Arab development and economies
are running into the ground, and oil stands in the way of change. What’s
keeping the Middle East from changing for the better?
The failure of Arab development
is multifaceted in nature, and manifests itself at all levels — economic,
political and geopolitical. Over the last three decades, three profound shifts
have marked the landscape of global political economy. While these have opened
new economic and political possibilities for the developing world, the Middle
East has remained insulated from these winds of change and their transformative
The first shift is political in
nature — often dubbed ‘the third wave of democratisation’ — and defined by a
gradual opening of the political system to more representative forms of
government. The second shift represents successful economic diversification in
several emerging economies of Asia, Africa and Latin America. A third trend is
represented by the growing prominence of intra-regional trade in developing
countries through their active participation in regional trade initiatives.
All of these shifts have bypassed
the Middle East. Judged by any of the above metrics, the region has either
stagnated, regressed or severely lagged behind. With the largest proportion of
autocracies, it is one of the few regions in the world that remains an outlier
to the third wave of democratisation.
On the economic front, the region
continues to be mired in primary commodity dependence while many of its
comparators have succeeded in diversifying their export structures. And, while
the Middle East has hosted numerous platforms for regional trade promotion,
mutual Arab trade remains hopelessly inadequate. Over the last four decades,
for example, intra-regional trade (as a share of total trade) has hovered at
around nine to 10 percent. This stands in sharp contrast to the dramatic growth
and significance of regional trade in emerging economies.
The region’s failure in these
three overlapping domains reveals the paradox of Arab underdevelopment, and
deserves an explanation that combines the economic, political and geo-political
aspects of development.
Consider the region’s failed
attempts at economic diversification. Every resource-rich country in the region
has faithfully adhered to tall promises of diversifying their economic
structure away from an excessive dependence on oil and gas revenues. Yet, if
anything, the region’s overall reliance on hydrocarbons has increased over
What explains this gap between
intentions and outcomes? To understand this, one must first acknowledge that
the core challenge of economic diversification is not technical, but political.
Clearly, the challenge of diversification is deeper than simply learning the
right lessons from successful experiences in Norway, Malaysia or Botswana.
After all, if the recipes for diversification are so widely known, why have
Arab countries not seriously pursued them?
To diversify their economies,
resource-rich countries need to develop the non-oil sector, which entails,
among other things, producing a greater number and variety of goods — including
those at the higher end of the value chain that involve more complex forms of
production. The problem is that the effects of doing so are rarely politically
neutral. Political scientists have long recognised that structural change in
the economy is usually accompanied by new forms of political contestation. New
sources of income breed new constituencies, since economic power can easily
translate into political power.
For this one needs to look no
further than Turkey whose recent political transition is undergirded by
fundamental economic changes on the ground. The appeal of Turkey’s Justice and
Development Party (AKP) is based, not just on its populist narrative, but the
material interests of a constituency empowered by Turkey’s vibrant economy. In
the Arab milieu, where the overriding concern of rulers is to separate the
economy from polity, a concerted drive towards economic diversification carries
genuine political risks.
With a prolonged legacy of
centralised rule, dating back to the Mamluk era, Arab regimes rest on two
pillars: patronage and control. Such a political order runs counter to the
logic of a dynamic economy that requires cultivating dense economic linkages
among various parts of the supply chain. There is a clear danger that such
vibrant linkages in the economy can serve as the basis for horizontal
In this context, it is hardly
surprising that resource-rich Arab economies have consistently failed to rise
up to the challenge of diversification. These economies are doubly deprived in
this regard, suffering both from the burden of history and oil. Whatever weak
constituency of private production was inherited by these countries was further
emaciated after the discovery of oil.
Even where rulers were more
dependent on merchants prior to the discovery of oil — such as Kuwait — oil
tied down the merchant class in state contracts and other forms of patronage.
While the private sector has shown greater dynamism in Gulf countries, it still
remains ‘structurally dependent’ on the state. Diversification is further
hindered by macroeconomic challenges that oil-rich economies face by virtue of
their exposure to commodity price cycles. The pro-cyclicality of fiscal policy,
which is a universal feature of Arab resource-rich economies, means that oil
cycles are accompanied by budgetary cycles that make planning for long-term
investment more difficult. Counter-cyclical fiscal policies, which require that
countries spend less in periods of higher oil prices, are politically difficult
to implement. The underlying political settlement in these countries gives rise
to extensive and sticky distributive claims in the form of salaries, subsidies
and defence spending.
As is widely recognised,
resource-rich economies also find it particularly difficult to build a
productive regime for competitive diversification since the dominance of the
oil sector is likely to lead to exchange rate appreciation, which prices their
non-oil exports out of global markets. But the absence of a competitive
exchange rate regime is not just the consequence of a dominant oil sector. An
overvalued exchange is also favoured by lobbies representing the non-tradeable
sector, which are strong and pervasive throughout the region. Historically, economic
exchange in the Middle East has stayed in the hands of importers and
distributors, who depend on simple arbitrage opportunities and prefer a fixed
and overvalued exchange rate.
This adverse politics of
diversification is difficult to bypass in the midst of multiple development
traps. While the region’s resource-rich economies are exposed to global price
shocks there are few institutional shock-absorbers to mitigate the effect of
such events. Herein lies the problem for oil rich countries: The same factors
that are needed to cope with oil price volatility are also needed for
diversification. This does not mean that diversification is impossible to
achieve in these economies. It is simply that diversification attempts are
selective, and often take forms that are politically more acceptable to local
elites. In the UAE, Bahrain, Oman and parts of North Africa, liberalisation of
the financial sector has provided such a politically safe avenue for
diversification. Financial sector liberalisation has offered lucrative
brokerage opportunities for state elites who, through carefully brokered
partnership opportunities with foreign banks, have derived additional rents.
Two additional factors make
financial liberalisation a politically palatable form of diversification.
First, the bulk of private sector credit extended by the financial sector is
earmarked for real-estate projects. Second, land is principally owned by the
state. Together, this means that even when the financial sector enhances its
lending to the private sector it is unlikely to give rise to independent forms
of accumulation that might threaten the political order.
But the political challenges of
diversification are by no means limited to the region’s oil-exporting nations.
Even resource-scarce countries are afflicted with similar constraints at
varying levels of intensity. Consider Morocco and Tunisia, the two countries
that have had some success in developing the private sector. Although export
structures in both countries are less concentrated than their other MENA
counterparts, exports have expanded mostly along the intensive, rather than
extensive, margin. Effectively, this means that these countries have mostly
relied on existing export relationships rather than establishing new products
and trading partners.
Additionally, in Tunisia, policy
regimes have traditionally segmented the offshore sector, which is mainly
export-oriented, from the onshore sector, oriented towards the domestic
markets. Furthermore, economic activity remains confined to a closed circle
that protects its privilege by virtue of its proximity to state elites. Such
systematic undermining of market competition serves a larger political purpose,
since it provides much-needed rents in countries where oil rents are either
absent or scarce but where rents are nevertheless needed to solidify elite
But while these market-generated
rents support the prevailing authoritarian order, the resulting crony
capitalism undermines productive capacity. It militates genuine economic diversification,
which requires a level playing field that reduces barriers to entry and
This pattern of economic control
is shared by other states in the region, including Lebanon, where concessions
to monopolies have long been used as a principal means of distributing
When pressed for reform, MENA
countries have been reluctant to take the leap, resulting in the ‘partial
reform syndrome’ where trade liberalisation is selectively pursued to protect
In Egypt, for example, average
tariffs have fallen since the mid-1990s, but their dispersion has increased at
the same time. This is because, despite the general reduction in tariff
barriers, sectors dominated by connected actors continue to benefit from
relatively higher protectionism.
Thus, a sector is more likely to
benefit from higher trade protection if a political or army crony is active in
the sector. Similar patterns are revealed through an analysis of non-tariff
barriers. In Tunisia, the greater presence of political cronies in a sector
increases the likelihood of that sector bring protected through non-tariff
measures (which are more discretionary and non-transparent).
In spite of the plethora of
excuses used to justify flagging economies, if Middle Eastern countries have
difficulty diversifying their economies despite their tall promises and
grandiose plans it is probably more to do with politics than the mere absence
of good policy, informed strategy or weak implementation.