NS4053 Spring Term 2017 Cammett: Chapter 2 Economic Performance and Social Outcomes

NS4053Spring Term 2017Cammett: Chapter 2Economic Performance and Social Outcomes

Overview I • Demographic Overview • In 2010 population of the MENA region 507 million • Eight percent of the population of all developing countries • Three countries in region • Turkey • Iran and • Egypt • Have populations exceeding 70 million • Also eleven countries in region with populations less than 10 million • Seven countries (Algeria, Morocco, Iraq, Saudi Arabia, Sudan, Syria, and Yemen) populations between 20 and 40 million

Overview II • Now more than four times as many people in MENA as there were in the 1950s • Region’s population growing at 2.2% per annum • Means it will double in 32 years • Within just three generations, the region’s population will have increased twelvefold. • Only the population of sub-Saharan Africa is growing more rapidly • Because of the rate of population growth most of the people in the region are young – one half under 24 • Large and growing percentage live in cities

Overview III • Income Overview • In 2010 the region’s GDP was $3.5 trillion – slightly more than Germany’s • Countries in the resource-rich-labor poor (RRLP) group had the largest GDP – about size of Mexico’s GDP • The resource rich labor abundant (RRLA) about the size of Malaysia and Thailand combined) • Resource –poor labor abundant (RPLA) about the size of Iran • Turkey ($730 billion) has the highest GDP in the region • Next Saudi Arabia ($527 billion) • MENA has huge diversity in per capita income – more than any other major region

Measurement Issues I • Economic growth and size usually measured by gross domestic product GDP • Reflects the output and income of a country • Several criticisms • For countries that sell oil – just selling off an asset, so not sustainable • Measurement problems go beyond negative environmental externalities – informal economy • Use of official exchange rate undervalues services and gives a measure lower than the true size of the economy • GDP per capita offers no evidence on distribution or happiness – often hard to infer increased GDP equates to increasing social welfare

Measurement Issues II • Other GDP Issues • Data often poor quality • Base year problem

Patterns of Long-Term Growth I • Region’s growth 1960-2010 fairly average by world standards • Growth averaged 4.9% per year • Higher than average for middle income countries (4.7%) • Also more than low income country average (3.4%) • However much lower than East Asia (7.3%) • However several reasons why growth performance much less positive • High population growth means per capita growth not that high • Economic performance varies significantly across countries • High variability in growth patterns

Patterns of Long-Term Growth II • In terms of differential rates of growth • RRLP did the best at 5.6% per annum • Fastest of any region except East Asia • Not surprising because of oil • RPLA group comes in second at 5.26% • Around the middle income average • RRLA rich in oil and people comes in distant third at 4.4% per annum • Group seems to have been hit the hardest by the oil curse • Countries in this group athat were once believed to have the greatest potential (Iraq, Iran, Algeria) got mired in internal and external conflicts • Syria has now entered this phase

Patterns of Long-Term Growth III • Variability of growth stems from • Dependence on volatile oil revenues • Effects of structural adjustment period in the 1980s • Two effects interacted in several ways • Oil prices two main periods of boom – 1973-79 and 1998-2014 • 1980s and parts of 1990s were marked by collapse of oil prices which forced policy adjustments and lower growth • Oil importers benefited from high oil prices even though they had to pay more for imported oil • Labor remittances and aid from oil producers went up and down with oil prices

Economic Rent I • Issue of Economic Rent • Rent is difference between market price of a good or factor of production and its opportunity cost • Owners of certain assets or providers of certain services enjoy strategic position in markets that allow them to set prices above opportunity costs • When oil prices quadrupled in 1970s new market price reflected neither increases in cost of production or new investment

Economic Rent II • Host of ills attributed to rents. Access to rents has • Allowed several states to avoid improving the efficiency with which their economies produce – especially traded goods • Rents have allowed governments to avoid heavily taxing their own citizens • Breaks link between government and the people they tax, out of such links, governmental accountability • External rents not confided to petroleum • Several Middle Eastern countries had access to “strategic rents” during cold war era • Enjoyed a particular geostrategic value and could count on financial flows and aid – Israel, Jordan, Egypt

Economic Rent III • Not all economic rents external • Notion of “rent seeking behavior” – search for strategic privilege in domestic markets • Such privilege usually bestowed by public authorities through issuance of licenses, franchises, protection • When privileged are protected from competition in specific markets products generated without improvements in efficiency • Also called a regulatory rent • Used by governments to strengthen elite coalition when other rents collapse.

Three Phases of Development I • Economic growth in MENA region determined in part by its development strategy • First, a rising period under import substitution and state activism • Ultimately led to economic contradictions • Second, a period of structural adjustment • Decade of low growth • Third – more liberal period focused on export-led growth • Saw larger but still relatively modest growth rates • The three phases were • Determined, • Delayed or • Exacerbated • By the oil cycle

Three Phases of Development II • Import-substitution and State-Led Industrialization Period: The 1960s and 1970s • Early phase of development • Post independence growth in MENA region among highest in the world • In 1960s, 1970s and early 1980s growth increased from relatively low levels in the 1950s • Region benefited from early phase of the state-led development model

Three Phases of Development III • Period was the height of movement that had started in the 1950s with the • Rise of nationalist states and the middle class • Investments in human development and • Dynamic growth policies fashioned on the Tuirkish Attaturk model • Economic growth rapid at 3-4% per capita annually • Reflected high rates of investment as well as increased productivity linked to human cpital • Oil producers did particularly well after the rise in oil prices after 1973 • Significant improvements in quality of life indicators

Import Substitution I • During 1950s sand 1960s import substituting industrialization (ISI) typically led by a highly interventionist state • Logic compelling • ISI designed to move traditional economies to an industrial footing by producing manufactured poducts for the local market • Receive protection before firms have infant industries have to face rigors of international markets • Idea to escape agrarian trap – area of comparative advantage but dead end • As industrialization gathered steam and raised domestic income, new markets would grow and new industries would achieve economies of scale that would make them competitive globally.

Import Substitution II • Process supposed to be cumulative • First industries will produce backward linkages • Stimulates new enterprises in • Capital goods • Basic metals • Machine tools • Turkey was first among Middle East states to pursue and ISI strategy • During the 1930s Turkish state began to launch industries in textiles, cement and basic industries • In Iran Reza Khan was moving in similar direction • With Algeria’s independence in 1962 the strategy was implemented as was the case in Egypt

Import Substitution III • With rare exceptions major states pursed the strategy to varying degrees and with different ideological underpinnings • ISI made good sense for the larger economies with important domestic markets that could sustain large industrial units • Made less sense for the small economies. • Most determined to follow Tukey were • Egypt • Iran • Tunisia • Algeria • Syria • Iraq and • Israel

Import Substitution IV • ISI strategies typically rely on publicly owned enterprises because • Initial investments usually very large and beyond capacity of local entrepreneurial groups • Public enterprises also confer instruments of social control on regimes that are eager to consolidate power • In spite of these efforts ISI experienced widespread setbacks in the Middle East and elsewhere • Stemmed from • Degree of protection granted infant industries and • Proportion of public resources devoted to them at the expense of the agricultural sector

Import Substitution V • Agricultural sectors were taxed to provide investable surplus for the new industries • Foreign exchange earned from agricultural exports went to pay for the technologies, capital. goods and raw materials required by the industrial sector. • When agricultural transfers caused slower agricultural growth, • Rural populations could not generate the demand to keep the new industries operating at full capacity • Idle capacity and production costs rose • Because industries were protected against cheaper imports they had no incentive to keep costs down • Because industries generally capital-intensive did not provide large number of jobs, they were unable to provide jobs for rural workers leaving depressed agricultural sector for urban areas

Import Substitution VI • Net result often high cost production • For domestic markets in which retail prices needed to be subsidized by the government • That could not be exported to pay for the imported raw materials and equipment • Thus the new industries contributed to growing twin deficits – fiscal and balance of payments • Culminated in a series of financial crisis that ended the ISI experiments in the 1970s and early 1980s

Import Substitution VII • Poorer among Arab countries with large rural populations could have adopted a strategy more focused on agricultural sector • Most relevant in 1950s and 1960s when most of region’s population in agriculture • Still applies in countries with sizable arable land • Morocco • Sudan • Yemen • Improving the productivity of land and/or labor could have been a workable way to develop agriculture as a means to industrialize

Import Substitution VIII • Process might create a virtuous circle: • Because of small domestic markets, much of crops would have been exported • As incomes of farmers rose, demand for local industrial goods would increase • Agricultural profits would have financed this initial capital deepening • Leading to a process of self-sustaining growth • Unfortunately reliance on agro-exports commonly associated in the 1950s with colonialism

Import Substitution IX • Period of fast growth in the 1960s could not be sustained • As elsewhere in the world (particularly Latin America) the strategy faltered after an initial period of fast growth • Labor productivity remained low • Region could not take advantage of fast growth in global trade as Asia did • For most of the RPLA countries increase in oil prices after 1973 created major problems • Financed oil imports by borrowing, but in the 1980s ran into debt problems • In countries with abundant oil (Algeria, Iran and Saudi Arabia) oil revenues and external borrowings allowed adjustment to be delayed until the 1990s • But the mid-1980s collapse of oil prices ended ISI in the region

Lost Decade I • Adjustment, the Lost Decades, and Export-Led Growth: The 1980s and the 1990s • First countries to start adjustment were • Morocco and Tunisia • Jordan followed in late 1980s • Egypt and Saudi Arabia began process in 1990s. • Public spending slalshed to reestablish macroeconomic balances • External debts were partially canceled by Western countries and institutions to support adjustment in • Morocco • Egypt and • Jordan

Lost Decade II • Macro-balances were restored over time and economic growth restarted by the mid 1990s • Transition costs were large • They have marked the political economy of the region ever since playing an important role in the genesis of the Arab Spring • Growth fell sharply in the 1980s and even into the 1990s for some countries • Region’s “lost decade” was longer than it was in other areas of the world.

Lost Decade III • Significant differences among MENA countries • In 1980s GDP per capita • -1.0% in the RPLA countries • -6.0 for the RRLA countries (devastation from Iran Iraq War) • -2.0% for the wealthy RRLP countries • Countries also slashed public expenditures, thus weakening the welfare state and reducing social mobility • Most of the region started to move in the direction of export led growth and private initiative • Foreign donor and creditor community pushed for taking this direction • Also belief that the private sector could adjust more rapidly than public sector to reducing costs, improving qulity and competing in external markets

Export-Led Growth I • New development model inspired by success of • South Korea • Taiwan, • India, and • China • Countries that had managed to become the manufacturing hub of the world • Even countries with small domestic markets industrialization could take place by exporting • With time skills developed, physical capital deepened and countries would move up quality ladder and improve their incomes by switching into ever more sophisticated products

Export-Led Growth II • Strategy requirements • Factors production – labor and capital need to be moved from inefficient and uncompetitive sectors that are more efficient and can compete abroad • Washington Consensus – done best by market mechanisms • Trade needs to be liberalized • Public enterprises to be privatized • Financial sector opened up, and • National currencies sharply devalued to encourage exports

Export-Led Growth III • Difficult in region with bad habits from ISI • Governments had to consider constituencies new strategy would alienate, some part of state apparatus itself • Owners and manages of IS industries might try to sabotage new experiment • Could find allies among the workers who risked being laid off as enterprises forced to cut costs • Urban constituents might see a sharp rise in cost of living • Problem – negative effects of new strategy would be felt immediately, but economic pay-off might take years to arrive

Export-Led Growth IV • Despite risks some ME countries moved in direction of export promotion and private enterprise • In late 1960s Morocco and Tunisia negotiated preferential trade agreements with the European Economic Community (forerunner of the EU). • Both hoped to attract light industry from Europe • Accelerated these efforts in mid 1980s but hurt by entry of former Communist countries into the European maket. • Also new competition from China

Export-Led Growth V • For more than three decades Turkey has aspired to full membership in what is now the EU • Trying to restructure economy (after Ataturk’s ISI strategy) to compete in European markets • Process took urgency in 1970s • with oil price increases and • Closing European labor markets to migrant Turkish workers • Export led growth started during turbulent period – • Political instability • Mounting domestic deficits • Balance of payments crisis and • High inflation • Ending in a financial crisis in 2001

Export-Led Growth VI • Emergence of Justice and Development Party (AKP) • Produced a period of macroeconomic stability • Consolidated reforms of the past and • Led to a highly successful export drive for Turkish manufacturers

Export-Led Growth VII • Israel’s economy has always been dependent on aid and trade • Has negotiated preferential trade agreements with EEC and has had great success in • marketing fruits and vegetables in the Europe, and • Later manufactured metal products and high-tech electronics • Equally important is Israel’s major role in international arms trade • Despite these successes, in early 1980s Israel had • Large deficits • High labor costs with limited competitiveness • Largest per-capita debt in the world and • Inflation rate second only to Bolivia’s

Export-Led Growth VIII • After 1985 Israel successfully pursued • Economic reforms at home, and • Export promotion abroad • By early 2000s Israel had become a global hub for high-tech industries.

Export-Led Growth IX • In oil exporting countries official strategy straight forward • Acquire revenue from mineral exports • Create an industrial base for sustained development after the natural resource was exhausted • But oil-based growth creates its own types of economic challenges in addition to political challenges • Export revenues accrue to the state • Oil exports lead to a change of relative prices that discourages economic diversification and • Oil revenues depend on oil prices which are highly variable • These three characteristics combine to forn the “Dutch Disease”

Export-Led Growth X • Hardest sector hit by Dutch Disease has been agriculture • Good policy can avoid many Dutch Disease problems • Expenditures can be smoothed by placing revenues in an oil fund and • Oil revenues can be used to strengthen sectors that become weakened • For example infrastructure can be subsidized to increase the productivity of the traded sectors • Seriousness of Dutch Disease and the cure have varied considerably from one country to another.

Export-Led Growth XI • Two groups of oil producers • Those with other resources and • Those entirely dominated by mineral resources • First group includes, Algeria, Iraq, Iran and Syria • Second set the Gulf states • State-led industrialization may seem a reasonable approach for the first group • Harder to imaging the Gulf States when oil runs out • However the first group has largely failed to become industrialized

Export-Led Growth XII • The Gulf countries have done much better. • Funds were used to expand infrastructure • A portion of revenues were invested in wealth funds • These countries invested in highly capital and energy intensive petrochemical complexes and other energy intensive industries • Instead of creating a future without oil they opted for increasing the value added in the final output of petroleum or energy intensive industries and • Finally, they started to diversify away form oil • Today, Saudi Arabia the largest exporter of industrial products in the whole region and • The UAE has been able to develop a service sector that is globally competitive.

Recent Growth: 2000 to 2010 I • Structural adjustment and macro-stability did yield some benefits • Once macroeconomic situation stabilized by around 2000, private sector put in charge of economic growth • Growth picked up for most countries in the region • Between 2000 and 2010 several countries grew by more than 3% per annum on a per-capita basis • Turkey, • Egypt • Iran • Jordan • Lebanon, • Morocco, • Sudan and • Tunisia

Recent Growth: 2000 to 2010 II • Pro market reforms which accelerated in the 1990s in most of the region started to transform the region into private-sector driven economice • Because the new arrangements did not lead to competitive and dynamic markets, growth remained modest • Moreover quality of economic growth deteriorated • Much less inclusive than in the past • Private sector became increasingly informal, monopolies and privileges rather than competitive markets became the rule • Little trickle-down • Income inequality rose

Recent Growth: 2000 to 2010 III • Central question of why the Arab region underperformed given what looked on paper to be impeccable market reforms – has been debated for years. Different views: • Economists: reforms did not go far enough • Political scientists: strategy of economic reforms first and political reforms later • Meant that as markets were liberalized rules that governed the markets were are applied in a way that benefitted “networks of privilege” – firms with personal and social ties to political elites. • Firms had myopic short term interests that stifled competition and innovation

Recent Growth: 2000 to 2010 IV • Supporting this view -- evolution of private sector in to a highly dualistic structure • With a few large firms on top • A large informal economy, and • Very few dynamic firms in the middle • World Bank study found countries that did as much to reform their economies as the MENA countries growth should have been one to two percent higher than actual growth rate • With reduced competition much capital was pushed to the few large firms that could be trusted by politicians, rather than toward firms that could use capital more efficiently

Recent Growth: 2000 to 2010 V • The patterns of growth that emerged after most of the countries in the region undertook structural adjustment programs reflect low dynamism of the private sector • The result • Manufacturing remained low, and • Exports rose only moderately. • Region went through several phases: • From high but inefficient investment to • To more efficient but lower investment

Recent Growth: 2000 to 2010 VI • From 1960s through 1980s MENA countries invested as high a proportion of GDP as other developing countries • Between 1970 and 1990s investment rates in three types of countries between 25 and 27% of GDP • Nearly half was made by public sectors in the region • Much went to public enterprises, and initially they had good returns in terms of growth • In some countries however returns were low especially when combined with import substitution • Large and inefficient investments mainly the problem of oil rich countries • Saudi Arabia in 1980s • Iran in the 1970s and 1980s and • Algeria, Syria and Iraq from the 1960s through the 1980s

Recent Growth: 2000 to 2010 VII • Algerian case interesting • For a generation Algeria invested over one third of its output – one of the highest investment rates in history • By late 1970s however generating additional dollar of output required twice as much investment as South Korea • Opportunity costs • Algeria could have invested in more productive endeavors and • It missed out on the fast export-oriented global economy of the 1980s which benefited East Asia

Recent Growth: 2000 to 2010 VIII • By the 1990s, countries with money-losing public enterprises could no longer bail them out • Rollback of the state hit pubic investment hardest • By end of the 1990s reforms had led to situation where return on investment was much improved • Other factors also improved and contributed to growth especially higher skill levels • Foreign direct investment (FDI) also remained relatively low • Both domestic and foreign private investment favored sectors such as mining and real estate rather than labor intensive sectors

Recent Growth: 2000 to 2010 IX • Structural Change: Services Rather Than Manufacturing • Development takes place when: • Incomes rise • Labor moves from low to high productivity sectors and • Productivity increases within sectors • Key development: Inability of the economies of the region to achieve a virtuous circle of high efficiency investment and growth. • Both reflected and caused by stunted pattern of structural changes • Agriculture fell but manufacturing did not rise • Low productivity services rose by default

Recent Growth: 2000 to 2010 X • Manufacturing in MENA geographically concentrated • Turkey, • Egypt, • Iran, • Israel • Saudi Arabia • Many country’s industries process agricultural outputs or produce textiles • Because of the labor-intensity and relatively well established technology of such industries many countries turn to them • The more industrialized countries produce significant quantities of machinery, chemicals • Most diversified are Israel and Turkey

Recent Growth: 2000 to 2010 XI • Mostly the residual category of “services” that picks up most of the slack accounting for one-third to more than one half of output • The share of services has increased by over 50% in most countries over past two decades – even higher in the GCC • Often takes place in the informal sector where firms • Have low capitalization • Sell in easily entered markets and • Offer low-paying and • Insecure jobs

NS4053 Spring Term 2017 Cammett: Chapter 2 Economic Performance and Social Outcomes