Algeria 282 265 241 235 257 307 321 4,955 5,276 )> Bahrain -101 - 96 -100 - 208 -199 - 253 - 271 -2,183 -2,707

Total 81 2 3,228 6,800 7,394 5,565 6,1 31 7,059 7,466 85,619 100, 144

Source: IMF, BolancePayments of Stath!ics.

©International Monetary Fund. Not for Redistribution COMMENT

SAMIH MASOUD

wish to express my thanks and appreciation to Mr. Ghassan EI­ I Rifai, Vice President, Office of Policy and Advisory Services, of the Multilateral Investment Guarantee Agency, and to Mr. Ahmed Abisourour of the Arab Monetary Fund for their valuable contribu­ tion to this seminar and to economic literature in general by present­ ing two papers on an important subject. The importance of the two papers emanates from the long experience of the authors and the fact that there has been little literature on the subject owing to the lack of data. I should perhaps point out from the outset that my comments will merely be an attempt to supplement the two papers and to raise a few questions that may assist in achieving a better under­ standing of them. The first paper, "Investment Policies and Major Determinants of Capital Flows to Arab Countries," by El-Rifai, seems to reflect writ­ ings by experts of the World Bank Group. It follows the same valid methodology that relies on data, sampling, analysis, and derivation of conclusions regarding foreign direct investment CFDI) flows, especially to the developing countries. I wish to focus on the following points. The author chose a sample of only seven Arab countries. 1 had hoped that the coverage would include all, or at least the majority, of the Arab countries, to give a more comprehensive and representative picture in dealing with such an impo11ant subject for all the Arab countries. Having selected a sample of only seven Arab countries (three Maghreb and four Mashreq countries), the author should have explained the criteria he employed in their selection. The clarification given in the paper seems insufficient. There, the author makes a casual reference to three factors, including location, the importance of the countries as hosts of FDI, and the availability of consistem data on FDI flows. High-income countries were excluded. The author should have included this category of countries and other lower-

139

©International Monetary Fund. Not for Redistribution 140 Samih Masoud income countries so that the conclusions could be based on a representative sample. The two main sources of FDI data employed by the author included the IMF balance of payments and the OECD/DAC data, which represent the same flows looked at from different angles. He also consulted other World Bank sources and sources from the countries concerned. According to El-Rifai, the average annual FDI flows to Egypt during 1986-90 were $155.8 million, while Abisour­ our put them at $1,183 million for the same period. For Saudi Arabia, the figure in El-Rifai's paper was $184.5 million, while in Abisourour's paper, it was minus $212 million. For Oman, the figure in El-Rifai's paper was $6.9 million, whereas it reached $104.6 million in Abisourour's paper. Data for Tunisia and Morocco were close in both papers as both authors relied on IMF sources. I fully agree with the author's conclusions that political and eco­ nomic stability represents the most important catalyst for attracting FDI flows to the Arab countries. In fact, this conclusion confirms a similar conclusion by the Inter-Arab Investment Guarantee Corpo­ ration within the framework of the studies, questionnaires, and surveys that have been carried out in recent years. These included reports on the investment environment in the Arab countries that the Corporation started to publish in 1985 and a study on investment constraints in the Arab countries. The author deplored the scarcity of data on FDI flows in the Arab countries and on flows of FDI among Arab countries. I fully agree with his assertions in this regard. This is probably the reason why the Arab Fund for Economic and Social Development, the Kuwaiti Fund for Arab Economic Development, and the Inter-Arab Investment Guarantee Corporation launched a joint study that included a field survey of flows of FDI among the Arab countries up to 1985. Upon completion of the study, the Inter-Arab Investment Guarantee Corporation will continue the effo1t of updating informa­ tion on Arab FDI flows up to 1991. I would like to make the fo llowing observations. The author mentioned that Italian, Dutch, and Japanese investments were spread quite widely among the seven host countries, with the excep­ tion of Egypt, although Table 5 shows otherwise. The author argues that Oman has a small domestic market and a very limited amount of natural resources. In fact, Oman enjoys

©International Monetary Fund. Not for Redistribution 3 and 4 Comment 141 • a variety of natural resources; land under cultivation currently amounts to 100,000 hectares, while arable land of medium- and high-reclamation quality exceeds 2 million hectares. Together with a wealth of rich fishing and livestock and a long-established farming tradition, Oman has a mineral wealth that includes copper, chrome. nickel, magnesium, lead, zinc, and iron ore. While recognizing that Oman in an earlier period lived in full isolation, it may be appropriate to indicate that during the period covered by the paper Oman embarked on economic and social development and focused on domestic reconstruction. Insufficient attention was paid to the promotion of FDI flows into the country. This fa ctor, rather than any absence of natural resources, explains the lack of FDI flows into Oman. In analyzing the natural factors that influence FDI flows, the author assigns a sizable weight to the geographical location, con­ tending that the size of the population is of little consequence, while giving less weight to natural resources. I believe that because of the interlocking and overlapping of these factors and other factors affecting foreign direct investment, it is difficult to single out one specific factor as having more weight than another. The author points to the presence of a strong relationship between literacy and FDI flows, which is generally true. But a deeper analysis of the sample and Table 7, which provided the basis for the above conclusion, would indicate otherwise. Saudi Arabia ranks first in FDI inflows, but third in the literacy rate. Tunisia ranks second on both counts, while Jordan, which ranks third in FDI inflows, ranks first in literacy. Oman also ranks third in FDT inflows but has a low literacy rate. Accordingly, other important factors should be taken into account, including facilities provided by the host state that would allow the foreign investors to bring in qualified expatriate labor. Bureaucracy as an impediment to the inflow of FDI should have been given greater weight in the analysis. The economic reforms in the Arab countries may bear fruit within a period of five or six years by achieving higher growth rates. But problems with bureaucracy that obstruct FDI inflows cannot be so quickly solved. In many Arab countries, administrative constraints and red tape present major obstacles. Even with the implementation of adjust-

©International Monetary Fund. Not for Redistribution 142 Samih Masoud ment programs, the complex and slow processes related to foreign investments stand as a stumbling block to larger FDI inflows. The author concludes by setting forth the determinants and gen­ eral factors that make for an attractive investment climate. These are extremely important in an era of major transformations in the world as a whole, including the Arab countries. The author's contri­ bution would have been more beneficial had it dealt with the specifics of individual Arab countries. For instance, more emphasis could have been placed on bureaucracy, which presents an obstacle in my opinion to greater FDI flows in at least two of the sample countries. By doing so, he would help to identify and possibly solve problems of FDI flows into these countries.

• • •

I enjoyed reading the second paper, "Arab Capital Flows: Recent Trends and Policy Implications" by Ahmed Abisourour. However, I wish to make the following points. The author argues that "although no breakdown is availahle for the sources of FDI flows into the Arab countries, indications are that a significant part origi­ nated from Arab sources, mainly the United Arab Emirates and Kuwait." Considering the importance of this information, it would have been helpful if he had cited his source. I agree with the author's assertions about the adverse effects of administrative constraints and government red tape on FDI inflows. In commenting on the first paper, mention was made of the obsta­ cles posed by government "routine" facing investors in many Arab countries. The author explains the reasons that limit FOI flows to Arab countries in terms of the restrictions imposed on FDI in capital surplus countries as well as those that until very recently were imposed by capital deficit countries. Although these arguments may have had some validity two decades ago or more, the situation is now quite different. Investment flows are increasingly accorded a prominent place in the economic policies of both types of countries. The author refers to the steps taken by some countries to adopt outward-looking investment policies (Egypt, jordan, Morocco, and Tunisia). It is necessary, however, in this regard to note that virtually all Arab countries have been pursuing such a policy for some time now, and not onJy these four countries.

©International Monetary Fund. Not for Redistribution 3 and 4 Comment 143 •

The author refers to the lack of sufficient financial instmments in the Arab countries and to the absence of proper market mecha­ nisms. This is generally tnJe, although we should not disregard the many positive developments that have recently taken place in the Arab countries to promote domestic financial markets. Although these have not been sufficiently ambitious, they represent positive steps in the right direction. Monitoring such steps would have enriched the paper, especially as they relate to the establishment of new stock exchanges (as in Oman, Bahrain, and Sudan), in addition to improving existing stock exchanges (in Egypt, Kuwait, Morocco, and Tunisia). With regard to remittances of Arab workers, r agree with the author that these remittances represent one of the important sources of capital in the recipient Arab countries. In the paper, the total remittances of Arab workers ($87 billion) are added to the assistance granted by the Arab surplus countries to the Arab deficit countries. To be more accurate, the author should have excluded the share of the remittances from the North African workers in the countries of Western Europe, especially if we consider that the remittances of such workers amounted to $24 billion, that is, 27 percent of the total transfers mentioned in the paper. The author points out that Arab development assistance was considerably more concessional than that from other sources and that Arab recipient countries have been the ones that benefited most from Arab aid. He concludes that the major challenge resides in the development and integration of Arab financial markets with a clear strategic objective to foster and facilitate the free movement of Arab capital between Arab countries. However, it must be empha­ sized that there is no link between official development assistance and the development of financial markets or the establishment of links between them. The author could have more usefully related the flight of Arab capital to the need for the creation of a favorable climate for its return, including the development of Arab financial markets and the establishment of links between them. The author points to the preference of Arab governments for debt instmments over equities. In fact, this is not a government policy, but a matter that governments had to pursue owing to the lack of sufficient equity investment to cover their financial needs.

©International Monetary Fund. Not for Redistribution 144 Samih Masoud

The author notes that the Arab states have passed investment legislation out of fear of foreign domination and to protect domestic investors. I believe that this conclusion is not totally accurate, as the investment laws passed by the Arab countries generally reflect the strong desire of these countries to attract foreign capital by granting several incentives and exemptions to foreign investors. Investment promotion laws in many Arab countries have, for some time, provided fo r equal treatment offo reign and local inves­ tors. There are laws in some Arab countries that offer fo reign investors more incentives and exemptions than are offered to local investors, which has led the latter in many of the Arab countries to demand equality with fo reign investors. Abisourour dealt ably with the conditions necessary for establish­ ing a financial market in a given country, arguing that each country in the region may be viewed as being unique in its institutional specifics, which requires that the techniques of financial market development be tailored accordingly. It would also have been use­ ful if he could have examined the present situation in Arab financial markets and pointed out the requirements that should be fulfilled in such markets, and especially that the Arab Monetary Fund has conducted field surveys of Arab financial markets and possesses adequate information in this regard. The same argument applies to the discussion in the paper about debt/equity swaps, as this method has been around already for some time. It would have been more useful had the author high­ lighted the efforts of the Arab countries in this area. In conclusion, the author must be congratulated once again on an excellent paper, the importance of which is in no way diminished by the above comments.

©International Monetary Fund. Not for Redistribution Inter-Arab Labor Movements: Problems and Prospects

TA YSEER ABDEL JABER

In trod ucrion

his paper deals with inter-Arab labor movements in the light Tof major developments in the Arab countries in the last two decades. With the quadrupling of oil prices and revenues in J 974, the oil expotting Arab countries witnessed an unprecedented eco­ nomic boom. This period lasted until 1983, during which time the infrastructure was enrirely constructed. With the drastic decline in oil prices and revenues, the economies of most Arab countries experienced negative growth during the 1980s. Inter-Arab labor movements followed the same pattern of eco­ nomic expansion and slowdown in the 1970s and 1980s. Moreover, such movements were also influenced by government policies. particularly in the labor-receiving countries. Although inter-Arab labor movements had a positive impact on Arab cooperation and development, the Middle East crisis and war dealt a heavy blow to this area through the sudden return of 1.5 million persons from the oil exporting Arab countries to their home countries. The size of the inter-Arab labor movements, their impact, and the resulting problems will be briefly presented in this paper, and since the emphasis of this seminar is on future implications, the prospects for inter-Arab labor movements will also be discussed. Before elaborating further, I would like ro make three introduc­ tory observations. l would like to say how pleased r am that the topic of labor movements has been selected as one of the areas affecting the prospects of Arab economies. ln spite of its economic

145

©International Monetary Fund. Not for Redistribution 146 Tayseer Abdel Jaber and social impottance, this subject has been almost outside the conventional economic literature. A few economists specialized in labor and human resources development studied labor movements. but it has not been given due anention in Arab economic thinking. Except for specialized articles and publications, it has remained the subject mauer of Arab labor conferences and related activities. Second, inter-Arab labor movements were and still are a debat­ able issue as they encompass human, cultural, social, economic. and political considerations. On many occasions, the treatment of workers was raised by states and led to high-level interventions. On the other hand, a lively debate is usually encountered when data related to the magnitude of imported labor and irs classification into occupation, sex, educational attainment, nationality, and other categories is discussed. But debate and perhaps disagreement on these aspects should not encourage us to avoid studying the subject and its implications. Labor flows and labor stock should also be differentiated. Labor stock consists of all workers residing in a given country on a given date. Of course, labor stock is influenced by the trend and magnitude of labor flows. Third, this paper does not tackle Arab migrant labor in Western Europe and other regions outside the Arab world. Although this movement is of great interest, it is outside the context of this paper, which confines itself to inter-Arab labor movemenrs. The migration of Arab workers to Western Europe and the Arab brain drain to the industrialized countries have significant implica­ tions. Arab countries, particularly in North Africa, are not able to provide enough remunerative job opportunities to their growing labor force. The number of migrant workers from Morocco, Algeria, and Tunisia in Western Europe is estimated at 2 million. Including their dependents, the number reaches about 3 million. To encour­ age migranr workers to return to their home countries, Germany and France introduced certain financial incentives. In recent years, and owing to the economic slowdown, the Euro­ pean Community (EC) applied strict regulations against the entry of migrant workers. This trend has been strengthened by the high unemploymem in the Community and the rise of nationalism. Arab labor migration to the European Community countries was one of the major issues raised in the 1970s in the EUJ·o-Arab dialogue

©International Monetary Fund. Not for Redistribution 5 Inter-Arab Labor Movements 147 •

meetings. It is still one of the elements of the EC Mediterranean policy.

Inter-Arab Labor Movements: Assessment of Their Impact The ra soni d'etre of inter-Arab labor movements has been the resource imbalance in the oil exporting Arab countries, particularly the countries of the Gulf Cooperation Council (GCC). With a limited population base and relatively large oil revenues, these countries have to rely on "imported" labor to carry out development projects, to assist in performing government administrative functions, and to help in running private sector enterprises. In contrast with the capital-surplus countries of the GCC area, the resource imbalance in other Arab countries consisted of a relative abundance of labor and a shortage of capital. Thus, a regional complementarity has been promoted on the basis of market forces since the early 1950s. At that rime, slowly but steadily, labor flows began to occur from Egypt, jordan, the Republic of Yemen, Leba­ non, the Syrian Arab Republic, and Sudan toward Saudi Arabia, Kuwait, and others. These flows consisted of all types of labor: teachers, clerks, engineers, translators, salesmen, unskilled labor, etc. The total population of GCC countries amounted in 1991 to 20.7 million with a GDP of $180 billion (Table 1). Although these countries accounted for 9 percent of the total population of Arab countries, their GDP amounted ro 43 percent of total Arab GOP, which reflected a striking disparity among Arab countries in per capita incomes and living conditions.

Table 1. Some Indicators of Labor-Importing Arab Countries

Population GDP Per Capita (millions) (million U.S. Income dollars) (U.S. dollars) 1980 1991 1980 1991 1980 1991

GCC countries 13.3 20.7 223,484.7 179,931.4 10,796 8,692 Iraq 13.2 19.6 53,586.6 55,633.6 4,060 2,838 libya 3.2 4.7 35,142.5 29,977.8 10,982 6,378 Other Arab countries 135.3 183.5 127,340.4 150,655.1 941 821 Arab countries 165.0 228.5 439,554.2 416,197.9 2,664 1,821

Source: Arab Economic Report, 1992, pp. 240-45.

©International Monetary Fund. Not for Redistribution 148 Tayseer Abdel Jaber

Up to 1973, the size of inter-Arab labor movements was limited. Some oil exporting Arab countries were even labor exporting: Iraq and Oman. However, with the jump in oil prices in 1974, oil export­ ing Arab countries began to experience a new economic era, during which their oil revenues multiplied, enabling them to initiate and implement ambitious development programs. Accordingly, many projects were executed establishing new infrastructure such as schools, hospitals, roads, ports, housing projects, communications, government buildings, and universities. The construction of these projects required the inflow of increasing numbers of workers of varied nationalities. Iraq and Oman also had to rely on imported labor. By the late 1970s, Jordan and Yemen had turned into labor­ importing as well as labor-exporting countries. Thus, Jordan contin­ ued exporting to the GCC countries skilled technical and profes­ sional manpower, while importing from Egypt unskilled and man­ ual labor, particularly in construction, agriculture, and the service sectors. Demand for labor also rose in the Libyan Arab Jamahiriya, whether from Arab countries (Egypt, Tunisia, and Sudan) or from other countries (Turkey, the Republic of Korea, Bulgaria, and oth­ ers). In 1980, expatriate labor in Libya was estimated at 545.5 thou­ sand, of whom 377.3 thousand were of Arab nationalities. Owing to unexpected changes in economic policies, in1ported labor varies from one time to another. Iraq has become a major labor-importing country, particularly from Egypt and Sudan. In 1980, expatriates amounted to 1.25 mil­ lion, of whom 1 million were Egyptians. In the 1980s, Iraqi demand for foreign labor increased, owing to the war with the Islamic Republic of Iran and the implementation of many development projects. It resotted to using Egyptian, Sudanese, Korean, and other labor, depending on the executing company. By the late 1980s, expatriate labor was 2 million. As of 1989, however, it declined, and with the Middle East crisis and war most non-Iraqi, including Arab, workers had to leave. In the light of the above analysis, this paper will concentrate on labor movements to the GCC countries. Table 2 presents the size of the labor force in the GCC countries for 1975, 1980, 1985, and 1990. In 1975, nonnationals amounted in the GCC countries to 1.1 million, thereby accounting for 46.5 percent of the total labor force there. Imported labor rose subsequently, to about 3 million in

©International Monetary Fund. Not for Redistribution 5 Inter-Arab Labor Movements 149 •

Table 2. GCC: National and Foreign Labor Force by Country of Residence (In thousands)

Percent of Country of Foreign Residence National Foreign Total to Total

1975 United Arab Emirates 44.7 234.1 278.8 84.0 Bahrain 45.8 38.7 84.5 45.8 Saudi Arabia 1,010.7 474.7 1,485.4 32.0 Oman 88.9 103.2 192.1 53.7 Qatar 11.7 57.0 68.7 83.0 Kuwait 92.4 21 7.6 310.0 70.2

Total GCC 1,294.2 1,125.3 2,419.5 46.5

1980 United Arab Emirates 53.9 470.8 524.7 89.7 Bahrain 59.3 78.2 137.5 56.9 Saudi Arabia 1,220.3 1,734.1 2,954.4 58.7 Oman 119.4 170.5 289.9 58.8 Qatar 14.7 106.3 121.0 87.9 Kuwait 180.5 392.6 501.1 78.3

Total GCC 1,648.1 2,952.5 4,528.6 65.2

1985 United Arab Emirates 71.8 612.0 683.8 89.5 Bahrai 72.8 100.5 173.3 58.0 n Saudi Arabia 1,440.1 2,661.8 4,101.9 64.9 Oman 149.8 335.7 485.5 69.1 Qatar 17.7 155.6 173.3 89.8 Kuwait 127.2 551.7 678.9 81.3

Total GCC 1,879.4 4,417.3 6,296.7 70.2

1990 United Arab Emirates 96.0 805.0 901.0 89.3 Bahrain 127.0 132.0 259.0 51.0 Saudi Arabia 1,934.0 2,878.0 4,812.0 59.8 Oman 189.0 442.0 631.0 70.0 Qatar 21.0 230.0 251.0 91.6 Kuwait 118.0 731.0 849.0 86.1

Total GCC 2,485.0 5,218.0 7,703.0 67.7

Note: See technical notes in annex.

©International Monetary Fund. Not for Redistribution ISO Tayseer Abdel Jaber

1980-65.2 percent of the total. In spite of the considerable slow­ down in the oil market during 1983-89, which was reflected in oil prices and revenues and in other economic activities in the GCC countries, the number of nonnationals continued to rise, to 4.4 million in 1985 (70.2 percent of total), and to '5.2 million (67.7 percent of total) in 1990. Saudi Arabia is the largest "importer'' of foreign labor. In 1990, nonnationals were estimated at 3 million, accounting for 59 percent of total nonnarionals in the GCC countries. The United Arab Emirates were next, followed by Kuwait and Oman. Some GCC countries depend almost completely on imported labor. As shown in Table 2, this dependence has deepened over the years. In 1990, nonnationals accounted for 91.6 percenl of the toral labor force in Qatar, 89.3 percent in the United Arab Emirates, and 86.1 percent in Kuwair. Nationals of these countries work either in the public sector or as employers in the private sector. As of the mid-1970s, the large income and wage disparities between the oil Arab countries and other Arab and Asian countries became widely felt. Travel to the GCC countries for work and higher income was the ambition of many unemployed or low­ paid workers. Labor-sending countries were unable to regulate the outflow and relied on market forces. In some Asian countries, the private sector established too many competing employment offices to handle the outflow of their labor, particularly to Arab oil coun­ tries. Accordingly, labor-importing Arab countries had to apply restrictive labor policies: tough visa restrictions were imposed. After­ wards, restrictions were enforced on dependents, instituting a mini­ mum salary to allow for the worker's wife to accompany him. Wage differentials between nationals and nonnationals performing the same work were also instituted. Nonnationals were not allowed to own real estate, stocks, and private shops. This constraint compelled many nonnationals to register their assets in the name of national partners against an annual fee. The labor-sending countries accepted the new pattern of labor relations. They actually had very Little control over the movemenl of their own workers. They also realized that inter-Arab labor move­ ments are beneficialfrom four aspects. First, the main benefitarising from labor movements emanates from the financial remittances of workers to their home countries. An International Monetary Fund

©International Monetary Fund. Not for Redistribution 5 • Inter-Arab Labor Movements I 5 I

study on financialflows among Arab countries showed that workers' remittances amounted to $10 billion annually from 1980 to 1984 and $6 billion annually thereafter. In fact, workers' remittances from the GCC countries were the most significant source of financial movement in the region, compared with official grants, loans, and investments. Remittances represented the main financial spillover to countries that were short of capital (Yemen, Egypt, jordan, the Syrian Arab Republic, Lebanon, and Sudan). The substantial amounr of workers' remittances helped meet part of the chronic balance of trade deficits of the labor-sending countries, ease their foreign exchange shortage, and finance indus­ trial and agricultural services and real estate projects. As shown in Table 3, the combined workers' remittances transferred to four labor-sending countries during the 1980s amounted to $57.7 billion ($32 billion to Egypt; $11.8 billion to the Republic of Yemen; $9.9 billion toJordan; and $4 billion to the Syrian Arab Republic). During the past decade, workers' remittances covered over 60 percent of the trade deficits of Egypt, Jordan, and the Republic of Yemen. It should also be noted that the above figures on workers' remit­ tances underestimate the actual magnitude. Not all remittances are effected through the banking system. Rather, about 30 percent of the figures above are added through money changers and the amounts hand carried in cash or in kind by the workers. Second, the GCC labor markets helped, particularly during 1974-82, to absorb part of the otherwise unemployed labor force in the labor-sending countries. These countries were facing structural unemployment owing to the high rate of population increase and the still higher rate of growth of their labor force. With the economic slowdown in the western Asia region in the 1980s, structural unem­ ployment worsened. Third, working in the GCC countries was also enriching for the nonnationals, particularly those who newly entered the labor mar­ ket. They gained skills and know-how. With people from a diversi­ fied background and many nationalities, the working environment becomes highly competitive. Many migrant workers returned with some savings but even more with new ideas on how to stan their own businesses at home. Fourth, size, nationality composition, and trends in inter-Arab labor movements were always influenced by inter-Arab political

©International Monetary Fund. Not for Redistribution Table 3. Remittances Accruing to Selected Arab labor-Sending Countries VI N (Millions of U.S. dollars)

II>--1 Total '< "' 0 Country 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1980s 0 .. Egypt '7)> Remittances 2,696 2, 181 2,439 3,666 3,693 3,212 2,506 3,604 3,770 4,257 32,024 Q. � Ratio of ..'7 femittances to II) trade deficit 88.88 55.7 65.7 80.4 63.7 61 .6 55.2 72.4 57.1 55.5 63.6 .... Jordan Remittances 794 1,033 1,082 1,110 1,237 1,022 1,184 938 895 627 9,922 Ratio of remittances to trade deficit 50.9 49.6 50.9 52.3 71 .9 62.4 83.0 63.9 63.4 85.5 60.9 Syr;an Arab Republic Remittances 747 436 41 1i 387 321 350 323 334 360 355 4,024 Ratio of remittances to trade deficit 40.8 19.9 25.2 18.4 17.3 16.7 24.4 38.4 56.4 35.8' 29.6 Republic of Yemen Remittances 1,609 1,335 1,591 1,652 1,521 1,214 864 1,01 8 581 438 1 1,823

Ratio of remittances to trade deficit 67.2 57.9 61 .8 68.9 72.6 73.5 72.1 66.7 42.2 39.2 63.4

Source:United Natiom fconomic and SodaI Commissionfor WesternAsia, based on computer printout, Departmentof International Economic and Social Affairs of the United Nations (New York, May 1991). 'Trade balan

Limitations on Inter-Arab Labor Movements In contrast with the 1970s, the 1980s were a "lost" decade in Arab economic development. In the 1980s, the Arab region suffered from many negative developments, including the war between Iraq and the Islamic Republic of Iran, the continuation of the civil war in Lebanon, the Palestinian intifada against Israeli occupation, the problem of external debt for many Arab countries, the economic slowdown with a high rate of population growth, the implementa­ tion of economic adjustment programs approved by the Interna­ tional Monetary Fund, and the disappointing momentum of the joint Arab action. To make things worse, oil-the main source of income-witnessed a severe decline, which affected overall eco­ nomic activities and the main economic indicators. The decline in the oil market was due to two fa ctors: the volume of oil exports and production dropped and the prices for oil decreased. Both factors led to a sharp drop in oil revenues. Production of oil in the Arab countries reached 22.2 million barrels a day in 1979 but was reduced to half this quantity in 1984 and remained below the 1979 level (16.1 million barrels a day in 1991). At the same time, oil prices reached $34.3 a barrel in 1981 and decreased thereafter to $13.5 a barrel by 1986. The drop in oil revenues was more severe. The value of Arab oil exports amounted to $213.6 billion in 1980. It declined to $45.2 billion in 1986, less than one-fourth of the 1980 level. Although Arab oil revenues improved afterwards, they were short of the level of the early 1980s. They amounted to $75.8 billion in 1991, given that the purchasing power of the dollar decreased.

©International Monetary Fund. Not for Redistribution 154 Tayseer Abdel Jaber

In addition to the economic slowdown of the 1980s, rhe Arab world witnessed new developments that adversely affected inter­ Arab labor movements. Labor-receiving countries initiated new pol­ icies to encourage greater participation of the national labor force. Owing to lower wages, a trend tOward replacing Arab with Asian workers was steadily taking place. Finally, the Middle East crisis and war dealt a devastating blow to inter-Arab labor movements by abruptly forcing about 1.5 million Arab workers to return to their home countries. Whether these negative developments are short-lived or not has yet to be determined.

Encouragement of Greater Participation of National Labor Force

Once most of the physical infrastructure had been constructed in 1974-82, the labor-receiving countries adopted new policies toward scrutinizing the inflow of foreign labor. One government after another has declared policies and programs for enhancing the participation of the national labor force. Some national develop­ ment plans of the mid-1980s considered addressing the population imbalance a major national objective. Another country declared specific quantitative targets for participation of nationals in govern­ ment departments, educational institutions, banks, etc. Most labor­ receiving countries decided to give priority in employment ro their nationals. Although the motive behind these policies was understood, and every state has the right to give priority to its own nationals, particu­ larly in the light of the population increase, the growth in the labor force, and the greater patticipation of women in the labor-receiving Arab countries, the application of these policies was nor so simple. It appeared that the private sector had already adapted to a division of labor with nonnational workers whereby the latter was relied upon not only for manual and skilled labor but also for the profes­ sional and technical categories. Greater participation was justified and was achievable, particularly in the public sector. More success in this direction was noticed in Bahrain and to a lesser extent in Saudi Arabia. As shown in Table 2, the percentage of nonnationals to the total labor force rose from 46.5 percent in 1975 to 56.2 percent in 1980 and to 70.2 percent in 1985. However, it went down in micl-1990 to 67.7 percent, with 5.2 million foreign workers in the GCC countries. Accordingly, the pa1ticipation of the national labor

©International Monetary Fund. Not for Redistribution 5 Inter-Arab Labor Movements 155 • force was concentrated in the public sector, whereas the private sector maintained its preference for Asian workers. Both these trends had limitations on the inflow of Arab workers.

More Reliance on Asian Labor

Available data show that Arabs and Asians were always the two major groups of nonnationals in the labor force of the GCC coun­ tries. In the mid-1980s, each accounted for approximately 47 percent of total nonnationals. U.S. citizens and Europeans were no more than 5 percent at that time. In the mid-1970s, Arab workers constituted a majority of 57 per­ cent whereas Asians accounted for only 36 percent. IL is believed that the shift from Arab to Asian workers took place in the early 1980s. Asfor the distribution of the labor force by nationality and country of residence, there were two main absorption countries for Arab labor in the mid-1970s: Saudi Arabia, with an Arab majority of 82 percent of total non-Saudi labor, and Kuwait, where Arab workers constituted 69 percent. The rest of the GCC countries mainly attracted Asian labor, with a percentage varying from 88 percent in Oman to 55 percent in Bahrain. With time, the percentage of Arab labor decreased in all GCC countries, and whereas it remained high in Saudi Arabia, it decreased to 60 percent in the mid-1980s. By that time the Asian labor force had become the majority in Kuwait. It is interesting to note that the Arab share in "work permits issued for the first time" in the private sector decreased from 40 percent in 1980 to 14 percent in 1985, whereas the Asian share increased from 56 percent to 80 percent. It is believed that the decreasing trend of Arab labor in the GCC countries observed during the first half of the 1980s continued during the rest of the decade. Available fr agmentary data from the two main attractive pools of Arab labor, Saudi Arabia and Kuwait, confirm this statement. In Saudi Arabia, for example, the Arab share in institutions employing 100 employees and over in the private sector did not exceed 7 percent during 1987-89, whereas the Asian share reached 57 percent during the same period. Although the above data cover a limited proportion of the total labor force, the low Arab share reflects a decreasing inflow of Arab labor into this country.

©International Monetary Fund. Not for Redistribution 156 Tayseer Abdel Jaber

Thus, based on the above, a reasonable "guesstimate" may place the Arab share in 1990 at between 30 percent and 35 percent of the total nonnational labor force in the GCC countries. One main reason for the decreasing Arab share is the difference in wages paid for Arab and Asian workers. Data available for 1987-89 related to wages in the private sector in institutions employing 100 employees and above in Saudi Arabia show that an Arab worker was paid on average twice as much as his Asian colleague in 1987 and three times more in 1989. Saudi workers were paid on average more than Arab and/or Asian workers in all occupations. For exam­ ple, a Saudi "professional and technical" worker was paid 1.4 times more than an Arab and 3.6 times more than an Asian worker per­ forming the same occupation. It is interesting to note that only Westerners were paid on average more than Saudis in almost all occupations. There are justifications for the increased reliance on Asian labor other than wage differentials. During the construction boom of 1974-82, large contracts were carried out by companies from Korea, India, the Philippines, the United Kingdom, and japan, which impotted thousands of Asian workers in a work camp arrangement. Their direct contact with the local society, whether positive or negative, was kept to a minimum. Some of these workers seeped into the country after their contracts had expired. Asian workers are considered or perceived to be more obedient and disciplined. They accept jobs that the Arab workers usually decline, namely, domestic helpers, nurses, and others. They do not insist on having their families accompany them. There are, of course, counterarguments. Arab workers tend to spend more of their incomes locally. They do not constitute a cultural and political threat to the character of the GCC countries. They also tend to be more educated.

Middle East Crisis and Abrupt Return of Arab Workers The most serious negative development that affected inter-Arab labor movements was the abrupt return of about 1.5 million Arab workers as a result of the Iraqi occupation of Kuwait on August 2, 1990 and the ensuing war. According to up-to-elate estimates, 731.8 thousand Yemeni workers had to return, mosdy from Saudi Arabia. Other returnees incluclecl 250 thousand Jordanian workers returning

©International Monetary Fund. Not for Redistribution 5 • Inter-Arab Labor Movements 157

mostly from Kuwait and 390.4 thousand Egyptians returning mostly from Iraq. Other Arab workers, though in much smaller numbers, included Sudanese, Syrians, and Lebanese. Of all returnees, it was those working in the private sector that suffered most. Ex-government employees were paid, albeit after some time, their end-of-service entitlements. However, this was not so for workers in the private sector, except for those working in large establishments such as banks. The major loss was incurred by those self-employed in their small businesses, who had to liqui­ date them abruptly and under adverse market conditions. A large number of the Yemenis and the Jordanians had to sell their busi­ nesses under buyer's market conditions. There were other cases of massive expulsion of Arab migrant workers for political considerations, which usually lie beyond the domain of the workers themselves. In 1976 and 1987 Tunisian and Egyptian workers, respectively, were deported from Libya. It took a long time for the Arab and international mediators to arrange for the deported workers to be paid their indemnities and to be compensated for their properties. The problems resulting from the massive return of workers go well beyond those of the individual worker. Their sudden return has caught their governments unprepared. Unemployment conditions have suddenly worsened. Remittances are expected, after a time lag, to decline. Pressures on schools, health fa cilities, housing, and other social and economic facilities mount. In addition, humanitar­ ian factors cannot be ignored when such a return of workers sud­ denly occurs. Problems related to inter-Arab labor movements were felt early on, before the Middle Ea:;t crisis and war, and came to the fore in one way or another. But whenever an opportunity arose to discuss these problems, they were avoided on the grounds of being sensi­ tive, political, or outside the agenda. Also, some of these problems were based on impressions and individual subjectivity. However, the attitude of labor-receiving countries boils down to the following. A large number of Arab workers were needed when infrastructure had to be built and until the human resources (teachers, physicians, government employees, etc.) had been developed. Now we no longer need these numbers, and we must balance the composition of our population. In any case, we need some workers without

©International Monetary Fund. Not for Redistribution 158 Tayseer Abdel Jaber their families, who cost a lot for education, medical care, and other services. High-income workers may have their families with them. Some jobs that require Arabic may need Arab labor until our pro­ gram of enhancing the pa1ticipation of national labor is totally implemented. For other jobs, we will leave the maner to the labor market, which will naturally see the value of Asian labor that is cheaper, more obedient, and less of a political and security problem. If Arab workers do not understand our policy, we shall enforce severe visa and residence restrictions. In any case, no real estate or business should be registered in their names. From the viewpoint of the labor-sending countries, it was believed that the benefits of employment abroad continued to out­ weigh the problems. They were not so happy with the increasing number and proportion of Asian workers. They felt that they had incurred large expenses to educate and train workers before they left. Remittances were not always used rationally: they led to infla­ tionary pressures, conspicuous consumption, and sky-rocketing prices, particularly in real estate.

Prospects fo r Inter-Arab Labor Movements

Owing to the uncertainty of political and economic developments the region, it is extremely difficult to present concrete proposi­ in a tion on the prospects of inter-Arab labor movements. One can only refer to trends, possibilities, and nonquantitative prospects. The most significant factors that will affect the magnitude and trends of inter-Arab labor movements are

• Oil prices, oil revenues, and the percentage of these revenues that is allocated to domestic development activities (in contrast with arms purchases, lending abroad, and official assistance).

• Security and political stability in the GCC region, including the Iraq-Kuwait situation, the prospects of lifting sanctions on Iraq, fundamentalism, Iranian policies in the GCC area, and border dis­ putes.

• Prospects for the Arab-Israeli bilateral and multilateral peace negotiations (stalemate, partial settlement, or overall settlement within a wider context of regional cooperation).

• Policies of the labor-receiving countries toward the nationality composition of expatriate labor. Linked with these policies is the

©International Monetary Fund. Not for Redistribution 5 • Inter-Arab Labor Movements 159

question of how much and when do we expect a revival of Arab cooperation in contrast with the fragmentation caused by the Middle East war.

With the uncertainty and complexity of the above major develop­ ments, one has to rely on a subjective assessment of the future. Without going into various possible scenarios, and judging from previous developments, the prospects for inter-Arab labor move­ ments seem to show the fo llowing most probable trends.

• Labor-receiving countries will continue to consider labor importa­ tion a matter of national sovereignty and an area of political relations. The implications of this position are that these countries will continue to control and scrutinize the size, national composi­ tion, security risk, and patterns of labor inflows. They also will be reluctant to give up these policy options in favor of agreed­ upon bilateral and/or multilateral agreements.

• The economies of the Arab countries are expected to grow over the coming decade but not at a high rate, probably between 3-4 percent annually. This means that the GCC countries will require additional foreign labor, although at a low rate of increase. Actu­ ally, when the economies of Western Asia recorded negative growth in the 1980s, nonnational labor increased in the GCC countries in 1985-90 by 3.3 percent annually. In addition to the demand for labor owing to economic growth, there is also some demand for replacement of the labor displaced during the Middle East crisis and war in addition to that caused by retirement. Thus, it will take up to the year 2000 and with an annual growth rate of 5 percent to reach the 1990 level of nonnationals in the GCC countries.

The percentage of Asian labor is expected to increase further. This may hold up to a certain point. Therefore, demand for Arab labor will continue, although it will be more selective and less of a massive flow. One might expect that the present state of "disenchantment with Arab joint cooperation" will come to an end in the near future. Bearing in mind the minimum level of Arab cooperation that prevails at present, the national move should be to rebuild Arab cooperation on new bases. Inter-Arab trade continues to be marginal (8 percent).

©International Monetary Fund. Not for Redistribution 160 Tayseer Abdel Jaber

Inter-Arab investments, though important for some countries, are not yet a prime mover of regional cooperation. Arab investments abroad are facing an unfriendly environment. The rationale for regional cooperation remains as convincing as ever, particularly with the present worldwide trend toward regional economic group­ ings. It is a given fact that inter-Arab labor movements depend on the overall relations among Arab countries. However, with the potential of regional complementarity, it is only rational to expect some revival of Arab labor cooperation, including more Arab investments in the labor-surplus countries.

Annex

Technical notes relate to the estimations given in Table 2. Sources of data. In general, estimates are based on available national censuses and/or labor force surveys. The main sources used, in addition to current statistics (labor/residence permits), cov­ ering 1974-89, are shown below.

Saudi Arabia 1975: National population was taken from lsmail A. Sirageldin, Naiem A. Sherbiny, and Ismail Serageldin, Saudis in Transition: 1be Challenge of a Changing Labor Market (World Bank: Oxford University Press, 1984). Nonnational population was estimated on the basis of the 1974 Saudi population census. 1980, 1985: Estimates are based on data provided by the labor force surveys for 1977, 1981, 1986, and 1987. 1990: Preliminary 1992 population census results.

Kuwait National population censuses for 1970, 1975, 1980, 1985, and labor force surveys for 1983 and 1988.

Qatar National population censuses for 1970 and 1986 (preliminary results), and the 1981 survey.

Bahrain National population censuses for 1971 and 1981.

©International Monetary Fund. Not for Redistribution 5 Inter-Arab Labor Movements 161 •

United Arab Emirates National population censuses for 1975 and 1980 (detailed results) and 1985 (preliminary results). Oman National labor force in 1975 and 1985, as given by World Bank (Sirageldin and others). Nonnational labor force based on World Bank and on total nonnationals employed in private sector and civil servants.

Bibliography Abdel]aber, Tayseer, "Present Situation and Prospects of Labor Exchange Among Arab Countries: Returnees from Oil Counrries," Arab Thought Forum (Amman, 1986), pp. 22-61 (Arabic). Addleton,]., "The Impact of the Gulf War on Migration and Remittances in As ia and the Middle East," International Mig ration, Vol. 29, No. 4 (December 1991). Anani,Jawad, "Policies and Labor Demand in the GCC Countries," UNDP­ ILO Seminar on Migration Policies in Arab Labor-Sending Countries,

Cairo, May 2-4, 1992. Birks, J.S., and C.A. Sinclair, Population and International Migration in the Arab Countries: Basic Data (Beirut: ESCWA-ILO, 1980).

___, Manpower and Population Evolution in the GCC and the Libyan Arab jamahiriya (Geneva: International Labor Organization, 1989). El-Borai, Ahmad, "The Legal Framework for the Protection of Inter-Arab Migrant Labor," UNDP-ILO Seminar on Migration Policies in Arab Labor­ Sending Countries, Cairo, May 2-4, 1992. Economic and Social Commission for Western Asia, TheReturn of jorda­ nian/Palestinian Nationalsfr om Kuwait: Economic and Social Implica­ tions for jordan (Amman: ESCWA, 1991). Fergani, Nader, Mig ration to Oil: Prospects of Mig ration fo r Work in the Oil Countries and Its Impact on Development in the Arab World (Beirut: Center for Arab Unity Studies, 1983).

---, In Search of Livelihood: Field Study on Eg yptian Mig ration fo r Work in Arab Countries (Beirut: Center for Arab Unity Studies, 1988). Kawari, Ali Khalifa, Toward an Alternative Strategy fm· a Cornp1·ehensive Development (Beirut: Center for Arab Unity Studies, 1985). Kossaifi, George, "Toward a Policy for Developing the National Labor Force in the GCC Countries," AI Mustaqbal a/ Arabi (Beirut), No. 114 (August 1988). ___, "Labor Arab Migration: Facts and Potenrial," ESCWA-ILO and University of jordan Seminar on Demographic and Socio-Economic

©International Monetary Fund. Not for Redistribution 162 Tayseer Abdel Jaber

Implications of International Migration in the Arab World with Special Reference to Return Migration, Amman, December 4-9, 1989. Miro, Carmen A., and Joseph E. Potter, Population Policy: Research Priori­ ties in the Developing World, Report of the International Review Group of Social Science Research on Population and Development (London: Frances Pinter, 1980). AJ-Nifay, Abdullah M., "Analysis of Socio-Economic Factors for Employing Nonnational Labor Force," unpublished paper commissioned by ESCWA, 1989. AJ-Omaim, Mussaed, "Nonnational Labor Force in the Private Sector in Kuwait," unpublished paper commissioned by ESCWA, 1989. Saad Eddin, Ibrahim, and Mahmud Abdel Fadeel, Arab Labor Migration: Problems, Impact, and Policies (Beirut: Center for Arab Unity Studies, 1983). AI-Salem, Faisal, and Ahmad Hajjal, "Labor in the Countries of the Arabian Gulf: A General Field Study" (Kuwait). Samient, J.N., "The Asian Experience in InternationalMigration ," Interna­ tional Migration, Vol. 29, No. 2 (June 1991). United Nations, Department of Jnternational Economic and Social Affairs, World Population Prospects, 1990, Population Studies No. 120 (New York, ST/ESA/SER.A/120).

©International Monetary Fund. Not for Redistribution COMMENT

MOHAMED AL-AMIN FARES

he seminar organizers have made the right decision in choosing TMr. Tayseer Abdel Jaber to write this paper, "Inter-Arab Labor Movements: Problems and Prospects." The author's involvement in labor issues goes back a long way­ to when he was responsible for the labor sector in his country. Labor has also been the main focus of his research work. This involvement continued throughout his tenure as Secretary General of the Economic and Social Commission for Western Asia (ESCWA). A critical phase of his pursuit of labor matters came when he closely monitored labor dislocation caused by the Middle East crisis. I would like, however, to make the following observations. The paper focused exclusively on labor migration to member countries of the Gulf Cooperation CounciJ (GCC). Although these countries may be the most important importers of labor, the author has neglected other countries that are no less important, such as the Libyan Arab Jamahiriya and Iraq (the latter ranking second among the major labor importers in the first halfof the eighties) and Jordan, both as a labor importer and exporter. It is likely in the nineties that both Iraq and Jordan could regain some importance as labor­ receiving countries. The paper's coverage seems to be exclusively confined to the members of ESCW A, even though it could usefully have been expanded to include all Arab countries and to discuss Arab labor migration to Europe. The author has been somewhat prudent in his approach, as he attempted to treat labor migration issues without injecting any controversy. This careful approach might be quite justifiable, but within a framework of exploring the prospects of Arab economies in the nineties, such an approach loses much of its rationale. Caution is particularly evident in the examination of the prospects for labor movements. Such caution is appropriate, given the uncer­ tainty surrounding the prospects of Arab economies. But the occa­ sion calls for taking some risk by offering options and scenarios,

163

©International Monetary Fund. Not for Redistribution 164 Mohamed AI-Amin Fares especially where vague references are made to Arab-Israeli peace prospects as they relate to labor movement and migration. The author has been in the right place to monitor the conse­ quences of the Middle East crisis on labor migration and movement. These consequences, however, go beyond the mass returnof work­ ers and the resulting hardships for both the returnees and their respective countries. It should have been possible to illustrate the new reality of migration and movement, a reality that has changed radically since the summer of 1990. This change is important for any consideration of labor movement prospects in the nineties. In addition to these general remarks, the five sections of the paper raise some specific comments and a number of questions. They are meant to stimulate discussion and to link the subject with the main topic of the seminar.

Inter-Arab Labor Movements: Assessment of Their Impact

In this section, the author relies on data relating to distribution of the work force between nationals and nonnationals in the GCC countries during 1975-90. It is difficult to compile such data in one table without recourse to estimations and assumptions. As such, they are subject to different interpretations. For example, it may be argued that the total work force in Saudi Arabia in 1990 was not 4,812,000, as mentioned in the paper, but rather 5,771,000, as indicated in the Fifth Development Plan. Sin1ilarly, other estimates in the paper may be debatable. In a seminar such as this, however, it may not be as important to agree on accurate forecasts as on the actual trends in labor movement flows. The "clean slate" offered by the paper for labor force distribution seems adequate for the purposes of the seminar. But a distribution of the expatriate work force , which is missing in the paper, would have provided a clearer picture, even though any relevant estimates may become subject to further objections and disagreement. References to these were made in another part of the paper; but it is quite easy to disagree with such estimates by presenting figures on the ratio of expatriate Arab workers to the total of the expatriate work force as follows in Table 1. In this section, the author argues that the labor policies of the GCC countries in the mid-seventies were developed along three

©International Monetary Fund. Not for Redistribution 5 Comment I 65 •

Table 1. Ratio of Arab Nationals to Total Expatriate Work Force in Main Labor-Importing Countries

1980 1985

Bahrain 19.0 15.2 Kuwait 21.7 69.0 Oman 10.8 9.1 Qatar 31.9 23.4 Saudi Arabia 77.6 56.1 United Arab Emirates 21.7 19.4 Total 58.4 56.1 jordan 77.9 26.4 Iraq 90.0 85.0

Source: Estimates prepared by the Department of Labor Force Development, Arab Labor Organization, from various sources. specific lines. Although there is validity in this argument, some observations regarding such policies are appropriate.

• The policy orientations referred to by the author have been in place since the beginning of the modem process of labor migration.

• The reference in the first place to the fact that visa restrictions were imposed despite the existence of an Arab Economic Unity Agreement and an Arab Common Market must be viewed in its proper context as nothing out of the ordinary: Kuwait is the only state that has acceded to that agreement. The same reference, however, raises an impottant question about the usefulness and credibility of established Arab conventions, including Convention No. 2 on Movement of Arab Workers (1967); Revised Convention No. 4 on Movement of Arab Workers (1975); Convention No. 14 on Entitlement to Social Security Benefits for Arab Nationals Working in Other Arab Countries (1981); Strategy of joint Arab Economic Action, adopted at the Eleventh Arab Summit Confer­ ence (Amman, 1980)_; and Declaration of Principles on Movement of Arab Workers (1984), issued by the Arab Economic and Social Council.

• The author then refers to the wage variations between nationals and expatriates, and to the argument that discriminatory treatment is actually practiced among the expatriates themselves. Wages, it is claimed, are not tied to the type of work performed, but rather to the different wage systems in the labor-exporting countries for

©International Monetary Fund. Not for Redistribution 166 Mohamed AI-Amin Fares

the same work. Wide wage variations do exist in wage levels in the labor-receiving countries. Whereas such variations tend to be narrower in the government sector, the private sector has enjoyed some immunity in the execution of contracts. Has the time come for a re-examination of such discriminatory practices in the light of the relevant international agreements and conventions?

Some people may find it acceptable to continue the practice of granting nationals preferential wages, arguing that part of such wages is not given in return for any specific work but rather as an entitlement by the nationals to a share in oil revenues. This would be similar to the other benefits enjoyed by citizens of a country pursuing a welfare-state policy. The discriminatory practices, however, are beginning to hurt the employment opportunities for nationals, with the absorptive capacity of the government sector reaching its limits. Has the time come, therefore, for a re-examination of this policy?

• The author then refers to the fact that expatriates are not allowed ownership of real estate, stocks, or private businesses. But this interdiction is not a monopoly of the GCC labor-receiving coun­ tries; it is an established practice in some other countries. The only difference is that anti-exploitation controls do exist in many of those countries, whereas in the Arab GCC countries excesses that are prohibited by law are common, including "name leasing."

• The author notes that the above-mentioned actions, or restrictions, have determined the labor policies of the GCC countries. How­ ever, other essential foundations of such policies may be advanced. The national labor laws, regulations, and schemes have generally fo llowed international and Arab labor standards, while at the same time upholding the sanctity of free enterprise and private sector activities and at times condoning violations of essential provisions of such laws and regulations. Stringent security policies that accord high priority to perceived risks and involve the sponsors of expatriate workers in the appli­ cation of these policies. Pursuit of a policy of temporary and fixed-term residence for expa­ triate workers as a basic deterrent against unapproved conduct.

©International Monetary Fund. Not for Redistribution 5 Comment 167 •

This section also examined the positive aspects of labor migration from the perspective of the Arab labor exporters, including the alleviation of unemployment problems in these countries. While this may seem a natural outcome, it is far from certain: migration is a selective process, especially in GCC countries, and expatriates are often in search of better incomes and not merely jobs that are lacking in their home countries. The exception may reside in the experience of labor migration to Iraq or to the Libyan Arab jamahiriya, where visa and contract conditions were not strictly enforced; these two countries repre­ sented the second choice of those workers who could not find employment in their home countries and failed to obtain contracts for jobs in the GCC countries. The question that should probably be asked-within the frame­ work of the prospects for Arab economies in the nineties-is whether the time has finallycome to consider more seriously export­ ing job opportunities to the Arab labor exporters, through expansion of investments, as a viable alternative to importing labor from them.

Limitations on Inter-Arab Labor Movements In this section the author presents some clarifications on two items: provision of more employment opportunities for the national labor force; and increased reliance on Asian labor. The policy of employing citizens as pursued by the labor­ importing countries is incontrovertible and legitimate. Such a policy has met with a measure of success in the government sector, although chances for further success have become somewhat lim­ ited for a number of reasons, including the following:

• The government sector has reached a point of saturation and is moving toward economic rationalization and privatization.

• The national work force has witnessed increased growth both in quantity and quality, thanks to extensive efforts in education and training and more participation by women in economic life.

For the above reasons, the issue of employment of nationals merits a degree of attention in terms of its relationship with the system of expatriate employment, especially in countries like Saudi Arabia, and perhaps in Oman, Bahrain, and Kuwait as well. Being the largest importer of labor, however, Saudi Arabia represents the

©International Monetary Fund. Not for Redistribution 168 Mohamed AI-Amin Fares most important case. The Saudi Fifth Development Plan (1990-95) forecasts that 574,000 new workers will join the labor force during the plan period, including 60,000 women (half of whom will be university graduates), while new jobs are estimated at only 354,400. Accordingly, 220,400 Saudis would replace non-Saudi workers dur­ ing that period. It is not the public sector that will provide jobs for the additional Saudi work force, considering that its capacity is estimated at only 8,700 jobs. The private sector will thus be counted on to employ a total of 204,800 people, that is, 95.9 percent, in addition to jobs released through replacement of expatriates, a process that involves the private sector as well. In this case, success of the policy of employing citizens is contingent on the extent of the private sector's willingness to employ nationals. The Saudi Development Plan predicts that achieving this target will be rather difficult and emphasizes the need for measures to reduce wage variations and to facilitate absorption of Saudi labor by the private sector. According to the plan, the main sectors where employment growth is to be expected include building and con­ struction (8.5 percent a year), the services sector (7.3 percent), and particularly personal services (12 percent), that is, about 789,000 during the plan period. It is therefore necessary to focus on the features of the changes occurring in the regulation of private sector employment on the one hand and to examine the composition of the work force that will influence the labor market, regardless of development plans and official orientations, on the other. In this context, it seems fair to question the validity of the plan's forecast that the amount of expatriate labor will drop by 1.2 percent a year. It seems appropriate to ask whether Arab or Asian workers will be the ones affected by any such decline. One should take note of the concern expressed in the Saudi plan that employing Saudis may be adversely affected if employment is left to market forces alone. In examining the apparent increased reliance on Asian labor, the author is right to point to the decline in the percentage of Arabs among expatriates; this percentage may have dropped to 30-35 percent in the GCC countries. Opportunities for Arab labor migra­ tion have generally been reduced with the loss of jobs in Iraq and the sharp decline of job openings in Jordan, even though some were still available in the Libyan Arab Jamahiriya.

©International Monetary Fund. Not for Redistribution 5 • Comment 169

Reliance on Asian labor is a phenomenon that merits further discussion. A priori, a number of facts must be set straight:

• Asian migration from India and Pakistan to the GCC countries goes back a long way, to the time of the former presence of the British in the region.

• The experience of Asian migration has been successful, in particu- lar through the execution of turnkey or ready-to-operate projects.

• Asian workers are well suited to perform personal services.

• Asian workers are paid lower wages.

• Access to Asian labor is easy.

However, a number of questions may be raised in this connection: Have the general impressions about As ian migration been sup­ ported by field research, especially with respect to their suitability and obedience? What is the role of private employment offices in Asia and labor importing offices in the GCC countries in promoting the advantages of Asian migration? Will the situation of Asian migra­ tion continue in the nineties in the light of the new international and Arab developments? What is the degree of compatibility between the pressing interests of employers and the medium- and long-term interests of the host countries in the area of Asian migration? It may be advisable to consider two factors that determine the position of Asian migration in the host GCC states. First, migration has become an important industry. Considering the modest size of the indigenous population in the majority of host countries, the recruitment of workers has often become an object in itself under the mandatory sponsorship system. The bene­ ficiaries of this industry have grown to include at least three major groups. The firstgroup consists of Asian employment officesand interme­ diaries. These derive direct benefit from the workers themselves in the form of commissions, transportation fees, and cash guarantees. They are closely associated with the labor recruitment offices in the recipient host countries. The second group consists of the sponsorship community whose members mostly obtain direct material and other benefits once sponsorship is granted or upon its renewal. The third group is represented by the private sector businesses that thrive on the consumption and employment of expatriates,

©International Monetary Fund. Not for Redistribution 170 Mohamed AI-Amin Fares such as housing services, restaurants, education, retail trade, and transportation. This impottant group is controlled by the private sector and represents an indispensable area of economic activity and source of income. The importance of the third group can best be illustrated by the real estate situation in Kuwait in 1992. According to a report of the Central Statistics Department in the Kuwaiti Ministry of Planning (February 1992), there were 47,000 vacant apartments, including 25,394 apartments in the Governorate of Hawally and 12,072 other apartments in the Governorate of Farwaneya. In comparison, the average number of vacant apartments during 1985-89 was only 6,358 apartments. It is in these two Kuwaiti governorates that most foreign workers live, and they must be served by a proportionate number of restaurants, shops, and other services. Hence, an impor­ tant section of the population relies on expatriate labor. The above-mentioned group encompasses a major section of the native population, which exerts influence on the labor-importing machinery, the number of workers, and their living conditions. That is why the relevant declared policies and plans have not been fully implemented. In the meantime, labor importing as an industry should perhaps be explored as to its prospects in the nineties together with the development of Arab economies. The second factor that merits examination, although it may seem somewhat bizarre, is the relationship of the expatriate situation to the new world order. Although different opinions exist on the shape, feasibility, and fairness of such a system, one of its major features is its reliance on the principle of human rights on the one hand and its stand on sovereignty and the limits of sovereignty on the other. Mr. Boutros Ghali, the Secretary-General of the United Nations, and one of the people directly concerned with this new world order, has argued that the rights of the individual and rights of peoples are based on a dimension of global sovereignty that is the property of mankind as a whole. It guarantees to all peoples a legitimate right to be preoccupied by the issues that affect the world at large. This meaning is increasingly reflected in the gradual expansion of international law. On another occasion, he argued that the principle of absolute and exclusive sovereignty no longer exists. On the occasion of preparations for the World Conference on Human Rights (to be held in Vienna, June 14-25, 1993), the coun-

©International Monetary Fund. Not for Redistribution 5 Comment 171 • tries of the Third World upheld the principle of nonintervention in the internal affairs of other countries or encroachment on their sovereignty on the pretext of human rights (recommendation of the Permanent Arab Commission on Human Rights, July 1992). It is clear, however, that this objection does not represent the final say, as the opponents also call for the "elimination of racial discrimi­ nation," the "observance of rights of association and of religious and cultural freedoms in the development of guidelines," and "studying the new challenges that obstruct the enactment of human rights, especially the rights of immigrants." Human rights are not confined to the Universal Declaration of Human Rights of 1948; there are more than 25 other conventions and covenants including the Convention on the Right of Migrant Workers and Members of TI1eir Families (adopted by the United Nations General Assembly); the Convention on the Elimination of all Forms of Discrimination against Women; and the International Convention on Elimination of all Forms of Racial Discrimination. As a consequence, it may be argued that the principle of sover­ eignty, as embodied in the laws and regulations of every state, is not a deterrent against the intervention of other parties with what­ ever means to establish what they consider to be "human rights." Such rights are covered by several international conventions and covenants that cover the status of expatriate workers and their protection. This is one of the issues that might confront us in the nineties, especially as it relates to equal pay for equal work, social security benefits, and other advantages. The above-mentioned factors illustrate the importance of state intervention to impose working conditions for expatriate labor in general and Asian labor in particular, in a manner that might limit the scope of freedom currently enjoyed by employers. Such mea­ sures also seem necessary for any meaningful effort to achieve full employment of nationals, and to prevent the spread of unemploy­ ment among the population of the host countries.

Middle East Crisis and Abrupt Displacement of Arab Workers The author offers useful but extremely brief information about this dramatic event that has changed the composition of expatriate workers and perhaps the whole picture of foreign labor in the

©International Monetary Fund. Not for Redistribution 172 Mohamed AI-Amin Fares decade of the nineties. It should have prompted the presentation of a scenario on the status of expatriates and their nationalities. But in the present conditions of uncertainty, this may be too risky and too speculative. The other topics of the seminar may perhaps assist in projecting the future of expatriate workers in the region, something that the author has attempted to do in the following section.

Prospects for Inter-Arab Labor Movements

While fully conceding the validity of the four factors that might affect the magnitude and trends of inter-Arab labor movements, the following considerations should be highlighted:

• The type of policies that the host countries will pursue toward private sector employers using foreign labor.

• The need to establish declared or undeclared quotas for foreign labor according to nationality.

• The willingness of host states to implement an active naturaliza­ tion policy for selective categories of expatriate labor.

• Possible restrictions on the importation of labor for personal services.

Another important factor depends on the migration cycle or length of stay of workers, as this will vary according to nationality, the host country, and the times. The shorter the cycle, the more it will allow for further migration movements without impinging on the actual stock of workers. This will, however, reflect seriously on the microeconomic level in the countries concerned. Among the four factors was the prospect for Arab-Israeli bilateral and multilateral peace negotiations-a vague consideration despite its validity. It might perhaps be desirable, during the discussion, to examine possible alternatives, especially those related to ambitious regional projects to be implemented in cooperative efforts between the Arab countries and Israel. There is no limit to the imagination in trying to visualize the outcome of such a development on the composition of the population and on the currents of labor move­ ments and migration, as well as the redistribution of the population and urban communities on the one hand and the distribution of wealth on the other. The debate might perhaps take the form of sterile controversy at this stage, but this does not mean that the fe asibility studies and projects that have already been prepared in this or that area should be neglected.

©International Monetary Fund. Not for Redistribution Environmental Policies and Sustainable Development in the Arab World1

MOSTAFA K. TOLBA

Introducrion

oncern for the environment is as old as civilization. History Cabounds with examples of the wide variations in human under­ standing of the environment and in our ability to maintain it in a healthy condition. Those societies that managed to provide their material, cultural, and spiritual needs in a sustainable manner were those that succeeded in reconciling their needs and aspirations with the maintenance of a viable environment. Whenever the outer limits of the physical environment were exceeded, civilizations declined or even vanished. As signs of irreparable damage to the environmenr have threat­ ened both the inner limits of basic human needs and the outer limits of the planet's physical resources, we have witnessed a quan­ tum jump in concern for the environment over the last two decades. The Stockholm Conference in 1972 turned a new page in the book of human concem for the environment We have seen intensive discussion of interactions between the environment and develop­ ment. A few examples suffice.

1The text of this paper has been revised by the author to incorporate some ofthe points raised by Salah £1 Serafy in his comment as published on pp. 197-203.

173

©International Monetary Fund. Not for Redistribution 174 Mostafa K. Tolba

Environment and Development

The capacity of the eanh to produce vital renewable resources must be maintained and, whenever practicable, restored or improved. The protection and improvement of the human environment is a major issue which affects the well-being of peoples and economic develop­ ment throughout the world. -Stockholm Declaration 0972)

Environmental management implies sustainable development. -UNEP Governing Cou ncil (1975)

Human beings must come to terms with the reality of resource limita­ tion and the carrying capacities of ecosystems and must rake account of the needs of future generations. -IUCN!UNEP/WWF: Wo ld Co nseruation (1981) r Strategy In essence, sustainable development is a process of change in which the exploitation of resources, the direction of investmems, the orienta­ tion of technological development, and institutional changes are all in ha1mony. - WCED: Our Co mmon Future (1987)

Environment and Economics

For society as a whole, environment is a part of its real wealth and cannot be treated as a free resource. Environmental issues may come to exercise a growing influence on international economic relations. They could influence the pattern of world trade, the international distribution of industry, the competitive position of different groups of coumries, their comparative costs of production, etc. Some environ­ mental actions by developed countries are likely to have negative effects on developing countries' export possibilities and their terms of trade. -Founex Report (1971)

Environment and International Relations

If the multiple bonds that characterize interdependence are convinc­ ingly present in any field, it is in that encompassing development and the environment, but the transition is not occurring smoothly and harmoniously; it is turbulent and beset with conflict. -South Co mmission: South Rep ort (1990)

Where We Were and What We Achieved

I do not wish to seem overdramatic; but I can only conclude that the members of the United Nations have perhaps ten years left in which

©International Monetary Fund. Not for Redistribution 6 • Environmental Policies and Sustainable Development 175

to subordinate their ancienr quarrels and launch a global partnership to curb the anm; race, to improve the human environment, to diffuse

the population explosion , and to supply the required rnomemum to development efforts. -U 7bant: UN Secretary-General (7969)

How far did we move to heed this warning? Specifically, how much have we improved the human environment? These world statistics provide the answer:

• In 1969 the world's population was 3.7 billion. In 1990 it reached 5.3 billion, and it is still growing by 1.7 percent a year.

• In 1989, $850 billion was spent on arms, while official aid ro developing countries was just $34.1 billion and the developing countries paid $59.5 billion in interest on loans. Since the end of World War II the world has spem about $20 trillion for military purposes. Developed countries have doubled their defense spending since 1960, and developing countries increased expen­ diture more than sixfold with the concomitant impact: misuse of human and natural resources, and the impact of war on the environment and natural resources. This region has seen some of the worst of these impacts.

• Today, it is estimated that over 200 tons of carbon dioxide are released each second and 750 tons of topsoil are lost; every day, 47,000 hectares of forest are destroyed and over 16,000 hectares of land become desert; between 100 and 300 species become extinct; and 40,000 children die of disease and malnutrition. As this goes on, more than 1 billion people in developing countries are living below the poverty line. The studies by the Club of Rome, the establishment of the United Nations Environment Program (UNEP) following the Stockholm conference of 1972, the reports of the Willy Brandt, the Olaf Palme, and the Gro Harlem Brundtland Commissions, the Charter ofNature, the two World Conservation Strategies, the Global Strategy for the Conservation of Biodiversity, and several other efforts were all steps toward responding to these problems and toward establishing a firm link between the environment and development and toward giving real operational meaning to the term sustainable develop­ ment that was coined by the Governing Council of UNEP 17 years ago. All this culminated in the Rio Conference on Environment

©International Monetary Fund. Not for Redistribution 176 Mostafa K. Tolba and Development in June 1992. Agenda 21 was adopted at that conference by almost all governments of the world, including more than 100 heads of state and government. Agenda 21 puts under one roof the whole effort of the past 20 years. It covers almost eve1y aspect of human endeavor and puts it within the context of what makes it environmentally sound and sustainable. Most of Agenda 21 is directed to governments, and it sets the tone for what needs to be done.

Global Trends

The Arab world cannot proceed with sustainable economic devel­ opment while protecting the environment and its natural resources in isolation from the world around ir.

Changing World Scene

The world has not been standing still while the debate on the environment and development has gathered momentum and while ideas, concepts, and issues have been emerging, clarified, and reiterated. The two decades since 1972 have witnessed major politi­ cal, economic, and social changes. The global political and eco­ nomic landscape has altered-not gradually-but in a number of dramatic and unforeseeable upheavals. As a result, the ideological and economic world maps of the seventies and eighties are no longer accurate in the nineties; the geopolitical assumptions that accompanied them do not hold true today; and the predictions of social change on which they were based have been proved inaccurate. The most dramatic and obvious political changes have been the most recent ones: the movement to democratic pluralism and the drastic economic, social, and political changes in the former Soviet Union and the countries of Central and Eastern Europe. The change from an essentially bipolar world in which two super­ powers and their supporters faced each other across an ideological and political abyss has created both opportunities and uncertainties. It may be some time yet before a new geopolitical map is finally drawn, but the nature of that map and the world it represents will owe more to the fundamental causes of those changes than to the changes themselves. The radical optimism of the early 1970s gave way under the pressure of the global economic recession that fol­ lowed the second oil shock in 1978. The belief that institutional

©International Monetary Fund. Not for Redistribution 6 Environmental Policies and Sustainable Development 177 • solutions could be found to human and social problems was replaced by a more individualistic, inward-looking, market-oriented philosophy. The drastic change in the economies in transition was accompa­ nied by two major developments in the marker economy countries. The European integration in the 12 countries of the European Com­ munity (EC) and the move by the countries of the European Free Trade Association (EFT A) to join the European Community. The impact of this integration on developing countries, including a number of the Arab states, is well covered in Mr. Langhammer's paper. I want to quote only three points from that paper: The former socialist countries increasingly concentra te their export supply on items that are also supplied by developing countries and they enjoy more generous access to the markets of the EC. Given the economic and cultural proximity of Eastern and Western Europe, there is reason for concern that the Europe agreements have a trade­ diverting potential to the detriment of developing countries. The association agreements with the former Czech and Slovak Federal Republic and with Poland and Hungary put all Arab countries in a less fa vorable position with respect to access to EC markets than before the collapse of the socialist system.

North American Free Trade Agreement (NAFTA)

This agreement imposed the environmental standards of a highly developed coumry like the United States on a developing, though industrializing, country like Mexico. It blurred the demarcation between developed and developing countries. The search for greater economic efficiency has led not only to the phasing out of the "command economies" worldwide, and particularly in Eastern Europe, but to a parallel deregulation of the financial, manufacturing, and service sectors in the West. One result has been a freer movement of capital between countries and between sectors. This globalization of production was also boosted by profound technological changes, particularly the rapid develop­ ment and spread of information technologies. Knowledge has suddenly become a business asset even more valuable than physical or financial resources. The traditional trans­ national corporation has been transformed from a collection of

©International Monetary Fund. Not for Redistribution 178 Mostafa K. Tolba semiautonomous local affiliates into a widespread network of pro­ duction and operational facilities that could be monitored and con­ trolled centrally in real time. At the same time modular production developed, with specialized firms producing just one module of a total product or service. As a result, many large corporations have come to depend on the small knowledge-intensive enterprise that spends a large proportion of its income on research and develop­ ment. These changes, among other things, have further reduced the ability of national governments to influence the activities of transnational corporations to achieve social or environmental goals. Although the flight of capital from already undercapitalized coun­ tries in the South has continued, there have also been waves of foreign investment in those economies that took advantage of the changed economic scene and gradual dismantling of the rather shaky protectionist measures instituted in many developing coun­ tries to nurture their emerging industries. The emergence of global markets and economic interdependence has largely been fueled by the extraordinary growth in trade since World War II. In the 40 years since 1950, world manufacturing output increased sevenfold. Between 1950 and 1973, export volumes from industrialized coun­ tries increased by 10 percent a year. Since 1984, the volume of world merchandise trade has consistently risen at a higher rate than growth in world outputs. However, both the trade boom and the growth in the global economy have been highly selective, bypassing most developing countries, including a number of Arab states. Although there has been a significant increase in developing country exports of manufactured goods during the last two decades, it is mainly accounted for by the relatively small number of newly industrializing economies in Southeast Asia, and, despite this increase, developing country exports are stiU only 15 percent of world trade in manufactures (UNCTAD, 1990). The few value-added products that are generated in developing countries are often blocked by lack of market access, as developing country commodity exports are affected by the "new protectionism" that followed the recession of the early 1980s. Nontariff barriers, voluntary export restraints, direct and indirect subsidies, and other obstacles have made developing country access to northern markets extremely difficult. According to the World Bank, the percentage of imports from countries of the Organization for Economic Cooper-

©International Monetary Fund. Not for Redistribution 6 • Environmental Policies and Sustainable Development 179

arion and Development (OECD) covered by nontariff barriers almost doubled between 1966 and 1986. Moreover, the percentage of trade affected by highly restrictive nontariff measures is greater for developing countries than for industrialized countries. Subsidies on agricultural produce within the OECD are in the vicinity of S300 billion a year. The cost (in 1990 dollars) to the global South in 1980 of trade protectionism in developed countries has been estimated at about $55 billion (World Bank, 1991). Over the past 20 years, both the World Bank and the IMF have shifted development priorities from import substitution to export­ led growth accompanied by severe structural adjustment programs. For most developing countries, including those of the Arab world with scant industrial capacities, there is little to export but natural resources, making them almost totally reliant on commodity exports. However, commodity prices have fa llen steadily since the early 1970s. By 1986, average real commodity prices were at their lowest recorded levels in this century (with the exception of 1932, the trough of the Great Depression). The World Bank forecasts that commodity prices are unlikely ro rise during this decade, with intensified South-South competition in saturated markets. The effects on developing count1y economics of trade protectionism and commodity price collapses are compounded by external debt. Although the world economy has grown considerably during that period, much of the growth has been in countries that were already consuming an inordinate share of the world's resources. Many of the least developed countries had little economic growth and a substantial fall in per capita production during the 1980s. These changes have been coupled with regional conOicts that have plagued the Middle East as well as much of Sout11east As ia and Africa for the last two decades. As a result, glaring anomalies in global patterns of resource consumption have been made worse, the standard of living of the poorest half of the world's population has fa llen even further, and the incidence of famine and disease in the poorest countries has increased. This includes a number of Arab countries. Poverty leads to increased environmental degrada­ tion and therefore to a vicious downward spiral of poverty and loss of productive capacity. Economic instruments have come to be considered alternative to, or complementary to, regulatory instruments for the proper

©International Monetary Fund. Not for Redistribution 180 Mostafa K. Tolba management of the environment and of natural resources. A com­ parative analysis of the results of direct regulation and economic incentives in the United States concludes that the former is more expensive than the laner (Lollar, 1990). The main thrust of economic instruments is to "internalize" those external environmental costs that are not usually taken into consid­ eration in the cost-benefit analyses on which investment decisions are based. Generally speaking, and according to OECD (1989), economic instruments are

• charges, based on the so-called polluter pays principle (PPP) voiced soon after Stockholm (OECD, 1975) and imposed on effluents, products, or users, sometimes as a tax differentiation;

• subsidies, as grants, soft loans, or tax exemptions, to encourage compliance with the regulations (particularly useful with small­ scale enterprises);

• deposit-refund systems that promote berter waste collection and better management; and

• market-creating instruments, for example, trade in pollution per­ mits, in recyclable waste, or insurance policies.

Energy

Total world commercial energy consumption in 1970 was 5,000 million tons of oil equivalent (TOE); in 1990 it was 8,100 million­ an increase of 62 percent. This increase is much slower than the growth from 1950 to 1970. In 1950 total commercial energy con­ sumption was 1,650 million TOE; in 1970 it reached 5,000 million­ an increase of 203 percent. This trend was accompanied by a lower share of oil and a higher share of natural gas, coal, and nuclear energy. Developed countries, which constitute 22 percent of world popu­ lation, use 82 percent of total world commercial energy. Developing countries, with 78 percent of world population, use 18 percent of total commercial energy. Per capita commercial energy use in OECD countries is ten times that in low- and middle-income developing countries. Between 1970 and 1990 average energy intensity in devel­ oped market economy countries fell by 29 percent. In Eastern Europe and the former U.S.S.R. ir fell by 20 percent. Thus, in all developed countries there was a decoupling of the levels of energy

©International Monetary Fund. Not for Redistribution 6 Environmental Policies and Sustainable Development 18 I • use and economic well-being, which did not happen in developing countries. On the contrary, energy intensities in developing coun­ tries increased by 30 percent during the same period.

Industry Total world manufacturing value added (MYA) increased from about $2,500 billion in 1975 to a little under $4,000 billion in 1990 at constant 1980 prices. The share of the developing countries only increased from 10 percent in 1970 to 14 percent in 1990. Developing countries have the largest share in those industries in which natural resources play the most important role (for example, petroleum refining and mining). Between 1980 and 1985 four of the five manufacturing sectors known to be most energy intensive as well as material and pollution intensive (iron and steel, nonferrous metals, nonmetallic minerals, chemicals, pulp, and paper) grew twice as fast in developing as in developed countries. Developing countries are expected to increase their share of "smokestack" industries. Attempts to lure industry away from urban centers in developing countries were not successful. The major difficulty was the high cost of providing the necessary infrastructure away from the major urban centers. There is a global trend away from the treatment of discharges to cleaner production. During the second half of the seventies, the concept of "low and non-waste technologies" (LNWT) emerged. The emphasis became the development and promotion of technol­ ogies that produce either less harmful discharges or none at all. As more attention was focused on the development of "clean" technologies-and as their economic and risk reduction benefits were demonstrated-the concept of "cleaner production" finally emerged. The comparative degree is now preferred, since there is no clear-cut distinction between "clean" and "dirty" production methods or products. This concept now encompasses the whole life cycle of a product (from "cradle to grave"), covering product design, production process, and management practices right up to the disposal of the discarded product. The concept could be clarified through a hierarchy of substitutions at different levels that contribute to achieving the goal (Huisingh, 1989):

• The process level, modifying the process to make it more environ­ mentally sound (for example, producing less pollution or waste).

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• The component level, adding a new component providing an advantage without changing the overall process (for example, "end-of-pipe" treatment plants).

• The subsystem level, substituting a better subsystem for an old one (for example, an electric motor in place of a gasoline engine in a car).

• The system level, substituting a whole system or one function for another (for example, mass transport system for private cars).

• The value level, questioning the very premise on which products or services are provided. This is the most difficult, since it impacts on culture, social organization, and value systems.

There is another global trend toward the fast development of new, high-technology-intensive industries such as microelectronics, information technology, and biO[echnology. Developing coun­ tries-including the Arab world-have yet to infiltrate these new technologies.

Understanding the Environment

Advances in Natural Sciences. The science of ecology began with Haeckel in 1866. It developed rapidly in the fo llowing decades. But the modern view of interacting socioeconomic/ecological sys­ tems has its roots in the work ofW.I. Vernadsky in 1926. Vernadsky warned of the increasing rates and scales of environmental transfor­ mations taking place, and he dreamed of a time when the biosphere and the technosphere would be in harmony. Modern concepts of sustainability and sustainable development demand such harmony. During the 1970s and 1980s much has been learned about the global nature of environmental systems. Particularly impressive are the insights gained into the biogeochemical cycling of elements essential for life, notably carbon, nitrogen, oxygen, phosphoms, and sulfur. This cycling has been called the environmental life­ support system by Tolba and White (1979). The last two decades have seen considerable advances in under­ standing the behavior of geophysical and ecological systems and of plant and animal populations and in developing a capacity to model them mathematically. New concepts have emerged: the car­ rying capacity of a region, the sustainable yield of a renewable resource, the assimilative capacity of a watershed or airshed, and the resilience of an ecosystem. Within the engineering sciences,

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the idea of industrial metabolism and material flows has been pur­ sued by Ayers (1989), Stigliani 0990), and others. A new scientific discipline-environmental toxicology (or eco­ toxicology)-has been born in the medical field. Advances in Social Sciences . Social scientists are making increas­ ingly important contributions to our understanding of the environ­ ment. One such contribution led to the birth of the subject of "ecological economics," a subject that valiantly attempts to blend economics with ecology and that is attracting a great deal of atten­ tion from economists. In the World Bank and elsewhere a serious attempt has been made to produce country environmental issues papers to identify the major stresses on the environment in particular country situations, to be supplemented by count1y environmental action plans aimed at improving count1y environmenrs through economic policies and other instruments. Refinements have also been made in measuring environmental impacts of projects, with attempts made to reduce or eliminate environmental damage through redesigning projects or even dropping them altogether. Progress has also been made in incorporating environmental externalities in project analysis. Fom1idable efforts were made to change the United Nations System of National Accounts so that environmental change is incorporated in economic measurements of income and wealth. This has been an initiative sustained for many years by UNEP jointly with the World Bank. The new United Nations System of National Accounts, to be arriculated later this year, will contain a set of national satellite accounts in which adjust­ ment to the national accounts can be made to reflect environmental degradation. Daly, Goodland, and El Serafy-all of the World Bank-edited a book, Population, Technology, and Lifestyle (l992), in which they furrher developed the concept of throughput, and in which they urged the developed countries to contain their throughput, deriving their growth to the extent possible from enhancing productivity and restn1cturing production to give developing countries the chance to grow as well as to develop with the aiel of increased throughput. The concept of "steady-state economics," also associated with the name of Daly, has also been fruitful in this regard . Greater attention is now being paid by development agencies to indigenous peoples and to the preservation of cultural property.

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Advances in Environmental Monitoring Sys tems and Data Inven­ tories. Since the early 1970s there has been an enormous growth in public demand for information on the state of the environment. In addition, there has been an increasing requirement by modelers, resource managers, and other specialists for particular kinds of data sets. This has led to considerable interest in the scientific aspects of monitoring. Advances in Computer Models. Mathematical models have long been used to predict weather, tides, urban air pollution, and many other geophysical phenomena, as well as some ecological pro­ cesses. In such applications, model performance can easily be eval­ uated by comparing observations and predictions. But models may also be used to simulate conditions that have not occurred; in fact, comparisons may be made of several alternative "futures" based on a range of possible human interventions in coming decades. As a result of increasing understanding of complex environmental systems and of advances in computer technology, model perfor­ mance has improved greatly in the last twenty years. What is surpris­ ing, however, is the increased degree of public acceptance of model-derived "futures" like climate change models, acid rain mod­ els, and nuclear winter models. Advances in Resource Economics and Environmental Econom­ ics. The current economic paradigm, based largely on economic growth and more loosely on the tenets of capitalism, enjoys contin­ ued popularity in spite of recurring bouts of recession and growing pessimism about the future. Daly (1987) makes a useful but often overlooked distinction between growth and development. Growth is an increase in the flows of matter and energy through the econ­ omy, whereas development is an improvement in nonphysical characteristics. Resource economics focuses primarily on methods to broaden conventional neoclassical economics to include the true costs of natural resources, particularly common goods such as air and water, in determining the optimal allocation of resources. Nonmarket valu­ ation methods have been developed that enable economists to determine the cost or benefit attributable to nonpriced natural resources. However, the fundamental precepts of neoclassical eco­ nomics are incorporated. Environmental economics, similarly fol­ lowing essentially neoclassical tenets, addresses issues of pollution

©International Monetary Fund. Not for Redistribution 6 • Environmental Policies and Sustainable Development 185 control, standard setting, waste management and recycling, exter­ nalities of private enterprises, conservation and use of common property resources, and so on, from the standpoints of providing guidance for the efficient allocation of resources and sound environ­ mental policy. Resource economics employs a number of tools, which include cost-effectiveness analysis (CEA), benefit-cost analysis CBCA), and models of the impacts of environmental change on the biosphere. Advances in Ecological Economics. Increasing realization in recent years that resource economics has left out vital economic/ environmental linkages has led to the emergence of ecological economics as an alternative (Daly, 1990). Three concepts are essen­ tial to an understanding of ecological economics: throughput, carry­ ing capacity, and entropy. Our economy, and indeed our very survival, relies on ecological throughputs. We need water for pro­ duction and transportation, minerals and soil for agriculture, and so on. At the other end, we rely on nature to act as a sink for our wastes. The second concept is carrying capaci�y. Under steady-state conditions , the carrying capacity of an ecosystem can be modeled with reasonable confidence. However, for an ecosystem including people, the real canying capacity will depend on human consump­ tion patterns (A.rizpe and others, fo rthcoming) and will vary geo­ graphically and over decades. Thus, it is difficult to estimate the population that the world can sustain. Erring on the side of caution is therefore desirable. Another kind of problem arises, because although the carrying capacity of region can be estimated for cattle or elephants, the a estimates for people depend on assumptions about their life-styles. While natural inputs can be easily identified, and carrying capac­ ity is intuitively understandable, entropy is neither easily identified nor understood. However, it is a very useful "trump card" for ecological economics. "In entropy terms, the cost of any biological or economic enterprise is always greater than the product. In entropy tenns, any activity necessarily results in a deficit" (Georgescu­ Roegen, 1973). Regardless of how efficient production processes become in terms of minimizing externalities or reducing waste, production will always contribute to the ever-increasing state of entropy in the universe.

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The goal of ecological economics might best he described as finding the best ways of living lightly on the planet and striving for a ''frugal society" (one that is based on a definition of thrift in terms of economic efficiency, and on achieving environmentally sound economic development) (Goodland and others, 1991). There are differing views among economists about where the difficulty lies. Norgaard (1989) believes that environmentally sound economk development will not be achieved through adherence to a single dogma such as neoclassical economics; rather, "method­ ological pluralism·· is to he encouraged. On the other hand, El Serafy, in his comment on this paper, believes that neoclassical economics is perfectly compatible with environmental protection if we realize that the environmenr is pan of society's capital and if we pay enough attention to the long run rather than to the short run, which has dominated monetary economics and the demand management approaches of stabiliza­ tion programs. The fault-if there is a fault-does not lie with economics but with those economists who have lost sight of the neoclassical approach of using their discipline to address society's practical problems. But there are many signs now that economists are moving in that direction. Natural Reso urces Acco11nting. Another major development is the establishment of natural resources accounting. The basic think­ ing was that current systems of national accounts give an illusion of wealth. The sales revenue of a natural resource like oil cannot be considered wholly an income, since it involves selling part of the capital assets of a country. Natural resources accounting was meant to include in the national accounting system depreciations resulting from the loss of natural resources. An important study has recently been undertaken by the World Resources Institute. It used the example of Indonesia to indicate that traditional measurements of economic growth greatly distoned actual economic progress. Indonesia's GNP grew at 7 percent annu­ ally between 1970 and 1984, but dropped ro 4 percent when a depletion factor for the loss of forests, soil, and fossil fuels was subtracted. Another recent study unde1taken in Japan deducted the cost of pollution from income, resulting in a major adjustment of 143 billion yen.

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However, aU the efforts that have been made over the past several years-Jed by UNEP in full cooperation with the World Bank-Jed only to the establishment of satellite accounting systems that express the loss of natural resources in separate accounts rather than includ­ ing them in a modified national system of accounts. One legitimate reason for the resistance to change the current system of accounts is the essential need for the time series of accounLo.;over long periods of time if meaningful trends are to be identified. What is needed is a change in our perception of wealth. Natural resource endowments must be included in every nation's inventory of wealth. True value must be put on the natural patrimony. Expanding the time horizons of economic practices riveted to quarterly results, monthly m01tgage payments or trade figures, and yearly national income accoums is extremely difficult. A first step is the integration of environmental priority into every dimension of macro- and microeconomic practices. Environmemal considera­ tions must be built into decision making, from industrial planning, research and development priorities, trade and agricultural subsid­ ies, and tax policies. Economics seem to remain ill equipped to do that. This problem is not new. Two centuries ago, Adam Smith, in The Wea lth of Nations, isolated the difficulty of estimating the market value of natural resources. He wrote, "Things which have the greatest value in use-such as water-have frequently liule or no value in exchange." Although the environment is embodied in all goods and services exchanged, the environment is not itself exchanged. It therefore avoids a market price and a market value. The upshot is that natural resources are treated as "gifts" of nature rather than as productive assets. Economics seem to have enormous difficulty placing a value on anything outside of mercantile activities. As a biologist, I find it difficult to understand that so many economists confine value to exchange, at the expense of nonmarket values like biological diversity or clean water. While natural endowments like climate and porr access were crucial to production specialization and comparative advantage in classical economic the01y, resource scarcity or pollution-sink capacity were largely irrelevant in the industrial revolution. Once a natural resource was depleted. a lake polluted, or virgin forests exploited, new water sources were found and new soils were culti-

©International Monetary Fund. Not for Redistribution 188 Mostafa K. Tolba vated. The environment was virtually ignored, because it seemed without limits. Resources were incorporated as a free good in pro­ duction methods; pollution was ignored as a market externality. "Land" has been all but banished from economic priorities-partic­ ularly in neoclassical economic models. Instead, economic develop­ ment is viewed almost exclusively as a function of capital. Therefore, while industrial plant, machinery, and buildings are treated as productive capital whose value depreciates over time, the natural wealth of nations, including the Arab world, is not so valued. Because the natural regenerative capacity of soils, forests, freshwater, and fisheries is overestimated, they are dangerously undervalued. It is only when countries begin to assess the task of rehabilitating damaged ecosystems that something like the true cost becomes apparent. In the face of widespread ecological damage, it is clear that too many economists have ignored one simple fact. Ecosystems provide the foundation upon which all economic systems depend. There will not be any economic systems unless economists every­ where, including those in the Ara b region, take a long, hard look at present environmental realities. Economists must find a realistic symmetry between the price of goods and services and the cost they entail to society by way of natural resource inputs and end­ of-pipe pollution. Putting a price tag on the-environment is not a new idea. Keynes's teacher, Professor Pigou, is credited with being the inventor of the "polluter pays" approach. In his view, the environment was not a free good. Those who used it-either by way of resource inputs or polluting outputs-must pay for it. Under standard accounting practices, the Exxon Valdez spill and the environmental deterioration that resulted from the Middle East war may be calculated at year-end as an increase in national GDP because of the jobs created for the clean-up and the capital expendi­ ture for repairs. Such a gain in income is of course an illusion when set against the perhaps irreversible damage to the marine environment. Economic development functions like ecological deficitfinancing-by which the immediate returnof income growth obscures the potential of long-term economic sustainability. The challenge is to standardize depreciation values to soils, water, and air. Put another way, reform is needed to include natural resource

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endowments and environmental factors systemmically in calcula­ tions of gross national product. The main obstacle is that no consensus yet exists in the economic fraternity on how to "price" a renewable resource accurately. Take soil, for example. To most of us it is a layer of mineral particles that can be used to grow crops. It is in fact a living community of roots and organic and microscopic life-a water storer and dis­ penser. It is a portfolio of capital that can be conserved in perpetuity, or by removing protective vegetation or irrigating it improperly, this living resource can be mined and destroyed in the space of a few years. We may not be able to put a true value on such a resource, but this does not mean that we should not try. We recognize that the tools at our disposal are imperfect and we must work hard to improve them. We can therefore be encouraged that there is a rapidly growing body of opinion beyond what might be termed the environmental constituency that we must tread a different path. Germany, France, the Netherlands, Norway, Canada, and Australia are already moving toward natural resource balance sheets, as are the World Bank, the International Monetary Fund, and a few other lending institutions. Such reforms in economic tools will take time. But we cannot proceed as if time is on our side. It is not. Two important tools are urgently needed. The first is indicators of national wealth, which can reflect quality and changes in underlying natural resource bases, and second, the means of quickly assessing the impact of environ­ mental decisions on international trade. Policy Instruments fo r Environmental Management. Careless technology coupled with inadequate standards, controls, and insti­ tutional arrangements has often allowed producers and consumers to disregard the costs of environmental degradation. These costs, which are known as "technological externalities" (for example, the emission of pollutants into air and water bodies) are the focus of many studies in environmental economics. The fo llowing are 12 policies that have been used for water, land, and air quality management. The choice of instruments depends on local circumstances and on the parricular type of pollutant to be controlled or the resource to be conserved.

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1. Prohibition, for example, harvesting of endangered species, dumping of some toxics or contaminants into an ecosystem. 2. Regulation, for example, of phosphorus concentrations in sewage effluents to control eutrophication; land-use zoning. 3. Direct government intervention to modify some ecosystemic fe ature, for example, building dams to create lakes. 4. Grants and tax incentives, for example, to indust1y to install pollution control equipmenr, or to a municipality to accept solid wastes. 5. Buy-back programs, for example, government purchase of flood-prone land. 6. Liability for compensation, for example, U.S. Superfund pro­ visions. 7. Compulsory insurance, for example, to compensate the vic­ tims of pollution for damages. 8. Effluent charges, for example, fees for waste disposal scaled according to the direct cost of treatment or ro the indirect cost associated with deleterious impacts on a receiving ecosystem; effluent charges may be incorporated into "delayed pollution control charges." 9. Resource rent, for example, a tax or charge on harvesters of a resource in order to recover a fair return for the owners (all the people) of the resource, and also to foster efficient use of the resource by discouraging overcapitalization. 10. Management of the demand, for example, through rate struc­ tures involving marginal cost pricing and/or peak responsi­ bility pricing to improve overall efficiency of use and to foster conservation. 11. Transferable development rights, for example, incentives to industry to develop in designated areas. 12. Transferable individual quotas, for example, rights to emit specific quantities of pollutants or to harvest specific quanti­ ties of fish or wildlife.

Environmental Impact Assessment (EIA ). An EIA is "an activity designed to identify and predict the impact of an action on the biogeophysical environment and mankind's health and well-being, and to interpret and communicate information about the impacts" (Muon, 1979), where an action could be a proposal to construct a

©International Monetary Fund. Not for Redistribution 6 Environmental Policies and Sustainable Development 191 • large engineering work, or to implement new legislation, policies, or operational procedures with environmental implicmions. In the 1970s, EIAs generally did not include assessments of socioeconomic impacts. Today, some jurisdictions include these factors within EIAs, whereas in others separate socioeconomic impact assessments (SIAs) are required. Management of Risk and Uncertainty. Risk assessment has emerged as a significant tool for environmental decision making (Miller and others, 1986). It has also helped to focus public attention on health and environmental issues and has been instrumental in clarifying the role of public participation and conflict resolution in the environmental field. Environmental Audits. Environmental audits have become an integral part of the EIA process (Munro and others, 1986). For large engineering works, these audits should cover the construction, postconstruction, and decommissioning phases, that is, a time period of at least forty to fifty years. For assessments that have a bearing on international conventions/treaties (for example, on acid rain, stratospheric ozone depletion, or shared water resources), environmental audits may need to continue for a century or more, merging into programs of general monitoring.

Regionalization and Globalization of Environmental Issues

In the past twenty years countries realized that all of their environ­ mental ills result from either development or lack of it, and that most of their environmental problems cannot be solved at the national level but rather require full international cooperation at the regional or global levels. Examples abound. For the Arab region cooperation at regional or subregional levels is a must for regional seas: the Mediterranean, the Red Sea, and the Gulf or for shared freshwater resources such as the Nile, the Euphrates, the jordan, the Nubian Sandstone aquifer, and so on. Global issues include ozone depletion, transboundary movement of hazardous wastes, trade in endangered species and in toxic chemicals, climate change and global warming, loss of biological diversity, and transboundary movement of air pollution. Since the early seventies, all these issues have forced governments, which

©International Monetary Fund. Not for Redistribution 192 Mostafa K. Tolba otherwise are totally different economically and politically, to sit around the same table to agree common actions to save their com­ mon heritage, land, air, water, sea, and, above all, to save the human health and well-being of their peoples. In these negotiations, once the environmental problem was identified, it became apparent that the major issues to be addressed were the impacts of any proposed agreement or treaty on the economic and social develop­ ment of the negotiating states as well as on trade to and from these countries. This is more concrete proof of the intricate relations between the environment and development.

The Arab World

It is true that the Arab world is quite homogenous with respect to language, culture, and most of its traditions. However, the variations between the Arab states regarding economic and social indicators are enormous.

• The size of populations in the Arab states range from about 0.5 million to over 50 million, with all the in-betweens.

• The annual rate of population growth varies between 0.2 percent and almost 4 percent.

• Access to safe drinking water in 1988 ranged from 50-100 percent in urban areas and from 20-100 percent in rural areas. Access to sanitation services ranged from 30-100 percent in urban areas and from 5-100 percent in rural areas.

• Commercial energy consumption in 1989 ranged from 1 giga­ joule per capita to almost 600 gigajoules.

• Freshwater withdrawals range from 28 cubic meters to 4,575 cubic meters a year and represent anywhere from zero to 660 percent of the available annual internal renewable water resources. Of course, the withdrawals include desalination capacities.

• Illiteracy, except for Jordan and Lebanon, where it is about 20 percent, ranges between 40 percent and 75 percent of the adult populations of the rest of the Arab states.

• Per capita gross national product varies from $170 a year to more than $18,000 a year.

• The land areas of Arab states vary widely, from 10,000 square kilometers (Lebanon) to more than 2 million square kilometers (Saudi Arabia, Algeria, and Sudan).

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• The total external debt of the Arab states varies from zero to about $40 billion.

• Urban populations in the Arab countries as a percentage of the total population range from just over 10 percent to more than 95 percent.

• Land with no inherent soil constraints in the Arab world ranges from as low as 10,000 hectares (Bahrain) to more than 90 million hectares (Algeria).

• The Arab world has reserves of a limited number of major metals, but the amounts vary widely.

These are some of the indicators that show the wide differences between the Arab states. They are of course in addition to variations in climate, topography, and availability of agricultural and pasture lands and forests and of mineral and other natural resources and energy sources. What I want to say here probably complements the variations in investment policies described in Mr. Ghassan EI-Rifai's paper. All these variations have to be kept in mind when making recom­ mendations for action by the Arab states.

Conclusions

The above discussion clearly shows that in planning its furure economic development the Arab world has first to prioritize what needs to be done according to the variations that I and others have mentioned; second, to identify activities that can be implemented to achieve specific targets in specific periods of time, costed, and the sources of funding identified. Institutional reform will have to go hand in hand with this exercise to ensure the proper follow­ up of these activities that are by necessity multidisciplinary and multisectoral. Third, it must plan its development with the aim of passing on to future generations productive opportunities of equal or greater value than the existing capital portfolio. This is easy £O state, but immensely difficult to achieve because, in essence, the transfer of three types of capital is being discussed: (a) critical natural capital such as biogeochemical cycles and species diversity-that is, the vital processes that sustain the life suppon systems of the earth; (b) natural resources-forests, marine life, topsoil, and air;

©International Monetary Fund. Not for Redistribution 194 Mostafa K. Tolba and (c) artificial capital such as technology. The Arab region also has to ensure that development does nm end in a deterioration of its natural resource base, which varies from one Arab country to another. Those who receive official developmem assistance have to Jive with the fact that the new developments in Eastern and Central Europe and the former Soviet Union are most likely to lead to a diversion of sizable sums of aid from developing countries, includ­ ing a number of Arab states, to neighbors in Europe. The Arab world should spare no effort to establi�>h its own natural and social scientific base and technological base. In this case a pooling of such resources of highly trained individuals may prove beneficial. Such a scientificand technological base should be geared to choosing the most appropriate and environmentally sound tech­ nologies available; developing local technologies based on local and traditional knowledge and applying the new science, using the best of the old and the best of the new; thrusting the Arab world into the arena of new technologies: microelectronics, information technology, and biotechnology; developing the most appropriate ways and means of using the renewable natural resources: land, water, and forest<;, particularly shared water resources; developing methodologies for applying the new economic loots that guarantee that development is sustainable; and developing the most credible data bases on what is happening to the environment and its natural resources in each of the Arab countries as a basis for proper pol­ icy decisions. The Arab world should achieve public consensus by sharing information and interpretation of data. It should formulate long­ term policies and not only short-term plans. The latter are no longer useful because of the enormous developments in understanding the relationships between people, resources, the environment, and development. This will probably be the most difficult part, because of the huge uncertainties about natural resources, potential needs, prices, monetary instabilities, and so on, although the new tech­ niques of managing risk and uncertainties should help. In planning for future economic development, the policymakers in the Arab world will have to follow the new and most logical concept, which states that "minimizing future regret is wiser than maximizing present benefit."

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References

Arizpe, L., R. Constanza, and W. Lutz, Primary ractors Affecting Popula­ tion and Natural Reso urce Use. Proceedings of International Conference on an Agenda of Science for Environment and Development into the Twenty-First Century (Paris: JCSU, forthcoming). Ayers, R.U., "Industrial Metabolism," in 'J'e cl:mo/ogy and Enuiro11ment, cd. by jesse H. Ausubel and Hcdy E. Sladovich (WashingtOn: National Academy Press, 1989). Daly, Herman, "The Economic Growth Debate: What Some Economists Have Learned but Many Have Not,"joumal of Eiwironmental Econom­ ics and Management, Vol. 14 (December 1987), pp. 323-36.

___,"Sustainable Development: From Concept and Theory Towards Operational Principles," Population and Deuelopmelll Review. P c ed­ ro e ings from a Hoover Institution Conference, 1990. Georgescu-Roegen, N., "The Entropy Law and the Economic Problems," in To ward a Steady-State Economy, eel. by Hennan E. Daly (San Fran­ cisco: W.H. Freeman, 1973).

Goodla d, Rob rt, Hem1an Daly, and Salah El Serafy, ed.<>., Envirownen­ n e tally Sustainable Economic Deuelopmelll: Building 011 Brundtland (Paris: UNESCO, 1991). Huisingh, D., "Cleaner Technologies Through Process Modifications.

Material Substitutions and Ecologically-Based Ethical Value, Industry• and Environment, Vol. 12, No. 1 0989). Lollar, C., "Eastern Europe Awakens ro New Worldwide ScientificOppor­ tunities," Science, Vol. 250 0990). Miller, C.T., P.R. Kleindorfcr, and R.E. Munn, eds., Conceptual Trends and Implications for Risk t

---, OECD Environmental Data: Compendium, 1989 (Paris: OECD, 1989).

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Stigliani, William M., "Chemical Emissions from the Processing and Use of Materials: The Need for an Integrated Emissions Accounting System," Ecological Economics, Vol. 2 (December 1990), pp. 325-4 1. Tolba, Mostafa K., and G.F. White, "Global Life Support Systems,'' joint Press Release of UNEP and SCOPE (1979). United Nations Conference on Trade and Development, Handbook of International Tra de and Development Statistics, 1990 (New York: United Nations, 1990). World Bank, World Development Report, 1991: The Challenge of Develop­ ment (New York: Oxford University Press, 1991).

©International Monetary Fund. Not for Redistribution COMMENT

SALAH EL SERAFY

his is a comprehensive paper by a world expert on the environ­ Tment who has been at the helm of the United Nations Environ­ ment Program (UNEP) for many years and who speaks authorita­ tively on the subject. The paper fits well into the framework of the seminar as it is usefully slanted toward development. The paper's main message-and it has several-is that in the Arab region we should be aware of the fact that we are part of the global environment and that we should behave with this fact consciously in mind. More specifically, we should heed the injunc­ tion-captured at the end of the paper-that to minimize regrets in the future, we should be careful not to harm the environment now. It is inevitable that we pay for the harm we do to the environ­ ment sooner or later, and if we imagine that we can get away with the reduced costs of production and consumption by harming our environment in the short run, we will eventually have to pay the price. Also, it is cheaper and more efficient to charge such damage as a cost to current activities, rather than to wait until the damage has been done, when the cost of repairing the environment is likely to be higher, and some of the damage will be irreversible. Mr. Tolba rightly views his paper as a contribution to the sustain­ able development that he so strongly urges. He is aware that sustain­ ability looks different to different people, and it is to his credit that although he comes to the subject from the direction of natural science in which he was trained, the paper contains much that belongs to the realm of the social sciences, diplomacy, and institu­ tional development, as well as much wisdom that reflects years of experience in a globally pivotal place. Since I have been asked to be a discussant, let me try, if I can, to find weaknesses and omissions in the paper. I must warn, how­ ever, that I am in general agreement with the tone and thrust of this paper. I wish that the paper was better structured. It begins with a regional focus, namely, a brief account of the great disparity of

197

©International Monetary Fund. Not for Redistribution 198 Salah El Serafy conditions, income levels, population and its growth, education, and health and sanitation among the Arab countries. I wish Mr. Tolba had also added the great variety of natural resource endow­ ments among them: space, climate, water, mineral deposits, soil, and the like. The second section, "Environment and Development," shifts suddenly to a global perspective, with emphasis on the great attention given progressively by the world to environmental issues over the past two decades. Here Mr. Tolba advances his argument quite effectively through a series of succinct quotations about the importance of the environment for national economic performance, as well as its contribution to determining international comparative advantage. These quotations include one from the South Commis­ sion regarding the harmony that should exist internationally between development and the global environment; the alarm sig­ naled by the Secretary-General of the United Nations in 1969 urging nations to subordinate ancient quarrels to improve the human envi­ ronment, diffuse the population explosion, and reduce the arms race so that development could receive focused attention. Mr. Tolba shows how very little has been done in response to such wise counsel, though he devotes a section to a number of notable steps taken in the past few decades, including convening the Rio Confer­ ence on Environment and Development. He reminds us that it was the Governing Council of UNEP that coined the phrase "sustainable : development" some 17 yea1s ago. This concept, which unfortu­ nately does not lack enemies, has contributed to many constructive initiatives, particularly in the economic sphere. After that, the paper largely proceeds along global lines, with the injunction that the Arab world has no alternative but to pursue its development sustainably and in harmony with global norms. Reviewing the global scene, Mr. Tolba mentions the collapse of the former Soviet Union and the bipolar world, the discredit of planning and the rise of market-oriented approaches, the strong movement toward regional economic and political integration, as well as the great technological strides made recently, including the revolution in information and communication technology. Endors­ ing Mr. Langhammer's views, he is pessimistic about the in1pact on the Arab countries of developments in the former eastern bloc; greater competition with Arab exports; the proximity of Eastern Europe to markets of the European Community (EC) to the detri-

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ment of Arab exports and those of developing countries; and the likely favorable treatment of imports into markets of countries of the Organization for Economic Cooperation and Development (OECD) at the expense of developing countries. He is also wary of the impact of the North American Free Trade Agreement between Canada, the United States, and Mexico, fearing that this will blur the demarcation between developed and developing countries (without saying why this is necessarily bad), and he is apprehensive that this agreement will impose the environmental standards of a highly advanced countty (the United States) on a Jess developed nation such as Mexico, and may thus affect Mexico's drive to indus­ trialize. A critic would find some contradiction between this last statement and Mr. Tolba's earlier statements to the effect that the Arab world should follow the global environmental initiatives, pre­ sumably including standards, which l think is more sound advice. The paper then attends to some interesting general issues and trends, including the growth of knowledge as an asset (perhaps more valuable than physical or financial resources); the worldwide integration and centralization of the transnational corporation caused by the revolution in communications, thereby reducing the powers of national governments in the developing world; the extraordinary growth until recently of world u·ade, albeit affecting only very few of the developing countries; and the great barriers that have been set up against expot1S from developing countries in the markets of the richer countries. Turning to the Arab world, Mr. Tolba notes the paucity of manu­ factured exports, and the ovetwhelming reliance of the region on the exports of primary commodities whose terms of trade have seriously deteriorated at a time when the debt problem has also become serious and the regional conflicts have worsened. In this part of the paper, which perhaps illustrates again my strictures about its structure, Mr. Tolba goes back to global themes, mentioning the drive among economists to internalize the environ­ mental costs of activities in line with the "polluter must pay" princi­ ple; the introduction of fiscal and other incentives to encourage energy savings and compliance with regulations for reduced pollu­ tion; and the development of devices such as trading permits and auctions for rights to pollute that are fixed in their aggregate.

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The paper then addresses the subject of energy consumption in a global context, citing the deceleration of world demand for energy since 1970, the small share in this demand of the developing coun­ tries, and the reduced energy intensity of OECD production, to be contrasted with an increased intensity in the developing countries. The paper dwells on the topic of industrialization in developing countries, noting that they contribute a very small share (14 percent in 1990) to total world industry; that energy-polluting industries, such as iron and steel, nonferrous metals, and pulp and paper, are growing faster in developing than in developed countries and that their relocation away from congested urban centers in developing countries has proved difficult and costly; and that there is now an established trend for developed countries to seek technologies that reduce pollution rather than attempt to clean up the pollutants after they have been generated. Mr. Tolba signals concern that such new technologies, which have yet to reach the Arab countries, will be costly, and access to them will affect comparative advantage, and hence the international localization of industry. He also notes the rapid growth in the developed countries of less polluting and high­ technology activities, including microelectronics, information tech­ nology, and biotechnology. Mr. Tolba will probably agree with me that such trends signal in1porrant changes in the industrial structure of the richer countries that will cause the polluting industries to migrate progressively to the developing countries. The paper then reviews major advances that have occurred, including the developmem of the fairly new science of ecology, which now seeks harmony between the biosphere and economic and social activities. He mentions the great strides made during the past two decades by scientists to enhance understanding of global environmental systems and to advance insights into the biological cycling of elements (such as carbon, nitrogen, phosphorus, and sulfur) essential to life, which he himself has named "the environ­ mental life support system." He further mentions progress made in understanding the behavior of geophysical and ecological sys­ tems, of the plant and animal roles, and the developmem of new concepts such as the "carrying capacity of a region," the "sustainable yield" of a renewable resource, assimilative capacity of a watershed or an airshed, and resilience of an ecosystem. He also cites advances

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in mathematical modeling and the development of a new medical field called "environmental toxicology." Mr. Tolba, wrongly, I believe, contrasts the significant scientific advances he mentioned with the lack of "spectacular" strides made by the social scientists in this regard. Although he and I may differ on what is spectacular and what is just important, and on what is conceptual or methodological progress and what is just improved application, I would mention the following. He himself has called attention to the birth of the subject of "ecological economics," a subject that valiantly attempts to blend economics with ecology and that is attracting a great deal of attention from economists. In the World Bank and elsewhere a serious attempt has been made to produce country environmental issues papers to identify the major stresses on the environment in particular country situations, to be supplemented by country environmental action plans aimed at improving country environments through economic policies and other instruments. There also have been refinements in measuring the environmental impacts of projects, with attempts made to reduce or eliminate environmental damage through redesigning projects or even dropping them altogether. I would also cite the progress made (and mentioned in Mr. Tolba's paper) to incorporate environ­ mental externalities in project analysis. But I would be remiss if I did not also bring to the attention of participants at this seminar the formidable efforts to change the United Nations System of National Accounts so that environmental change is incorporated in economic measurements of income and wealth. This has been an initiative sustained for many years by UNEP under Mr. Tolba's leadership, jointly with the World Bank on whose behalf I have played a certain role. The new United Nations System of National Accounts-to be enunciated later this year-will contain a set of national satellite accounts where adjustment to the national accounts can be made to reflect environmental degradation. Mr. Tolba mentions the distinction between growth and develop­ ment, which my friend and colleague at the World Bank, Herman Daly, has proposed, and the concept of throughput (the natural material and energy content of economic activities that eventually produces harmful emissions). He will probably be pleased to know that in association with Robert Goodland (also of the World Bank) and myself, we edited a book published in 1992 called Population,

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Te chnology, and Lifestyle, where we developed this concept further, and urged the developed countries to contain their throughput, deriving their growth, to the extent possible, from enhancing pro­ ductivity and restructuring production to give the developing coun­ tries the chance to grow as well as to develop with the aid of increased throughput. The concept of "steady-state economics," also associated with the name of Daly, has also been fr uitful in this regard. To this I must add the greater attention now being paid by development agencies to indigenous peoples and the preservation of cultural property. I do not share Mr. Tolba's unhappiness with what he describes as the "single dogma of neoclassical economics." Neoclassical eco­ nomics, as I have illustrated in several publications, is perfectly compatible with environmental protection if we realize that the environment is part of society's capital and if we pay enough atten­ tion to the long run, rather than to the short run, which has dominated monetary economics and the demand management approaches of stabilization programs. The fault-ifthere is a fault­ does not lie with economics as such, but with those economists who have lost sight of the neoclassical approach of using their discipline to address society's practical problems. But there are many signs now that economists are moving in that direction. The paper then devotes space to enumerating environment friendly policies that have been proposed or applied in many situa­ tions, and also mentions practices that have been advocated for environmental impact assessments, risk management, and environ­ mental audits. I have nothing to say on this. I liked the emphasis on regional impacts rather than impacts within an individual coun­ try, since much of the environmental harm created is transboundary and even global. UNEP under Mr. Tolba's able leadership must take pride in the development of several global initiatives, including the Montreal protocol to protect the ozone layer, and the setting up of the global environmental facility. Of his conclusions, which focus on the Arab region, I liked best the injunction to pool research and development efforts relating to the environment in our region. I wish the paper had elaborated on the damage done to the environment by the recent armed conflicts and mentioned the allied use in the Middle East war of the so-

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called uranium shells, which, according to recent U.S. press reports, have left radioactive effects in Iraq and perhaps also in Kuwait. I also wish that Mr. Tolba had mentioned the problem of water scarcity in the region and its likely aggravation in future; also petro­ leum depletion and the economic measures that should be under­ taken to address these. I hoped too that he would have touched on endangered species such as the buzzard, which is hunted merci­ lessly in our region every year. Having said that, I want to reiterate my admiration for his lucid and comprehensive account of progress and problems. The paper is filled with wisdom and very well serves the purposes of this seminar.

©International Monetary Fund. Not for Redistribution ·7·

Human Development in the Middle East and North Africa Region

STEPHEN P. HEYNEMAN

he Cold War has ended. The distortionary environment imposed Tby the Cold War within and between Middle Eastern and North African (MENA) countries has also ended, providing them with the opportunity to address regional problems without being biased by externally imposed exigencies. Two major items should take priority in the regional agenda: the first is the discrepancy between rich and poor countries; the second is the challenge of competing with the new European Community for trade in the global marketplace. The key to solving both problems is to improve the region's produc­ tivity in human resources.• The ideas set forth in this paper are based on the belief that comprehensive human resource development covers universal basic education, health, nutrition and food security, and the full development of families, including security for women, children, and the elderly. This paper attempts to address these issues within the context of cultural, historical, and recent development experi­ ence, and is divided into three parts: the shared starting conditions (demography, Islam, social indicators); the key political pressure points (youth unemployment, gaps in the social safety net, over-

1lt is assumed that the reader is familiar with the major new advances in the economics of human capital-the four Nobel prizes dedicated to human capital issues (Jan Tinbergen, T.W. Schultz, Gary Becker, and Edward Dennison), the four World Development Reports by the World Bank on human capital (1980, 1984, 1990, and 1993), and other recent reportS on human capital issues by UNICEF, UNDP, UNESCO, WHO, ILO, etc.

204

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reach of public administration); and a checklist of national human development strategies and potential regional and international responses.

Shared Starting Conditions The first major shared factor is the dynamics of demographic change. Excluding small outliers like Tunisia and Lebanon, MENA countries are still in the low mortality/high fertility transitional phase, with total fertility rates of between four and six per woman. Yemen andjordan have still higher total fertility ra tes. 2 It is important to recognize, however, both that fertility in most MENA countries has declined dramatically in the last thirty years, especially in Tuni­ sia, and that the effect of reduced fertility on overall population growth rates works only gradually through successive childbearing cohorts. Therefore, assuming zero net migration in the longer term, MENA population growth rates, now ranging from 2.5 percent to 3.5 percent, will fall, at most, by 1 percent a decade under the most optimistic scenario (see Chart 1). No country will attain a stationary population (replacement-level fe rtility and constant-age composi­ tion) before about 2025. In this respect, MENA countries are most like sub-Saharan Africa and least like their competitors in Europe and the Far East. Fertility declines in MENA countries have three proximate deter­ minants: age of marriage, contraceptive practice, and breastfeeding. These determinants are influenced by demand-side variables, such as rising education and employment opportunities, direct and indi­ rect costs of childbearing, and by the supply of family planning services and products. It is important to remember that family plan­ ning services and products are only part of the "solution" and will have limited effects without changes in demand. Changes in demand, however, are not always predictable. For example, sponta­ neous fe rtility reductions can be attributed to negative economic factors, such as acute housing shortages in Algeria; conversely, what would otherwise be rated as positive developments, such as increasing female employment in the modernsector, can paradoxi-

2The text refers consistently to "Yemen," although charts refer to the Yemen Arab Republic and the People's Democratic Republic of Yemen separately.

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Chart 1. Total Population Growth (In percent per annum)

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jordan 4

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Morocco

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-1 �--�--�-----L----�--�----�----�--�----_J 1960-65 65-70 70-75 75-80 80-85 85-90 90-95 95-00 00-05 05-2010

cally have the opposite effect by altering breastfeeding and weaning practices. Contraception is acceptted in varying degrees by all five branches of Islamic Law.3 Contraceptive prevalence in MENA coun­ tries generally ranges between 35 and 40 percent (Yemen and Tunisia outliers), well below the 60 percent of Latin America and the Caribbean, but above the 20 percent of sub-Saharan Africa. Desired fa mily size declined by as much as 29 percent in Egypt and 24 percent in Morocco in the 1980s. "Unrnet demand" for family planning in MENA countries-the proportion of married women who want to limit or space births but do not use family planning­ is still substantial (for example, 18 percent in Morocco). The unmet

5Donna Lee Bowen, Islam and Fami{yP/anni11g, World Bank, EMENA Technical Department Publication, No. 1 0991).

©International Monetary Fund. Not for Redistribution 7 • Human Development in Middle East and NorthAfrica 207 demand for family planning argues for improved service delivery as a priority investment. The unusual age stmcture of the MENA populations is its most problematic characteristic. The age dependency ratio is very high (see Chart 2). Approximately one person in three in Yemen, Algeria, Morocco, and jordan is of school age (see Chart 3). This implies extreme pressures to expand the education system broadly without proper attention to quality, and schools of low quality inevitably have lower student retention rates (see Chart 4). The least "digest­ ible" group is the huge bulge of 15- to 20-year olds, and, to a lesser degree, 20- to 25-year olds. These largely undereducated groups, moving slowly up the age pyramid, will have irreversible policy influences within this decade. These include pressures on job mar­ kets and training outlays, special preventive health care demands, different savings and consumption patterns, and, of course, the specter of political unrest. The age structure phenomenon compli­ cates many other dilemmas faced! by MENA governments, coincid-

Chart 2. Age Dependency Ratio, 1 990 (Percentage of population aged 0-1 4/percentage of population aged 15-64)

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©International Monetary Fund. Not for Redistribution 208 Stephen P. Heyneman

Chart 3. School-Age Population, 1991 (Percentage of total population aged 6-7 7)

3S r------�

ing unhappily with the "morning-after" austerity in macrostabiliza­ tion and restructuring policies. International migration and its ramifications are a distinctive fea­ ture for MENA countries. The magnitude of the economic effects of migration is hard to exaggerate. In 1985, there were 5.1 million migrant workers in the Gulf Cooperation Council (GCC) region, constituting over 70 percent of its labor force. Moreover, in 1990, there were over 2.1 million Algerian, Moroccan, and Tunisian citi­ zens legally employed in eight Western European countries.4 In 1989 workers' remittance credits exceeded 6 percent of GOP in Morocco and 10 percent of GDP in the People's Democratic Repub-

4-fhis estimate excludes undocumented Maghrebian migrants and workers who have recently entered these co ntries on four-month tourist visas for short-term u seasonal employment.

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Chart 4. Percentage of School Dropouts by Grade 6, 1988

80

70

60

50

40

30

20

10

0 �(ij �(ij l' .._(

lie of Yemen, Egypt, and Jordan.' The recent changes in Europe and Central Asia have caused migrational shifts parallel to those in MENA countries. The combination of both has caused countries in the European Community to re-examine their labor and immigration policies. Policy changes have implications for MENA countries that could affect many aspects of their economies-future prospects for renewed flows of talent, the skills profiles of workers who now do not migrate, and economic relationships with the European

'Official inflows (credits) are those recorded in the International Monetary Fund's Balance of Payments Statistics. Total inflows are the sum of three categories: workers' remittances (total value of transfers from workers abroad for more than a year); migrant transfers (flows of goods and financial assets associated with an international move); and labor income (factor income of migrants working abroad for less than a year). Sharon Stanton Russell, "International Migration in Europe, the Soviet Union, Middle East and North Africa: Issues for the World Bank," ECA­ MENA Technical Department, Population and Human Resources Division (1992 working paper, p. 15).

©International Monetary Fund. Not for Redistribution 210 Stephen P. Heyneman

Community, including many kinds of protection such as labor, agricultural and industrial products, and services. The rate of population growth in most major urban centers and its concentration on already congested coastal strips or water courses exacerbate infrastructure bottlenecks, increase pressure on real wages, and raise the political stakes of social ills of any origin. Between 1965 and 1988 the percentage of the labor force in agricul­ ture in Egypt declined from 55 percent to 38 percent; in Tunisia from 49 to 22 percent, and in Morocco from 61 percent to 46 percent. The urban population increase between now and the year 2000 will range from 2.7 percent in Tunisia to 6 percent in Yemen. In each country, the urban population increase will exceed overall demographic growth by about 25 percent. Islam is the second obvious constant. As yet, external agencies, such as ours, are ill equipped to appreciate Islam's impact on human development, and much else besides. Our brief forays into this subject have focused on the different strands of Islamic family law as they pertain to reproductive rights, land tenure, and gender differentiation in education and the workplace.6 We are aware of religiously anchored charitable institutions (waqf) supporting vari­ ous social services in most MENA countries.7 This is promising background information, but it may be context specific. As yet there is little immediate generalization ro be drawn across countries. Stereotypes of the pros and cons of single-sex schools, for instance, or of the acceptability of different family planning methods, or of the relationship between a formally restricted public role for women and economic growth, all yield to counter examples-from the Atlas Mountains to Java.

6Contrary to popular western assumptions, countries with high proportions of Muslim populations are not "behind" in the rate of female school enrollment independent of GNP per capita and other measures of resources available for education. See Stephen P. Heyneman and Simel Esim, "Female Educational Enroll­ ment in the Middle East and North Africa: A Question of Poverty or Culture?" World Bank, ECA!MENA Technical Department (December 1992 draft). 7Ahmed Dallal, "The Islamic Institution ofWaqf: An Historical Overview," World Bank, ECA-MENA Technical Department, Population and Human Resources Divi­ sion (1992 working paper); Mohammed Hussain, "The Use of Zakat, Ushr, and Waqf Resources in Pakistan," ECA-M ENA Tt:chnical Department, Population and Human Resources Division (1991 working paper).

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Moreover, it may be worth noting that an "Islamic" view of development priorities may be quite different from that of "the West," and equally legitimate. Desired living standards-low infant mortality, full school enrollment, etc.-may be similar to countries of the Organization for Economic Cooperation and Development (OECD), but the trade-off between those standards and societal changes that are associated with many OECD countries (for exam­ ple, increased crime, changes in family structure, family break­ down) may be quite different. Achieving the OECD's level of economic development without necessarily duplicating all of society's ills is a reasonable, even laudable, ambition. Asian and Latin American countries have chosen paths for human resource development that have not mirrored in exact terms the assumptions of WesternEurope and NorthAmerica. These countries are attempting to strike a balance between the individual's rights and privileges and the individual's obligations toward the family and the community. This balance is germane to this discussion because the path chosen may affect the state's role and efficiency in human resources. The extent to which MENA countries can capitalize on their traditional support for family secu­ rity (for example, through waqf) may help determine the degree to which the state may concentrate financing for issues in which it may have a comparative advantage (for example, in health and education). MENA countries therefore may have the opportunity to choose a path for human resource development that mirrors the best attributes of their more wealthy OECD counterparts but at the same time provides a region-specific example of sustained human development. It is commonly perceived that development assistance agencies concerned with the region may not sufficiently appreciate the need to protect the social fabric as it is understood locally. For example, under Islamic family law a female may inherit a smaller portion than a male. Nevertheless, males are held financially responsible for children and the elderly. If one were to argue, on grounds of economic efficiency, that females ought to have parity of inheri­ tance, one would presumably have to accept a parallel shift in family support responsibilities in the fa mily environment.11The case

�under socialism (the People's Democratic Republic of Yemen, Afghanistan, Ethiopia, and the states of the former U.S.S.R.), Islamic family law was altered

©International Monetary Fund. Not for Redistribution 212 Stephen P. Heyneman for changing such Jaws may very well rest on the relative economic importance attached to maintaining the stabiliry of the social fa bric. More generally, it is necessary to be cautious about reaching premature conclusions concerning the impact of major institu­ tions-marriage and the family-on the economy and vice versa. The pressures of urbanization, scarce housing, rising health and school costs, and changing trade, price, and wage patterns can transform the incentive landscape and, ultimately, seemingly immu­ table institutions in as little as one generation. And this transforma­ tion may occur ahead of enabling legislation, as witnessed by the upward trend in female labor force participation in many countries. This perspective should caution against simplistic views of "cultural factors" as being binding exogenous constraints. In my view, this seems especially worth keeping in mjnd when establishing a dia­ logue with governments, both secular and religious. The third common fe ature is that MENA countries invest relatively heavily, but achieve only modest returns, in human development. As a group, the seven current MENA countries and Iraq and the Syrian Arab Republic are reasonably homogenous in terms of real per capita GOP (Yemen and the Syrian Arab Republic outliers), government expenditure share of GOP (30-39 percent, Iraq and the Syrian Arab Republic outliers), and public health and education share in GOP (6-8 percent, except Jordan and the Syrian Arab Republic). The proportion of public expenditure directed at human development is thus not out of line with OECO experience. In comparison with OECO's military expenditures, however, the con­ trast is more problematic (Chart 5). The proportion of GNP devoted to the military in MENA borrowers is roughly 30 percent more than in OECO countries (9 percent as opposed to 6 percent). With MENA countries in general the difference is more significant still (15 per­ cent as opposed to 6 percent), thus suggesting that a decline in

radically to resemble western principles of individual rather than family ri ghts and responsibilities. These alterations have been associated with atheism, and it remains to be seen whether they will survive the fall of Marxism and Leninism. For Yemen, see Maxine Molyneux, "The Law, the State and Socialist Policies with Regard to Women: the Case of the People's Democratic Republic of Yemen 1867-1990," in Wo men, Is lamand the State, ed. by Deniz Kandiyoti (Philadelphia: Temple University Press, 1991).

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Chart 5. Percentage of GNP Spent on Military E pendi ure, 1986 x t

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35 MENA countries I Regional overages

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20

15

10

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• MENA borrowers.

regional tensions could have a significant impact on human resource investments in the aggregate. Nevertheless, the real problems of human resource development in MENA countries concern not the aggregate levels of investments but rather the intrasectoral details. Intrasectoral priorities vary widely, thus affecting the ability to increase the returns on invest­ ments in human development. For example, primary education in MENA countries may represent as little as one-third of a country's education budget. Morocco, for instance, spends about 14 percent more on an elementary school student than it spends on a student in tertiary education; jordan spends about 12 percent; Tunisia, 8 percent. Compare this with Japan, where per pupil expenditmes are roughly equal between primary and tertiary education; or the OECD average, which is 49 percent. This suggests that investmem in human capital in MENA countries at the base is both weak and out of balance with other parts of the sector. The efficiency and effectiveness of the region's aggregate spend­ ing on human resources is belied by the improving but still generally

©International Monetary Fund. Not for Redistribution 214 Stephen P. Heyneman weak social status indicators. Only rwo countries, jordan and iraq, have brought adult illiteracy below 40 percent. Four countries­ Yemen, Morocco, the Islamic Republic of Iran, and Egypt-have not yet attained universal prima1y education, the key to closing the illiteracy door over time. Only jordan, the Islamic Republic of Iran, Tunisia, and the Syrian Arab Republic have infant mortality (barely) below 50 per thousand (compare Mauritius at 22 and Kuwait at 17 per thousand), although they and several other MENA countries, notably excluding Yemen, have health infrastructure and personnel densities closing fast on European no1ms. The prima1y school gen­ der gap, a predictor of the opening up of opportunities and attitudes across generations, ranges from a low 2 percent in jordan to a high 27 percent in Yemen. Part of the problem is that MENA countries, while progressing over time, have continued to lag behind their industrialized trading partners in Western Europe. This is illustrated in Charts 6 and 7: in essence, Western Europe was able to afford an expenditure roughly seven times that of the Arab states in 1970 and eight times

Chart 6. Public Recurrent Expenditure per Pupil in Pre-Primary, First-, and Second-Level Education, 1988

Arab States (240)

Latin America and Caribbean (180)

South Asia (86)

Sub· Saharan Africa (70)

East Asia/ Oceania (55)

©International Monetary Fund. Not for Redistribution Human Development in Middle East and NorthAfrica 2 I 5 7 •

Chart 7. Expenditure Per Pupil for Primary Education, 1985 (U.S. dollars)

more in 1988.9 None of the MENA states has succeeded in joining other countries in assessing levels of math and science achievement, leaving them therefore without any source of impartial measure­ ment of effectiveness. Nevertheless, it is quite clear that the educa-

9Unit expenditure: figures in health, education, transport, agriculture, and other sectors are extremely difficult interpret because of the very different prices and 10 the methodological complexity of calculating pricing parities. The cost of a teach­ er's or doctor's service is very different in Cairo than it is in New York, and the value may not reflect the differences in cost. That said, there arc two reasons why international expenditure figures are worth noting. Differences in expenditures are in no way correlated in linear fashion with the product (in this case educational achievement), but they are related. It is a fact that in poorly equipped schools in developing countries, children learn to read in a fashion significantly worse than in schools in OECD countries. Moreover, the pricing in OECO countries, although much higher, is based upon the demand for service in an environment where

©International Monetary Fund. Not for Redistribution 216 Stephen P. Heyneman tiona! systems are overburdened and are likely to produce levels of learning well below the dynamic requirements of modern open economies. But questions remain: Where are the region's most problematic areas? Are they in higher education? Are they in hospital management? Are they in migration policies? The answer, in my opinion, is that they lie in a few common pressure points.

Key Political Pressure Points Massive youth unemployment, a political "Achilles' heel," is a symptom of both supply-and demand-side distortions. Open unem­ ployment rates appear to be in almost all MENA countries in the high teens or above, although definitions are tricky. Given the region's unusual demography, the 15-25 age group, the largest subset of whom have never held a regular job, dominates the ranks of the unemployed, and the urban unemployed are much more visible than their rural counterparts. Moreover, given recent improvements in the coverage of general education in most MENA countries, the unemployed who are at least partially educated (grade 7 and up, but attained at around age 17 and up) form a vocal constituency. Their importance may be somewhat exagger­ ated thanks to fa mily solidarity: richer/more educated people can often afford to wait for steady fo rmal-sector employment and are more likely to claim open-unemployment status; poorer/less edu­ cated people cannot. Nevertheless, the fact remains that there is a large-scale, long-term excess supply of partially educated labor in most MENA countries. Youth unemployment presents a dilemma for at least four rea­ sons: because MENA governments and their reform policies can stand or fa ll depending on how they address it; because it is symp­ tomatic of several underlying human development constraints; because "quick fix" approaches can actually make matters worse

education is unive rs al, an ambition of all coumries. When MENA countries achieve universal education through secondary school, and the demand for human resources is similar in structure to OECD countries, the pricing of teacher service will shift and may eventually resemble the pricing in OECD countries. In sum it is a valuable piece of information to know what is being spent on the rypical pupil or patient in both MENA and OECD countries, though comparisons must be made with caution.

©International Monetary Fund. Not for Redistribution 7 • Human Development in Middle East and North Africa 217 beyond the immediate political horizon; and because today's dis­ couraged drifter is tomorrow's family head and potential competi­ tive edge. The first point does not need belaboring, especially in the wake of recent elections in the Maghreb. As to the second, the unem­ ployed can be victims of a number of macro imbalances and distortionary government interventions in goods, labor, and money markets, including misguided efforts to increase capital intensity, and/or social protection of the few at the expense of wage or tax barriers for the many. These problems are well understood in the abstract, but are rarely linked to specific anti-unemployment initiatives, which tend to focus on incremental "job creation" expenditure. Youth unemployment also derives from supply-side structural problems, especially insufficient job market information and failure of the educational and vocational training systems to adapt to the much changed (from the times when most education/training sys­ tems were introduced) and rapidly changing needs of the modern marketplace. This in turn is linked to credentialism and wage scales inherited from a bygone era of civil service dominance of the econ­ omy. Therefore, typical emergency programs, for example, those designed to absorb school leavers in fairly long "technical" educa­ tion with no specific job in sight, or park them in ad hoc public sector jobs, are likely to compound the problem over time, as well as being fiscally counterproductive. Finally, the misery of unem­ ployment or underemployment of long duration, especially after massive initial public and private investment in the unemployed's human capital, carries the potential for permanenr damage to life­ time motivation, productivity, and incomes, and the transmission of the attendant values to the next generation. All MENA countries espouse explicit or implicit welfare state social contracts, and none can fully afford them. As a result, the rhetoric of full employment, of unlimited free access to basic educa­ tion as well as free higher education subject to merit, of free preven­ tive and curative medical services, and of subsidized wage goods far outstrips ability to deliver; further, governments are unable to deliver basic services (potable water, rudimentary sanitation, access to minimal housing, etc.) to large segments of their populations. The political arbitrage is clear: the most visible heads of expencli[Ure

©International Monetary Fund. Not for Redistribution 218 Stephen P. Heyneman are maintained, though not in line with demographics, and the implementation of others is quietly allowed to fall behind. Thus generalized food subsidies coexist with malnutrition, primary edu­ cation enrollment and quality stagnate while public higher educa­ tion expands, and new hospitals are built while prima1y facilities, if they exist, lack elementary inputs. Yet the "big ticket items" like universities themselves fall far short of what is demanded and needed.10 Thus, to argue for improved quality of basic service deliv­ ery solely through internal rea llocation may not be realistic, unless some credible low-pain alternative is offered to satisfy middle-class expectations. The same kind of logic applies to cash benefitsand other second­ ary income transfers: pensions, family allowances, health benefits, open subsidies, and subsistence grants, loosely bundled under the headings "social insurance" and "social assistance." In MENA coun­ tries, especially those with a strong socialist legacy, the total flows involved are large: for example, more than two-thirds of the public health system of Algeria is financed through an arbitrary levy on the social security funds. Only a minority of the work force is insured, mostly in the sharply downsizing public sector, and yet a variety of unfunded benefits have been voted in an effort to provide off-budget assistance to this constituency. When the parastatal insurer becomes insolvent, the taxpayers will have to step in, and tl1ey tend to be poorer than the insured. In essence, this is a tacit "reverse Robin Hood" arrangement. More broadly, there has been widespread blurring in MENA coun­ tries of the lines between (a) insurable risks, especially retirement, sickness, and disability, as the joint responsibility of employers and employees, and (b) uninsurable risks, such as morally grounded subsistence support provided by the state, designed simply to keep people, regardless of employment status, above a defined poverty

10We are well beyond the s ta ge of emphasizing the needed quality improvemeniS in basic education and health care and ignoring what is equally obvious: the declining state of universities and hospitals that have expanded in size without any due attention to budgetary rigidities. While direct cost recovery in these expensive institutions is low, it is also true that conditions faced by patients and university students are dismal. See, for instance, james Coffman, "Algerian Higher Education: Comments on the State of the lnstirution and liS Future," World Bank, Population and Human Resources Operation Division 0991 working paper).

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line. Consequently the "safety net" and basic needs provision arrangements of MENA countries fall short of meeting the equity test, the fiscalsustainability test, the microeconomic effi ciency test (minimize incentives adverse to employment), and the more limited goal of manageability. Second only perhaps to countries in Europe and Central Asia (former centrally planned economies), MENA countries have deep­ rooted traditions of statism and centralized decision making, although some MENA countries have started along the road to deconcentration, and, to a lesser extent, decentralization, of govern­ ment services. In almost all countries, private provision of social services is still rare, except for general practitioners and secondary and tertiary establishments catering to the urban elite.'' Community schools, especially Quranic schools and preschools, are tolerated by the modern state but are generally restricted and not financially supported.12 Most public health and education professionals and most ancillary workers are central government civil servants and, indeed, account everywhere for half or more of the civil service wage bill.13 Their recruitment, assignment, and career structure is often decided centrally, without regard to local conditions and

11The Islamic Republic of Iran is a panial exception; it has initiated innovations in education and seems poised to extend innovations into other important human development sectors. 12'faking the Arab states as a base, the proportion of the age-relevam cohort enrolled in preschools has climbed gradually from 3.9 percent in 1970 to about 15 percent in 1988. It is fair to say that we have paid nowhere near enough attention ro this mechanism in our social safety net discussions, nor have we sufficiently explored the possibilities for interlinking the all too often segmented objectives of better health care delivery and nutritional rargeting. It remains to be demonstrated conclusively, but is not unreasonable to assume, that the experience of a solid fo undation of preschool programs, as in OECD countries, adds consider­ ably to the requisite co gnitive fo undation and considerably improves the effective­ ness of basic education. 1Yfhe aggregate level of t11ese employees should not be ignored: they constitute a considerable portion of the work force. For instance, teachers accounted for between 5 percent and 7 percent of the nonagricultural population in the Syrian Arab Republic, jordan, and Morocco in 1988. Considering prospects for female employment, however, increases the attention to this category. Of the females employed in nonagricultural activities, 21 percent were engaged in teaching in Morocco, 28 percent in the Syrian Arab Republic and jordan. It is true to say that we have not sufficiently focused on this element.

©International Monetary Fund. Not for Redistribution 220 Stephen P. Heyneman needs: reassignments are subject to a variety of restrictions. The link between local budget investment funding-where it exists in part, as in Morocco-and a local say in governance and personnel policy is almost totally absent. The consequences of this "imperial overstretch" are well under­ stood in most countries. They include centrally imposed ra tioning of opportunities, lack of user involvement, critical lack of credibility, a chronic squeeze on nonsalary operating budgets, and gender and urban-rural discrimination in recruitment and assignment. Most seriously, perhaps, for those countries like Morocco whose social expenditures have reached a saturation share of the cenrral budget, there is simply no feasible way to attain universal access to basic education with an unchanged cost structure, 90 percent of which is civil service salaries. Most likely, the same will apply to secondary education for all countries in the group, of which only three have over half of the secondary age group enrolled. And the congestion in public universities cannot be alleviated without diversifying both the providers and the funding base. The lack of autonomy in resource allocation decisions at the university level, in a world so dependent on rapid technological change and information flows, is particularly striking.

National Strategies and Suggested Operational Responses No single policy menu can painlessly free MENA countries from the kinds of tough trade-offs just reviewed. Every MENA country has developed unique policy packages, especially in the sensitive area of human resources. This said, it is worth attempting to distill two or three overarching objectives from the first twosections. The objectives in the table below appear to be unexceptional: who can quarrel with generalizing basic services, improving quality at all levels, or implementing effective safety nets? The acid test will lie in the transparency of the process used to establish firm priorities and ensuring the fiscal sustainability of resulting choices. The opera­ tional relevance of this list, as it is fine-tuned, will stem from (a) the proposed vertical ranking, wherein basic service coverage precedes everything else; and (b) the horizontal correspondence between each goal and its specificassociated policy reforms, especially those designed to mobilize savings internalto the human resources sector. This table might be used as a crude but useful set of benchmarks,

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Objectives Accompanying/Enabling Policies

Attain general basic coverage' Financial diversification: local • primary health care governments, private voluntary and • family planning community organizations, and well­ • basic education chosen user fees • clean water and proper Raising efficiency: management and • • sanitation merit incentives, civil service pay reform, quality improvement of privatization of production and • services approaching status of distribution of health and education MENA's trading partners supplies Retrenchment (narrowing of • objectives): curriculum breadth, transport, and lodging facilities, etc.

Improve and rationalize higher­ Diversification of fiscal burden through: level services: educational vouchers for private sector • universities competitive with provision, deferred payment and work­ + MENA trading partners study schemes hospitals provide appropriate, corporatized (internal market) provision • • cost-effective care of higher education, vocational training, vocational training systems hospital care • driven by marketplace needs spreading risk via health insurance +

Effective employment and social eliminate critical barriers to • assistance policies: employment-wage regulations, capital increase labor mobility and subsidies, taxes on labor • versatility limit state responsibility for • implement an effective safety employment, develop selective labor • net based on a poverty line market interventions-information, alleviate the political tension counseling, employer-driven training and • over youth unemployment re-training rationalize social insurance benefits and • ensure actuarial viability establish well-targeted poverty relief • programs in cash or in kind

'For practical purposes, the term "general" means universal. However, providing cover­ age to the remaining 5-10 percent of the population might require unrealistic per capita investments, or involve intractable demand-side constraints (e.g., formal rural education for the seriously handicapped). Thus, 1 00 percent coverage might, of economic necessity, exclude some of the population in favor of quality improvements for the vast majority already reached.

when calibrated for country circumstances, against which to gauge the "commitment" to human development.

Development Assistance Agency Responses

Family Security. Development assistance agencies can assist the populations of MENA countries, as quickly as fe asible, to achieve

©International Monetary Fund. Not for Redistribution 222 Stephen P. Heyneman their desired levels of fertility. These effortswill require the strength­ ening of existing, well-developed programs (for example, in Tuni­ sia). In most other countries, comprehensive efforts are needed to coordinate two sets of activities. First, maternal and child health programs, including promotion of breastfeeding, and assistance for family planning and nutrition, need to be expanded. Second, this cluster of activities should be related to and coordinated with related social marketing/mass media programs, and with universal basic education activities that place emphasis on female education. Yo uth Unemployment. Agencies can also be more proactive in investment projects, not excluding support for workfare schemes, but concentrating on long-term development of employment ser­ vices and systems of contract training aimed at specific private sector jobs. These operations face serious absorptive capacity limits, however. In particular, skill mismatches originating in excess public sector employment are unlikely to be remedied by training schemes designed entirely by civil servants. I believe we should be prepared to cover very high shares of local costs and finance subsistence grants for trainees on a large scale. And we should put priority on parallel reform of secondary and postsecondary education systems. These responses may seem less glamorous than a "war on unem­ ployment" centered on wage subsidies and artificial public sector employment, but they are a more effective application of scarce resources. There is no single solution to be offered. We should therefore be wary of single project level solutions, particularly where the employment policy environment is heavily distorted. In future, as a minimum, we should be serious about labor market analysis, requiring an adequate policy framework based on agreement of what distortions really matter. If it is judged that public sector wage/ hiring policies are a major barrier, for example, they should figure prominently in discussions of adjustment loan conditionality. For countries with good macro and micro policies, we should consider adjustment lending that indirectly channels budgetary resources toward public works employment to targeted groups. Basic Needsand Social Safety Nets. In addressing the understand­ able political pressure to provide high-end services at the expense of improvements in low-quality universal basic coverage, the only logical response is to encourage new funding and management

©International Monetary Fund. Not for Redistribution 7 • Human Development in Middle East and North Africa 223

strategies. These include the expansion of health insurance coupled with cost controls, a facilitating environment for private education, including state-supported deferred financing options (student loans, national service, or graduate taxes), and corporatization, against performance criteria of the relevant publicly provided ser­ vices. That is, in most MENA countries, devising and resting alterna­ tive ways of funding programs that compete for resources with critical public goods, such as preventive health care, may be at least as important as supportingthe latter's delivery systems directly. In terms of the broader safety net, there should be ample scope for intervening with adjustment or sector lending predicated on rebalancing the welfare state, that is, in moving toward broader off-budget social insurance coverage of a more limited but sustain­ able kind, and reshaping budget -financed social assistance based on the poverty line. Depending on country circumstances (food subsidies are complex enough in their own right), this kind of policy conditionality could be combined or, at any rate, coordinated with the labor market support loans discussed above. In some country settings, especially during emergencies, "social fund" investments can close critical gaps in basic services or social assis­ tance. In considering options, we should be clear about the relative importance of two different project rationales that are combined in practice: (a) the need to repair or recapitalize minimum nutrition, health, and basic education services, if necessary, by bypassing established funding and implementation channels, and (b) the workfare approach to transitional unemployment and income sup­ port (see below). The social fu nds undeniably have a "kill two birds with one stone" appeal to external donors-they recapitalize and retarget. However, underlying problems might be papered over with this approach: for example, if budget discipline and/or government administration of social services has effectively col­ lapsed, then a one-shot injection of working capital will not be sustainable; conversely, if labor market problems are paramount, they have to be addressed in their own right. Public Administration. The firstset of policy responses has been mentioned above, that is, off-budget financing and/orcost recovery of hospital and higher education, through insurance and time­ deferred payment mechanisms. This should be carried further, to support nongovernment secondary schools' development, includ-

©International Monetary Fund. Not for Redistribution 224 Stephen P. Heyneman ing through pa1tial investment subsidies and even operating subsi­ dies (as in the Chilean voucher programs), at least on a pilot basis. Next, local government financing and governance options for pri­ mary facilities need to be developed actively. Initially. the possibili­ ties of establishing community-based institutions under centrally agreed regulation, but without civil service status, should be exploited to the maximum. (Regional equity and religious freedom issues inevitably surface in these areas.) Finally, consensus will need to be reached on civil service reform, encompassing the entire web of service conditions and conducted as a search for greater motivation for productivity. Civil service reform will not work if ir is viev:ed as "punishment for rhe unproductive." Systemic changes, such as the deceptively simple one of paying reachers based on current responsibilities, not years of pre-service education, need apply only to fun1re recruits. But the effort required of MENA coun­ tries and donor agencies in mobilizing the requisite skills would be considerable under any scenario.

Regional Responses-Cooperation and Applied Research

Many responses can be implemented immediately by individual countries with or without donor pa1ticiparion without much fanfare. However, extending beyond the single-country context may be more efficient in the fo llowing two areas. In these instances high­ level political commitment is a necessity. 7beme 1: Employment and Growth. We share the urgent concern of MENA governments for reabsorbing unemployment, not just the concern for "getting the prices right." The intent is to close the big gap between, on the one hand, macroeconomic remedies that are widely perceived as treating employment as a residual, and, on the other, popular transitional solutions with little explicit economic content, that is, the caricature of social safety nets as a thinly dis­ guised political bandage. r believe we should acknowledge the real hardship and human waste of unemployment, even for the nonpoor, trace its demand-side and supply-side origins, and high­ light the limits of (positive) government res ponsibility in a market economy. From that base, we should be committed to supporting cost-effective short-tenn relief on a substantial scale, within longer­ range structural reforms of the "productive" sectors and the educa­ tion and training systems.

©International Monetary Fund. Not for Redistribution 7 Human Development in Middle East and NorthAfrica 225 •

Theme 2: Achieving Better Coverage Th rough Nongovemmental Involvement. As a first step, countries in the region may want to facilitate the broadest possible coverage of basic services. The limit­ ing factor is the capacity of the public sector to do everything­ plan, allocate, finance, and provide. The challenge is how to expand and diversify opportunities by leveraging public funds, but without central authority governance. For our part, we will be ready to help design and finance joint-venture initiatives at all levels. In education, joint ventures should be created between govern­ ments and enterprises, as users of skills and technology, and between governments and communities, nonprofit groups, and proprietary establishments, as service providers. Governments, per­ haps aided by the donor agencies, can provide indirect incentives­ underwriting student loans, providing targeted subsidies and tax benefirs-as well as a share of investment costs. The main parallel in the health field is supporting the spread of (modest) national health insurance systems, thereby releasing public resources for preventive services and coverage of vulnerable groups. Care should be taken to distinguish this call for collaborative public and private effortS from the negative stereotype of "privatizing" public activities at all costs, including imposing cost recovery without regard for equity. Back to the Drawing Board. Without further dialogue, it would be premature to advance specific suggestions in two critical areas. The first is the broad heading of "sense and nonsense in employ­ ment creation." A consistent framework does not exist for guiding countries in how to organize transitional anti-unemployment programs. One option is to provide indirect budget assistance for possible use in work relief, public works, wage subsidies, conversion grants, etc. However, with none of these do we have confidence in their being fiscally efficient. Another option, with proportionally greater institutional ramifications, usually involves the "emergency social fund" paradigm, which MENA countries need to evaluate carefully. These demand-driven instruments, based on funding contracts between a high-powered new central entity and panicipatory local interest groups, are not easily replicated; some attempts to simulate them in more authoritarian contexts have back­ fired.

©International Monetary Fund. Not for Redistribution 226 Stephen P. Heyneman

Further down me road, countries need to consider how, and how far, they should press the issue of civil service reform, which goes far beyond health and education. What successful strategies­ direct and indirect-have been adopted elsewhere? What are the risks and the payoffs? Both donor agencies and MENA countries can benefitfrom the exchange of dialogue as they search for solutions to pressing problems. Demographic Change Revisited. This paper concludes where it began-with the concern that me dynamics of demographic change be understood and internalized not just as a "sectoral" issue. Or is this issue given, and should the focus be primarily on providing best-practice support to meet locally determined demand, plus the long-term change in desired family size that comes from education, urbanization, and economic growth? Or, finally, is this issue rooted in the "administrative overreach" syndrome-in the fa ilure, to date, of the public sector to be clear about any limited set of priorities? Oppo11Une moments in history rarely reveal themselves with such clarity as this moment. The end of the Cold War has awakened and strengthened desires for constructive social change. The consci­ entious improvement in human resources in real terms is the key to alleviating regional inequalities and restoring regional economic and trade competitiveness. We have the opportunity to strive for consensus on many sensitive points: in the reallocation of resources away from unproductive sectors and the military, in the courageous re-examination of current ineffective public sector strategies, and in me significant increases in targeted external assistance programs both from within the region and from international institutions. Development banks concerned with the region should be ready to provide assistance that reinforces the strengths of cultural norms-the stability of the fa mily, the security of youth and the elderly, and the interconnection between social cohesion and sound social development. 14

'•Human resources lending in MENA is currently projected to reach $1.2 billion in new commitments in the fiscal year 1993-95 pe iod This represents only 18 r . percent of total World Bank lending in the region. Increases are certainly possible. and depend, in the human resources sector as in other sectors, on strong sectoral policy dialogue and effective implementation.

©International Monetary Fund. Not for Redistribution COMMENT

BADR MALALLA

r. Heyneman's well-balanced paper offers a new platform for Mdebate and a framework for a pragmatic approach to the subject. The balance is based on a realistic assumption that perme­ ates explicitly and sometimes implicitly the different issues that have been dealt with in the paper. This assumption derives its realism from its emphasis on the fact that the new world order, which brought with it an end to the Cold War, provides a historic opportunity to resolve international and regional conflicts and to settle conflicting issues by peaceful means. This would provide the countries of the developing world with a timely opportunity to divert military spending and the other costs of conflicts to develop­ ment. The costs of the Iraqi invasion of Kuwait and the subsequent Middle East war, for example, have been estimated at over $600 billion-more than half of the expenditure on development in the Arab world throughout the 1980s. The paper emphasizes one significant element, namely, that the key to solving the problems of underdevelopment and to paving the way for a truly comprehensive and well-balanced growth lies with the development of human resources, considering that man is the goal and means of development. Contemporary development thought is beginning to recognize this fact; man's place and his role in the development effort is increasingly assuming a new impor­ tance. The evolution of such thinking was not in the realm of theoretical conclusions, but came rather as a result of a pragmatic analysis of the Arab development effort during the past four decades. The concept of human development, which considers people as resources, is beginning to emerge from the confines of purely economic calculations into a more comprehensive context that takes into account other social and political variables. This shift involves cultural and humanitarian concerns that are more developed. If the similarity between human resources and natural resources is true in some aspects, the human resource is the master

227

©International Monetary Fund. Not for Redistribution 228 Badr Malalla and enforcer of this transformation. The human resource also pro­ vides an inexhaustible source of energy. This shift has led to a new approach that seeks to develop man as a human being with all the elements of development that are required to satisfy his needs. It has also led to the creation of a highly credible theoretical frame­ work that looks at the development process as a comprehensive, complex, and interrelated one, encompassing social, political, administrative, and economic dimensions all at once. Let us take, for instance, the relationship between investment for education and level of income. Although statistical coefficients associate higher per capita incomes with higher education levels, linking education to development through the use of quantitative methods actually represents a simplification and a superficialunder­ standing of the problem. The issue of economic growth is not necessarily one of overall development, although it plays a signifi­ cant role therein. Overall development is an integrated undertaking that maintains a balance among economic, social, and cultural aspects, with systems of education occupying a key position in the process. In addition to economic growth, development today means catching up with the rapid changes in the structure of the world economy and the attendant changes in the social and political areas. This is to be achieved through better production techniques, higher output ratios, a stronger linkage between man and technology, improved scientific research, and the fulfillment of cultural and psychological needs. The attainment of these objectives should go beyond the boundaries of quantitative calculations about the relationship between investment for education and development. It should take place through an overall approach emphasizing the importance of contemporary sciences and development of educa­ tional systems that can interact harmoniously with the requirements of modern societies on the one hand and the development of man's intrinsic capabilities on the other. The issue of human development in the Arab world appears to be much more complex than one might imagine and is too broad to be tackled by one discipline. I do not claim in this brief presenta­ tion to possess any magical tools of knowledge to resolve all the problems and obstacles facing human development. This goes beyond theoretical research and reaches into the realm of practice, especially in areas related to politics in contemporary Arab society

©International Monetary Fund. Not for Redistribution 7 • Comment 229

and their impact on the paths of socioeconomic development. But an important fact that Mr. Heyneman·s paper was able to capture should be highlighted, namely, that the policies and decisions on development have remained captive in the hands of officialgovern­ ment agencies. The type of political regimes and traditions that exercise authority as well as the sttucture of the contemporaty Arab state have been among the most significant obstacles to a true development effort based on self-rel iance. This presents a strong case for democracy and human rights to fill the existing deep rift between official statements of policy and the true mobilization of the masses to launch development effons. Rather than embarking on panial solutions. the issues raised in the paper-especially those related to unemployment, domination by bureaucratic agencies, and an inability to satisfy basic needs­ will require reorganization of the state machinery to mobilize the various social classes that are capable of creativity and innovation as well as the creation of the necessary political, legal, and social conditions for building a modern society on a solid base of demo­ cratic institutions. There is no doubt that the Arab countries, even though in varying degrees, have succeeded fa irly well in resolving some problems and bottlenecks and in moving fo rward in their development efforts. It should be emphasized, however, that the area of human develop­ ment still contains a sizable number of problems and constraints, whether related to the population, housing, health, or nutrition. Heyneman's paper has depicted some of these problems, '"hich I shall attempt to discuss with the objective of elaborating on them further. The overall population of the Arab world reached about 229 million in 1991 and is expected to reach some 299 million in the year 2000-an average annual growth of 3 percent. Compared with an average worldwide natural growth of 1.7 percem, this rate is quite high. Although such population growth may have some strategic importance, it means more burdens in terms of investment for economic development and the pursuit of social development poli­ cies. Moreover, looking at the age distribution of the population, we find that the population pyramid is dominated by the young age group, representing a broad base of about 45 percent. At the same time, the age group of 65 years and over represents only 2.9

©International Monetary Fund. Not for Redistribution 230 Badr Malalla percent. The two indicators thus reflect a high natural growth rate and a lower average age. Among the salient fe atures of the demographic scene in the Arab world is the growing impact of urbanization, which reached such a degree that it led to the "slurnization" of many Arab cities. This phenomenon resulted from the inability to control rural/urban migration and a fa ilure to implement well-balanced urban planning schemes. It is expected that this phenomenon will have serious adverse effects on the Arab metropolis. To develop and improve education, serious difficulties and prob­ lems must be confronted. It seems that these are not confined to the present situation but go beyond that into the future with a snowballing effect. The number of students attending government educational institutions in the Arab nation during the school year 1988-89 was estimated at about 44 million students at all levels- 22 percent of the total population. Primary education accounts for about 64 percent, preparatory education, 19 percent, secondary and technical education, 13 percent, and higher education, 4 percent of the total number of students. To shed some light on the various aspects of the problem, reference may be made to some statistical indicators. The rate of enrollment at the primary level is much lower than that of the natural population growth. The distribution of high school students also reflects a lack of compatibility with the occupational and technical requirements. The rate of high school attendance is about 87.6 percent, while the rate of attendance at teacher training institutes is only 1.9 per­ cent. The problem of inappropriate student distribution among specializations becomes more apparent in higher education. Although enrollment rates in higher education have risen from 6.9 percent in 1975 to 12.3 percent in 1985, there is an apparent distor­ tion in student distribution among specializations and an incompati­ bility with needs. About 61 percent of the students enroll in humani­ ties, while 35 percent specialize in pure and applied sciences. The problem of illiteracy figures prominently on the list of problems faced by Arab society. Available data show that the number of illiterates in the Arab nation for the age group 15-45reached about 35.5 million in 1985-44 percent of the total population in this age group. This percentage exceeds 50 percent in the low-income Arab

©International Monetary Fund. Not for Redistribution 7 Comment 23 I • countries and it does not seem from the available data that any decrease has taken place from 1985 to 1991. According to figures from the United Nations Educational, Scien­ tific, and Cultural Organization (UNESCO), the illiteracy rate in the Arab world is not expected to fall below 40.2 percent of the total population by the year 2000. An expert study reports that by that year, the educational system in the Arab world might find it difficult to implement universal primary education and that there might be some 8 million children locked out of the educational systems. If education has capacity problems, lhe biggest problem seems to be in the quality of the educational content and the effective drop in the standard of regular education, together with the dominance of theoretical education. This has produced incongruity between the system's outputs and the technical and social requirements of eco­ nomic development. It is unfortunate that these problems of quality in the early phases of public education apply equally to higher education. The crisis in the latter, however, appears to be greater because of its direct link to the employment market. It is sufficient to mention here that the division of sciences in Arab "academia" was based on western university practices. If the various disciplines in these universities had emerged and developed against the backgrounds of the eco­ nomic and social conditions prevailing in their environments, the division in Arab academia might have been quite different. Arab academia has thus adopted an unrealistic approach in the division of social science-producing disciplines with a mission to produce "clerks" for employment in the government sector. A close look at the economics of education in the Arab world, especially as they relate to financing, does not produce a promising picture for the future. Let us take, for example, the comparison advanced by Heyneman between spending on basic necessities and military spending. If we go back to 1980, the ratio of education expenditure to overall government spending ranged from 8 percent to 24.3 percent, while the ratio of military spending to government spending ranged between 18 percent and 44 percent. Taking into account current regional political developments, we shall see that the future does not augur well for any reversal in these trends. The problems of manpower development add a new dimension to the record of human development in the Arab nation. Expert

©International Monetary Fund. Not for Redistribution 232 Badr Malalla studies confirm that Arab labor suffers from a lack of specialized education and culture. They also refer to the qualitative and quanti­ tative deficiencies in the training centers and programs and the low effectiveness of efforts and techniques pursued in manpower planning and related information systems. Any search for a realistic formula to resolve these problems must be based on an overall perspective that takes into account three points: the link between the labor force and the educational system; employment planning patterns; and rate of unemployment forecasts. This also requires a process to achieve compatibility between the output of educational systems and labor market requirements and needs. It should be pointed out that the process of adjustment in the patterns of reform and educational innovation in the Arab world is usually one-sided, taking as a point of departure only the output of the educational system, that is, the supply side. This is done through constant emphasis on restructuring of specializations and curriculum development. But it should be accompanied by an effort to diversify investment patterns in development projects and the creation of new employment opportunities. It also requires the achievement of realistic formulas for manpower planning and development that are compatible with development objectives and provide the necessary tools for reducing future unemployment rates that might result from incompatibility between the educational sys­ tem's output and the requirements of the labor market. It is inappropriate to address human development without con­ sidering the basic needs of the society, namely, the interrelated system of social, physical, and environmental needs that form the infrastructure for human development. If this system is of such complexity and is closely tied to our comprehensive theory of human resource development, we cannot address human resources and their contribution without examining conditions of nutrition, health, and housing. With regard to nutrition, concrete progress can be observed in most Arab countries, as the amount of food available and per capita needs in terms of calories during 1985-90 reached 90 percent of the daily requirements. However, it should be pointed out that this indicator does not reveal the existence of variations in the geographic and social distribution of available food supplies. There are large sections of the population of the poorer Arab countries

©International Monetary Fund. Not for Redistribution 7 Comment 233 • in which the per capita intake of food reaches about half the above­ mentioned percentage or even less than the average daily needs in some cases. I believe that this variation, together with the serious consequences it entails for the destitute social classes of the poorer countries of the Arab world, will increase owing to inflation in Lhe prices of foodstuffs and the inadequate rate of growth in food production. With regard to health, statistical indicators show evidence of some improvement in infant mortality rates and life expectancy at birth, together with an increase in the number of physicians and hospital beds. However, using the same indicators to compare the situation in the developed industrialized countries or the richer Arab countries with the poorer Arab countries reveals a huge gap, which explains the uner deterioration of the health conditions in most Arab countries. While infant mortality rates do not exceed 10 per thousand in the developed industrialized countries, the rate exceeds 100 per thousand in 10 Arab countries, and amounts to 154 and 143 per thousand in north Yemen and Somalia, respectively. Life expectancy at birth, which exceeds 75 years in the developed countries, is below 60 years in 13 Arab countries and drops to 43 years in Somalia and 44 years in both Mauritania and Yemen. Despite higher numbers of physicians and nurses, there is a consid­ erable shortage in these specializations, pa1ticularly in the low­ income Arab countries where one physician is available for 16,000 persons in Somalia, for 12,000 in Yemen, and for 7,000 in Morocco, whereas in the industrial countries the ratio stands at one physician for 553 persons and one physician for 345 persons in the former socialist countries. Excluding the oil producing Arab countries, the health conditions in the Arab world are far from providing the minimum for a proper healthy life. The Joint Arab Economic Repo1t refers to a serious crisis in the housing sector since the mid-1970s caused by higher urban development and population growth rates. This should call for further efforts to overcome the serious housing crisis that seems to defy any solution within the framework of the current housing policies and the reduced financial resources available to the rich and poor Arab countries alike.

©International Monetary Fund. Not for Redistribution 234 Badr Malalla

This cursory examination of the human development problems of the Arab nation gives only a preliminary picture of the dilemma of Arab development. It shows to what extent it has become neces­ sary and crucial to concentrate on the issue of human resources. Authoritative Arab reports show that the social conditions in the Arab countries seem to be quite modest when compared with international standards. If we approach these conditions from the perspective of international ranking of human development, we find that only two Arab countries have been able to achieve a high degree of human development: Kuwait, which ranks 45, and Qatar, which ranks 47 among countries of the world. Two other countries are classified at the medium level of human development, with a ranking of 50 for Bahrain and 95 for Algeria. The Arab countries that are classified in the lower level include Morocco, Egypt, Yemen, Sudan, Mauritania, Somalia, and Djibouti. This raises a crucial question regarding the possibility of confront­ ing the problems of human development and the ability of the Arab countries to do so. In fact no clear-cut answer can be given to this question. If the Arab countries possess tools and agencies through which they draw up and implement their human development programs, the effectiveness of these agencies depends in no small measure on the following factors: the amounr of financial resources available for the purpose; the distribution among the various sectors of human development in accordance with well thought-out priori­ ties; and the effectiveness of the use of resources within each sector.

©International Monetary Fund. Not for Redistribution European Economic Integration and the Arab Countries

ROLFj. LANGHAMMER

EC-1992, the European Economic Space, and Extending Integration Toward Eastern Europe: Checking the Meanings

ver the last few years, a comprehensive insight into the effects Oof the single market program (hereafter entitled EC-1992) has become more difficult because of the parallel steps of extending integration toward the member countries of the European Free Trade Area (EFTA) as well as toward Central and East European countries (through so-called Europe agreements). Both deepening integration through EC-1992 and extending integration involve a number of measures that since the publication of the Emerson Report (1988) have been principally discussed under the dimension of European Community (EC) internal adjustment and challenges rather than under the external dimension. Such a bias can easily be explained by the fact that the majority of policy measures were aimed at freeing internal trade in goods and services, liberalizing movements of factors, and removing all sorts of border controls. The absolute level of external protection either remained unaffected or was subject to multilateral trade nego­ tiations under the Uruguay Round. Direct overlaps between the internal measures and the external dimension could be detected in a few product groups where remnants of national trade policy sovereignty had to be scrapped and replaced by a common trade policy. In these items, the customs union had to be completed more than twenty years after its formal establishment in 1968 when the common external tariff was introduced and internal customs

235

©International Monetary Fund. Not for Redistribution 236 Rolf J. Langhammer duties were abandoned. Automobiles, bananas, some electronics, and some so-called hypersensitive textile items under the Multifiber Arrangements (MFA) were among these "Jaggers." Apart from that, EC-1992 basically means the liberalization of services and the free movement of factors. This focus justifies research that concentrates on relations between countries of the Organization for Economic Cooperation and Development (OECD), as EC companies primarily compete with other OECD-based com­ panies under conditions of intra industry specialization, oligopolistic competition, and increasing returns to scale. Developing countries operate their trade with the Community more under interindustry specialization, constant returns to scale, and perfect competition. The effects on this part of world trade were analyzed mainly with respect to trade diversion in favor of the EC periphery as well as to short-run income-induced effects on import demand. Since developing countries in general are neither large exporters of busi­ ness services nor exporters of capital, research on the effects of EC-1992 mainly concentrated on merchandise trade. Here, studies were numerous for specificregions like sub-Saharan Africa (Daven­ port and Page, 1991; Tovias, 1990; Stevens and Faber, 1990); Asia (Verbiest and Tang, 1991); Latin America (Langhammer, 1992a, 1992b); Southeast Asia (Wagner, 1991); and even with respect to individual countries like India (ICRIER, 1990) and the Republic of Korea (Young and Kang, 1991). The second facet of European integration-the European Eco­ nomic Space (EES) (or Area)-is a free trade area in merchandise trade and services combined with free factor movements, but with­ out common policies in trade and agriculture. Its likely effects were scrutinized mainly for the competitive position of EFT A companies under imperfect competition (Venables and Smith, 1988; Norman, 1989). Until 1992, the external dimension of the EES does not seem to have played a role in empirical research, presumably because it was thought to be similar to EC-1992. Nor did its impact on developing countries attract much interest, mostly for the same reasons. Finally, there are the three Europe agreements negotiated in December 1991 with the former Czech and Slovak Federal Republic, Poland, and Hungary. These are association agreements with a special status of a pre-stage to full membership later. Their trade

©International Monetary Fund. Not for Redistribution 8 • European Economic Integration and the Arab Countries 23 7 parts, which came into force in March 1992 as interim agreements before ratification, are basically free trade arrangements in manufac­ tures to be achieved over ten years. Preconcessions are given first by the EC. They are to be followed by concessions by the Central and East European countries. Unlike the EES, the Europe agreements have an important exter­ nal dimension, in particular for developing countries. The fotmer socialist countries increasingly concentrate their exports on items that are also supplied by developing countries, and they enjoy more generous access to the EC markets than other contracting parties to the MFA, for instance. In addition to quotas lifted on textiles and clothing (in particular for outward processing), the former socialist countries were the first nonmember countries that were granted access to EC markets for products like beef, pork, Jamb, dairy products, potatoes, grains, and oilseeds, which are usually subject to the restrictions of the Common Agricultural Policy (CAP). Although such concessions are still small in quantitative terms (Tangennann, 1992), they nevertheless can bother competing suppliers from developing countries (in particular from Latin America) that for years were denied similar concessions. The resource endowments of Central and East European countries on the one hand and of developing countries on the other are likely to become similar during the process of economic transformation. Given the economic and cultural proximity of Eastern and Western Europe, the Europe agreements could well have a trade-diverting potential detrimental to developing countries in agricultural products as well as in textiles and clothing. Other sectors could fo llow. To identify the likely effects of European integration for a devel­ oping region like the Arab countries, it is therefore appropriate to concentrate on EC-1992 and to some extent on the Europe agree­ ments ra ther than on the EES. However, before such effects are discussed in a later section, the sectoral and regional structure of EC-Arab trade relations is highlighted in the following section to assess the degree of vulnera­ bility of Arab oil and non-oil exports to trade diversion as well as the income elasticity ofEC demand for Arab goods. Thereafter, Arab exports to the EC are related to the bilateral trade and cooperation agreements that the EC negotiated with Maghreb and Mashreq

©International Monetary Fund. Not for Redistribution 238 Rolf J. Langhammer countries and that are summarized together with other agreements under the umbrella term of "global Mediterranean policy." In later sections the future of these institutionalized relations is questioned in the light of recent dramatic changes in the hierarchy of privileges that the EC kept unchanged for a long time. A final section summarizes the results.

Regional and Sectoral Structure of EC-Arab Trade Relations: Vulnerable to EC Integration Measures?

Arab countries do not form an economically homogeneous bloc. Instead, there are vast differences in market size, level of per capita income, and resource endowment. Above all, oil producing and non-oil producing countries should be differentiated. Furthermore, for historical and institutional reasons, a distinction between Magh­ reb and Mashreq countries is appropriate. Hence, in Table 1, EC trade with the Arab countries is not only sectorally but also region­ ally disaggregated, with Maghreb countries, Mashreq countries, and the Middle East countries (called countries of the Organization of the Petroleum Exporting Countries-OPEC) forming three sub­ groups of EC trading partners. In addition, trade shares are pre­ sented for two subperiods of the pre-1992 period, that is, the "announcement" period (1985-88) and the ''implementation" period 0988-91). Finally, to account for historically determined differences in the intensity of bilateral trade relations, the EC is broken down into the four leading economies, west Germany, France, Italy, and the United Kingdom. The major findings from the statistical breakdown in Table 1 can be summarized as follows. First, the role of Arab countries in extra­ EC non-oil imports is fairly modest. In 1985, Arab countries accounted for 2.1 percent of EC imports followed by a slight upswing in 1988 and 1991 (2.6 percent). Hence, in the implementa­ tion period, which was also a period of rapid EC economic growth (partly induced by EC-1992 anticipatory cross-border mergers and acquisitions), Arab countries failed to capture a larger share of EC imports. Such stagnation coincides with the observation that trade shares were overproportionately higher and grew faster in the less buoyant submarkets of France and Italy while they were much

©International Monetary Fund. Not for Redistribution Table 1. Share of Ara b Countrie.s in EC Merchandise Trade

Maghreb Mashreq

Agricultural Textiles, Mineral Total Grand Agricultural Textiles, Mineral Total Grand goods clothing Chemicals oil non-oil total g

Share in Extra-EC Imports Q) EC 1985 1.7 4.1 1.8 9.8 1.0 3.4 0.2 0.7 0.2 3.8 0.3 1.3 • 1988 2.1 5.3 1.6 8.6 1.3 2.2 0.2 0.8 0.2 2.7 0.3 0.6 m c: 1991 2.9 6.4 1.3 9.2 1.6 2.7 0.3 0.9 0.1 3.6 0.3 0.8 . �a "' Germany (west) 1985 0 .. 8 3.4 0.7 9.6 0.6 2.2 0.1 0.6 0.1 4.6 0.2 1.0 Q ::. 1988 0.8 3.9 0.3 10.0 0.7 1.4 0.1 0.5 0.1 1.5 0.2 0.3 111 1991 1.1 4.1 0.1 7.4 0.7 1.3 0.2 0.6 0.0 4.6 0.2 0.6 ::.a 0 France 1985 6.2 13.6 2.8 14.2 3.1 7.1 0.1 0.8 0.6 2.9 0.3 1.2 3 � 1988 6.5 20.0 2.9 13.2 3.4 5.0 0.2 1.0 0.1 2.4 0.4 0.7 1991 8.1 23.4 2.4 12.6 4.2 5.8 0.2 1.0 0.2 4.0 0.3 1.0 :;-

Italy 1985 2.5 2.1 4.7 12.4 1.3 6.1 0.1 1.3 0.3 7.9 0.7 3.8 �

1988 4.4 2.0 3.7 6.6 3.4 4.0 0.3 1.3 0.7 8.4 0.6 2.1 ::.g. 1991 6.6 3.8 3.2 9.2 4.0 5.1 0.4 1.5 0.2 6.8 0.7 1.9 Q ::. Q. United Kingdom 1985 0.4 0.2 0.6 3.2 0.3 0.8 0.4 0.3 0.1 1.0 0.2 0.4 s 1988 0.7 0.2 0.8 4.0 0.2 0.5 0. 5 0.5 0.0 1.1 0.2 0.2 "' l> 1991 0.9 0.6 0.7 3.3 0.2 0.6 0.6 0.6 0.2 1.3 0.2 0.3 o-a

Share in Extra-EC Exports &'c: � EC 1985 5.6 3.5 2.6 2.3 3.1 3.0 5.8 2.0 2.8 1.2 2.6 2.6 "' 1988 3.9 4.7 2.4 2.3 2.3 2.3 4.5 1.1 1.8 1.0 1.7 1.7 1991 3.7 6.6 2.2 3.1 2.6 2.6 3.0 1.1 1.7 1.7 1.6 1.6 IV w -.o

©International Monetary Fund. Not for Redistribution N Table 1 (continued). J>,. 0

Maghreb Mashreq ;tl 0 Agricultural Textiles, Mineral Total Grand Agricultural Textiles, Mineral Total Grand =;; � goods clothing Chemicals oil non-oil total goods clothing Chemicals oil non-oil total r � ::1 Germany (west) 1985 3.7 3.1 1.2 1.3 1.6 1.6 3.2 1.0 1.9 0.6 1.8 1.8 OQ :J 1988 2.1 4.7 0.9 1.5 1.1 1.1 3.3 0.5 1.2 0.6 1.1 1.1 � 1991 1.2 5.6 0.7 0.3 1.1 1.1 2.6 0.7 1.1 0.5 1.0 1.0 3 3 � France 1985 8.6 92 7.4 7.8 8.6 8.6 6.4 2.8 3.0 1.6 3.2 3.1 .., 1988 4.8 13.1 6.0 1.9 6.0 5.9 5.2 1.7 1.8 1.0 2.5 2.5 1991 7.8 19.0 5.9 2.8 7.1 7.0 2.6 2.0 2.0 1.4 2.5 2.5

Italy 1985 7.6 2.1 4.2 4.1 3.4 3.4 6.7 3.1 5.0 3.3 4.2 4.2 1988 8.9 1.5 3.7 6.6 2.7 2.8 4.9 1.5 3.7 1.9 2.5 2.4 1991 5.9 2.6 3.9 11.3 3.4 3.6 3.1 1.7 3.7 4.3 2.8 2.9

United K1ngdom 1985 2.9 0.5 0.4 0.2 0.8 0.7 2.1 2.2 2.9 0.4 2.0 1.8 1988 0.9 0.4 0.5 0.3 0.5 0.5 1.5 1.3 2.0 0.2 1.4 1.4 1991 0.8 1.1 0.4 0.4 0.6 0.6 1.8 0.9 1.6 0.1 1.2 1.1

OPEC Arab Countries Agricultural Textiles, Mineral Total Grand Agricu ltura l Textiles, Mineral Total Grand goods clothing Chemicals oil non-oil total goods clothing Chemicals oil non-oil total

Share in E.x.tra-EC Imports

EC 1985 0.3 0.7 1.7 32.4 0.7 9.3 2.2 5.5 3.7 46.0 2.1 14.0 1988 1.0 1 .1 2.5 36.0 1.0 5.3 3.3 7.2 4.4 47.3 2.6 8.1 1991 0.9 1.5 1.9 35.4 0.8 5.8 4.1 8.8 3.3 48.2 2.6 9.2

Germany (west) 1985 0.3 1.2 0.2 25.6 0.5 4.8 1.1 5.2 1.0 39.8 1.4 8.0 1988 1.1 1.8 0.4 31.3 0.5 2.9 2.0 6.2 0.8 42.8 1.4 4.6 1991 1.4 1.9 0.4 25.0 0.5 2.7 2.7 6.6 0.5 37.0 1.4 4.6

©International Monetary Fund. Not for Redistribution France 1985 0.2 0.3 0.7 31.9 0.4 11.4 6.5 14.6 4.1 49.0 4.0 19.6 1988 0.6 0.6 1.6 28.9 1.0 5.6 7.3 21.7 4.6 44.6 4.8 11.3 1991 0.7 1.3 2.0 33.9 1.3 7.7 9.1 25.7 4.5 50.5 5.8 14.5

Italy 1985 0.9 0.8 2.9 42.9 1.7 19.4 3.5 4.1 7.9 63.2 3.7 29.3 1988 2.3 1.2 4.1 50.4 1.3 10.4 7.0 4.5 8.5 65.3 5.3 16.4 1991 1.4 1.7 2.6 53.7 1.0 11.8 8.4 7.0 6.0 69.7 5.6 18.8 United Klngdom 1985 0.3 0.5 0.9 15.9 0.9 3.6 1 .1 1.0 1.6 20.2 1.4 4.8 1988 0.4 0.4 1.1 19.5 1.6 2.7 1.6 1.1 1.9 24.6 2.0 3.4 1991 0.5 1.0 0.4 18.2 1.2 2.9 2.0 2.2 1.3 22.8 1.6 3.8 co Share in Extra-EC Exports • I"Tl EC 1985 13.9 6.4 7.2 4.7 9.1 8.8 25.2 11.9 12.6 8.2 14.8 14.4 c:

1988 11.9 3.7 5.6 3.2 6.2 6.1 20.3 9.4 9.8 6.4 10.2 10.1 �a n 1991 9.7 3.0 5.4 5.9 6.7 6.7 16.5 10.8 9.4 10.7 11.0 11.0 Q ::> I"Tl Germany (west) 1985 12.0 3.0 4.2 1.7 6.7 6.7 18.9 7.1 7.3 3.6 10.1 10.0 " 0 1988 10.1 1.0 3.3 1.0 4.2 4.2 15.5 6.1 5.3 3.0 6.5 6.5 ::> 0 1991 11.4 1.1 3.4 0.8 5.0 5.0 15.1 7.4 5.2 1.6 7.1 7.1 3 ;::.· France 1985 8.9 6.8 5.4 2.5 7.3 7.1 23.9 18.8 15.8 11.9 19.1 18.8 :;- 1988 8.9 4.2 4.3 2.1 5.1 5.1 18.9 19.0 12.1 5.0 13.6 13.5 !i 1991 7.0 4.2 5.0 2.1 6.7 6.6 17.5 25.2 12.9 6.3 16.4 16.2 "'"·a 0 Italy 1985 11.2 5.7 9.5 20.6 13.7 14.0 25.4 10.8 18.7 28.0 21 .4 21 .6 :::. 0 1988 9.2 3.7 6.8 13.5 8.0 8.2 23.0 6.7 14.1 22.0 13.2 13.4 :::. 0... 1991 6.7 2.3 7.2 26.8 8.1 8.6 15.7 6.6 14.8 42.5 14.3 15.1 "'g. United Ki ngdom 1985 13.1 14.1 1.7 12.0 10.7 14.8 13.2 18.8 23.8 15.7 17.3 2.4 ::1>- 1988 15.6 6.9 13.0 1.0 10.5 10.0 17.9 8.6 15.5 1.5 12.4 11.9 t:ra 7.9 1991 11.6 5.9 9.6 0.9 10.7 10.3 14.2 11.7 1.4 12.4 11.9 () 0 c:: Sources: EUROSTAJ, EEC ExternalTrade (Combined Nomenclature} 1988-90, No. Supplement 2/1 991 (CD-ROM). EUROSTAT, Monthly EEC ;a � External Trade (Combined Nomenclature) No. 7/1992 (CD-ROM). EUROSTAT, External Trade (Nimexe) 1976-1987, No. Supptement 1/1991 "' "' (CD-ROM). Note-Maghreb: Morocco, AJgeria, and Tunisia. Mashreq: Egypt. Lebanon, Syrian Arab Republic, and jordan. OPEC: Libyan Arab jamahiriya, N .I>. Sudan, Somalia, Iraq, Islamic Republic of Iran, Saudi Arabia, Kuwait, Bahrain, Qatar, United Arab Emirates, Oman, and Republic of Yemen. Arab countries: Mag.hreb plus Ma�req plus OPEC. ©International Monetary Fund. Not for Redistribution 242 Rolf J. Langhammer

lower and also stagnant in the largest and most absorptive west German market.1 Second, gains in trade shares in specific sectors like textiles and clothing and agricultural goods could not compensate for the weak position of Arab countries in human-capital-intensive manufactures, which have been the most rapidly growing import sectors in the EC and in which the highest import-demand effects of the additional growth induced by EC-1992 are expected. What is relevant in the EC- 1992 context is that the Arab countries enjoyed overproportionately high trade shares and gains in shares on the French market for textiles and clothing (14.6 percent to 25.7 percent over the entire period compared with a much smaller increase at a lower level of 5.2 percent to 6.6 percent on the west German market). Because of the strictly monitored national quotas for some items in France, this market has been one of the most protected. A Community­ wide quota after 1992 is likely to result in stronger import competi­ tion, lower import prices, and perhaps losses in trade shares for established suppliers on the French market. Some Arab suppliers might belong to this group. Third, splitting the Arab countries into OPEC and non-OPEC countries reveals strong divergences in growth patterns. While the three Maghreb countries succeeded in raising their share in extra­ EC non-oil imports from 1.0 percent to 1.6 percent, and the Mashreq countries stagnated at 0.3 percent, the Middle East countries lost during the buoyant subperiod (1988-91). Fourth, the Arab countries maintained an almost 50 percent share in EC oil imports. Again, this share was far from uniform in all EC submarkets. In addition to the United Kingdom relying on domestic resources in the North Sea, west Germany also diversifiedsourcing toward non-Arab countries. Fifth, given the declining terms of trade for oil producers over the last few years, it does not come as a surprise that the absorptive capacity of the Arab countries in general and the OPEC countries

1ln 1991, the west German share in extra-EC non-oil importS was 30.6 percem compared with 26.8 percem three years previously. Such a rapid increase was partly due to the "once-and-for-all" effects of rising domestic absorption in the aftermath of German reunification. However, it may also reflect Germany's expected role as a leading beneficiary of the single market.

©International Monetary Fund. Not for Redistribution 8 European Economic Integration and the Arab Countries 243 • in particular declined sizably. Between 1985 and 1991, the share of Arab countries in extra-EC exports declined from 14.4 percent to 11.0 percent. No subregion escaped this trend. Declines in trade shares were most visible in the OPEC countries. Overall, EC-Arab trade relations since the second half of the eighties can be characterized as stagnating, or at least as not very dynamic, even if the few rising trade shares are taken into consider­ ation. Reasons can be fo und on both demand and supply sides. On the demand side, the second enlargement of the EC by countries whose export supply overlaps with the Arab countries is likely to have resulted in some trade diversion and deteriorating market access in the medium run. On the supply side, rising macroeco­ nomic imbalances, coupled with declining private investment ratios in relatively outward-oriented economies like Tunisia (Pfeffermann and Madarassy, 1992, Table 1), may have impeded the flow of resources into nontraditional export sectors.

Institutional Underpinnings of EC-Arab Economic Relations: Cooperation Agreements with Maghreb and Mashreq Countries

In 1976 and 1977, the EC concluded cooperation agreements with the Maghreb and Mashreq countries, respectively. These agree­ ments offered free access to EC markets for manufactured goods and some special provisions for selected agricultural goods on a nonreciprocal basis, plus financial aid and improved social security for Maghreb and Mashreq workers in the Community (Pomfret, 1986, p. 23; for the genesis of the agreements, see also Tovias, 1977). Undoubtedly, the trade parts of the agreements meant real privileges in sectors that otherwise were strong!y protected by the Community against more competitive third parties, for instance, the MFA products. They were also helpful in attracting foreign direct investment (FDI) if supply factors were favorable. But they also made the recipients most vulnerable to any changes in the pyramid of privileges in which the Maghreb and Mashreq countries were highly ranked. Instability of access was high, as the EC could intro­ duce "safeguards" against "sensitive" imports. Some countries like Tunisia, Egypt, and Morocco were particularly affected as they had a large share of so-called semisensitive and sensitive manufactures

©International Monetary Fund. Not for Redistribution 244 Rolf J. Langhammer

(in particular textiles) in their expo1t supply (Langhammer, 1988, pp. 198-99). Yet the major challenge to the agreements did not come from the safeguards but from the insurmountable gap between the privileges of full EC membership and the preferences provided by the cooperation agreements. With the second enlarge­ ment of the Community by Greece, Pottugal, and Spain, the trade parts of the agreements lost much of their value for the Arab coun­ tries because of the large overlap in agricultural supply between the northern and the southern Mediterranean countries. The preference status declined substantially for countries like Morocco, Tunisia, and Egypt in agricultural products (citrus fruits, wine, and oilseeds) in which the three applicant countries could enjoy the full basket of EC price suppott and border protection. By offering full member­ ship to some members of the region, the Community drove a wedge into the so-called global Mediterranean policy, which was supposed to include also Turkey, Malta, and Cyprus (association agreements), Yugoslavia (nonpreferential agreement), and Israel (free trade agreement). With a phasing out of the MFA, the erosion of Maghreb and Mashreq preferences would be continued, and the value of the agreements would basically be equal to the amount of the financial aid that is made available through them. The latest conditions on aid given through the budget, in loans from the European Invest­ ment Bank, and in budgeta1y credits to support economic reforms were agreed upon in 1991, but they also included non-Arab coun­ tries from the Mediterranean. In total, a package of 4.4 billion European currency units (ECUs) was negotiated for EC financing of agricultural and infrastructure projects in Maghreb and Mashreq countries for 1992-96 (for the institutional details of EC-Arab rela­ tions, see Hudson and Ludlow, 1991, pp. 338-53). New links were built up between the EC and the Arab Maghreb Union (comprising the Libyan Arab Jamahiriya and Mauritania in addition to the three traditional members), the Gulf Cooperation Council (GCC), and under the Euro-Arab dialogue. It is well known from other experi­ ences in Latin America and Southeast Asia that the Community favors dialogues with regional groupings and offers some minor benefits to honor efforts to "regionalize" common issues, for instance, by offering cumulative treatment in rules of origin under the Generalized System of Preferences (GSP). Yet it does not seem

©International Monetary Fund. Not for Redistribution 8 • European Economic Integration and the Arab Countries 245 too far from reality to conclude that neither of the interregional initiatives in negotiating with the Arab world made much headway except for opening channels to discuss issues of mutual interest. It is reported that the Euro-Arab dialogue came to a standstill when the Middle East crisis affected relations in the Arab League but that it would emerge unscathed once the crisis was over (Hudson and Ludlow, 1991, p. 344).

Likely Effects of EC-1992 on Arab Countries

Trade Effects Short-run trade effects along the static customs union theory are the standard tools of empirical analysis on EC-1992. They can be decomposed into price effects (trade diversion) and income effects (sometimes also called external trade creation), the latter derived from additional demand for third countries' products owing to higher growth in the EC. The Emerson Report 0988) estimated that such growth impulse ranged between 4.5 percent and 7.0 percent. How large the income effects are for third countries depends on price elasticities of import demand (preferably substitution elastici­ ties between imports of different origins) for trade diversion and on income elasticities of import demand for external trade creation. Such elasticities differ systematically by sectors and by industries. They are mostly less than zero for food and agricultural commodities and higher for manufactures. For trade diversion, assumptions have to be made concerning the impact of EC internal cost reductions on price reductions leading to a shift from non-EC sources to EC sources. Overall, in the Emerson Report (1988, pp. 180-82), this shift was assumed to be cumulatively 10 percent of extra-EC imports. Furthermore, there is a net ba•ter terms of trade effect, which results from lowered world market prices for manufactures owing to more competition after EC-1992 cost reductions and a rise in commodity prices following additional demand. Developing countries as net importers of manufactures are therefore expected to achieve a terms of trade gain. Davenport and Page 0991, pp. 11, 19, and 85-89) and Page (1992, pp. 46-53) have calculated such effects for two Maghreb countries (Tunisia and Morocco), for all three Maghreb countries as a group, for all Mediterranean countries (including Turkey, which

©International Monetary Fund. Not for Redistribution 246 Rolf J. Langhammer is not included here), as well as for all OPEC countries (including Venezuela, Nigeria, Gabon, and Indonesia). Table 2 summarizes their findings. The estimates expose small trade gains for the Medi­ terranean countries including the Maghreb countries of below 1 percent of their 1987 exports to the EC. Gains are small because the positive income effects (external trade creation) for the countries exporting commodities to the EC are partlyoffset by assumed losses in manufactured exports caused by trade being diverted from non­ member countries to member countries. Hence, the more the third country exports goods for which EC substitutes are available, the net effects become less or even negative. These substitutes are basically manufactures. For exporters of manufactures, trade diver­ sion is therefore expected to exceed the income effect. Under this assumption, OPEC countries are much better off (trade gains of 3.7 percent) because they export commodities rather than manufac­ tures. Gains are expected to be even larger for the Middle East countries because the export mix is even more biased toward com­ modities than for the rest of the OPEC countries including Indonesia. Taking all developing countries (including the newly industrializing economies that are exporters of manufactures) as a yardstick (net trade effect of 1.5 percent of their exports) reveals the OPEC coun­ tries as relative gainers and the Maghreb countries as relative losers. Terms of trade gains are dependent on the relative volume of imports from the EC versus exports to the EC. Countries with a trade deficitwith the EC are expected to gain because they benefit overproportionately from lower import prices owing to fiercer com­ petition on world markets for capital goods. Special effects are appropriate for items with national quotas like footwear, textiles, and some energy products. With respect to textiles under the MFA, it is argued that since the Mediterranean countries are outside the MFA quotas, they have been protected through the MFA against competition from the large Asian suppliers (Erzan, Goto, and Holmes, 1989). Discarding national quotas in the EC-1992 context would intensify competition enough for the Mediterranean countries to stand to lose. Yet such effects are mar­ ginal compared with the phasing out of the entire MFA. In all such microeconomic analysis, assumptions on changes in the competi­ tive environment in the hitherto protected French market after 1992 are the crucial unknown variables. Before 1992, Maghreb producers

©International Monetary Fund. Not for Redistribution Table 2. Trade Effects of EC- 1 992 for Arab Countries (1 98 7 base values, in miffion ECUs)

Maghreb Mediterranean OPEC All Developing Morocco Tunisia Group Countries Countries Countries

ExtemaJ Trade Creation (Income Effect)

Commodities 24 26 244 733 1,556 2,804 Q) Manufactures 99 96 370 1,434 515 4,434 • Ol <: Trade Diversion a � til Q Manufactures 106 108 534 1,918 847 5,655 ::. Total trade effects (in 0� percent of exports ::. 0 to EQ 0.8 0.9 0.9 0.8 1.8 1.5 3 ;:;· Tenns of trade effects 90 474 312 1,196 :;- Total effect 170 724 1,535 2,778 ;; O'Q "' Q � Sectoral Effects 0 "' Q Footwear 71 "' 16 1,367 C>.. s- Source: Davenport and Page {1991, pp. 11, 19, and 85-89) and Page (1 992, pp. 46-53). til )>. a tr

"'b' � ::!. tb ...

1'-) � '-I

©International Monetary Fund. Not for Redistribution 248 Rolf J. Langhammer enjoyed special and differential treatment in this market for a num­ ber of products. Although some losses in economic rents for the Maghreb suppliers after 1992 (owing to the dismanrling of national quotas) are not denied, their magnilllde is unknown.2 Beyond such details, there is reason to underline the static charac­ ter of the empirical estimates. Page 0992, p. 33) admits that just those countries that are labeled short-run losers from trade diversion are most likely to be able to take advantage of the medium-term options offered by EC- I 992 because of their flexibility and availabil­ ity of skill. These are the fast-growing exporters of manufactures and not the exporters of commodities. How income inelastic is Arab export supply compared with other developing countries' suppliers has been observed in the second subperiod (1988-91), when many EC-1992 measures were imple­ mented and when the EC enjoyed anticipatory response from domestic and international investors (Table 3). Unlike all develop­ ing countries for which the ex post income elasticity of EC import demand (ratio between EC import growth rate and EC GDP growth rate) rose from 0.65 to 0.92 (for non-oil products), Arab countries incurred a drop of the same ratio from 1.64 to 0.93. Except for the Mashreq countries, which benefited from a small increase in the elasticities, all subregions suffered a decline. It would be misleading to attribute such a disappointing performance solely to supply fac­ tors. However, it is certainly true that the positive effects of external trade creation did not emerge for Arab countries during a period in which some of the income effects of EC-1992 had already partly materialized. Overall, therefore, it is unlikely thac the Arab countries that are still concentrating on exporting narural resources or resource-intensive goods will easily join the group of gainers in the medium run.

Investment Effects

For many third countries, the diversion of foreign direct invest­ ment has become more of a threat rhan trade diversion because access to foreign risk capital has been accepted as an indispensable

20avenpon and Page 0991, pp. 8';-89) painstakingly discuss such changing access for a numher of products exported hy Morocco and Tunisia, such as horticultural and fish products, textiles and clothing, and oil refining.

©International Monetary Fund. Not for Redistribution 8 European Economic Integration and the Arab Countries 249 •

Table 3. Ex Post Income Elasticities of Demand in the EC for Arab Exports 1

EC Imports from 1988/85 1991/88

Maghreb Countries Agricultural goods 0.33 1.87 Textiles 1.92 2.54 Chemical products -0.14 0.07 Oil -3.34 2.10 Non-oil products 1.79 1.59 Total trade -1.72 1.84

Mashreq Countries Agricultural goods 1.11 1.86 Textiles 1.06 2.39 Chemical products 0.75 -1.69 Oil -3.92 3.23 Non-oil products 0.26 0.46 Total trade -2.84 2.15

OPEC Countries Agricultural goods 5.04 -0.05 Textiles 2.65 3.12 Chemical products 2.11 -0.05 Oil -2.60 1.70 Non-oil products 1.97 0.08 Total trade -2.20 1.46

Arab Countries Agricultural goods 1.28 1.35 Textiles 1.91 2.61 Chemical products 1.01 -0.08 Oil -2.84 1.87 Non-oil products 1.64 0.93 Total trade -2.1 3 1.62

For Comparison: Extra EC Sources Agricultural goods -0.45 0.37 Textiles 0.71 1.66 Chemical products 0.29 1.12 Oil -2.93 1.78 Non-oil products 0.65 0.92 Total trade -0.12 1.03

Source: OECD, Main Economic Indicators, Table 1. 1Ratio between the average annual growth rates of EC imports and EC nominal GDP.

©International Monetary Fund. Not for Redistribution 250 Rolf J. Langhammer contribution to technological diffusion and skill formation. On the other hand, one of the early effects of EC-1992 was the growing attractiveness of the Community to OECD countries' investment, in order to circumvent local content requirements and to benefit from the harmonization of technical standards. For both the United States and Japan, the EC became a more important host as measured by an increasing EC share in home countries' investment.3 Given missing information on the regional stnJCture ofArab countries' foreign direct investment, the diversion issue can only be addressed by resorting to EC countries' data on flows to and from Arab countries. Tables 4-6 report such informa­ tion for three major EC member states-France, west Germany, and the United Kingdom. Overall, FDI outflows from, and inflows to, the region support the view that the Arab countries neither suffered from a clear drain of foreign risk capital toward the EC nor succeeded in attracting investment from EC member states that might have become unprofitable in the new economic environment. The French data (Table 4), which could be disaggregated by two subregions and for which shares beyond 1 percent can be observed, include non­ Arab OPEC countries like Nigeria, Venezuela, and Indonesia. There­ fore, they are not meaningful as far as Arab OPEC countries are concerned. The "outlier" result of a "once-and-for-all" flow of FDI to OPEC countries in 1989 seems to refer to French investment in the Nigerian oil sector and has nothing to do with the single market. On balance, neither the French flow data nor the German stock data (Table 5) suggest that Arab investment in the EC increased during the period under observation. Both in absolute terms as well as in terms of shares, Arab FDI in the two countries seems to have even declined slightly. U.K. data on this direction of FDI are not available, but residual figures on total inward investment in the United Kingdom suggest that Arab investment was small (Table 6). This is not surprising, since Arab capital exporters traditionally prefer portfolio investment over

'For such an analysis of U.S. and Japanese inveslmem flows to the EC, see Langhammer (1991) and Gundlach and others (1993).

©International Monetary Fund. Not for Redistribution Table 4. Flows of Net Direct Investment Between France and Arab Countries

Maghreb Countries OPEC Countries

To France From France To France From France MJ71ion francs Percent• Milfion fr ancs Percenf Million francs Percen t1 MiJ/ion fr ancs Percenf

1 985 151 0.8 328 1.7 1,1 19 5.6 1,055 5.3 1986 210 0.6 81 0.4 658 1.8 857 4.5

1987 182 0.3 6.3 0. 2 748 1.4 559 2.0 1988 -36 -0.1 105 0.2 590 0.8 402 0.9 1989 147 0.1 59 0. 1 4,424 3.8 838 1.4 1990 196 0.1 68 0.1 516 0.4 -224 0.5

Sources: 8anque de France, lo Balance desPoiements de Ja France, RapportAnnuel, 1 985-90. 11n percent of total net inflows of France. lJn percent of total net outflows of France.

©International Monetary Fund. Not for Redistribution 252 Rolf J. Langhammer

Table 5. Share of Arab Countries in Stock of German FDI Abroad and FDI in Germany

German Investment in Arab Countries Arab Investment in Germany Million deutsche mark Percent Million deutsche mark Percent

1985 782 0.9 1986 1,300 0.8 802 0.8 1987 924 0.6 692 0.7 1988 1,243 0.7 61 3 0.6 1989 1,173 0.6 544 0.4 1990 1,102 0.5 620 0.4

Source: Deutsche Bundesbank, Die Kapitalverflechtung der Unternehmen mit dem Ausland nach Uindern und Wirtschaftszweigen 1984 bis 1990. Beilage zu Statistische Beihefte zu den Monatsberichten der Deutschen Bundesbank, Reihe 3, Zahlungsbilanzstatistik, Apri/ 1992, Na. 4.

Table 6. Share of Arab Countries in U.K. Net Investment Abroad and Foreign Net Investment in the United Kingdom1

U.K. Investment in Arab Countries Arab Investment in United Kingdom Million pounds Percent Million pounds Percent

1985 -72 -0.8 1986 83 0.7 1987 -199 -1.0 1988 -16 1989 -50 -0.2

Source: United Kingdom, Central Statistical Office, Business Monitor, MA4, 19B9 Overseas Transactions, london, 1991 . 1Minus sign indicates net disinvestment abr ad. o direct investment.4 Furthermore, France and west Germany operate the so-called insider system of close relations between banks and private companies holding each other's equity shares. Under such a system, hostile takeovers are virtually impossible. The British "outsider" system, which allows for such operations from nonaffili­ ated sources, may have been more open to Arab participation or even to majority ownership in the British capital stock but data on Arab investment in the United Kingdom are not available. Yet there

•1n quantitative terms, portfolio investment from Arab countries in the EC seems to have been much more important than FDI, judging from scattered information. But given the volatility of such flows and their short-term determinants, it not is possible to relate them to EC-1992 measures.

©International Monetary Fund. Not for Redistribution 8 European Economic Integration and theArab Countries 253 • is much evidence from residual figures on inward investment in the U.K. figures that such investment must have been small. Regarding the other direction of flows, Arab coumries fa iled to benefit from a spread or "trickling-down" effect of investment originating in neighboring Europe. French net investment in the Maghreb states stagnated in absolute terms and declined relative to other hosts. So did German investment in all Arab countries. U.K. capital exporters even clisinvestecl in the region. Overall, Arab countries' relatively poor performance in auracting EC private risk capital fits into the general observation that develop­ ing countries have increasingly been bypassed by OECO investors except for a very few newly industrializing economies. FOI flows today concentrate on the intra-OECD area. This seems to be a general trend that began before the single market program was announced. It is therefore very likely that the determinants of this intra-OECD concentration are deeply rooted in macroeconomic stability and in the low transaction costs that benefit OECD hosts compared with developing countries.

Implications of Dynamic Effects of EC-1992 on Arab Countries

Process Innovations. The implementation of a single marker is expected to produce a number of dynamic effects in the sense that both the volume and the composition of the capital stock change. The best-known effect is the realization of economies of scale through mass production. Full exploitation of economies of scale is likely to occur in physical capital-intensive industries. Haaland and Norman (1992), applying the Smith-Venables type of comput­ able general equilibrium models, assess two effects of the single market: one refers to lower real trade costs between European markets (simplified border formalities and savings in costs owing to harmonized product standards), and the other relates to the integration of formerly segmented markets by the law of one price (that is, abolishing intra-EC price discrimination in imperfectly com­ petitive product markets). Such effects will emerge primarily in skill-intensive industries where market segmentation was strong in the pre-1992 period but also in physical capital-intensive industries that benefit from the realization of economies of scale. Among physical capital-intensive industries, the gains to EC pro­ ducers in terms of lower trade costs and higher market integration

©International Monetary Fund. Not for Redistribution 254 Rolf J. Langhammer are estimated to be highest in the chemical industry (Haaland and Norman, 1992, Table 13). Here they report production changes of 0.5 percent of the base value owing to lower trade costs and 1.4 percent of market integration. This industry includes petrochemi­ cals, which is an important resource-based industry in oil producing Arab countries. Hence, EC-1992 could lead to cost advantages for EC suppliers competing with Arab producers. The latter could be forced to incur a terms of trade loss by reducing expo1t prices to offset the competitive advantages of EC producers. Otherwise they would lose in market shares. Another process innovation linked to economies of scale could result from accelerating resource-saving technological progress, including savings in energy consumption per unit of output. It would fu1ther delink resource consumption from growth in produc­ tion and might inhibit further growth of exports of energy and nonenergy resources from Arab countries. Incentives for resource­ saving technological progress could also arise from stricter environ­ mental regulations, including obligatory recycling of waste for which common policies will set higher minimum standards. Although beyond the common minimum standards national author­ ities would still be free to set even higher national standards (home country rule), stricter minimum standards could discipline all EC producers into reducing the consumption of resource inputs. Finally, Arab producers concentrating on exports of resources or resource-based processed goods to the EC may incur losses in terms of trade or even losses in market shares in the long run if they do not change their supply mix. Product Innovations. EC-1992 will not only lead to cost reduc­ tions in traditional industries but will also shift the product mix from labor-intensive and physical capital-intensive industries to skill-intensive industries and services. In short, those industries within the Community that were strongly segmented in the past either through high "natural" transaction costs (such as the costs of bridging economic distance) or through policy-induced barriers (border controls, different national standards, or protection of domestic producers) are expected to gain overproportionately from the single market. In total, the EC will pass through a catch-up process in making services tradable to achieve a level in the supply

©International Monetary Fund. Not for Redistribution 8 • European Economic Integration and the Arab Countries 255 of services that integrated markets like the United States have already achieved. What is relevant for third-country exporters is the import content of newly emerging industries compared with traditional industries, and in particular the commodity content in imports of intermediates. Input-output analyses suggest that this content is lower in services than in manufactures and lower in skill-intensive industries than in physical capital-intensive industries. As a result, in the medium run structural change in EC supply parterns could also hamper the prospects of commodity exporters like those in many Arab countries. Localional Innovations. Apart from the short-run effects of capi­ tal drain mentioned above, the completion of the single market and its enlargement with EFTA countries is likely to have additional medium-term effects on the profitability ofEC hosts relative to non­ EC hosts. For instance, it is expected that labor-intensive industries located in high-income EFTA countries will move to the periphery of EC member countries (Norman, 1989) where unit labor costs are lower. However, such locational shifts will be only transitional. This can be expected because the absorptive capacity of the low­ income countries is limited. If this capacity is exceeded, comple­ mentaryfactors of production wiH become bottleneck factors. Their prices will rise especially if the factors are immobile, which has already happened. Owing to a massive inflow of risk capital from the EC center to the periphery (in particular Spain and Portugal), prices of nontradables (in particular wages but also rents) have risen faster than those of tradables. This price rise was equivalent to a real appreciation of the periphery countries' currencies (espe­ cially in 1989/90) and to a deterioration in international competitive­ ness. If such tendencies cannot be corrected in time because currency realignment through markets in the European Monetary System (rather than through bureaucracies) is needed, investors could reconsider their previous decisions to locate in the EC periph­ ery and instead move to non-EC hosts. The November 1992 currency realignments in the EC leading to depreciations of the Spanish and Portuguese currencies bear wit­ ness to such tendencies. But even if currency realignment runs smoothly, a built-in upward movement in prices of labor owing to the single market cannot be denied. There is strong political pres-

©International Monetary Fund. Not for Redistribution 256 Rolf J. Langhammer sure toward "social harmonization," that is, to harmonize wage legislation throughout the EC and to equilibrate wage levels in the periphery up to the levels prevailing in the high-income member countries. Avoiding competition in wages (often misleadingly labeled wage dumping) is one of the main objectives of social harmonization in the EC. Nonmember countries have reason to expect imports of risk capital from the EC as a result of EC hosts losing in competitiveness. Stricter environmental regulations and other restrictions (for instance, in biotechnologies) may foster such EC capital outflows. Whether Arab countries can benefit from "outmigration" of EC capital depends primarily on their endowment of immobile resources, including the macroeconomic environment and the insti­ tutional setting. Here, Arab countries seem to face a competitive disadvantage relative to other third countries. Their resource endowment is biased toward investment based on primary com­ modities (petrochemicals, energy) but in such sectors it is unlikely that important shifts from EC hosts to non-EC hosts owing to EC- 1992 will occur, because EC member states are basically resource poor. EC sourcing is already taking place from resource-rich areas like sub-Saharan Africa, Latin America, Australia, Canada, and the Middle East. Parts of this sourcing occur through party-related trade (EC FDI); other parts comprise nonaffiliated trade. Another option to attract foreign investment in domestic market­ oriented industries is difficult to realize for two reasons. First, domestic markets in Arab countries are relatively small, and, second, the Arab region is highly unintegrated. Attempts to liberalize trade within the region through regional free trade areas or even more advanced integration schemes have failed for a number of reasons, both economic and political. Regions that at least recently have made serious efforts toward regional integration, like the Associa­ tion of South East Asian Nations (ASEAN) or Mercosur in Latin America, are much better off in this respect. A third option, to attract EC export-oriented investment in manufactures, is equivalent to strong competition from host countries in East and Southeast Asia and increasingly in Central and Eastern Europe. In addition, it would have to cope with the specific disadvantage of economies that are richly endowed with natural resources. Such economies cannot easily sterilize the adverse effects of volatile prices in commodity

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markets on the real exchange rate. Especially in periods of price hikes, the so-called Dutch disease effect leads to a real exchange rate appreciation if capital inflows cannot be sterilized. Such effects penalize the noncommodity sector in general and export-oriented activities in particular. It is well known from past experience that this effect (sometimes also called the Kuwait effect) has often plagued oil exporting countries. Relatively resource-poor, small economies in the Arab world like Tunisia and Morocco had more success in attracting EC investment in export-oriented, labor-intensive indus­ tries (textiles and clothing). Alternatively, they linked domestic suppliers to EC companies by benefiting from special quotas for outward processing. However, as mentioned above, a phasing out of the MFA and the emergence of new suppliers from developing countries in Asia and Latin America as well as from Central and Eastern Europe could lead to losses in market shares if supply­ side obstacles like macroeconomic instability and unsustainable domestic absorption cannot be overcome.s

Effects on Migration

Flows of migrants from the Arab countries in the Mediterranean area into the Community have a long tradition. In the early sixties, about 232,000 migrants from the three Maghreb countries lived in EC member countries. By 1974, this number had risen to 718,000. Afterstopping recruitment, migrant inflows dropped, but it is esti­ mated that by early 1988 at least 621,000 migrants still stayed legally inEC member states (Korner, 1990; OECD, 1991). The total number of people from the Maghreb countries living in the EC was 1.9 million in 1989, that is, about one-fourth of the total non-EC popula­ tion in the EC. There are some grounds for assuming that migration from this part of the Arab world will become an important issue in EC­ Arab relations. First, the demographic gap between the EC and the

ssince the beginning of falling world oil prices in 1982 many Arab countries have moved into a crisis of reconciling present living standards and domestic absorption with the lack of foreign exchange earnings (Overseas Development Council, 1991; Overseas Development Institute, 1992).

©International Monetary Fund. Not for Redistribution 258 Rolf J. Langhammer southern part of the Mediterranean region will remain almost as large as it was in the seventies and eighties.6 Second, the migration potential in the Maghreb countries is high, because the share of the population under 14 years is high (40-45 percent) and because more than 50 percent of unemployed people in Tunisia (80 percent in Algeria and 70 percent in Morocco) belong in this group. It is estimated that, because of the poor conditions in domestic labor markets, the annual migration potential will amount to 0.8-1 million people at the minimum (Korner, 1992). Third, the income gap between the EC and the Maghreb countries threatens to widen if EC regional funds are increasingly channeled into the EC periphery;the single market is instrumental in improving living standards in the Mediterranean member states; and the macro­ economic conditions in the Maghreb countries remain as dismal as they are in the early nineties. Fourth, other Arab countries in the GCC region suffer from severe problems of adjustment to lower oil prices and postwar conditions and might not be prepared to host a larger number of migrants from the Mediterranean region. Fifth, inflows will concentrate on Italy, France, Spain, and Portu­ gal rather than on Central and Northern Europe because of a higher cultural affinity with the local population, including the migrants already living there. This concentration may raise a problem of acceptance insofar as a problem currently exists in Central Europe toward inflows of migrants and refugees from Eastern Europe. Sixth, illegal migration can increase rapidly and threatens social stability in host countries when competition for low-income jobs intensifies. Seventh, fu rther impetus will arise once border controls under the single market are virtually scrapped. The Maastricht summit responded to such challenges by formulat­ ing three basic elements of a European immigration policy: first, a

6Between 1975 and 1990, the natural rates of growth of population amounted to 3 percent in Algeria, 4.3 percent in Libya, 2.7 percent in Morocco, and 2.6 percent in Tunisia and Egypt, compared with 0.2 percent in the northern pa of rt the Mediterranean ba sin. Although in 1950 the European countries of the region still accounted for 55 percent of the total population in the region, it is estimated that by the year 2025 this share will have declined to 40 percent (Di Comite, 1990).

©International Monetary Fund. Not for Redistribution 8 • European Economic Integration and the Arab Countries 259 passive or reactive immigration policy that is likely to set social, economic, and humanitarian criteria for immigration and quotas by home countries; second, an active migration policy that includes all trade policy measures-technical and financial assistance and incentives for private investment in the migrants' countries to induce potential migrants to stay in their home countries; and third, policies to improve the social status of those migrants and their families who already have lived in the EC for a long time. Given the widening income gaps between Europe and its south­ ern and easternneighbors and the rapidly rising number of migrants and refugees, it is fairly safe to say that defensive measures to control and contain migration will be one of the early effects of EC integration that are going to become apparent to parts of the Arab population. Such measures are likely even if the active part of the EC immigration policy is substantial enough to encourage physical capital formation in Arab countries in close cooperation with the governments. With the transaction costs of migration fa lling steadily, migration has become an investment strategy for many families in which the risk of failure is minimized (or at least spread) by leaving parts of families at home (portfolio strategy). Such invest­ ment is unlikely to be fully discouraged even by opening EC markets extensively to Arab goods and/or by increasing the amount of financial assistance to those countries.

Deepening Integration and the Arab Countries: Polarization or Spread Effects as Second-Round Implications? The effects discussed above are likely to emerge directly as first­ round effects. Beyond them are two kinds of second-round effects that will affect the Arab countries as well as other nonmember states indirectly. First, deepening integration will make part of the existing capacity of the EC obsolete and will trigger a substantial amount of physical and human investment in sectors that, because of deregulation and the dismantling of market segmentation, will become profitable. As the increasing EC current account deficit since 1989 has amply witnessed, EC domestic savings are insufficient to finance invest­ ment. Access to external investment is now needed where pre­ viously important capital exporters from the GCC area also raise domestic absorption after the Middle East war and where Central

©International Monetary Fund. Not for Redistribution 260 Rolf J. Langhammer and Eastern Europe also badly need externalsavings. To encourage the mobilization of both domestic savings and the inflow of risk capital from abroad, EC member states' monetary authorities will have to keep real rates of interest high, which will impede a rapid return to high economic growth rates. Demand for energy may remain sluggish, and high real rates of interest on international capital markets will not allow Arab countries to fuel domestic absorption by deficit spending. Inshort, competition for risk capital will intensify worldwide. Given the different positions of net capital importers and exporters in the Arab world, capital shortages could lead to widening income gaps between the Arab countries. Highly indebt�d countries that today are already subject to credit rationing could face even more difficultadjustment problems than in the past. Second, deepening integration, which will lead to a catch-up process in the Mediterranean member countries, may fuel the con­ sumption of internationally mobile resources in the Mediterranean basin such as the environment (using the Mediterranean Sea as a sink, for instance) and maritime resources. If the Arab countries­ perhaps because of demographic pressure-also accelerate the exploitation of such resources, this would create a strong argument for EC-Arab policy coordination and cooperation to prevent further negative cross-border externalities from emerging in the region. With more former national public goods becoming public interna­ tional goods (including regional political security), it is in the interest of the EC to prevent a further widening of income gaps. Otherwise the success of integration deepening would be threatened externally at the southern borders of the Community as it is threatened at its eastern borders. A revitalization of the global Mediterranean policy receives its strongest political and economic rationale from the existence of cross-border externalities in the Mediterranean basin.

Widening Integration Toward Eastern Europe: The Hierarchy of Privileges Under Revision

For years the hierarchy of privileges conceded to third countries was not subject to change (Mishal:aniand others, 1981; Faber, 1990). In addition to EFTA countries, the African, Caribbean, and Pacific (ACP) countries were at the top, followed by the Mediterranean countries. Nonpreferential cooperation with other regional group-

©International Monetary Fund. Not for Redistribution 8 European Economic Integration and the Arab Countries 261 • ings such as the ASEAN and the GCC came at the bottom of the pyramid. With the collapse of the former socialist economies and the con­ clusion of association agreements with the three forerunners in economic transformation (the former Czech and Slovak Federal Republic, Poland, and Hungary), the latter have moved from the bonom to the top, thereby bypassing all Arab countries. This change in the ranking includes duty-free access to EC markets for manufac­ tures, some special conditions for exports of CAP products (meat, dairy products, and vegetables), and in particular a more rapid removal of tariff barriers and quantitative restrictions on so-called sensitive products (MFA products, for instance) than for other third parties, including Arab countries. The objectives of the association agreements are free trade areas to be achieved within ten years, with the EC dismantling their trade barriers first.The option of future full membership is explicitly given and is politically undisputed. If the success of internal transformation is constrained by the three countries' export capacity because capital imports cannot be financed by access to international markets or by financial assis­ tance, the EC will have to open further those markets in which the not as indispensable modernization of the capital stock is as in other sectors. These markers are basically the labor-intensive indus­ tries and the agricultural sector in which some Arab countries from the Mediterranean basin also have their stakes. It cannot be excluded that in such usually highly protected markets the Central and East European countries will enjoy clear privileges over compet­ ing suppliers from other third countries. Such a process was already initiated with the extension on March 1, 1992 of normal quotas for MFA products and of special quotas for outward processing (interim agreements to start with the trade parts of the association agreements). In brief, the association agreements could duplicate the process of trade erosion and trade diversion to the detriment of Arab coun­ tries that startedwith the second enlargement of the EC. This process has been described by Plummer 0991, pp. 178-79), investigating the effects of the Greek accession, as of particular concern to North African agricultural exporters (especially Morocco, Algeria, and Tunisia) and to exporters of manufactures now enjoying GSP status. Recent export data on Central and East European countries strongly support the argument that the provisions of the agreements

©International Monetary Fund. Not for Redistribution 262 Rolf J. Langhammer

have already triggered labor-intensive exports to the EC and that the countries benefit especially from extended quotas on outward processing of clothing and footwear. As such quotas are not similarly extended to the Arab countries, their preferences will be eroded. Given the importance of outward processing, for instance, to Tuni­ sia in the past, this country could be among the main suppliers in the Arab region suffering from such an erosion. To conclude, integration widening is very likely to have a negative effect on market access for Arab countries if the transformation process succeeds in removing some of the supply constraints. The OECD Group of 24 initiative to support this process with sizable financial transfers (the so-called PHARE program) can be an impor­ tant instrumentin reintegrating these countries into the international division of labor, but in protected markets the burden of such support has to be shouldered by the nonbeneficiaries, for instance, Arab countries. They can hope for a phasing out of agricultural and textile protectionism in the framework of the General Agreement on Tariffs and Trade (GA TI) but during a transitional period the Central and East European countries will be better off. They seem to enjoy more patronage from Germany and its traditionally less restrictive trade policies than the Arab countries enjoy from the southern EC member states including France.

Conclusion

At the beginning of the nineties, the Arab countries from the Mediterranean basin as well as from the GCC area suffer from supply constraints, macroeconomic imbalances, and deteriorating conditions of access to the EC relative to other nonmember coun­ tries. Given their supply patterns, they are not among those that stand to gain most from European integration. Estimates on short­ run trade effects of EC-1992 suggest that income effects (external trade creation) should be positive for Arab countries because of the higher EC demand for primary commodities but trade shares for the "implementation period" (1988-91) show that such effects either have not yet materialized or were offset by other supply­ side constraints. Medium-term effects give reason for concern that Arab countries might be affected by resource-saving technological progress and that such effects might be more important than the

©International Monetary Fund. Not for Redistribution 8 European Economic Integration and the Arab Countries 263 • terms of trade gains because of lowered prices for impons of capi­ tal goods. Investment flows between the EC and the Arah countries have remained marginal, but Arab investors may find it more attractive after 1992 to invest in the EC rather than at home. Capital drain from the Arab region would make it more dirflcult for domestic suppliers in Arab countries to benefit from the options of a single market in Europe. Migration will probably become the most comroversial issue in the Euro-Arab dialogue if the single market attracts more migrants than in the past. On this issue, the Arah countries compete for political interest, with East and Central European countries also sending migrants. Given the link between economic transfonnation and migration, the East and Central European exporters of migrants still attract more political interest in EC circles than do the Arab countries. However, the demographic structures support the hypothesis of larger medium-term flows of migrants to the EC from the south than from the east. Finally, integration widening toward Eastern and Central Europe poses a new challenge to the Mediterranean preferences. The asso­ ciation agreements with the former Czech and Slovak Federal Republic, Poland, and Hungary put all Arab countries in a less favorable position with respect to access to EC markets than before the collapse of the socialist systems. This is relevant in industries and sectors in which nonmember countries have to queue up owing to binding quantitative restrictions. Textiles and clothing are those industries that could worry Arab suppliers as the three former socialist countries seem to offer promising conditions for export­ oriented investors. Under such conditions, the future of the EC global Mediterranean policy in which Arab countries figured promincndy is open to revision. This policy should concentrate more on policy coordina­ tion in issues of mutual interest (collective international goods), such as migration, environmental protection, efficientexploitation of cross-border mobile resources, and pove1ty relief, than on tariff preferences. To restore macroeconomic stability in Arab countries, the EC must open its market multilaterally, expand adjustment assis­ tance, and refrain from any policy that would give rise to polariza­ tion effects at its southern borders.

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©International Monetary Fund. Not for Redistribution COMMENTS

ASS/A BENSALAH ALAOU/

would Like, first of all, to thank the organizers of this seminar Ifor giving me the opportunity to take part in this important event. My congratulations go as well to Rolf Langhammer, whose excellent paper makes my job easier. Allow me also to emphasize the complexity of such an exercise. It is hard to analyze the full implications of a process that is stiJJ in the making. It is true that in an era of quick changes the Arabs will have to manage-not the end of history, as some have described it-but the acceleration of history, to meet the increasing demands of their growing populations for a bener life and genuine political participation. To remain in the limited framework of this seminar, it is appro­ priate to stress what we all know: rhe vulnerability of Arab countries to the impact of the European Community (EC). Although the EC remains their key economic partner, they account for only 3-4 percent of total EC trade. Moreover, their trade balance with the EC has recorded a deficit since 1985; their principal exporL to the EC, oil (over 90 percent), is suhject to declining terms.1 The non-oil producing Arab countries face tremendous development challenges for a fast-growing demography, under extreme financialconstr aints, and, for the Maghreb, a heavy dependence on the EC. Indeed, the Arab countries' macroeconomic imbalances and supply patterns do not favor them to gain most from European integration, as Rolf Langhammer argues, but neither does the insecure institutional framework linking the free trade of lhese countries to the EC. It defeats any feasible long-term development strategy. Moreover, the preferential status of Maghreb and Mashreq coun­ tries declined substantially with the enlargement of the EC to include

'The trade deficit was $11.89 million in 1988; see Bichara Khader, ''L'Europe et le Monde Arabe: Cousins, voisins," Quorum (Ccrmac, France, 1992), Annex !V.l, p. 203.

267

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Greece, Spain, and Portugal. It was further eroded by the extension of the free trade area of the EC/European Free Trade Association (EFTA) to some non-EC member Mediterranean countries. The European agreements, contracted on March 1, 1992 with the three East European countries to establish a progressive free trade zone within ten years, will certainly duplicate this erosion. The option of future full membership is clear. These agreements secure for the East better access to EC markets during the transition period for sensitive products that are also exported by the poorer Arab coun­ tries. Also, the financial backing provided through the PHARE pro­ gram and the European Bank for Reconstruction and Development to restore the East European economies is no match for the marginal package allocated to eight Mediterranean countries. Based on these trends, Langhammer's overall conclusions do confirm most of the Arab countries' fears about EC-1992 and their growing concerns regarding integration moving toward Eastern Europe. Allow me at this point to make a few remarks on the analysis proposed by Rolf Langhammer. The reference periods-1985-88 and 1989-91-are ones in which the price of energy has decreased in real tenns, hurting the oil exporting countries' budgets; the Maghreb went through a profound financial crisis, mainly in external payment terms, while at the same time structural adjustment plans were being carried out. This period saw the enlargement of the EC to Spain and Portugal. It was also a period in which the protection levels implemented by the European Community were probably the highest for farm products and petrochemicals, for instance. Accordingly, if this period was somehow disappointing, it does not represent a valid basis for future trends and performances. On the other hand, the macroeconomic improvements recorded by countries like Morocco and Tunisia, albeit still modest, have not been taken into account. The evolution, for instance, of EC­ Moroccan trade contradicts some of Mr. Langhammer's findings as do the EC investment flows into that country. The evolution of demand within EC-92, as foreseen in the paper, is probably more optimistic than the looming recession will allow. The implications of the full integration of Spain and Portugal (in 1996) have not been estimated.

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The overall assumed impact of the EC openness toward the East remains ambiguous. What would be the impact of an "improved" income in the East European countries on their trade with the Arab countries? Could it increase, for instance, our exports of energy and farm products to that region? Finally, the potential changes in international and regional envi­ ronments and their implications for Euro-Arab relations were not touched upon. What impact would the conclusion of the Uruguay Round negotiations have on European-Arab trade? What would be the potential changes in the Arab region itself if peace talks were concluded, or if Arab cooperation in general and in the Gulf Cooperation Council (GCC) area and the Maghreb in particular were reinforced? Much more concrete and predictable is the change within the interregional framework. The new cooperative approach, initiated by the EC with Morocco (to be extended to Tunisia and in due course to Algeria) will certainly alter the scope and the structure of the global relations of the subregion with the EC. Before discuss­ ing that issue, it is appropriate ro focus on the Arab subgroups identified. The oil criteria appear valid for differemiation within the Arab region, at least as far as trade and investments are concerned. The Arab oil producing countries enjoy an undenied advantage in their relations with the EC, which depends on them for almost half of its oil imports. This group is qualified by Rolf Langhammer as "relative gainers" from EC-92. He estimates that they could be forced to incur a terms of trade loss, not to lose market shares in chemical industry products, given the projected high gains to EC producers in that sector. Nevertheless, their exports in that particular fieldremain marginal. Oil actually represents a vety high proportion of EC imports from Arab countries. It is not hampered by any new EC norms, unless the highly controversial eco-tax of $2 a barrel is established. New securiry nom1s to be respected by tankers may also prove detrimental. The question evolves around the future levels of oil consumption in the Communiry. In the medium run, these should be fostered by the dynamic effects of EC-92. A European GDP growth of 5 percent a year should increase EC energy imports by 1.5-2 percem a year. The Arab countries are in a position to benefit most from

©International Monetary Fund. Not for Redistribution 270 Assia Bensalah Alaoui this increase. The overall gain should not exceed $2 billion.2 The GCC countries have the largest resources. Algeria is linked to Europe by long-term gas supply contracts and by an important network of gas pipelines through the Mediterranean. This advantage will be further enhanced when the ambitious project to supply Spain and the rest of Europe, through Morocco, via another gas pipeline is carried out. The rules of origin established since December 31, 1979 for oil products from Algeria exempt these products from customs duties and the quota system, as does the European Coal and Steel Community (ECSC) agreement between the EC and Algeria for iron ore. Faced with severe external debt and a domestic crisis, however, Algeria does not seem in the best position to compete for the foreign investment and financialbacking it badly needs. The other Maghreb oil producing country, the Libyan Arabjamahiriya, depends heavily on its oil exports to the EC.5 Its oil products are subject to duties and quotas, since the Libyan Arab jamahiriya has no particular agreement with the EC, but crude oil, which is its principal export (77.5 percent), is not. Long-term prospects seem dimmer for energy expo1ts to the EC. As Langhammer argues, energy savings through technological progress and environmental regulations could lead EC producers to reduce consumption levels. How far the implied losses could be offset by potential higher energy costs and lower EC export prices is still unknown. Indeed, the Arab countries will benefit, like all other countries, from lower import prices owing to fierce competition in world capital goods markets, which are the bulk of their imports from the EC. The 6 percent decrease in prices owing to the dynamic effects of EC-92 will still have to materialize. The looming recession might force the experts to lower this figure. Lower prices for EC services might, on the other hand, boost Arab imports to meet their increasing demand in that sector.

Trade Effects Non-oil producing Arab countries are presented by Langhammer as "relative losers" from EC-92. In fa ct, their relations with the EC

2Ibid. Yfhe EC absorbs 84.4 percent of Libya's total exportS, oil representing 95.6 percent of that share.

©International Monetary Fund. Not for Redistribution 8 • Comments 271 are more complex and their dependence heavier, as will be the full implications of EC-92. Much more than for the other Middle East countries, EC-92 and the integration widening to the East mean more severe norms to comply with and fiercer competition for market shares and for foreign direct investment. They cannot meel this challenge without canying out the appropriate reforms and transformation of their economies. Some of them have already started. The implementation period, 1988-91, is also a period in which the preferences of those countries had eroded due to enlargement of the EC, despite the specific measures taken. However, the Mashreq countries djd not lose their market shares in EC non-oil imports and the Maghreb countries managed to raise theirs by 0.6 percent. Overall estimates for trade effects after 1992 are contrasted. A 1989 survey shows substantial reductions in exports to the EC by most Arab countries, boiling down to a financialloss of over 268 million European currency units (ECUs). These pessimistic prospects are confirmedby some Arab League studies. On the other hand, Daven­ port and Page,4 and more recently Page' establish gains-not losses-for the Mediterranean region and the Maghreb. Small trade gains indeed: ECU 250 million for the Mediterranean, including ECU 80 million for the Maghreb over the period 1993-98. The-> commodity export gains, it is argued, are partly offset by losses in manufactures. Prospects for commodities raise hopes for the short run, but concernsfor the longer run. A report by the United Nations Industrial Development Organization (UNIOO) estimates that addi­ tional EC imports of commodities should not exceed $5 billion (6 percent of present imports). Only Mauritania for iron ore, and Morocco, Tunisia, and jordan for phosphates would benefit from this increase. Their overall gains should be about $100 million. The longer-term effects of EC-92 might inhibit further growth of commodity imports owing to reductions in resource inputs and to environmental considerations. Under the combined effect of the Common Agricultural Policy (CAP) and of environmental concerns

4Michael Davenport and Sheila Page, Europe: 1992 and the Developing World (London: Overseas Development Institute, 1991). �sheila Page, "Some Implications of Europe 1992 for Developing Countries," OECD Technical Papers, No. 60 (April 1992).

©International Monetary Fund. Not for Redistribution 272 Assia Bensalah Alaoui linked to new fe rtilizer strategies, European consumption of phos­ phates is assumed to decrease-from now to the year 2000-by 16-26.5 percent.6 Great efforts are being made by the Arab phos­ phate exporters, and especially by Morocco, to promote scientific and technical use of this commodity to comply with sustainable development requirements. Manufactures is another kind of a problem. The EC Commission itself estimates that EC demand for manufactures should decrease by 10 percent.7 Besides trade diversion to EC countries, trade diver­ sion to the East European countries under the European agreements is to be expected. Competition will be intense, given the clear privileges granted to these countries. Textiles and clothing represent the main exports to the EC for Morocco (48 percent), Tunisia (35 percent), and Egypt. It is too complex a sector to do justice to in this limited space.8 However, what is worth mentioning is that the self-limitation arrangements with the EC certainly inhibit the further growth of this sector, although they have improved over the years. For a country like Morocco, for instance, only trousers are still subject to quotas.9 It is also argued that Community-wide quotas would be detrimen­ tal to Maghreb suppliers, which might lose their "historical" privi­ leges of "free" access to the hitherto overprotected French market. In any case, the phasing-out of the MFA will introduce worldwide competition, which will certainly be intense from the larger Asian suppliers. Egypt might suffer less, given the high quality of its long­ fiber cotton goods. The others will have to significantly improve the quality of their products. According to Page, fast-growing exporters of manufactures may take more advantage of the medium-term options offered by the EC-92 than exporters of commodities. Some Arab countries do belong to this group. EC-92 may, in reality, seem much more of a

6World Institute for Phosphates. The survey presents three scenarios that might lead to a 16 percent reduction, or a 19 percent reduction, or 26.5 percent reduc­ a tion. 7European Community, "The Economics of 1992," European Economy, No. 35 (March 1988). 8Among numerous recent studies is "Le fil d'Ariane," in Enjeux (Morocco), No. 46 (November 1992), pp. 48-61. 9According to the EC this quota is largely bypassed by real exports.

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challenge and an opportunity for Arab exporters to improve the competitiveness of their products and economies for the benefit of domestk consumers as well. Community-wide norms are, at times, perceived as additional obstacles to entering EC markets. Even if these markets are more demanding, in both quality and security, it will certainly be simpler for exporters to comply with a much more limited number of norms (2,000 is the figure estimated for 1993 instead of the previous 27,000).10 This evolution will oblige the captains of Arab industry to keep an eye open for Brussels regulations and decisions. Suppliers from the Maghreb could also take advantage of the close links they have established over the years with their fellow Europeans. All Arab countries will have to better penetrate the distribution networks, a sector expected to undergo considerable restructuring under EC-92. joint ventures, strongly encouraged by the new European-Maghreb approach, will be a powerful tool to achieve that goal. Equally prominent for Maghreb exporters is the issue of farm goods. CAP regulations will certainly remain a stumbling block, despite the increased flexibility expected from the combination of the CAP amendment and the Uruguay Round negotiations. Morocco and Tunisia, which are greatly concerned, will need expertise and talent to defend their exports in that sensitive sector. Given the differences in climate, the European agreements do not seem as much of a threat to the Maghreb as has sometimes been argued.11 Much more threatening for Arab countries will be the European agreements in the field of competition for foreign risk capital.

Investment Effects

Langhammer argues that Arab countries have failed up to now to attract substantial capital from EC member states. They may in future suffer from the growing attractiveness of the EC itself (and

10Moroccan Center for Conjunc(ure, "The European Single Market: What Predict­ able Implications for Moroccan Entrepreneurs," in Letter (December 1992), p. 11. 11The three East European countries were granted access to EC markets for CAP products like beef, pork, lamb, dairy products, potatoes, grains, and oilseed�. Except for potatoes, exported by Morocco, the Maghreb countries do not produce enough of these products for their own consumption.

©International Monetary Fund. Not for Redistribution 274 Assia Bensalah Alaoui its EC/EFTA free trade area) to host foreign investments, including a capital drain from their own region. There is not much to add to such a prospect, hut we can only hope it does not materialize. Nevertheless, l will make a few comments on some points Rolf Langhammer touched upon briefly, and perhaps provide some additional information. Among the implications of the dynamic effects ofEC-92, "European companies and those from other industrialized countries will, in fa ct, have numerous reasons to prefer EC rather than the Third World for their investments," as Emmerij puts it.12 But some EC hosts may lose in competitiveness, as shown by Langhammer. Morocco and Tunisia seem in a position to be successful candidates for such outflows of capital. They have actually succeeded in doing so already, in export-oriemed, labor­ intensive industries like textiles and clothing. They have managed also to benefit from a "trickle-down" effect from neighboring Europe, contrary to what Langhammer states. In a country like Morocco, where investment flows from the EC have increased by 50 percent in the last three years, France was still the first foreign investor in 1991. Spain, whose economy was boosted by EC mem­ bership, has considerably increased its investments in Morocco (reaching the third rank among foreign investors), as has Italy in Tunisia. Some large French and Spanish companies have launched joint ventures with a few Moroccan companies in the sensitive sector of expOit-oriented farm goods-an interesting trend for more than one reason. Beyond the numerous implied gains for Morocco, in terms of labor creation, skills training, technological transfers, quality improvement, and so forth, it may be the key to securing the presence of Moroccan products on European markets. Certainly, this evolution will not wipe out the opposition and lobbying by the European peasants against Moroccan products. Even some EC members are occasionally victims of such procedures.1j But the process once initiated may in time promote imerdependence rather than dependence and may ultimately help cooperation to prevail over confrontation.

12Louis Emmerij, "Nord-Sud, Ia grenade dcpou illct!," First, Paris 0992), p. 41. 1�Spain's strawberries and Italy's wines, for instance, subject to intense arc boycon by French producers.

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At this point, allow me to elaborate brieOy on the nature or the relations between the two rims of the Mediterranean and particularly between Europe and the Maghreb region.

Global Relations

Beyond the asymmetric relationship between the EC and the Arab countries, what is at stake cannot be approached through simple quantitative terms and arithmetic gains and losses. The fig­ ures are certainly important to have in mind-especially when they are so detrimental to the free trade Arab countries and so marginal for the EC-but what is really involved is the global stability of the Euro-Arab region. This aim can certainly not be achieved without lowering the prosperity gap within individual nations in the south, and between the EC and its southern ··frontier," nor can the latter be achieved by market rules alone. The oversensitive human dimension and concerns with security have to be duly reckoned with. One of the basic motivations of the Spanish-Italian policy stance was certainly the trade-off: more investment in the southern shore for less migration toward the north. This argument is also strongly behind the U.S. strategy toward Mexico: short-term financial backing and debt-reduction through the Brady Plan to restore the severely damaged Mexican economy, and a longer-term free trade area through the NAFTA. This multiple­ aim strategy is expected, among other things, to provide work for potential migrants in their own counl!y, stabilize the extensive U.S. southern frontier, and also improve U.S. competitiveness vis-a-vis Japan and Europe. Along with the deepening of its own integration, Europe had to make the appropriate adjustmems to meet the new responsibilities implied by the collapse of communism. But its ·'external" attention­ under the drive of cultural solidarity and a powerful Germany­ seems to be monopolized by the East, newly born to democracy and to a market economy. As legitimate as these priorities may be, they have led to sheer indifference toward the Mediterranean frontier. Benign neglect of this fragile southern "front" may prove highly detrimental to Europe's overall security and prosperity. In a world reduced to a "global village," Europe cannot lock itself in its shell of prosperity when other needs are crying out at its door.

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Although immigration was largely encouraged up to the early 1970s, it is now opposed by Europeans. No longer needed because labor markets are closed, it is no longer desired because xenophobia is rising. The integration of large Muslim communities with distinct cultural and religious differences may prove difficult to implement. But European policies, in this respect, have been restrictive rather than integrative. No containment strategy, as promoted by strict visa policies to prepare for EC-92 and by the "Schengenland," can alone put an end to the overwhelming trend of migration to Europe. The underlying factors have to be properly addressed to keep the candidates in "self-imposed" exile in their own countries. This remark raises the global equation of the Maghreb situation, the closest Arab neighbor of the EC and present in Europe through its Community ties. There is not enough time to elaborate on this complex issue here. I can only say that the Maghreb is increasingly analyzed in terms of "risks." These risks do indeed vary, in their nature and degree, from one counuy to another. Mainly demo­ graphic, social, and economic, they are inherent in the very process of modernization and political change that the whole developing world is facing. Most feared of all, religious fundamentalism (responsible for the open crisis in Algeria) is itself nourished by economic frustrations. As distinct from "threats," where military means are necessary, these "risks" have to be addressed by a wide range of measures within development strategies. Although these remain the prime responsibility of Maghreb policymakers, they are certainly inhibited by the heavy dependence on the EC and the prevailing cooperation schemes. The vital link between the concept of security and the process of development is too well established to be repeated here. Stability and development in the Maghreb are certainly a component of overall European security; they cannot be met by lip service. I would like to conclude by discussing the new approach initiated with Morocco and extended recently to Tunisia, hoping it will be help to clarify the situation.

EC-Morocco : A New Framework Substantial implied gains for both partners are expected from the new approach to relations between the EC and Morocco. It is of course too soon to evaluate the potential impact, as the concrete

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terms of the agreement are soon to be negotiated. It is supposed to be a turning point, launching an era of political and economic partnership. It should be very close in substance to the European agreements without, of course, the full membership option. The application Morocco had made to the EC in 1987 had been turned down on the basis that Morocco was not a European country. The transitional period toward a free trade zone should cover up to 12 years. Safeguards and the progressive dismantling of barriers should allow the appropriate adjustments and the reinforcement of the Moroccan economy to take place without major disruptions. Ample challenges will certainly have to be faced. Among them are, immediately, much lobbying and diplomacy to convince the reluctant member states of the validity of Morocco's claims to meet their own self-interestS-not so easy to achieve-since its main "sponsors" and advocates in Brussels-the Mediterranean Euro­ pean countries-are Morocco's competitors in sensitive productS. Second, carrying out properly the most difficult negotiations ever undertaken in Moroccan history, followed by much sweat and tears for the lame-duck companies and for some sectors (about 40 percent of the manufacturing industry is estimated to disappear and about 20 percent to incur severe damage in order to survive); there are prospectS of much suffering also for the important underground economy, which will have to be absorbed; compliance with stricter norms and a greater respect for property rights and copyrightS; upgrading the transport and communications infrastructure and also improving managerial techniques; rationalizing administrative procedures and harmonizing and completing legislative measures; and reducing macroeconomic imbalances and adapting the whole production pattern to new realities. In sum, tremendous changes have to be made ultimately to secure some competitiveness with giants! Finally, legal matters in the state have to be reinforced, a greater respect for human rights secured, and democratic improvements implemented in the wake of the changes in the Constitution of September 1992. Even if we genuinely consider that major reforms-through structural adjustment measures backed by many other policies and reinforced by trade liberalization-have paved the way during the last decade, a huge task remains.

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But what is at stake is worth it, for the new vision means much more hope for all. The new relationship with the EC is backed by a consensus of Moroccan public opinion. Morocco's link with a much larger area should involve a number of gains, and above all, a green light for a long-term coherent national development strat­ egy. This strategy still has to be devised by Moroccan policymakers once the precise content of the new framework is defined. We cannot demand coherence of our partners and be severely Jacking in such a virtue ourselves. A green light is also expected from this link to foreign capital for direct investment, including non-EC, and to Moroccan emigrants' savings; modernization of the economy, transfer of technological and training skills, and quality gains; and better incorporation into the European distribution networks, mainly through partnership. These are some of the salient issues that can be perceived at this stage. One can legitimately wonder why Morocco has been the first choice of partner for the EC's change of vision. Beyond the particular context of the proposal (refusal of the European Parliament of the fourth financial protocol for Morocco in january 1992 and the use by Morocco of the fishery agreement), a few reasons can briefly be sketched. The move toward a more comprehensive approach by the EC came in fact in response to Morocco's long-standing claim, but also from the recognition, albeit late, of Morocco's specific accomplishments. Morocco engaged, as early as the 1980s, in harsh reforms to reinforce the basic options of political and economic liberalism operated since independence. The results have been judged satisfactory by most observers, including the institutions present here. We have had to pay a high price for such relative success, in terms of external debt, still to repay, and in terms of social deficit, still to make up for. If I recall these facts, it is not to apologize for my country. I have already mentioned what tremendous tasks are in store to ensure the well-being of all Moroccan citizens. But it is is only to say that if the East can benefit from Europe's fears, we Arab countries, to improve our status with our main partner, Europe, can only rely on the confidence and reliability we can convey. We still have to carry out or continue economic and political reforms, settle our conflicts, and enhance our regional cooperation. This recognition will certainly encourage our partners to bear their share of responsi-

©International Monetary Fund. Not for Redistribution 8 Commencs 279 • bility. "The European Community and each member state need to recognize that to dismiss problems of the Arab world as peripheral to its own concerns is shortsighted."14 The proximjty of the Arab world demands a coherent response, a long-term vision of our common future, and a concerted program of action to address immediate perils. Allow me to state the obvious when I say: becom­ ing closer may be the only way to avoid being torn apart.

MABID AL-JARHI

would like at the outset to express my appreciation to Mr. I Langhammer for his valuable paper, which offers a good review of Euro-Arab trade relations, while showing how they can be affected by the deepening and widening of European integration. The importance of the study stems not only from the historical relations between the two regions and the common interests they share, but also from the timely issues underlying the topic of the study, both theoretically and empirically. I will therefore first discuss the paper's conclusions and then the economic policy implications for Europe as well as for the Arab region. The paper limited itself to Euro-Arab trade relations and migration issues. With the exception of the investment issues, it did not deal with financial and banking relations. I will therefore start by com­ menting on the paper's conclusions in relation to trade and labor migration, before outlining the main fe atures of financial and bank­ ing relations.

Trade Relations The paper presents the fol lowing results regarding the future of Euro-A.rab trade relations.

14David McDowall, ed., "The European Community and the Arab World," Europe and the Arabs: Discords or Sy mbiosis? Royal Institute of International Affairs, Middle East Program (1992), p. 39.

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• The Arab countries face, alongside their trade relations with Europe, supply-side constraints as well as internal economic imbalances. In addition, the terms of their entry to the European market have deteriorated relative to market members.

• The increase in income associated with the unification of the European market could have led to larger Elll·o-Arab trade (the income effect). This, however, did not materialize because of supply constraints.

• In the medium term, resource-saving technologies in Europe could lead to lower demand for Arab products, especially oil. This effect appears to exceed the gains from the expected improvements in Arab terms of trade with Europe, which might result from lower prices for Arab imports of European capital goods.

• Trade preferences given by the European Community CEC) to the Mediterranean Arab countries have been eroded following the agreements recently concluded between the EC and the East European countries. In the light of these results, the paper calls upon the EC to assist the Arab countries to regain macroeconomic stability by opening the European market to Arab products on a multilateral basis, as well as providing more support for adjustment programs. In addition, it calls for a new European policy in line with both Arab and European interests in the Mediterranean basin, focusing on coordination in the fields of migration, environment protection, poverty relief, and exploitation of cross-border mobile resources, rather than on tariff preferences. In this regard, it is worth noting that the paper refers to the relatively less importance of the Arab market to the EC, as the Community draws from the Arab market only 9 percent of its total imports and directs to it only 11 percent of its total expons. How­ ever, the EC is the main trading pa11ner of the Arab world, as 32 percent of Arab exports were directed to the EC in 1991, compared with 35 percent in 1985, and 42 percent of Arab impolts came from the EC in 1991, compared with 41 percent in 1985. It must therefore be stressed that trade relations with Europe have special importance for the Arab countries. Also, the paper overemphasizes supply constraints and imbal­ ances in Arab economies, whereas most of the blame should fall

©International Monetary Fund. Not for Redistribution 8 • Comments 281 upon the structural inadequacy of the European trading system, particularly with regard to subsidies and quantitative restrictions, which directly threaten Euro-Arab trade relations. A special source of concern is that those relations have witnessed a number of unfavorable developments as a result of the completion of the European market, including the removal of trade preferences that had been given to some Arab exports after many years of dialogue and negotiations; the cancellation of the preferential quota system applied by France on the exportS of Arab Maghreb textiles and clothes; the inaccessibility of European markets to Arab prod­ ucts because of subsidies and quantitative restrictions; and the possi­ bility of decline in European demand for Arab oil, owing to policies of energy conservation, increasing use of non-Arab oil sources, and the attempt to bypass the carbon tax. As noted, since the Arab trade deficit vis-a-vis the EC countries reached $5.2 billion in 1991, compared with a trade surplus of $36 billion in 1980, the fear of a continuing deterioration of the Arab trade balance with Europe becomes justifiable. The recommendations provided by the paper seem to be reason­ able. Yet they require further strengthening through clear European policies aimed at introducing structural reforms to the European trade regime, including the elimination of export subsidies and quantitative import restrictions, especially against the Arab coun­ tries. In addition, the EC countries must do their best to reduce the level of protectionism with the completion of the European market, to compensate for the trade diversion effects of their economic integration, and to promote competition within their own industries. It is rather unfair for the Arab countries to findthat theirtrade gains realized through years of Euro-Arab cooperation have suddenly evaporated. Those gains should as a minimum be maintained. In addition, the EC can take part in encouraging regional and subre­ gional cooperation among the Arab countries, as it would lead to intratrade liberalization, and in the long run would facilitate future Euro-Arab cooperation. In parallel, the Arab countries are called upon to persist in reform­ ing their economic systems in a manner that would strengthen their relations, based on both liberalization and outward orientation. They are also urged to negotiate with the EC as one bloc, as the

©International Monetary Fund. Not for Redistribution 282 Mabid AI-Jarhi gains from trade liberalization increase as irs scope widens, and as more Arab as well as European coumries are included.

Migration Issues The paper dealt with a number of migration issues, especially the expectations of unfavorable changes in attitudes toward Arab workers in Europe in favor of migrant workers from Eastern Europe. Arab workers in Europe have already been exposed to several pressures, including me imposition of tougher procedures to obtain residence visas and the provision of financial incentives to return to their home countries. The preferential treatment they have enjoyed in France, Belgium, and Spain may also be lost as a result of the unificationof labor, employment, and entry regulations across the EC.

Financial and Banking Relations Despite the importance of financial and banking relations, the paper did not touch on them. Arab banks operating in the EC countries have been one, if not the most important, of the Arab investment channels in Europe. They have 190 banking institutions, representing an investment of close to $4 billion. In comparison, there are about 120 branches of European banks operating in the Arab countries, most of which are from the EC. They attract about 10 percem of Arab banking activities. In addition, the liabilities of European banks toward four Arab countries (the United Arab Emirates, Saudi Arabia, Kuwait, and Iraq) approached $45 billion in 1990, mostly in deposits. There is concern that Arab banking activities in the EC may face difficulties owing to the application of the principle of reciprocity, as it would be rather difficult for some Arab countries to open up their markets completely to foreign banks, and especially that European banking activities in the Arab countries assume a larger proportion than their corresponding activities in the EC. The paper also pointed out mat the completion of the European market could attract a large proportion of Arab investment out of the region. In the same manner, European investment flowstoward Arab industries could retreat in favor of a larger and more integrated European market. In addition, the EC adheres to me classification

©International Monetary Fund. Not for Redistribution 8 Comments 283 • of the Arab countries (except for Saudi Arabia) as relatively high­ risk countries. This can undoubtedly raise difficulties in the face of new European investment flows to the Arab region. Also, more European aid and loans to finance Euro-Arab trade and to support Arab economic development-panicularly in the agricultural sector-had been expected in the light of the EC pro­ posal to consolidate all outstanding bilateral agreements to coordi­ nate aid on a regional basis. Nonetheless, the rate of interest on the financing of risk capital has been raised from 1.0 percent to 2.5 percent. The EC has also started, as Mr. Langhammer pointed out in his paper, to limit aid to government budgetary requirements within an economic adjustment program. Naturally, this would fur­ ther tighten aid conditionality and procedures. Besides, EC aid directed to the Arab region may decline in favor of aid to Eastern and Central Europe. Finally, the best development aid that the EC can possibly provide to the Arab countries is to open the European market to Arab products. This can only be accomplished through the reorientation of European commercial, agricultural, and industrial policies toward a greater degree of openness vis-a-vis the Arab region. The ongoing economic adjustment efforts in a number of Arab countries and the continuous attempts to reach integration at the regional and subregional level could create the appropriate climate for greater movements of goods and capital between the EC and the Arab countries.

©International Monetary Fund. Not for Redistribution l'hispage intentionally left hlank

©International Monetary Fund. Not for Redistribution List of Participants

Moderator

Said El-Naggar Professor Emeritus University of Cairo Egypt

Authors

Ahmed Abisourour Arab Monetary Fund Abu Dhabi

Mohamed El-Erian International Monetary Fund Washington, D.C.

Ghassan El-Rifai Multilateral Investment Guarantee Agency Washington, D.C.

Stephen Heyneman World Bank Washington, D.C.

Tayseer Abdel Jaber Former Executive Secretary Economic and Social Commission for West Asia Amman, Jordan

Rolf ]. Langhammer Kiel Institute of World Economics Kiel, Germany

Shamsuddin Tareq International Monetary Fund Washington, D.C.

Mostafa K. Tolba Former Executive Director United Nations Environment Program Nairobi, Kenya

285

©International Monetary Fund. Not for Redistribution 286 List of Participants

Discussants

Assia Bensalah Alaoui Professor of Law Rabat, Morocco

Mohamed Al-Amin Fares Arab Labor Organization Cairo, Egypt

Mabid Al-jarhi Arab Monetary Fund Abu Dhabi

Salah El Serafy World Bank Washington, D.C.

Mustapha Kara Arab Monetary Fund Abu Dhabi

Badr Malalla Arab Fund for Economic and Social Development Kuwait

Samih Masoud Arab Organization for Investment Guarantees Cairo, Egypt

Participants

Ghazi Abdul-Jawad Gulf International Bank Manama, Bahrain

Abdulla Daud Abdulla Central Bank of Oman Oman

Abdulla Alattiya Qatar Monetary Agency Doha, Qatar

©International Monetary Fund. Not for Redistribution Ust of Participants 287

Hassan Al-Ebraheem Kuwait Society for Arab Children Kuwait Yousef Al-Ebraheem Professor of Economics University of Kuwait Kuwait Abdulbar Al-Gain Meteorological and Environmental Agency Jedda, Saudi Arabia Taleb Ali Consultant Kuwait Abdel Rahman Al-Jaafari Consultant Doha, Qatar Ali Al-Khalaf Ministry of Finance and Economy Doha, Qatar Jassem Al-Manaie Gulf Investment Organization Kuwait Majed Al-Moneef Professor of Economics King Saud University Riyadh, Saudi Arabia Abdulla Al-Mulla Gulf Cooperation Council Riyadh, Saudi Arabia Abdulla Al-Nibari Member of the National Assembly Kuwait Juma Ahmed Al-Salami Chairman, Business and Economists Association United Arab Emirates

©International Monetary Fund. Not for Redistribution 288 List of Participants

Yousef AJ-Shirawi Minister of Development and Industry Manama, Bahrain

Mohamed Al-Tawail Institute of Public Administration Riyadh, Saudi Arabia

Yousef K. Al-Yousef University of the United Arab Emirates Abu Dhabi

Henri Azzam Consultant Jedda, Saudi Arabia

Fakhri Bazzaz Professor Harvard University Cambridge, Massachusetts

Adnan N. Bseisu Consultant Manama, Bahrain

M.J. Chadwick Research Director Stockholm, Sweden

Ahmed Dhakkar UNDP Resident Representative Manama, Bahrain

Soraya Ahmed Ebaid Economic and Social Commission for West Asia Amman, Jordan

Mohamed Al-Awad Jalal El-Din Consultant Khartoum, Sudan

Ali Fakhro Minister of Education Manama, Bahrain

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Mohamed Finaish International Monetary Fund Washington, D.C

George Houranieh Former Minister of Economy Damascus, Syria

Idriss Jazairy Former President International Fund for Agricultural Development Rome, Italy

Taher Kanaan Industrial Bank Amman, Jordan

Gouda Abdel Khalek Professor of Economics University of Cairo Cairo, Egypt

Mohamed Kherbash Ministry of Finance and Industry United Arab Emirates

Jaafar Hamed Mohamed Ministry of Planning and Development Sanaa, Yemen

Yacoub Mohamed Arab Monetary Fund Abu Dhabi

Saleh Nsouli International Monetary Fund Washington, D.C.

Awad Al-Kareem Osman Central Bank of Sudan Khartoum, Sudan

Abdel Kareem Sadek World Bank Washington, D.C.

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Siddig Abdel Majeed Salih World Institute for Development and Economic Research Helsinki, Finland Abdulla Saudi Arab Bank Corporation Manama, Bahrain Salwa Soliman Professor of Economics University of Cairo Cairo, Egypt Umayya Toukan Financial Market Amman, jordan Abdel Hassan Zalzala Consultant Ottawa, Canada

Arab Fund for Economic and Social Development Abdlatif Al-Hamad Director General and Chairman of the Board Omar Al-Nuss Ismail Al-Zabri Abdel Hameed AI Zikallaie Mervat Badawi Sami Iskander Badr Malalla

Arab Monetary Fund Osama Faquih Director General and Chairman of the Board Ahmed Abisourour Samir Abyad Mabid Al-jarhi Mustapha Kara

©International Monetary Fund. Not for Redistribution