Chapter 2: The Challenges of Globalization

 

[Introduction | Strategic Rents |  Oil Rents | Trade | Capital Flows | References | Table of Contents ]

 

The MENA, which has hesitated more than any other region of the world to adopt the reforms needed to benefit from the new international division of labor, is being pushed ever harder to adopt the Washington Consensus as its basis for formulating national economic policies. Global changes are breaking the cocoon that had once protected the MENA from major structural changes. Although the region continues to attract a disproportionate share of attention from external powers, notably the United States, it no longer receives the abundant strategic and petroleum rents that had previously insulated it from the need to reform, as will be discussed in this chapter. As a result, most of its states are compelled to seek to attract compensatory capital flows, which in turn is driving the process of economic structural adjustment. That this process is proceeding unevenly attests to those states’ different internal capacities for reform, the topic which will be taken up in Chapter Three.

Strategic Rents: Foreign Aid and Arms Transfers

The end of the Cold War has had a more direct impact on the MENA than on any other region of the Third World. Instead of dampening external interventions in the region, the end of the Cold War simply reconfirmed the MENA's special vulnerability. The United States-led military intervention against Iraq in 1991 would not have materialized without a weakened and complaisant Soviet Union and China's abstention in the Security Council, nor would the United States have so easily risked subsequent strikes against Iraq without fears of political or military retaliation by any rival power. Not outside intervention but rather an American monopoly on this intervention is the principal difference between the region's traditional entanglements and the New World Order. Yet historians of the Middle East's exceptionalism have observed that no great outside power long exercises hegemony in this part of the world (Brown, Elizabeth Monroe Britain's Moment). In fact America's "moment" may already have passed. Historians may eventually conclude that the failure of the United States to persuade most of its Arab allies to join Israel at the Fourth Economic Summit convened in Doha, Qatar, in November 1997 marked the decisive turning point. United States influence will continue to decline in the region if it cannot broker a credible peace between Israel, the Palestinians, and other Arab neighbors, failure to do so being the cause of the partial Arab boycott of that Summit.

But even if peace materializes, Pax Americana is still likely to be transitory. France, Russia, China, and possibly Germany and Japan are awaiting their opportunities to develop Iraq's bountiful oil fields, once Anglo-American efforts to isolate Iraq falter and UN sanctions are relaxed. Unilateral American efforts to isolate Iran are further enhancing the influence of Europeans and Asians. In coming years U.S. involvement in the region may focus less on its monopolized, failing peace process, and more on balancing off other contenders. Whether one or several powers contend for influence in the region, however, the traditional stakes of the game are diminishing, eroding the region's special advantages. Passages from the Mediterranean to India are no longer of much interest to Western Europeans, aircraft flying from Europe to Asia now overfly the region rather than refuelling in it, new weapons technologies reduce the significance of location, and access to the MENA’s abundant oil is, except for the U.S., considered almost exclusively in financial terms.

The lowering of the stakes of Great Power military and overall geo-strategic competition is reflected in declines of rents that the competitors had previously paid to states of the region, of which foreign aid is a fair measure. Military and economic development assistance of foreign powers had been one of the mainstays sustaining the region's governments’ heavy expenditures in the past, supplementing their other traditional means of subsistence--oil revenues earned directly or indirectly. But neither of these forms of rent has kept pace with the region's expanding needs or the rate of growth of the world economy. The unrelated changes of the end of the Cold War and downturn in oil prices converged to hit this region of the developing world the hardest. The international community diminished official development finance to the Third World just as the prices of internationally traded oil plummeted from their high points in 1981 to new lows in 1986 and 1998. (see Table 2-1 1975-97 aid and oil prices) Not only did development assistance decline in general in the 1990s, but the MENA region lost "market share," reflecting its diminished importance in the world.

Indicators of strategic rents other than official development assistance are military aid and weapons transfers to countries in the region. During the Cold War the Middle East had been the major recipient of arms from the United States and the Soviet Union, but in the 1990s the picture changed. In nominal dollar amounts, inflated by high prices charged to the Gulf states, the region still absorbed 40 per cent of the arms in world trade in 1996 (International Institute of Strategic Studies, The Military Balance 1997/98, London 1998, http//www.isn.ethz.ch/iiss/mb7.htm), conforming to its stereotype as the world's most tension-ridden region. When measured more accurately, however, Asia has displaced the Middle East as the primary purchaser of arms. According to the Stockholm International Peace Research Institute (Sipri), which calculates dollar prices for various major weapons systems, the Middle East and North Africa constitute only 24 per cent of the market, whereas East Asia now accounts for over one-third of the world's arms purchases (Table 2-2). Figure 2-1 shows Asia to have dramatically expanded its share in the mid 1990s, whereas arms transfers to the MENA declined after a brief flurry of activity following Iraq's expulsion from Kuwait by the US-led coalition. Despite official American pressures for further arms purchases, the markets in the Gulf are no longer as lucrative for United States weapons manufacturers as in earlier decades. Strapped for cash, Saudi Arabia in the 1990s intermittently postponed receiving and paying for arms for which it had contracted.

The region still receives an abnormal degree of attention from the outside world because of its alleged involvements with international terrorism and unconventional weapons of destruction. These concerns do not, however, translate into significant strategic rents for the allies of the United States such as Bahrain, Egypt, Israel, Jordan, Kuwait, Morocco, Saudi Arabia, Tunisia, or Turkey against the "rogue states" -- as the White House labelled them -- of Iran, Iraq, Libya. and Sudan. Gone are the Cold War days when the United States bid against the Soviet Union for clients in the region. The local allies who still receive American funding were instead subject to cutbacks in 1990s so that more US foreign aid could flow to the Eastern European countries no longer ruled by the Soviet Union.

Neither the aid recipients, with the exception of Israel, nor the oil exporters allied to the United States, share the official American perceptions of the rogue states. The Arab states can not be counted upon for full support of possible American interventions against other Arab states or even against Iran. A reinvigorated peace process between Israel and the Palestinians and agreements between Israel, Syria, and Lebanon may strengthen Arab support of US goals in the region, notably the nonproliferation of unconventional weapons, and thereby attract more US public financing of the region's economic development. The promised amounts ($750 million toward the capital for a Middle East Development Bank) are small, however, compared to the expected inflow of private sector funds that depend on a timely implementation of structural reforms discussed below. If the peace process were to languish and political tensions to rise in the region, US public financing would likely diminish.

The European Community has maintained an interest in the region because its southern and eastern Mediterranean countries remain Europe's "soft underbelly" in a social if no longer in a strategic sense. North Africa and Turkey are contiguous with Europe and constitute a threat to its social and political stability. North African guestworkers in France and Turks in Germany have already ignited racist backlashes that could one day, if allowed to grow, threaten their respective democratic orders. Turkey, a founding member of the Council of Europe as well as NATO and the OECD, is almost part of Europe, although the European Union rejected its application for full membership in 1989. The compromise of a Customs Union, launched on January 1, 1996, "gives the Turks closer economic relations with the EU than any other nonmember countries except Iceland and Norway." (Yesilada, 1998: 182-183) In exchange for opening up its markets to Europe, it receives substantial economic assistance as well as full access to European markets including "reciprocal concessions" on agricultural products. To stem the potential waves of "boat people" and other illegal immigrants from the countries of the Southern Mediterranean Basin, the European Community meeting in Barcelona launched a Partnership Initiative in November 1995 calling upon them to join in building a free trade zone (for non-agricultural products) by 2010. The EC supported its Barcelona Declaration with a budgetary commitment over four years (1996-99) of ECU 4.7 billion in grants to finance projects preparing for free trade as well as for other developmental objectives. The European Investment Bank, though primarily conceived to finance Eastern European development, was to commit an equivalent amount in loans.

Europe's new concern with its "Mexico" thus promises some additional public funds to the region. Participation agreements, already signed with Tunisia (17 July1995), Morocco (26 Feb 1996), Turkey ( ), and Israel ( ), and currently being negotiated with Algeria, Egypt, Jordan, and Lebanon, give financial incentives for structural reform. The rapid reformers are supposed to receive greater shares of the allocated funds than the more recalcitrant countries, so EC support does not offer resources for delaying reform, as traditional strategic rents did. The funds, however, are limited and depend upon MENA countries surrendering their preferential access to the EC’s agricultural markets, while allowing the EC free access to all of their markets. They are also predicated on the recipient countries carrying out structural reforms to become more competitive and better able to face the new international competition accelerated by the successful completion of the Uruguayan Round. But this competition is going to be very intense. The Multifiber Agreement, for example, which prior to the Uruguay Round had protected Europe against cheap Asian textile imports, had simultaneously guaranteed access to its traditional North African and Turkish sourcing. The Barcelona Declaration will not provide much buffer for Europe's "Mexico" from some of the most destabilizing effects of the free trade agreements already negotiated multilaterally under the Uruguay Round.

The funding is not particularly generous because MENA is less of a European priority than Eastern Europe and Russia and because the EC is not in a financial position to replace declining American aid commitments to the region. Much of the promised ECU 4.7 billion is to go over the four year period to other states in the region as well as the Maghrib, but the total amounts only to as much foreign exchange as Algerians, Moroccans and Tunisia’s working in Europe to provide each year to their families back home.

Remittances from the region’s guest workers in Europe and in the GCC countries are in fact the only external MENA resource that appears, at least for some countries, to be keeping up with inflation. The biggest recipients are Egypt, Turkey, and probably Algeria also, in fact. Despite fears in the early 1980s that decreasing oil revenues would diminish the chances of Egyptians for lucrative employment in the Gulf states, remittances held roughly steady until the mid-1990s. Table 2-3 shows that they increased dramatically after Egypt's participation with the Saudis and Kuwaitis in the coalition against Iraq earned Egyptians more jobs in Saudi Arabia. But they then tapered off, whereas Turkish remittances have weathered recessions in Europe and kept pace with inflation. Algeria has twice as many guest workers as Morocco’s, located mainly in France, but their remittances are largely unrecorded, moving through informal channels. Some of the other Arab states were more vulnerable than Egypt to declines in oil revenues, war, and local politics, such as the official Kuwaiti perception that their Palestinian guests had betrayed them during Iraq's occupation. But Jordan, most affected by the expulsion of the Palestinians from Kuwait in 1991, was receiving more remittances in 1992 than in 1989, the year before the Iraqi invasion. Yemen was another loser in the war. The Saudis expelled at least 750,000 Yemenites in 1990 because their home government had tried to be neutral. Yet the remittances declined only by one-third and subsequently held steady.

Remittances act like strategic rents by cushioning the region from the full effects of globalization. Exposed to European labor conditions or to generous pay scales in the Gulf oil states, guest workers have acquired expectations that their home economies can not match. In much of the MENA Arab labor is priced out of competitive international markets. Its skills, motivation, and productivity do not keep up with nominal wages, making the MENA's real costs of labor uncompetitive comparatively high by the standards of the developing world. Confined to unskilled tasks in industrial economies, or to their protected labor markets at home, workers have little incentive to improve their skills. As noted in chapter 1, the MENA seems to be declining relative to other developing countries on the Human Development Index. This index measures education, longevity, and literacy as well as per capita income, and every MENA country except Israel and Lebanon scores lower than per capita income averages would predict. Further analysis shows that only Israel, Jordan, Lebanon, and Turkey score higher in education and literacy than income would predict. The safety valve of labor migration for Algeria, Egypt, Morocco, and Tunisia thus probably saps efforts to improve labor competitiveness -- in a region otherwise characterized by an abundance of cheap labor that should normally benefit from expansions of world trade (Stolper - Rogowski). The region confronts the challenge of reducing dependence on foreign labor markets before recessions, wars, social unrest or substitution of local labor closes them down. Remittance "rents" seem bound, like military and economic aid, to diminish in real terms in coming decades.

Oil rents (back)

The region's other special resource is oil, but international markets have seriously eroded its value since the early 1980s. After the dramatic price rises of 1973-74, the region's political economies, except those of Israel and Turkey, were reoriented to the assumption of high petroleum rents or subsidies from rentier states. The shift in international bargaining power from western multinational oil companies to the Organization of Petroleum Exporting Countries (OPEC) lasted barely a decade, however. By 1983 OPEC was no longer able to set the price for internationally traded crude petroleum because, once supply overtook demand, it could not control the output of its member states. The industrial consumer states had meanwhile not only implemented successful conservation policies but also gained access to new supplies developed by the multinationals outside OPEC territories. OPEC lost market share in the 1980s without being able to reduce its production sufficiently to keep prices up, and the more market share it lost, the less control it might have in future efforts to protect prices by reducing production. By 1998 the Arab members of OPEC and Iran were producing only 34.1 per cent of the world's crude oil production although they shared about 68 per cent of its proven reserves (BP Statistics). Total revenues accruing to these states diminished from $250 billion in 1981 (check, complete Table 2-1) to about $120 billion in 1998.

In effect international market forces and security considerations restrict MENA production despite the fact that its costs of production (under $2 per barrel in much of the Persian Gulf) are much lower than in other parts of the world. Prices need to be above $12 to $14 per barrel to meet marginal costs of production in the more expensive regions; otherwise the MENA will gain in market share and its potential ability to raise prices. Possibly the special Saudi-American relationship contributed to price stability in the past, but Saudi Arabia, with less than 13 per cent of the world's production, no longer seems able or willing to be the swing producer, unilaterally setting prices by increasing or decreasing the supply. In March 1998 Mexico, not a member of OPEC, agreed with Saudi Arabia and Venezuela to reduce their collective production in a desperate effort to halt sliding prices from being pulled down further by Asia's financial turmoil and expected resumptions of Iraqi oil deliveries. Their commitment was contingent on other oil producing states following their lead, and prices remained low until a further agreement in March 1999 jacked up prices to $20 per barrel later in the year. The prospects for any further recovery of the MENA's oil rents, however, are not promising--at least not short of some major catastrophe shutting down either Saudi Arabia or at least two other major producers in the region. After Iraq's invasion of Kuwait in August 1990 both countries had been shut out of international oil markets, yet Iran and Saudi Arabia made up the deficits in production with relatively little rise in prices for consumers. In 1998 Iraqi production permitted under Security Council regulations averaged over 2 million barrels/day, approaching prewar levels.

International oil prices in turn dramatically affect the budgets as well as international trade balances of Algeria, Kuwait, Saudi Arabia, and other oil producing states. Algeria’s oil and gas revenues, for instance, constitute 97% of the country's export earnings and about 60% of the government’s revenues. Feld and MacIntyre (1998) report that "every $1/bbl drop in the price of Algerian Saharan blend results in a $560 million/year revenue loss (around 4.3% of normal export levels, 2.6% of the country's budget, and 0.8% of gross domestic product. The impact of lower oil prices on Saudi Arabia's fiscal balance is even greater because the export earnings constitute about 75% of government revenues. For every dollar decrease in the price of a barrel of crude oil, the Saudi budget deficit increases by over 1 % of GDP. But even in the smaller MENA producers oil and gas constitute vital elements in their small baskets of exports. During the decade of the 1990s such exports accounted annually for almost two thirds and about half of Syria’s and Egypt’s merchandise exports, respectively. Table 2-4 presents the oil revenues of MENA's small as well as large producers, coupled with estimates of their respective shares of export earnings and government revenues in 1997 (Page 1999:64)

Trade (back)

The specter of declining oil rents is already reverberating throughout the region, affecting not only the budgets of the oil producers, but also the job security of many other Arab nationals employed in the Gulf. Apart from the petroleum sector and its petrochemical derivatives, the MENA apparently has little to offer the world economy. Mineral fuels constitute two-thirds of the region's exports. Its ratio of trade to GDP, a conventional measure of the degree of integration of a country or region into the world economy, is relatively high, but much of it is in exchanges of a single raw material for food and manufactured products. Better measures of integration into the world economy are the respective economies' openness to trade and the degree to which the trade is tied to international production processes. Its terms of trade, primarily reflecting crude oil prices, are 15 times more volatile than those of developing countries as a group (Mohammed A. El-Erian, "Middle Eastern Economies' External Environment what Lies Ahead?" Middle East Policy 53 (March 1996), 141). As noted in chapter 1, the region is not keeping up with the explosion of world trade driven by globalized production. However, when the diminishing oil revenues are removed from the region's total exports, per capita exports show modest increases in the 1990s, reflecting successes of the early adjuster states discussed further in chapter 3 (see Table 3-1).

The conclusion in 1994 of the Uruguay Round of multilateral tariff reductions has further accelerated the expansion of trade for the developing as well as the industrialized nations of the world. It also eliminates special treatment, however, accorded by industrial countries to their favored former dependencies, as permitted under previous GATT agreements. With the exception of the GCC countries, most MENA countries have benefited from a variety of special trade relationships with the EC, the United States, and Japan, and liberalized trade now threatens their traditional export markets. The European Union's Barcelona Declaration is in part as an attempted to alleviate the MENA's losses of special trading privileges. To benefit fully from participation agreements with the European Community, the Southern Mediterranean Basin countries are required to open themselves to further trade in non-agricultural products. The early adjusters, Israel, Morocco, and Tunisia, have also been the first to undertake the necessary commitments.

The region hesitates, however, to take advantage of the full range new trading opportunities offered by the Uruguay Round and by the EC. While the trade regimes of the Gulf Cooperation Council states are relatively liberal, most of the others in the region maintain high tariff barriers. Egypt, Israel, Morocco, Tunisia, Turkey, and some of the GCC states joined the World Trade Organization, but the applications of Algeria, Jordan, and Saudi Arabia were still pending in 1999, and Iran applied only for observer status. Iraq, Lebanon, Syria, and Yemen have not applied for any WTO status. Algeria, Egypt, and Jordan are negotiating participation agreements with the EC, whereas Lebanon apparently awaits a Syrian green light for both of them to negotiate their agreements.

With the exceptions of Israel, Turkey, and the GCC countries, even early entrants into the WTO have retained high tariff barriers (see chapter 3). Despite being the first Arab state to sign an agreement with the EU and to join WTO, Tunisia’s average tariffs remain higher than the others. Cutting tariffs poses special problems for some of the smaller countries, such as Lebanon, which heavily relies upon customs revenues to finance government expenditures. And it is far from clear to most of these countries whether the benefits of free trade really do outweigh the costs as the IMF and the World Bank claim. Much of the MENA has very few obvious competitive advantages outside the petroleum sector. More free trade will endanger their exports in the short run, regardless of their policy responses. Free trade is also a threat to indigenous manufacturers servicing presently protected local markets. In Egypt, for example, the once export-oriented textile industry is now not only uncompetitive on international markets, but is capable of servicing local markets only because they are protected by high tariffs and an overvalued currency. Significant reduction of tariffs and a devaluation of the Egyptian pound would result in a flood of Asian textiles swamping local markets, presumably driving many private producers out of business and causing the government either to increase its already burdensome support for public sector textile manufacturers, or to let them go to the wall.

Any prospective benefits of MENA countries from free trade depend in part on the degree to which they are already engaged in intra-industry trade (IIT), in other words the percentage of their total industrial imports and exports that are specialized within given industrial sectors. This IIT index tends to be much lower for the Arab countries than for the members of the European Community. With the exceptions of Oman and Tunisia, Arab countries score lower than their per capita income predicts, either because their trade regimes are more restrictive than the global norm or because their industrial structures (in the oil states) are relatively underdeveloped for their income. Controlling for per capita income, their respective IIT indices were substantially lower than a sample of Asian countries, but they were not appreciably lower than the Latin Americans. Table 2-5 indicates, however, that Egypt, Jordan, and Morocco, as well as Tunisia, have substantially increased their IIT since the mid-1980s and are catching up with Turkey, even as Turkey and Israel forge ahead. (Oman’s score is inflated by the reexport of tobacco and other products.) A disaggregated view of the Arab countries' IIT indices also shows substantial increases since the mid-1980s in certain manufacturing categories. In particular certain chemical products, soaps, plastics, electrical distributing machines, ships and boats, aluminum, lead, leather, clothing, and footwear were all sectors with average Arab IIT indices of 50% or more. In theory these and a number of other sectors could benefit from greater trade liberalization. Economic analysts conclude that "the high levels of IIT in so many 3-digit SITC products suggests that the degree of specialization attained enables Arab countries to be competitive in a world market setting." (Oleh Havrylyshyn and Peter Kunzel, 1997:21) The Arab countries' IIT indices tend also to be greater for the ten per cent of goods traded among each other than for their trade with the rest of the world. A further liberalization of intra-Arab trade could therefore enhance the international competitiveness of their respective industrial bases.

The liberalization of trade in services was also included in the Uruguay Round, but the MENA countries shied away in the multilateral negotiations from making voluntary commitments. Algeria, Bahrain, Egypt, Israel, Kuwait, Morocco, Tunisia, and Turkey joined the General Agreement on Trade in Services (GATS), and others have applied, but, of the Arab states, only Lebanon is preparing in its negotiations with the EC to liberalize services without referring to GATS' protective clauses. Further liberalization could enhance the region's services and be of special benefit to countries where tourism is important.

Nevertheless, the prescription promoted by the Washington Consensus (and the European Community) of removing or even gradually diminishing trade barriers, whether in goods or services, is threatening to most of the MENA countries, especially to those with the highest barriers and the lowest IIT percentages. Even the wealthy GCC oil exporters, with relatively liberal trade regimes, need to develop more competitive export capacity outside the petroleum sector, now that the oil rents appear to be stagnating for the foreseeable future. How well the MENA countries succeed in becoming more competitive - raising their IIT indices -- will depend in part upon the trade liberalization measures they adopt, but also, as the IMF and the World Bank advise, by complementary fiscal and other macroeconomic and regulatory reforms. Their major related challenge is to attract foreign contributions to the necessary investments in industrial development and renovation and related infrastructure. The specter of low oil prices inclines even wealthy Saudi Arabia to consider incorporating private foreign capital into its long range investment plans to increase oil production capacity.

Capital flows (back)

To become more competitive, the MENA needs to be more integrated into global financial markets. Major changes in financial flows to developing countries became apparent in the 1990s. Official public sector assistance to developing countries, fuelled by the Cold War, tapered off whereas the private flows of capital became almost indiscriminate torrents in search of emerging markets, at least until the 1997 Asian crises. Table 2-6 summarizes the major sources of capital into the developing world from 1990 to 1997.

Official Development Assistance (ODA) is clearly stagnating and being replaced by the private sector in a total pie which increased almost four-fold during these years to just under $340 billion. Total private capital flows to low and middle-income countries increased from $41.9 billion to almost $286 billion. The biggest source was foreign direct investment, but portfolio investments in bonds and equities soared from $3.2 billion to $68.8 billion, easily exceeding all forms of public assistance. Commercial bank lending and trade financing increased, too, but not by as much as other forms of financing. The banks’ share of private capital flows declined from 36 to 20 per cent during this period.

Yet the MENA region is in large part denied access to these capital markets. As the deputy director of the IMF's Middle Eastern Department observed, "the region has attracted a disproportionately small share of recent international equity flows to developing countries...and the total flow of private capital (i.e. equity, bond and foreign direct investment) to the region has only been about 2 percent of that going to developing countries." (El-Erian 1996, 141) Table 2-6 shows how poorly the MENA region (without Turkey) fared in 1997, compared to other regions competing for private capital.

The region fares poorly in part because its trade barriers and other obstacles have discouraged multinationals from investing. Judging from the low IIT indices, there is comparatively little intra-multinational trading with MENA countries , despite the fact that a full third of all merchandise trade is conducted between affiliates of multinational firms (Sachs). Such trade forms a vital part of global production chains, in which MNCs assign specialized tasks in the production of individual commodities to different countries in order to minimize costs. The low IIT indices for the MENA indicate that for the most part MNCs have yet to locate there even single links of their production chains. Investment outside the petroleum and related sectors remains very limited, in part because before the mid 1980s most countries in the region did not need to attract foreign capital. Until the Gulf states' finances were squeezed by declining oil revenues, most of them could count on generous public or private investment flows from these Arab sources. Including workers' remittances, the Gulf states provided $140 billion to other Arab countries between 1973 and 1989 (see Pierre van den Boogaerde, Financial Assistance from Arab Countries and Arab Regional Institutions, IMF, Sept 1991, p. 76), of which over $50 billion constituted official assistance (p72). Extra rents enabled many of them, including Egypt, Jordan, and Syria as well as the wealthy investors, to postpone internal reforms toward more market-oriented economies friendly to foreign investors. Even legislation designed, as in Tunisia, to attract foreign investment is often cumbersome, limited to certain sectors, or excluding certain "strategic" ones and requiring too many official permits and perhaps other favors as well. However, other factors also discourage foreign investors. Political factors will be examined more fully in chapter 3, but one of them deserves special mention here: the illiberal, "information-shy" character of most of the incumbent regimes. Investors have information needs that information-shy regimes restrict in a number of ways. In efforts to control all politically related information, they often make it difficult for economic news to be properly disseminated. Moreover, their banking systems, many of them largely state-owned, further constrict the free flow of economic information. The "German" or "French" state capitalism prevailing in much of the region is inimical to the development of stock markets, yet portfolio equity is one of the principal sources of capital in the financial integrated markets of the new world order.

Information needs for attracting private capital understandably vary, depending upon the type of financial flow, whether it be international bank lending, bond issues, foreign direct investment, or portfolio investment in local stock markets. International bankers have the least need of publicly available information. They have their own confidential sources, such as their clients, other banks, local government officials, in-house country risk analysts, teams of external consultants, and expensive country risk publications. Commercial banks used to be the principal source of private capital flows to developing countries, and they carry the fewest potential ripple effects on the political structures of borrowing countries. Although they supported IMF and World Bank policies of economic adjustment crafted in the interests of the creditors in the 1980s, their direct impact upon host political structures is minimal and the net effect of their loans may have been to delay needed reforms. International bankers prudently avoid any appearance of involvement in host country politics, and governments can rely on their discretion. But unfortunately for information-shy regimes, traditional commercial bank lending is giving away to more open capital markets which require greater transparency if they are to function properly. All three of these expanding streams of private capital require more publicly available information than the commercial banks or foreign aid donors. Portfolio investors and managers are particularly demanding, and probably more so in the wake of the collapse of "emerging markets" in Southeast Asia in 1997. Demands for public information and signals are potentially more troubling and politically destabilizing for information-shy regimes than are the discrete private queries of international bankers or public donors.

While bondholders will be less demanding than shareholders or certain kinds of direct investors, their requirements may still disturb some information-shy regimes. Investors in bonds are principally concerned with the macro-economic stability of the country issuing or guaranteeing the bond. One sign of future long-term stability and prudent macro-economic policies of interest to bondholders may be the independence of a country's central bank (Sylvia Maxfield 1997: 35-37). Just how much central bank independence can be tolerated in most MENA countries, however, is a moot point. Any real independence -- and greater transparency of the country's commercial banking system -- may expose sensitive political patronage networks, yet international managers of bond portfolios may insist on greater openness, especially in light of recent experiences with the Thai, Indonesian, and other Asian banking systems. Information requirements are less demanding than for attracting portfolio investment in local stock markets, however, and some countries, like Tunisia, have recently raised substantial funds on the Japanese and Eurobond markets.

Portfolio investment in local stock markets is more problematic. In addition to macroeconomic stability, required as a protection against foreign exchange risk, portfolio investors in equities seek active, relatively liquid local markets, displaying a wide variety of traded companies. As Table 2-6 indicates, the region was making some progress by 1997, when it attracted 7.8 per cent of the investment in "emerging" stock markets. With Turkey, the region’s share approached 10 per cent. Foreign direct investment is the biggest source of capital for developing countries, however, and the rest of the region’s share of it plummeted from 11.6 to about 3.3 per cent. Table 2-7 analyzes the cumulative net flows of capital into the region from 1993 to 1997 by country, including Turkey, and type of resource. The biggest winners of FDI were Israel, Turkey, Egypt, Morocco, and Tunisia, but Syria and Iran also attracted some investment in their petroleum industries.

With the exception of the energy sector, multinationals are deterred from investing because of trade and other restrictions, but also for lack of transparent economic information. And some of the most visible foreign presences are not FDI in manufacturing industries, which would increase the IIT indices of MENA countries so that they might better compete in world markets, but rather projects, like fast food chains, aimed at local consumers. MENA seems to be hosting its fair share of MacDonalds and Kentucky Fried Chicken, but these franchises do not amount to much, if any, foreign direct investment. Rather, they represent a reverse flow of capital to corporate headquarters from the local investors who buy the franchises.

Just as the MENA is only partially integrated into global trade networks, its financial systems remain relatively insulated from international capital markets. Following IMF interventions in the 1980s to alleviate their unsustainable international debt burdens, many of them underwent some structural adjustment funded by the World Bank. Turkey and Tunisia led the way in the mid-1980s in reforming their respective commercial banking sectors, joined in the early 1990s by Egypt, Jordan, and Morocco. There are limits to the amount of reform some of them could undertake, however, without endangering their political regimes. Turkish financial structural adjustment, for example, stumbled in 1988 over the fate of Ziraat Bankasi, the state's huge agricultural bank and extension service, a very important dispenser of patronage at election time. The Washington Consensus favors competitive financial markets and privatization wherever possible, but the governments of Turkey, Tunisia, and Egypt prefer to maintain big state banks and, through them, informal controls over the others. Credit allocation lies at the heart of most patronage systems and hence finance is a "strategic" sector that cannot be fully opened to international inspection.

Yet given their adverse trade balances, deteriorating oil revenues, and limited prospects for official development assistance, most of the region, including the wealthy oil states, is in need increasing its external financing. The alternative to a further opening of MENA's capital markets to the rest of the world is increased debt. For countries with favorable risk ratings for their sovereign long-term debt, issuing sovereign bonds is a relatively inexpensive means of attracting portfolio capital. As of November 1996 Bahrain, Oman, and Tunisia were "investment grade," and Tunisia took advantage of its Baa3 rating to issue sovereign bonds in 1995 at only 162 basis points above LIBOR. Lebanon, rated neither by Moody's nor Standard and Poor's (WDI T5.9), paid 320 basis points for its sovereign bond issue that year, and Turkey, which had slipped down the scale to the speculative grade of Ba3, had to pay 297 basis points above LIBOR (GDF T5_4). Sovereign bonds are cheaper than traditional forms of lending but prices depend upon the judgments of the rating agencies, the "new superpowers," as one Lebanese economist complained (Ibrahim Warde, Rating Agenciesthre New Superpowers? at http//www.idrel.com.lb/idrel/sufimafi/archives/docs/iwarde1.htm)

 

For countries unwilling, like Saudi Arabia, or unable to issue sovereign bonds at reasonable costs, the alternative to opening themselves to international capital markets is increased reliance on those traditional forms of borrowing that require less transparent economies. Much of the region, except the wealthy oil producers, has been under the tutelage of international financial institutions since the mid-1980s, and the region has, as a result, lightened its international debt service requirements. One of the largest debtors, Egypt, was also aided considerably as a result of joining the coalition in 1990 against Iraq. Many of its official creditors forgave substantial portions of its outstanding long-term debt, thus lowering its debt service requirements and even enabling the local currency to appreciate, a process further encouraged by high interest rates paid on local currency deposits. The Egyptian experience illustrates major benefits of debt relief for developing countries but, conversely, it offers a warning of the adverse effects to a country's competitive position of a big international debt overhang.

 

Egypt and many other countries in the region carried heavy debt servicing requirements in the 1980s. For the most part, their situations have improved, and the region's debt service ratios to GDP and to exports of goods and services remain substantially lower than Latin America's and only barely exceeded those of East Asia. Table 2-8 compares their debt service to exports ratio with an illustrative sample of other developing countries. It can be seen that only Algeria and Morocco ever traversed the 40 per cent line, and they were still paying back the banks over 30 per cent of their export revenues. Turkey is almost as heavily burdened, while Egypt and Tunisia were paying back 15 and 17 per cent of their respective export earnings in 199x. These countries, together with Jordan and Lebanon, might afford heavier debt burdens, but then they would risk losing the benefits of relatively strong domestic currencies, such as lower inflation rates. With a debt service ratio of only 5 per cent, Syria also appears capable of bearing a heavier load of international debt, but its total external debt amounted to 134.8 per cent of GDP in 1995. It benefited from bilateral concessional loans, presumably from Saudi Arabia, Kuwait and the United Arab Emirates. Syria had also been the largest beneficiary of official assistance from the Gulf states. From 1973 to 1989 it received grants totalling $12.3 billion, $3 billion more than Egypt (Pierre van den Boogaerde, Financial Assistance from Arab Countries and Arab Regional Institutions, IMF, Sept 1991, p. 72). With the shrinkage of their oil revenues, however, these countries no longer appeared to be offering their northern neighbors much aid, whether as grants or subsidized loans.

Governments in need of external as well as domestic resources may borrow them on local markets if they are ready to pay high interest rates to prop up their local currencies. One extreme case is Lebanon. By 1998 its domestic debt amounted to 95 per cent of GDP or more, depending on conflicting estimates of GDP. Treasury bills, bought mainly by the commercial banks, constituted over 80 per cent of the domestic debt (BDL Quarterly Bulletin 74 3rd qu 1997,p 15), yet the government deficit of over 50 per cent of revenues closely reflected the servicing of the national debt and shows no signs of diminishing. The government preferred to increase its external indebtedness because interest rates were lower. The prime minister also remained committed to a strong Lebanese pound, one indeed which like Egypt's was pegged to the dollar despite higher local inflation rates. The inflation rate and government deficit, met by printing more money, put considerable pressure on the pound. Kuwait, Saudi Arabia, and the United Arab Emirates temporarily rescued Lebanon in late 1997 and early 1998 by depositing hundreds of millions of dollars at the Banque du Liban, Lebanon's central bank. A number of governments in the region would risk being caught in similar debt traps if they borrowed more. Table 2-9 indicates that the governments of Jordan and Israel are almost as highly indebted as Lebanon. (check Saudi monetary authority data) With substantial external as well as internal indebtedness they have limited financial options and depend upon strategic rents from the United States. Egypt has also significantly increased its domestic debt in the wake of the write-off of much of its external debt, but the exact magnitude of that increase is a contentious issue. The Central Bank claimed in early 1999 that total governmental domestic debt was LE135 billion, whereas other sources put the figure at LE200 billion. This raises the question of whether part of the attractiveness to Egypt and other countries of substituting domestic for foreign debt is the lack of transparency surrounding internal transactions. Another possible attraction is that the comparatively high interest rates paid for treasury bills and bonds denominated in local currencies guarantee the nominal profitability of public sector banks that in Egypt, for example, purchase virtually the entirety of such offerings. In Lebanon such loans account for well over half the portfolios of the private sector banks owned in part by former Prime Minister Hariri, so in this case, and maybe others, domestic borrowings guarantee profits for those in the government responsible for managing the state’s finances.

Most MENA countries are not as heavily indebted both internally and externally as Israel and Jordan. Table 2-9 shows that only Sudan was carrying more external debt to GNP than Jordan in 1997. The others still have some margin for manoeuvre and, while awaiting more foreign investment, could take on more debt, either by issuing bonds or by directly borrowing in traditional fashion from the big international banks. But more debt could also jeopardize their competitiveness and hence their attractiveness to global capital, which may be one of the reasons why domestic debt figures are surrounded by considerable ambiguity as MENA governments seek to conceal the real magnitude of domestic borrowings. When external and domestic debt reach substantial proportions, even when much of the domestic debt is to the private sector rather than to government owned banks, further increases risk either being inflationary, putting pressure on foreign exchange rates, or crowding out private enterprises to the detriment of economic growth. Despite their diminishing debt service ratios, for example, Egypt and Tunisia still had external debts in 1995 of respectively 73 and 57 per cent of GDP, and their outstanding domestic credit amounted to 104 and 71 per cent of GDP. Algeria, Morocco and Turkey carried heavier debt servicing obligations of their external debt and were also trying to limit their domestic government borrowing. Most governments in the region, which generally account for a far larger share of total borrowings than the private sectors of their economies, are trying to reduce their fiscal deficits and borrowing needs, but often with great difficulty.

With many unhappy experiences of international debt in the recent past -- and some histories of losses of financial autonomy or outright colonization in the nineteenth century -- many countries prefer to find less costly capital either in the form of foreign direct investment or portfolio investment into their local stock markets. Even Algeria and Palestine have established stock exchanges. The mainstream of the Palestine Liberation Organization traditionally favored a liberal economy and had anticipated the experience of self-rule in freewheeling Lebanon. Once it was transformed into the Palestinian Authority as a result of the Oslo Accords of 1993, however, the political imperative to generate patronage for the quasi-state structure caused that Authority to take measures highly inimical to the interest of business entrepreneurs. Algeria's initiative, coupled with its efforts since 1991 to encourage foreign direct investment upstream in its petroleum sector, is more surprising. That this former socialist "revolutionary" state should do so is a tribute to the widespread if still abstract and hesitating acceptance of the new global economy in the region. But translating such acceptance at the verbal, theoretical level into actual practice provides a challenge that all are finding difficult to meet.

Virtually all the MENA countries have stock markets and new laws to attract foreign investment. They hesitate, however, to implement the reforms that might allow them, as the "serious economists" of the Washington Consensus intimate, to take full advantage of the emerging global economy. Globalization, which offers numerous advantages to them, also poses very substantial threats. It implies reduced international public assistance, reduced oil revenues, and even reduced arms subsidies. It means opening most domestic markets to foreign competition that is usually better equipped in skills, capital, and marketing power than the local producers. Just as European imports in the nineteenth and early twentieth centuries had destroyed much of the MENA’s handicraft industries, so a new wave of competition could annihilate years of independent state capitalist development in much of the region, including Israel. The economists advise these governments to privatize their SOEs in order to stop the haemorrhaging of public funds subsidizing their losses and, more generally, to make their economies more competitive in tradeable goods. Tourism is also encouraged, the way already prepared by colonial town planners who conserved the "traditional" medina or kasbah for future generations.

Even the GCC states feel the pinch of the global economy, not so much because of low oil prices as because their small populations are growing and seek employment. Declining oil revenues discourage governments, the traditional fountainhead of employment in the Gulf as elsewhere in the Arab world, from more overstaffing. Instead, the governments require their private sectors to hire indigenous staff and limit the employment of expatriates, including other Arabs. Private sectors prefer, however, to limit local hires, viewed generally as less efficient and more expensive than expatriates from Asia. The wealthy Gulf states suffer internal forms of colonialism that more indigenous employment may alleviate in the long run. In the short run their private sectors face reduced efficiency and possible declines in their modest manufacturing capabilities if they hire nationals. So, for example, textile plants that have been established in the lower Gulf and which employ Asian labor almost exclusively, would be forced to close their doors if they had to hire local Arab labor.

The employment situations of the GCC countries amplify the general problem alluded to earlier that faces the region, which is overpaid and undermotivated or underskilled labor, protected by government regulations. Unemployment is higher in the MENA than in other regions of the world, averaging about 15 per cent, but reaching about half of the labor force in some of the worst performers, including Algeria. Better paid and protected workers tend to be clustered in the state-owned enterprises. It is as difficult for governments to privatize them as for the Gulf states to convince their private sectors to hire nationals. Whether in the Gulf or elsewhere, private sectors are reluctant to hire nationals without appropriate qualifications, lest they lose whatever competitive edge they might enjoy. The way out of the employment dilemma involves a combination of short term policy changes, such as reversing progressive labor legislation that benefits relatively small proportions of workers, and long term development strategies, such as reform of the educational systems that fail adequately to educate or even train their graduates. But the short term policy changes are politically problematical and the long term developments will not impact the present generation and are themselves dependent upon policy changes that most governments find difficult to make.

Globalization, in sum, is becoming associated with new forms of cultural confrontation reminiscent of the colonial dialectic. From Casablanca to Tehran, from Istanbul to Riyad, the MENA has already moved into the global economy at least at an abstract level. They all have their stock markets, imported (or locally assembled) cars, cosmetics, and other western consumer items, and they are developing manufacturing capabilities that may in time and in part withstand global competition. Except in Iraq and Syria they also have their Internet service providers and in Israel, Turkey, and some GCC states, the use of the Internet and is widespread as is access to other forms of global electronic communication. In other Arab countries the new users tend to be upper middle class, often with university degrees in science or technology, and associated at least indirectly with local capitalists and high government officials. These are the potential beneficiaries of globalization, sufficiently nimble and polyglot to find niches of comparative advantage in the information age. Certain of the local capitalists and the high government officials can also find their way in the new world order. But the Anglo-American form of capitalism connoted by the stock market is not congruent with their established state capitalist traditions. Governments hesitate to unlock their economic secrets, much less open their protected industries and labor markets to international or internal competition and thereby provoke opposition.

The strategies of incumbent regimes in the region vary considerably with respect to their will and capacity to engage in the reform process. As will be discussed in the next chapter, political considerations take precedence over economic priorities. The early adjusters, despite their cultivated images of openness to the world economy, can not engage as radically in the reform process as the World Bank recommends without risking major domestic backlashes and/or the prospects of the steady decline of state-controlled resources that underpin the rule of incumbent elites. Even the apparent globalizers in local business communities tend to advocate liberalization for others while trying to protect their own market niches and special privileges. Yet international markets supported and oriented by the industrial powers continue to reshape trade and financial markets in ways that oblige even the most recalcitrant regimes in the region to respond positively, or to face ever bleaker economic prospects.

 

References (back)

Feld, Lowell, and Douglas MacIntyre, "OPEC nations grappling with plunge in oil export revenues," Oil and Gas Journal, Sept 21, 1998, pp. 29-35.

Oleh Havrylyshyn and Peter Kunzel, "Intra-Industry Trade of Arab Countries: An Indicator of Potential Competitiveness," IMF WP/97/47

Page, John, "The Impact of Lower Prices on the Economies of Gulf States," Middle East Policy 6:4 (June 1999), pp. 59-67.

Yesilada, Birol, "The Mediterranean Challenge," in John Redmond and Glenda G. Rosenthal, eds., The Expanding European UnionPast, Present, and Future, Boulder CO: Lynne Rienner, 1998, pp. 177-193